The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLP, analyzing a recent decision of interest:
In Ad Hoc Committee of Holders of Trade Claims v. Pacific Gas and Electric Company (In re PG&E Corp. (“PG&E”), 46 F.4th 1074, 2022 WL 3712478 (August 29, 2022), the United States Ninth Circuit Court of Appeals (the “Ninth Circuit”) held that in a solvent Chapter 11 case the debtor’s plan had to pay unimpaired unsecured creditors who were not allowed to vote postpetition interest at the contract or state law default rate rather than the federal judgment rate.
PG&E can be found by clicking here.
The opinion and dissent in PG&E total a weighty 51 pages. The dissent itself is quite long. This report will try to distill the absolute essentials distilled from it. PG&E Corporation (the “Debtor”) filed a Chapter 11 case in 2019 to deal with massive claims arising when its allegedly faulty equipment was responsible for Northern California wildfires and the widespread damage they caused. Despite the size of the claims, the record in the bankruptcy indicated that the value of the Debtor’s assets substantially exceeded the claims against it.
The Debtor proposed a full-payment plan of reorganization. The plan proposed to pay general unsecured creditors the full amount of their claims plus postpetition interest at the federal judgment rate, then about 2.59%. Because it was paying general unsecured creditors in full with interest, it classified them as “unimpaired” under Bankruptcy Code (the “Code”) § 1124(1), which meant that they were not entitled to vote on confirmation of the plan because under § 1126(b) they are deemed to have accepted it.
A group of general unsecured claimants, appellant the Ad Hoc Committee of Holders of Trade Claims (the “Committee”) objected to confirmation of the plan, contending that they were entitled to postpetition interest at any applicable contract rate or at the state default rate, both of which were much higher than the federal judgment rate. The difference would have produced an extra $230 million for the Committee’s members. The Bankruptcy Court overruled the objection, concluding that both Ninth Circuit precedent in In re Cardelucci, 285 F3d 1231 (9th Cir. 2002) and cumulative provisions of the Code require that only the federal judgment rate apply. On appeal by the Committee, the District Court affirmed, relying on Cardelucci. The Committee then appealed to the Ninth Circuit, which reversed, joining other Circuits in holding that unimpaired creditors are entitled to postpetition interest at the contract rate or state law judgment rate.
The Ninth Circuit succinctly stated the issue on appeal as, “[W]hat rate of postpetition interest must a solvent debtor pay creditors whose claims are designated as unimpaired under § 1124(1) of the Bankruptcy Code?” (footnote omitted). In its discussion, it found both that, contrary to the analyses of the Bankruptcy Court and District Court, Cardelucci was not controlling, and that the Code when it was passed in 1978 retained the relevant “long-standing ‘solvent debtor’” jurisprudence that arose under its predecessor, the Bankruptcy Act (the “Act”) (and indeed, under English common law before that).
As a backdrop to the rest of the opinion, the Ninth Circuit noted that the solvent debtor exception arose under English common law and was imported judicially into practice under the Bankruptcy Act of 1898. The idea behind the doctrine is that otherwise insolvent debtors would reap a windfall in surplus value at the expense of their creditors. This setting informs both the treatment of Cardelucci and the analysis of the implications of the statutory environment of the Code. The Ninth Circuit noted as well that in solvent debtor cases there are two classes of creditors that may receive different treatment. One is a class of impaired creditors, that is, those creditors whose rights are altered by the plan, even though their principal amount will be paid in full at some point. Such creditors are entitled to vote on the plan, § 1126(a), and to treatment that is “fair and equitable” per § 1129(a)(7)(A)(ii), the latter meaning that those who vote against the plan also must receive as much as they would were the debtor liquidated. By contrast, unimpaired creditors are those whose rights are not altered at all by the plan. (Note that the Ninth Circuit’s view of impairment is so broad that it includes alterations of a creditor’s rights that might actually favor the creditor. In re L&J Anaheim Assocs., 995 F.2d 940 (9th Cir. 1993).) They cannot vote on a plan, being deemed to accept it.
The Ninth Circuit’s treatment of whether, as the Bankruptcy Court and District Court concluded, Cardelucci controls the rate of interest for unimpaired creditors focuses on § 726(a)(5). That provision requires creditors of a solvent debtor be paid interest at the “legal” rate. This has been interpreted to mean the federal judgment rate. Otherwise applicable only in Chapter 7 liquidations, § 726(a)(5) applies in Chapter 11 through the “best interests” test of § 1129(a)(7). But by its terms, the best interests test is linked to impaired creditors only. Though that opinion is silent on the subject, Cardelucci involved impaired creditors. Thus, contrary to what the Bankruptcy Court and District Court decided, it does not control what kind of interest is paid to unimpaired creditors under a Chapter 11 plan, that is, Cardelucci did not decide that the legal rate applies to all unsecured creditors in a solvent debtor case, but only that it is the appropriate rate for impaired creditors.
Effect of the Code
The Ninth Circuit next rejected the conclusion of the Bankruptcy Court that the Code displaced the practice of awarding contract or state default rates that accompanied importation of the solvent debtor exception into the Bankruptcy Act. The parties agreed that the solvent debtor exception had survived passage of the Bankruptcy Act. As the Ninth Circuit wrote, “No Code provisions . . . unambiguously displace the long-established solvent-debtor exception . . . .” This is true of both § 726(a) and § 502(b)(2)’s proscription of unmatured interest on claims. In the case of § 726(a), the reasons why it does not govern unimpaired claims are noted above. For § 502(b)(2), the Ninth Circuit reasoned that it is essentially the equivalent of the provision of the Bankruptcy Act — § 63 – that it replaced, thus there was no intent on Congress’s part to reform practice regarding payment of unimpaired claims in a solvent debtor case. In addition, the Ninth Circuit explained that § 502(b)(2) excludes unmatured interest as part of an allowed claim, but says nothing about payment of postpetition interest on an allowed claim.
Before turning to what interest rate is appropriate on an impaired claim, the Court summarized its arguments distinguishing between payment of interest on impaired claims and unimpaired claims in a solvent debtor plan. “But PG&E wants to have its cake and eat it too: it seeks to pay [the unimpaired] plaintiffs the same, reduced interest rate as impaired creditors, while depriving them of the statutory protections that impaired creditors enjoy.”
Applicable Interest Rate for Unimpaired Creditors
Having decided that “legal” federal judgment rate that applies to impaired creditors does not govern unimpaired creditors in a solvent debtor case, the Ninth Circuit turned to deciding what rate does. Making short work of the subject, it focused on the meaning of “unimpaired” as not altering the creditor’s rights. That, in turn, effectively means that the creditor is entitled to its contract rate or the default state rate on judgments when there is no contractual rate. But in a potentially important caveat, it stated that courts will have the right to choose different rates if equity so requires under narrow circumstances. An example might be that granting of a higher rate to unimpaired creditors of a solvent debtor might render the debtor insolvent, thereby unduly depriving junior creditors of what they would otherwise be entitled to.
The core of the dissent is the author’s disagreement with what it sees as the majority’s fundamental mistake. According to the dissent, the majority incorrectly says that absent a clear indication to the contrary, pre-Code practice is binding, whereas under United States v. Ron Pair Enters., Inc., 489 U.S. 235, 241 (1989), the opposite is true: if the Code is clear on an issue, courts may not refer to pre-Code practice to contradict it. The text of the Code is clear on the interest issue: it does not authorize postpetition interest to unimpaired creditors. Pre-Code practice only is relevant with respect to omissions, ambiguities or the meaning of concepts adopted by the Code from the Act. No such justifying grounds for referring to pre-Code practice exist on the interest question.
The dissent notes that there are exceptions specified by Congress in the Code to the otherwise uniform Code rule that claims do not include the right to postpetition interest. Those few exceptions demonstrate that Congress knew how to ensure postpetition interest in the Code when it wanted to. This means that its omission for unimpaired unsecured creditors, far from being an ambiguity or omission, was deliberate.
The dissent goes on to make a number of other, lesser arguments why the majority’s opinion is mistaken. They are too lengthy to review here, but are worth reading, both for their substance and as exercises in judicial analysis.
The opinion and dissent are a mind-boggling battle of the application of principles of judicial interpretation. It is the truly inept judge who cannot find things to support one side of the debate or the other. It is hard to tote up points on the two sides with any confidence. The trouble with the canons of judicial interpretation is that they are rarely satisfied point-for-point in the real world of actual cases. In the end, perhaps the best assessment is based on policy. Here, in the author’s view the majority is the winner. Why should an unimpaired creditor fare worse than an impaired creditor in a solvent case? And, indeed, in a solvent case why should a debtor and its equity take home the value that would go to its creditors if it can afford the hit on its bottom line. On this last point, the Ninth Circuit wisely reserved the equitable right of courts to alter the interest rule in any particular case where equity might so counsel. An obvious example is if payment of postpetition interest at the contract or state judgment rate would so deplete the estate that, although leaving it technically still solvent, the debtor’s ability to continue operating would be in doubt, thus implicating the “feasibility” requirement of Code § 1129(a)(11). Such a situation would contravene another important Chapter 11 policy: preservation of jobs and the debtor’s business with other businesses. Such an equitable consideration, cautiously employed, would be entirely consistent with the equitable considerations underlying the solvent debtor exception itself.
One other note. It probably is fair to say that if Congress really meant to abrogate a practice as important as the solvent debtor exception when it passed or amended the Code, it would have done so expressly, at least in the legislative record if not in unimpeachable language in the Code itself (e.g., “Postpetition interest shall not under any circumstances be included in or added to any unsecured claim.”)
As for the dissent, its characterization that the Code is clear on the issue of postpetition interest is not altogether convincing, supported as it is by various inferences from Code provisions rather than directly by any specific Code provision either by itself or when unequivocally combined with another provision.
These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLP, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.