In short, the common law solvent debtor exception means that a solvent debtor must generally pay post-petition interest accrued during bankruptcy at contractual or state law rates before collecting the appreciation of the debt. bankruptcy assets. Several recent bankruptcy court decisions have discussed the solvent debtor exception, and some have questioned the solvent debtor exception. On August 29, 2022, the United States Court of Appeals for the Ninth Circuit, in a split opinion, became the first circuit court to address the issue that has resulted in divergent findings among bankruptcy courts: what interest rate after petition must be solvent debtor pay to creditors whose claims are designated as intact under a plan pursuant to Section 1124(1) of the Bankruptcy Code?
In reversing the decision of U.S. Bankruptcy Judge Dennis Montali of the Northern District of California, the Ninth Circuit held that (i) while there may be exceptions based on the equity of each case, uncompromised creditors of a solvent debtor enjoys an equitable right to contractual protection or default interest of state law after the petition prior to the attribution of the capital gains tax from a bankruptcy estate; and (ii) contrary to what some bankruptcy courts believe, the adoption of the bankruptcy code did not repeal the solvent debtor exception.
The Pacific Gas & Electric Company (PG&E) filed Chapter 11 on January 29, 2019. At the time of filing, PG&E’s assets exceeded its liabilities by approximately $20 billion, making it, by any measure, a solvent debtor. PG&E’s Chapter 11 plan, however, classified the claims of the Ad Hoc Committee of Trade Debtor Holders (the “Ad Hoc Committee”) as general unsecured claims and provided that creditors would be paid in full plus post-debt interest. federal petition. 2.59% judgment rate under 28 USC § 1961(a). The plan also classified creditors’ claims as unimpaired, meaning they were deemed to automatically accept the plan and had no power to vote against or argue that their treatment was not “fair and equitable.” under 11 USC § 1129(b)(1).
The ad hoc committee and other similarly situated creditors opposed confirmation of PG&E’s plan and argued that PG&E must honor its contractual obligations before its shareholders reap any surplus from the bankruptcy estate. Prior to PG&E’s bankruptcy filing, the ad hoc committee plaintiffs and similarly situated creditors had a contractual right to interest on unpaid debts, either at the rates stipulated by their contracts or at the California default rate of 10 %. The ad hoc committee claimed that by paying their claims at the federal judgment rate, the plan denied them approximately $200 million that they would have been paid in accordance with the interest rates in their contracts, or in the absence of such conditions, the default of the State of California assess.
The bankruptcy court disagreed and, relying on precedent in In re Cardelucci285 F.3d 1231 (9e Cir. 2002), held that unsecured creditors of a solvent debtor, regardless of their state of impairment, are entitled only to post-petition interest at the federal judgment rate. The district court upheld the bankruptcy court’s decision. The Ninth Circuit, however, reversed the decision and returned to the bankruptcy court to determine the appropriate interest rate for uninjured creditors.
The Ninth Circuit decision
In a 2-1 decision by the panel that heard the case, the Ninth Circuit disagreed with the bankruptcy court’s finding that, in a creditworthy debtor bankruptcy case, unsecured debts do not are entitled only to post-petition interest at the federal judgment rate, regardless of impairment status. . The Ninth Circuit made the essential distinction between claims that are impaired and claims that are not impaired (such as the appellants’ claims) under a plan of reorganization. The majority held that the Ninth Circuit’s previous decision in Cardelucci was not binding in a matter involving intact claims of a solvent debtor. The majority felt that Cardelucci merely interpreted the meaning of the words “interest at the statutory rate” in Section 726(a)(5) of the Bankruptcy Code. The majority decision focused on whether Section 726(a)(5) would be relevant in determining whether a plan meets the “best interests of creditors” test of Section 1129(a)(7). )(A)(ii), which examines whether impaired claims will receive as much under a plan as under a hypothetical Chapter 7 debtor. The Court concluded that, because the categories of intact claims are not subject to 1129(a)(7)(A)(ii), Cardelucci was not binding as to the post-petition rate of interest to be paid on the undamaged claims of the ad hoc committee. Under the Ninth Circuit’s ruling, debtors in a similar situation will now face a choice: “compensate the creditors in full, pursuant to the solvent debtor exception, or designate them as aggrieved creditors entitled to the full the [Bankruptcy] substantive and procedural protections of the Code.
Although the majority was clear throughout the opinion that its decision was based on the ad hoc Committee’s claims not being impaired, it left open the possibility that the contractual rate could apply to incumbents impaired debts. Specifically, in a footnote, the majority observed that bad debts would be subject to the foreclosure provisions of Section 1129(b)(1) of the Bankruptcy Code, which the Sixth Circuit, in Dow Corning, owned would require impaired creditors in a solvent position to receive interest at the contractual rate before the equity can be recovered. The majority chose not to rule on this point, noting that: “[w]We express no opinion on this issue, merely pointing out that PG&E’s designation of plaintiffs as intact precluded them from potentially making this argument in bankruptcy court.
The majority also disagreed with the bankruptcy court’s alternative ruling that the bankruptcy code limited the ad hoc committee to post-petition interest at the federal judgment rate. The panel held that the Bankruptcy Code did not repeal the solvent debtor exception, which was an equitable principle prior to the adoption of the Bankruptcy Code. On the contrary, the text, history and structure of the Bankruptcy Code compel the conclusion that creditors, like the ad hoc committee, continue to possess an equitable right to negotiate post-petition interest when a debtor is solvent. . Accordingly, the majority held that failure to “compensate creditors in accordance with such equitable right under a bankruptcy plan results in impairment” under Section 1124(1) of the Bankruptcy Code.
While the majority strongly suggested that the bankruptcy court should have applied the contractual or state interest rate, the Ninth Circuit remanded the bankruptcy court for a final determination of the correct interest rate. The majority’s finding that the solvent debtor exception was a fair principle required that there be a finding on the rate to be applied based on the fairness of the case. However, the majority stated that:
We are convinced that in most credit debtor cases involving uncompromised creditors, the fair role of the bankruptcy court will be “simply to enforce the rights of creditors in accordance with the terms of the contracts which created those rights”. However, we recognize the possibility that cases may arise where the payment of contractual or default interest could impair the ability of other creditors in a similar situation to be paid in full, or where other “compelling equitable considerations” could plead in favor of paying post-petition interest at a different rate.
The dissenting judge on the panel took an even narrower stance than either of the lower courts and concluded that the solvent debtor’s defense did not survive the enactment of the Bankruptcy Code. In the dissent’s view, if Congress had intended the exception to survive, it could have included the exception in the Bankruptcy Code, but by not doing so, there is no basis for payment. post-petition interest in any Chapter 11 case, whether or not the debtor is solvent.
Key points to remember
- The solvent debtor exception is alive and well in the Ninth Circuit (at least in the opinion of the majority of the three-judge panel).
- The Ninth Circuit will now be among the creditor-friendly venues for holders of intact claims from creditworthy debtors, although creditworthy debtors are quite rare. It is possible that later there will be a split of the circuit court if or when other circuit courts decide this issue.
- This decision could impact the dynamics of negotiating reorganization plans involving creditworthy debtors, as creditworthy debtors and their creditors will weigh the pros and cons of being deemed sound against the vote on the debtor’s plan.
- The decision emphasized that the solvent debtor exception does not give courts unlimited discretion to redistribute rights, nor does it automatically mean that creditors would be paid at their contractual interest rate. Instead, the majority was clear that the contractual rate would be the starting point, subject to future courts being able to impose a different rate, taking into account the impact on creditors in a similar situation or that subsequent interest petition be paid at a different rate based on equitable interest. considerations.