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On the Eve of the EFH Confirmation Hearing, Bankruptcy Court Issues Opinion on Unsecured Noteholders’ Entitlement to Post-Petition Interest
In re Energy Future Holdings Corp., No. 14-10979, 2015 WL 6660787 (Bankr. D. Del. Oct. 30, 2015)
On the eve of the multi-week confirmation hearing scheduled in the chapter 11 cases of Energy Future Holdings Corp., Judge Sontchi of Delaware’s Bankruptcy Court issued several significant decisions, one of which—analyzed here—rules on whether unsecured creditors are entitled to receive post-petition interest on their claims under four sections of the Bankruptcy Code—section 502(b)(2), section 1129(a)(7) (“Best Interests Test”), section 1129(b) (“Cramdown”), and section 1124(1) (“Unimpairment”).* First, as a threshold matter, the Court held that an allowable portion of an unsecured claim cannot include post-petition interest under the plain language of section 502(b)(2). Second, the Court analyzed whether payment of post-petition interest on an allowed unsecured claim is required for a chapter 11 debtor to confirm a plan of reorganization and, if so, at what rate. In sum, the Court held that: (1) to satisfy the Best Interests Test, an unsecured creditor must receive post-petition interest at the Federal judgment rate only if it would be entitled to such a distribution in a hypothetical chapter 7 liquidation; (2) to properly Cramdown an unsecured rejecting class, the plain language of section 1129(b)(2) does not require the payment of post-petition interest but a court may award such payment if equitable, at either the contract rate or such other appropriate rate; and finally (3) Unimpairment may occur without the payment in cash of post-petition interest at the contract rate but such determination must be made by a court on the facts of the case and pursuant to the court’s equitable power.
In the instant case, UMB Bank, N.A. (“UMB”), as the indenture trustee for certain payment-in-kind notes (the “PIK Notes” and for such holders, “PIK Noteholders”), filed an unsecured claim (the “PIK Claim”) asserting $1.57 billion in principal plus interest and fees, including, among other things, post-petition interest at the contract rate. The Debtors filed a partial objection relating to UMB’s claim for post-petition interest. As noted above, the Court held that the allowable portion of the PIK Claim could not include post-petition interest under the plain language of section 502(b)(2) (excluding allowed claims for “unmatured interest”). It may only include principal and accrued fees and interest due as of the petition date. But that was only “the beginning of the [Court’s] analysis” as “there is a distinction between the payment of interest on an allowed claim as opposed to as an allowed claim.” Op. at *3 (emphasis in original). While section 502(b)(2) governs the calculation of an allowed claim, sections 1124 and 1129 of the Bankruptcy Code govern what a creditor must receive on account of its allowed claim for a plan to be confirmed. The Court analyzed those provisions in the context of post-petition interest and came to the following conclusions.
In situations where a claimholder within an impaired class rejects a plan, section 1129(a)(7) requires that the holder “receive or retain under the plan on account of such claim…property of a value, as of the effective date of the plan, that is not less than the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7 of [title 11] on such date.” To satisfy this Best Interests Test, courts look to section 726(a) of the Bankruptcy Code, which sets forth a waterfall distribution scheme. The second priority of distribution provided thereunder is payment of allowed unsecured claims, while the fifth priority is the payment of post-petition interest at the legal rate on allowed unsecured claims. Reviewing these Code provisions, the Court held that unsecured claimholders, such as the PIK Noteholders, must receive post-petition interest at the legal rate to satisfy the Best Interests Test, if applicable, so long as such payment would occur in a hypothetical chapter 7 liquidation scenario. Moreover, the Court reaffirmed that the “legal rate” for such purposes is the Federal judgment rate. See In re Wash. Mut., Inc., 461 B.R. 200 (Bankr. D. Del. 2011) (holding that the legal rate of interest under sections 726(a) and 1129(a)(7) is the Federal judgment rate).
Moreover, in situations where Cramdown is necessary (i.e., where not every impaired class has accepted a plan), section 1129(b)(2) conditions confirmation on a plan that is, among other things, fair and equitable to each impaired rejecting class. With respect to such classes of unsecured creditors, section 1129(b)(2)(B)(i) provides that satisfaction of fair and equitable “includes” that “the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim[.]” If a debtor must rely on this subsection to Cramdown, Judge Sontchi held that post-petition interest is not required to be paid given that this subsection only measures proper distributions by considering allowable portions of unsecured claims, which as noted above do not include post-petition interest under section 502(b)(2). Nonetheless, the Court did acknowledge UMB’s argument that the word “includes” has meaning and held that “[a]t most, it allows a court to weigh equitable considerations in deciding whether to award post-petition interest.” Op. at *16. The Court was quick to state that “it is not necessarily the case that equitable considerations require the payment of post-petition interest to unsecured creditors” under section 1129(b)(2)B)(i) and that such determination will vary on a case by case basis and must be supported by an evidentiary record. Id. at *16-17. In cases where the payment of post-petition interest is found appropriate, Judge Sontchi noted that the rate may be the contract rate or such other rate as deemed appropriate by a court.
And finally, in situations where unsecured claims are deemed unimpaired under section 1124(1), the Bankruptcy Code requires that a plan “leave unaltered the legal, equitable, and contractual rights to which such claim…entitles the holder of such claim.” While UMB argued that, under the Debtors’ proposed plan, the PIK Claim must receive post-petition interest at the contract rate for it to be unimpaired, the Court disagreed. Under established Third Circuit case law, claim impairment is determined by considering a creditor’s rights as affected by the Bankruptcy Code. See In re PPI Enterprises (U.S.), Inc., 324 F.3d 197, 202-03 (3d Cir. 2003). Thus, if an unsecured claim is not allowed to receive post-petition interest under section 502(b)(2)—a statutory impairment—then the failure of a plan to provide for a distribution on account of such interest does not necessarily render a claim impaired under section 1124(1). However, because section 1124(1) contemplates an equitable impairment (in addition to legal and contractual impairment), Judge Sontchi held that, if the equities allow, a court must be entitled to award post-petition interest at the contract rate or such other rate as deemed appropriate by a court.
*On the same day, Judge Sontchi also issued two Memorandum Opinions in favor of the Debtors on certain make-whole claims brought by the indenture trustees for the PIK Notes and the Second Lien Notes, which substantially incorporated his previous rulings analyzed here and here in these cases on the make-whole claim brought by the indenture trustee for the First Lien Notes. Our readers can find those respective Memorandum Opinions here and here.