Four decades and several years ago, Congress repeals the Federal Bankruptcy Act of 1898 and replaces it with the Bankruptcy Reform Act of 1978, aka the “Bankruptcy Code.”[Fn. 1]
A decade later, Justices on the U.S. Supreme Court are still disparaging the new Bankruptcy Code as the “sweeping changes Congress instituted in 1978” and “the radical reforms of 1978.”[Fn. 2]
Another decade later, still trying to calm those “sweeping changes” and “radical reforms,” a unanimous U.S. Supreme Court declares that it “will not read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure.”[Fn. 3]
I remember those days, back in the 1980s, when courts were trying to figure out what the details of the Bankruptcy Code might mean in actual practice:
- it was common, back then, for courts to look to prior practice for guidance; but
- such looking-to-the-past tended to fade quickly—it’s like an employee changing jobs and referring, in the new job, to how the old employer did things (such references quickly become old-and-tired and out-of-favor).
So, its startling in these 2020s to see courts harkening back to the Federal Bankruptcy Act of 1898 for guidance on how to construe the Bankruptcy Code, with its many amendments over the past four decades and several years.
What follows is a summary of two opinions: (i) the first (Ultra) follows an 1898 Act rule, and (ii) the second (Hertz) does not and reaches an opposite result.
Ultra Petroleum Opinion
The latest opinion that follows the Bankruptcy Act of 1898, in construing today’s Bankruptcy Code, is In re Ultra Petroleum Corporation, Case No. 21-20008 in the Fifth Circuit Court of Appeals (decided October 14, 2022).
The Ultra opinion begins like this.
- Bankruptcy is ordinarily for the insolvent.
- Sometimes, however, initially insolvent debtors regain solvency during extended bankruptcy proceedings—Ultra is one such case.
Here’s a summary of the Ultra facts:
- Debtor is a family of natural gas exploration and production companies;
- In 2014 and 2015, sharp declines in natural gas prices drive Debtor into insolvency and, then, into Chapter 11;
- But during the bankruptcy, natural gas prices rebound and make Debtor “massively solvent”;
- So, Debtor proposes a $2.5 billion Chapter 11 plan that pays creditors in full and in cash on the effective date of the plan—including post-petition interest at the federal judgment rate; but
- Creditors object to the plan, claiming entitlement to post-petition interest at the interest rates specified in their contracts—rates that are far higher than the federal judgment rate.
A question before the Fifth Circuit Court of Appeals in Ultra is this:
- whether the solvent-debtor exception, created under the Federal Bankruptcy Act of 1898, applies under today’s Bankruptcy Code—so that post-petition interest must be calculated at the high contract rates, rather than at the low federal judgment rate?
The amounts of additional interest at stake (i.e., the difference between post-petition accruals at contract rates and at the federal judgment rate) total $120 million.
The Fifth Circuit holds: since Debtor is solvent and since Congress “has not clearly abrogated the solvent-debtor exception,” creditors are entitled to recover post-petition interest at their contract rates.
Here is its rationale.
- History. For three centuries, courts have held that when a debtor’s assets exceed its liabilities, post-petition interest accrues at the creditors’ contract rates. Under the Federal Bankruptcy Act of 1898, the U.S. Supreme Court declared that England’s solvent-debtor exception is “carried over into our system” (see, City of New York v. Saper, 336 U.S. 328, 330 n.7 (1949); and United States v. Ron Pair Enters., Inc., 489 U.S. 235, 246 (1989)).
- Bankruptcy Code language and Congressional silence. Unless abrogation of a prior bankruptcy practice is “unmistakably clear,” the U.S. Supreme Court says that the prior practice continues. Bankruptcy Code provisions on post-petition interest “do not clear this high hurdle”:
- § 502(b)(2) of the Bankruptcy Code is a terse recodification of § 63 of the Federal Bankruptcy Act of 1898, which did not stop courts from applying the solvent-debtor exception back then; and
- the Supreme Court in 2021 applied an analogous interpretive approach—noting that the Patent Act of 1952 has “similar language” to its precursor statute on the judicial exception of assignor estoppel, thus suggesting that the statutory language did not evince sufficiently plain Congressional intent to abrogate the doctrine.
A contrasting opinion, rejecting the 1898 Act rule and reaching an opposite result, is In re Hertz from the Delaware Bankruptcy Court.[Fn. 4]
Hertz files Chapter 11 bankruptcy, due to disruptions caused by the Covid-19 pandemic. In the bankruptcy:
- Hertz sells its business at auction;
- then, Hertz proposes a Chapter 11 plan that provides for payment of all claims in full (including post-petition interest at the federal judgment rate) and in cash on the effective date of the plan;
- the Bankruptcy Court confirms the Plan but preserves the rights of creditors to claim additional post-petition interest at their contract rates, instead of at the lower federal judgment rate; and
- then, creditors sue to recover post-petition interest at their contract rates—seeking an additional $272 million.
The Bankruptcy Court dismisses creditors’ suit, at Debtor’s request, for failure to state a claim upon which relief can be granted. What follows is a summary of the Court’s rationale.
–Solvent Debtor Exception
Creditors claim entitlement to post-petition interest at contract rates under the equitable doctrine known as the “solvent debtor exception”—arguing that the Bankruptcy Code incorporates such equitable concept and provides that creditors receive their full contract rights when debtor is solvent.
In Hertz, Debtor is both solvent and awash in cash.
–Express Statutory Language
- equitable principles cannot override express provisions of the Bankruptcy Code, such as § 502(b)(2) which disallows all unmatured interest on general unsecured claims, without regard to whether a debtor is solvent[fn. 5]; and
- § 726(a)(5)[fn. 6] and § 1129(a)(7)[fn. 7] require payment of post-petition interest on general unsecured claims in solvent cases—but only at the federal judgment rate, not at the contract rate.
- § 1129(a)(7) only incorporates section 726(a)(5) in chapter 11 cases for impaired claims; and
- since creditors’ claims are unimpaired under the plan, any limitation on post-petition interest to the federal judgment rate in those sections is not applicable to them.
The Court declares:
- § 1129(a)(7) and § 726(a)(5) provide, by their express terms, what treatment impaired creditors are to receive in a solvent Chapter 11 case; and
- the Bankruptcy Code is silent on what treatment unimpaired creditors must receive in a solvent chapter 11 debtor case, but Congress’s repeal of § 1124(3), which dealt with unimpaired creditors is instructive.
–Repeal of § 1124(3)
In 1988, Congress repeals this § 1124(3) provision from the Bankruptcy Code: a claim is unimpaired when “the holder of such claim . . . receive[s] . . . cash equal to the allowed amount of such claim” on the effective date of the plan.
Such repeal was prompted by a Bankruptcy Court decision that unimpaired creditors are not entitled to post-petition interest in a solvent case—none whatsoever. Congress deemed such no-interest result to be “unfair” to unimpaired creditors and explained:
- In a recent bankruptcy decision, unsecured creditors were denied the right to receive post-petition interest on their allowed claims even though the debtor was solvent;
- In order to preclude this unfair no-interest result in the future, the Committee finds it appropriate to delete § 1124(3) from the Bankruptcy Code; and
- A failure to pay any interest to unsecured creditors in a solvent Chapter 11 case would make them impaired and thus eligible to be paid interest under §§ 1129(a)(7)—at the federal legal rate.
–U.S. Supreme Court Precedent
Notably, under U.S. Supreme Court precedent, a bankruptcy court cannot use equitable principles to modify express language of the Bankruptcy Code. United States v. Noland, 517 U.S. 535, 538 (1996). Accordingly, the following Bankruptcy Code provisions control over equitable principles because:
- § 502(b)(2) expressly disallows claims of unsecured creditors for unmatured interest, without distinguishing between solvency and insolvency of the bankruptcy estate; and
- When a debtor is solvent, § 726(a)(5) and § 1129(a)(7) allow post-petition interest but only at the “legal rate.”
Additionally, the solvent debtor exception survives passage of the Bankruptcy Code only to a limited extent—only as expressly codified. The Bankruptcy Code expressly codifies the solvent debtor exception in only two respects:
- As to over-secured creditors in § 506(b); and
- As to unsecured and under-secured creditors in solvent cases under § 726(a)(5) and § 1129(a)(7).
Further, applying § 726(a)(5) and § 1129(a)(7) to both impaired and unimpaired unsecured creditors, where debtor is solvent, has these benefits:
- it supports the basic policy of the Bankruptcy Code to assure that creditors of the same priority receive like treatment;
- it provides an easy and predictable rule to apply (as opposed to determining interest based on each creditor’s contract rights or relying on discretion exercised by the court on a case by case basis); and
- it is based upon a clear and unequivocal analysis under the plain language of § 726(a)(5) that applies equally to all unsecured and under-secured claims in a solvent estate.
Resurrecting, in the 2020s, an old and tired principle under the Federal Bankruptcy Act of 1898 to resolve issues under the “radical” Bankruptcy Code with it’s “sweeping changes” . . . is startling!
It also has the feel of wanting to get a certain result and then resurrecting an old equitable argument, in the face of contrary Bankruptcy Code language and activity, to get there. That’s because Congress, in the Bankruptcy Code:
- enacted the solvent debtor exception for over-secured creditors;
- enacted the solvent debtor exception for all unsecured creditors in Chapter 7 — but allowing post-petition interest only at the “legal rate”;
- enacted the solvent debtor exception for unsecured creditors that are impaired under a Chapter 11 plan — but allowing post-petition interest only at the “legal rate”;
- rejected the solvent debtor exception for unsecured creditors that are unimpaired under a Chapter 11 plan (providing for no post-petition interest at all) — but then repealed that rejection:
- without specifying which rate would apply;
- leaving interest for impaired unsecured claims at the “legal rate”; and
- leaving unchanged the basic bankruptcy policy that unsecured claims are to be treated similarly.
Presumably, this will all get to the U.S. Supreme Court — and/or to Congress — at some future occasion, for final resolution.