Fifth Circuit Opinion on Solvent Debtor Illustrates Tension Between Text and Tradition

Bankruptcy opinions tend to rely on two major tools for interpreting the Bankruptcy Code: the statutory text and pre-Bankruptcy Code practice. These two methods came into conflict in the Fifth Circuit's recent opinion in Ultra Petroleum Corp. v. Ad Hoc Committee (In re Ultra Petroleum), No. 21-20008 (5th Cir. 10/14/2022), which can be found here.   The majority relied on pre-Code practice to allow creditors of a solvent debtor to recover their full contractual interest. 

A Series of Fortunate Occurrences

Ultra Petroleum had a very good problem. It went into bankruptcy insolvent, recovered when natural gas prices rebounded, and was able to pay all of its creditors in full. However, when it proposed to pay its unsecured creditors post-petition interest at the federal judgment rate, they objected. The creditors argued that they were entitled to their full contractual interest based on Make Whole provisions in their contracts. The bankruptcy court disagreed. Creditors of a solvent chapter 7 estate are entitled to post-petition interest at the "legal rate" under 11 U.S.C. Sec. 726(a)(5), which the Court interpreted to mean the federal judgment rate. Therefore, the Bankruptcy Court approved a plan which paid unsecured creditors post-petition interest at the federal judgment rate which, at the time was 0.58%. The difference between rates was significant and the debtor set aside $400 million to cover the additional interest should it lose.

Make Whole Amount Not Allowed by Code

The Debtor won the argument about whether a Make Whole Amount was not an allowed claim. Under 11 U.S.C. Sec. 502(b)(2), claims for "unmatured interest" may not be allowed. The Fifth Circuit ruled that "unmatured interest" included the “economic equivalent of ‘unmatured interest’” as well.  The Court explained how the Make Whole Amount worked as follows:

Contractual make-whole amounts, like the one at issue here, are expressly designed to liquidate fixed-rate lenders’ damages flowing from debtor default while market interest rates are lower than their contractual rates. Lenders’ damages equal the present value of all their future interest payments. In other words, a make-whole amount is nothing more than a lender’s unmatured interest, rendered in today’s dollars.

Opinion, pp. 9-10. The Court found that the Make Whole Amount was the economic equivalent of unmatured interest. So, did the Debtor win? No, because that was not the end of the analysis.

Pre-Code Practice Carries the Day

The Court then turned to the Solvent Debtor exception. The current Bankruptcy Code has been in effect since 1978. However, the Court went back 300 years to find the authority for its ruling. The Court wrote:

For some three centuries of bankruptcy law, courts have held that an equitable exception to the usual rules applies in the unusual case of a solvent debtor. When a debtor proves solvent—that is, when the debtor’s assets exceed its liabilities—bankruptcy’s ordinary suspension of post-petition interest is itself suspended. When a debtor can pay its creditors interest on its unpaid obligations in keeping with the valid terms of their contract, it must.  

As with many of our bankruptcy rules, this doctrine originated in eighteenth-century English practice. See 2 William Blackstone, Commentaries *488 (“[T]hough the usual rule is, that all interest on debts carrying interest shall cease from the time of issuing the commission, yet, in case of a surplus left after payment of every debt, such interest shall again revive, and be chargeable on the bankrupt . . . .”)(additional citations omitted). Our forebears adopted English practice in our nation’s nascent nineteenth-century bankruptcy system. (citation omitted). And as the Supreme Court has said, the English solvent-debtor exception “ha[s] been carried over into our system.”  (cleaned up, except that I left in the reference to Blackstone's Commentaries because that was just too cool to take out).

Opinion, pp. 18-20.  Thus, because the Debtor had the ability to pay its creditors in full according to their contracts, it was required to do so. 

Trump Appointee Says Not So

Judge Andrew Oldham, a Trump appointee, dissented. He wrote:

The majority correctly concludes that the Make-Whole Amount is unmatured interest in disguise. And it acknowledges that the Bankruptcy Code bars all unmatured interest. See 11 U.S.C. § 502(b)(2). In my view, it necessarily follows that the Code bars the Make-Whole Amount. The majority nevertheless holds that an unwritten solvent-debtor exception “operates in this case to suspend § 502(b)(2)’s disallowance of [the] Make-Whole Amount.” I recognize that the majority is attempting to faithfully apply confusing Supreme Court precedent in a difficult case. But the clear statutory text governing this issue compels me to respectfully dissent

Opinion, p. 35.

Take-Aways

The first and easiest take-away is that Make-Whole Amounts are not allowed claims in the Fifth Circuit absent a solvent debtor. This will help to eliminate these claims in most cases.

Second, this case illustrates the tension between two different forms of statutory interpretation: text and pre-Code practice. These two schools of thought are illustrated by two Supreme Court decisions. In United States v. Ron Pair Enterprises, Inc., 489 U.S. 235 (1989), the Court held that oversecured creditors were only entitled to costs and fees arising under a contract and not under a statute. It reached this decision, in part, on the placement of a comma within 11 U.S.C. Sec. 506(b).  In contract, Dewsnup v. Timm, 502 U.S. 410 (1992) held that a lien passed through Chapter 7 unaffected even though a code provision appeared to reduce the amount of the lien to the value of the collateral. The Court relied on pre-Code practice to reach this result in apparent derogation of the statutory text.

A cynic might argue that resort to pre-Code practice allows a judge to disregard reasonably clear Code text whenever he doesn't like the result. After all, in this case, the Bankruptcy Code provision of  11 U.S.C. Sec. 502(b)(1) said that Make Whole Amounts are not allowed while 11 U.S.C. Sec. 726(a)(5) set the interest rate for a solvent estate at the federal judgment rate. Judge Oldham thought this was a clear repudiation of the pre-Code practice. His colleagues in the majority, Judges Elrod and Jolly, thought otherwise.  In support of her historical approach, Judge Elrod, writing for the majority appealed to Antonin Scalia, who offered supporting words in a book he wrote on statutory interpretation who said “the good textualist is not a literalist”.  As long as the Supreme Court allows resort to pre-Code practice, clever lawyers faced with inconvenient text will do well to crack open Blackstone's Commentaries and look for a different result. 

The final take-away is that judges are not slaves to the ideology of the President who appointed them, especially when dealing with cases that are technical and apolitical. In this case, Judge Jennifer Elrod, appointed by President George W. Bush, and Judge Grady Jolly, appointed by President Ronald Reagan, ruled in favor of the creditors in their quest for payment of their full interest. Judge Andrew Oldham, appointed by President Trump, took the opposite position. Three judges appointed by Republican Presidents disagreed on how the law should be applied in this particular case.