The following is a case summary written by Gary M. Kaplan, a partner at Farella Braun + Martel LLP in San Francisco:
In In re Cuker Interactive, LLC, No. BR 18-7363-LA11, 2020 WL 7086066 (Bankr. S.D. Cal. Dec. 3, 2020), Judge Louise Adler of the Bankruptcy Court for the Southern District of California, addressing an issue where the courts nationwide are split, held that unsecured creditors of a solvent debtor in Chapter 11 are only entitled to postpetition interest at the federal judgment rate, rather than at the potentially higher contract rate or state judgment rate. To view the opinion, click here.
The debtor, which was solvent, proposed a Chapter 11 plan that would pay secured creditors in full with interest at the contract rate. With respect to general unsecured creditors, the plan also provided that they would be paid in full, with postpetition interest at the “legal rate,” or a rate determined by the Court that left the creditors “unimpaired” within the meaning of Bankruptcy Code Section 1124. Section 1124(1) provides that where a Chapter 11 plan “impairs” a claim or interest, the impaired class is entitled to vote on the plan unless it “leaves unaltered the legal, equitable, and contractual rights” of the holders. Unsecured creditors in this case argued that they were “impaired” because the plan did not require the debtor to pay postpetition interest at the contractual rate or a higher state law judgment rate.
The Bankruptcy Court disagreed, finding that the applicable interest rate payable to unsecured creditors resulted from operation of the Bankruptcy Code, rather than the provisions of the proposed plan. Judge Adler thus determined that paying interest to the unsecured creditors at the federal judgment rate did not render their claims impaired, and they accordingly were not entitled to vote on the debtor’s proposed Chapter 11 plan.
The Bankruptcy Court held that binding authority dictated that the federal judgment rate applied to unsecured claims of a solvent debtor. Judge Adler primarily relied on In re Cardelucci, 285 F.3d 1231, 1234-35 (9th Cir. 2002), where the Ninth Circuit Court of Appeal held that “interest at the legal rate” due to general unsecured creditors of a solvent chapter 11 debtor is the federal judgment rate. The Bankruptcy Court rejected the unsecured creditors’ argument that Cardelucci was distinguishable because it involved a “best interest of creditors test” analysis for impaired claims under Bankruptcy Code Section 1129(a)(7) and, in turn, the applicable rate of interest payable to creditors of a solvent debtor in a Chapter 7 case under Bankruptcy Code Section 726(a)(5). In doing so, Judge Adler noted that the “Ninth Circuit phrased its holding broadly to apply to all unsecured claims.” The Bankruptcy Court also relied on the Ninth Circuit Bankruptcy Appellate Panel’s opinion in In re Beguelin, 220 B.R. 94, 101 (BAP 9th Cir. 1998), which held that solvent debtors must pay postpetition interest to unsecured creditors at the federal judgment rate.
Judge Adler found further support in a recent published decision by Judge Dennis Montali of the Northern District of California Bankruptcy Court in In re Pacific Gas & Electric Co., 610 B.R. 308 (Bankr. N.D. Cal. 2019). There, Judge Montali read Cardelucci expansively and ruled that its holding applied to all unsecured creditors in a solvent-debtor case and was properly applied to an “impairment” analysis under Bankruptcy Code Section 1124. Id. 610 B.R. at 312-313, 315.
Judge Adler refused to adopt the “solvent debtor exception” applied by some courts in other Circuits, which allows creditors of a solvent debtor to receive interest at the higher contract rate based on state law principles. See, e.g., In re Ultra Petroleum Corp., 16-322032, 2020 WL 6276712 (Bankr. S.D. Tex. Oct, 26, 2020). In addition to noting that it was bound by the Ninth Circuit’s Cardelucci opinion, the Bankruptcy Court observed that application of the solvent-debtor exception would pose “a significant threat to the bankruptcy court’s administrative efficiency in larger cases” as it would require determining “the individual contractual rights of each individual unsecured creditor; and perhaps, resulting in different treatment to creditors of the same class.” As Judge Adler pointed out, both the Court of Appeal’s decision in Cardelucci and the Bankruptcy Appellate Panel’s decision in Beguelin found the federal judgment rate preferable because it promotes uniformity and efficiency.
Judge Adler’s opinion is sound, and it is difficult to find fault with her well-reasoned analysis. In light of this decision and the equally compelling opinion by Judge Montali in the PG&E bankruptcy case, both of which rely on Ninth Circuit precedent, it is increasingly clear that unsecured creditors of a solvent debtor will only be entitled to postpetition interest on their claims at the federal judgment rate in the Ninth Circuit.
These materials were prepared by ILC member Gary M. Kaplan, a partner at Farella Braun + Martel LLP in San Francisco (email@example.com), with editorial contributions from ILC member M. Douglas Flahout of Arent Fox LLP.