Hertz: Third Circuit Weighs in on Make-Whole Premiums and the "Solvent-Debtor Exception" in Chapter 11 Cases

A handful of recent high-profile court rulings have considered whether a chapter 11 debtor is obligated to pay postpetition, pre-effective date interest ("pendency interest") to unsecured creditors to render their claims "unimpaired" under a chapter 11 plan in accordance with the pre-Bankruptcy Code common law "solvent-debtor" exception. Some of these decisions have also addressed: (i) whether a claim for a "make-whole premium" payable under a debt instrument qualifies as "unmatured interest" that must be disallowed in a bankruptcy case; and (ii) the appropriate rate of pendency interest that must be paid to unsecured creditors by a solvent debtor under a chapter 11 plan. 

The U.S. Court of Appeals for the Third Circuit weighed in on all of these questions in In re Hertz Corp., 117 F.4th 109 (3d Cir. 2024), as amended, 2024 WL 4730512 (3d Cir. Nov. 6, 2024), reh'g denied, Nos. 23-1169 and 23-1170 (3d Cir, Nov. 6, 2024). A divided panel of the court ruled that a bankruptcy court correctly disallowed certain noteholders' claims for a make-whole premium because it was both "definitionally" and the "economic equivalent" of unmatured interest. However, because the debtors were solvent, the Third Circuit panel, concluding that the solvent-debtor exception survived enactment of the Bankruptcy Code as part of the "fair and equitable" requirement for cramdown-confirmation of a chapter 11 plan, held that the bankruptcy court erred by ruling that the debtors' plan need not pay pendency interest on the noteholders' claims at the contract rate of interest, while distributing more than $1 billion to existing shareholders in violation of the "absolute priority rule" and the Bankruptcy Code's priority scheme.

In so ruling, the Third Circuit became the sixth federal circuit court of appeals to conclude that the solvent-debtor exception is alive and well and requires a solvent debtor to pay pendency interest to unsecured creditors to render their claims unimpaired under a chapter 11 plan. 

The Bankruptcy Code's Priority Scheme

The Bankruptcy Code sets forth certain priority rules governing distributions to creditors in both chapter 7 and chapter 11 cases. Secured claims enjoy the highest priority under the Bankruptcy Code. See generally 11 U.S.C. § 506. The Bankruptcy Code then recognizes certain priority unsecured claims, including claims for administrative expenses, wages, and certain taxes. See id. § 507(a). General unsecured claims come next in the priority scheme, followed by any subordinated claims and the interests of equity holders.

In a chapter 7 case, the order of priority for distributions on unsecured claims is determined by section 726 of the Bankruptcy Code. The order of distribution ranges from payments on claims in the order of priority specified in section 507(a), which have the highest priority, to payment of any residual assets after satisfaction of all claims to the debtor, which has the sixth or lowest priority. Fifth priority in a chapter 7 liquidation is given to "interest at the legal rate from the date of the filing of the petition" on any claim with a higher liquidation priority, including various categories of unsecured claims. See id. § 726(a)(5) (emphasis added).

Distributions are to be made pro rata to parties of equal priority within each of the six categories specified in section 726. If claimants in a higher category of distribution do not receive full payment of their claims, no distributions can be made to parties in lower categories. 

Thus, if the bankruptcy estate in a chapter 7 case is sufficient to pay claims of higher priority, creditors are entitled to postpetition interest before the debtor can recover any surplus.

In a chapter 11 case, the chapter 11 plan determines the treatment of secured and unsecured claims (as well as equity interests), subject to the requirements of the Bankruptcy Code. 

Impairment of Claims Under a Chapter 11 Plan

Creditor claims and equity interests must be placed into classes in a chapter 11 plan and treated in accordance with the Bankruptcy Code's plan confirmation requirements. Such classes of claims or interests may be either "impaired" or "unimpaired" by a chapter 11 plan. The distinction is important because only impaired classes have the ability to vote to accept or reject a plan. Under section 1126(f) of the Bankruptcy Code, unimpaired classes of creditors and interest holders are conclusively presumed to have accepted a plan. Section 1126(g) provides that classes of creditors or interest holders that receive or retain nothing under a plan are deemed not to have accepted the plan.

Section 1124 provides that a class of creditors is impaired under a plan unless the plan: (i) "leaves unaltered the legal, equitable, and contractual rights" to which each creditor in the class is entitled; or (ii) cures any defaults (with limited exceptions), reinstates the maturity and other terms of the obligation, and compensates each creditor in the class for resulting losses.

Section 1124 originally included a third option, then section 1124(3), for rendering a claim unimpaired—by providing the claimant with cash equal to the allowed amount of its claim. In In re New Valley Corp., 168 B.R. 73 (Bankr. D.N.J. 1994), the court ruled that, in light of this third option, and because sections 726(a)(5) and 1129(a)(7) of the Bankruptcy Code (the latter discussed below) are applicable in a chapter 11 case only to impaired creditors, a solvent debtor's chapter 11 plan that paid unsecured claims in full in cash, but without pendency interest, did not impair the claims. The perceived unfairness of New Valley led Congress to remove this option from section 1124 of the Bankruptcy Code in 1994. Since then, most courts considering the issue have held that, if an unsecured claim is paid in full in cash with pendency interest at an appropriate rate, the claim is unimpaired under section 1124. See, e.g., In re PPI Enterprises (U.S.), Inc., 324 F.3d 197, 205–07 (3d Cir. 2003).

Section 1124(1) "define[s] impairment in the broadest possible terms," so that "any change in legal, equitable or contractual rights creates impairment." In re Taddeo, 685 F.2d 24, 28 (2d Cir. 1982); accord PPI, 324 F.3d at 202 ("If the debtor's Chapter 11 reorganization plan does not leave the creditor's rights entirely 'unaltered,' the creditor's claim will be labeled as impaired under § 1124(1) of the Bankruptcy Code."); In re L&J Anaheim Assocs., 995 F.2d 940, 942 (9th Cir. 1993) (adopting the Taddeo approach).

However, the Second, Third, Fifth, and Ninth Circuits have concluded that, because section 1124(1) expressly refers to impairment imposed by a "plan," it does not apply to modifications that occur by operation of the Bankruptcy Code. See In re LATAM Airlines Grp. S.A., 55 F.4th 377, 385 (2d Cir. 2022) (noting that unsecured creditors' contractual right to post-default interest, "'as applied to postpetition debts, was superseded by the Code—specifically, by § 502(b)(2)'s prohibition on the inclusion of "unmatured interest" as part of their claim,'" meaning that the creditors' claims were not impaired by the chapter 11 plan), cert. denied, 143 S.Ct. 2609 (2023); PPI, 324 F.3d at 204 ("[A] creditor's claim outside of bankruptcy is not the relevant barometer for impairment; [courts] must examine whether the plan itself is a source of limitation on a creditor's legal, equitable, or contractual rights."); In re Ultra Petroleum Corp., 943 F.3d 758, 763 (5th Cir. 2019) ("The plain text of § 1124(1) requires that 'the plan' do the altering. We therefore hold a creditor is impaired under § 1124(1) only if 'the plan' itself alters a claimant's 'legal, equitable, [or] contractual rights.'"), cert. denied, 143 S.Ct. 2495 (2023); In re PG&E Corp., 46 F.4th 1047, 1063 n.11 (9th Cir. 2022) ("[A]n alteration of pre-bankruptcy rights that occurs by operation of the Code does not result in impairment."), cert. denied, 143 S.Ct. 2492 (2023).

Cram-Down Confirmation Requirements

If a creditor class does not agree to impairment of the claims in the class under the plan and votes to reject it, the plan can be confirmed only under certain specified conditions. Among these conditions are requirements that: (i) each creditor in the impaired class receive at least as much under the plan as it would receive in a chapter 7 liquidation (11 U.S.C. § 1129(a)(7)) (commonly referred to as the "best interests" test); and (ii) the plan be "fair and equitable" (Id. § 1129(b)(1)).

Therefore, in the case of a chapter 11 debtor that can pay its creditors in full with interest, the best interests test in section 1129(a)(7) would arguably require that any impaired unsecured creditors be paid pendency interest on their allowed claims "at the legal rate." See id. § 726(a)(5). However, the meaning of "the legal rate" is unclear—it could mean the contract rate, the post-judgment rate, the federal statutory rate specified in 28 U.S.C. § 1961, or some other rate. See In re Hicks, 653 B.R. 562 (Bankr. N.D. Ill. 2023) (discussing the disagreement among courts on the issue). 

The best interests test, however, applies only to impaired classes of claims or interests. This was not always the case. When the Bankruptcy Code was enacted in 1978, the provision applied to all classes—impaired or not. Congress amended section 1129(a)(7) in 1984 so that it now applies only to impaired classes. See Bankruptcy Amendments and Federal Judgeship Act of 1984, 98 Stat. 333, Pub. L. 98-353 (1984) § 512(a)(7); In re Wonder Corp. of Am., 70 B.R. 1018, 1024 (Bankr. D. Conn. 1987) ("[T]he 1984 Amendments also modified § 1129(a)(7) so that its provisions now only apply to 'each impaired class of claims or interests' rather than to 'each class of claims or interests.'").

Section 1129(b)(2) of the Bankruptcy Code provides that "the condition that a plan be fair and equitable with respect to [an unsecured] class includes" the requirement that creditors in the class receive or retain property of a value equal to the allowed amount of their claims or, failing that, if no creditor or equity holder of lesser priority receives any distribution under the plan. This is commonly referred to as the "absolute priority rule," which was derived in part from common law and practice under the former Bankruptcy Act of 1898 (as amended). 

Disallowance of Claims for Unmatured Interest and the Solvent-Debtor Exception

Section 502(b)(2) of the Bankruptcy Code provides that a claim for interest that is "unmatured" as of the petition date shall be disallowed. See generally Collier on Bankruptcy ("Collier") ¶ 502.03 (16th ed. 2024) ("fixing the cutoff point for the accrual of interest as of the date of the filing of the petition is a rule of convenience providing for equity in distribution"). Charges that have been deemed to fall into this category include not only ordinary interest on a debt but items that have been deemed the equivalent of interest, such as original issue discount. Id. This means that, unless there is an exception stated elsewhere in the Bankruptcy Code (see below), any claim for postpetition interest will be disallowed.

The bar on recovery by creditors of interest accruing after a bankruptcy filing pre-dates the enactment of the Bankruptcy Code and is derived from English law. Nicholas v. U.S., 384 U.S. 678, 682 (1966) (explaining that "[i]t is a well-settled principle of American bankruptcy law that in cases of ordinary bankruptcy, the accumulation of interest on claims against a bankruptcy estate is suspended as of the date the petition in bankruptcy is filed[, which rule is] grounded in historical considerations of equity and administrative convenience"); Sexton v. Dreyfus, 219 U.S. 339, 344 (1911) (recognizing the rule that interest ceases to accrue on unsecured debt upon commencement of bankruptcy cases is a fundamental principle of English bankruptcy law, which is the basis of the U.S. system). Section 63 of the Bankruptcy Act of 1898, as amended by the Chandler Act of 1938, expressly disallowed unmatured interest as part of a claim. Bankruptcy Act of 1938, ch. 575, § 63, 52 Stat. 840 (repealed 1978).

English law contained notable exceptions to the rule. One of those was the "solvent-debtor" exception, which provided that interest would continue to accrue on a debt after a bankruptcy filing if the creditor's contract expressly provided for it, and would be payable if the bankruptcy estate contained sufficient assets to do so after satisfying other debts. See In re Ultra Petroleum Corp., 913 F.3d 533, 543-44 (5th Cir.) (citing treatises and cases), opinion withdrawn and superseded on reh'g, 943 F.3d 758 (5th Cir. 2019), cert. denied, 143 S.Ct. 2495 (2023). In such cases, the post-bankruptcy interest was treated as part of the underlying debt obligation, as distinguished from interest "on" a creditor's claim. Id.

The fundamental principle barring creditors from recovering postpetition interest on their claims was incorporated into U.S. bankruptcy law—as were some of the exceptions, but only in part.

In pre-Bankruptcy Code cases where the debtor possessed adequate assets to pay all claims in full with interest—meaning that the payment of interest to one creditor did not impact the recovery of other creditors—principles of equity dictated that creditors be paid interest to which they were otherwise entitled, most commonly at the rate determined by their contracts with the debtor. See Am. Iron & Steel Mfg. Co. v. Seaboard Air Line Ry., 233 U.S. 261, 266–67 (1914) (concluding "in the rare instances where the assets ultimately proved sufficient for the purpose, that creditors were entitled to interest accruing after adjudication"); Debentureholders Protective Comm. of Cont'l Inv. Corp. v. Cont'l Inv. Corp., 679 F.2d 264, 269 (1st Cir. 1982) (in refusing to confirm a plan under chapter X of the Bankruptcy Act because it did not pay postpetition interest on unsecured claims, noting that "[w]here the debtor is solvent, the bankruptcy rule is that where there is a contractual provision, valid under state law, providing for interest on unpaid [installments] of interest, the bankruptcy court will enforce the contractual provision with respect to both [installments] due before and [installments] due after the petition was filed"); Ruskin v. Griffiths, 269 F.2d 827, 832 (2d Cir. 1959) ("where there is no showing that the creditor entitled to the increased interest caused any unjust delay in the proceedings, it seems to us the opposite of equity to allow the debtor to escape the expressly bargained-for" contractual interest provision); Sword Line, Inc. v. Indus. Comm'r of N.Y., 212 F.2d 865, 870 (2d Cir. 1954) (explaining that "interest ceases upon bankruptcy in the general and usual instances noted … unless the bankruptcy bar proves eventually nonexistent by reason of the actual solvency of the debtor"); Johnson v. Norris, 190 F. 459, 466 (5th Cir. 1911) (determining that debtors "should pay their debts in full, principal and interest to the time of payment whenever the assets of their estates are sufficient").

Even though section 502(b)(2) of the Bankruptcy Code provides that a claim for unmatured interest shall be disallowed, there are specific exceptions to the rule included elsewhere in the Bankruptcy Code. For example, section 506(b) of the Bankruptcy Code provides that an oversecured creditor is entitled to interest on its allowed secured claim.

In addition, as noted above, in a chapter 7 case, the distribution scheme set forth in section 726 of the Bankruptcy Code designates as fifth in priority of payment postpetition interest on an unsecured claim at "the legal rate."

Whether the solvent-debtor exception survived enactment of the Bankruptcy Code in 1978 is disputed. However, prior to Hertz, five federal circuit courts—albeit with vigorous dissents in certain cases—had ruled or suggested that the exception survived. See, e.g., LATAM, 55 F.4th at 385–86 (ruling as a matter of first impression that the solvent-debtor exception requiring a solvent debtor to pay pendency interest to unsecured creditors to render their claims unimpaired survived the enactment of the Bankruptcy Code); Ultra Petroleum, 51 F.4th at 156 (a divided Fifth Circuit panel concluded that "the solvent-debtor exception is alive and well" and ruled that a solvent chapter 11 debtor was obligated to pay a make-whole premium to unimpaired noteholders amount "even though … it is indeed otherwise disallowed unmatured interest"); PG&E, 46 F.4th at 1062 (a divided Ninth Circuit panel ruled that "pursuant to the solvent-debtor exception, unsecured creditors possess an 'equitable right' to postpetition interest [under section 1124(1) of the Bankruptcy Code] when a debtor is solvent"); Gencarelli v. UPS Capital Bus. Credit, 501 F.3d 1, 7 (1st Cir. 2007) (stating that "[t]his is a solvent debtor case and, as such, the equities strongly favor holding the debtor to his contractual obligations as long as those obligations are legally enforceable under applicable non-bankruptcy law"); In re Dow Corning Corp., 456 F.3d 668, 678 (6th Cir. 2006) (noting that "[t]he legislative history of the Bankruptcy Code makes clear that equitable considerations operate differently when the debtor is solvent: '[C]ourts have held that where an estate is solvent, in order for a plan to be fair and equitable, unsecured and undersecured creditors' claims must be paid in full, including postpetition interest, before equity holders may participate in any recovery'" (quoting 140 Cong. Rec. H10,752–01, H10,768 (1994)), cert. denied, 127 S.Ct. 1874 (2007).

Hertz

Citing disruption to their car rental business caused by the COVID-19 pandemic, the Hertz Corporation and its affiliates (collectively, the "debtors") filed for chapter 11 protection on May 22, 2020, in the District of Delaware. After an auction process, the bankruptcy court confirmed a chapter 11 plan for the debtors on June 10, 2021, under which the debtors' assets were sold to a group of private equity funds. At that time, the debtors' financial fortunes had vastly improved and they were solvent. 

The plan provided for the payment of unsecured creditors in full, including the holders of two series of senior unsecured notes issued by the debtors prepetition (the "22/24 Notes" and the "26/28 Notes," and collectively, the "Notes"), together with pendency interest at the federal judgment rate, as well as a distribution to shareholders of approximately $1.1 billion in cash and new warrants or subscription rights. The plan accordingly provided that the Noteholders' claims were unimpaired, meaning that the Noteholders were deemed to accept the plan. 

In accordance with the terms of the relevant indentures, the Notes were accelerated upon the debtors' bankruptcy filing. In addition, redemption of the Notes prior to the stated maturity date under certain specified conditions (including the confirmation of a plan repaying the Notes) triggered the debtors' obligation to pay the Noteholders a "redemption" or make-whole premium designed to compensate the Noteholders for the loss of future interest payments if the debt was paid off before maturity.

The plan confirmation order preserved the rights of the Noteholders to assert entitlement to make-whole premiums and additional interest as necessary to render their claims unimpaired. The plan, which expressly provided that the Noteholders would be paid whatever was necessary to render their claims unimpaired, went effective on June 30, 2021.

On July 1, 2021, the Noteholders (through their indenture trustees) filed a complaint seeking a declaratory judgment that, in addition to the principal and prepetition interest paid to the Noteholders on the effective date of the plan (in excess of $2.7 billion), the debtors were obligated to pay approximately $272 million, consisting of: (i) make-whole premiums due under the Notes totaling approximately $147 million; and (ii) pendency interest at the contract default rate (approximately $125 million), which at that time was 30 times greater than the federal judgment rate. The debtors filed a motion to dismiss the complaint. 

The bankruptcy court concluded that the 26/28 Noteholders stated a plausible claim that make-whole premiums were due under the indentures because the redemption of the 26/28 Notes was at the debtor's option, rather than involuntary—i.e., a consequence of acceleration of the 26/28 Notes triggered by a bankruptcy filing that the debtors were forced to make due to the pandemic. However, due to the different language contained in the indentures, the court granted the debtors' motion to dismiss the 22/24 Noteholders' claims for make-whole premiums. 

Next, the bankruptcy court considered whether, even if due under the terms of the indenture governing the 26/28 Notes, the make-whole premiums should be disallowed under section 502(b)(2) as the "economic equivalent" of unmatured interest, an issue that has been disputed by the courts. See generally Collier at ¶ 502.03[3](a) (collecting cases). 

The bankruptcy court initially declined to decide the issue, but did so in a subsequent opinion (discussed below). In this initial ruling, the court noted that, based on relevant case law and other authority, it was "not prepared to conclude, as a legal matter, that make-wholes cannot be disallowed as unmatured interest," but determined that more evidence of the economic substance of the make-whole premiums was necessary. Hertz, 637 B.R. at 791. 

The bankruptcy court then examined whether, even if the make-whole premiums were the economic equivalent of unmatured interest, the 26/28 Noteholders' claims, in accordance with the solvent-debtor exception, would be impaired under the debtors' plan if the 26/28 Noteholders were not paid the premiums. Initially, citing Ultra, PPI, and PG&E, it explained that "any modification of the Noteholders' claim to unmatured interest or to the [make-whole] premium (if it is the economic equivalent of unmatured interest) is an impairment of the Noteholders' contract claims by operation of section 502(b)(2) of the Bankruptcy Code, not the Debtors' Plan." Id. at 794. As a consequence, the court ruled, the 26/28 Noteholders' claims "are not impaired within the meaning of section 1124(1)." Id. 

The bankruptcy court noted that, "in essence," the Bankruptcy Code "is silent on what treatment unimpaired creditors must receive in a solvent chapter 11 debtor case." Id. According to their express terms, it explained, "sections 1129(a)(7) and 726(a)(5) provide what treatment impaired creditors are entitled to receive, not what treatment unimpaired claims are entitled to receive in a solvent chapter 11 debtor case." 

The court rejected the debtors' argument that, by repealing section 1124(3), lawmakers intended that unimpaired creditors must be paid their contract rate of interest in a solvent-debtor chapter 11 case. Congress, it explained, could have so provided by either: (i) amending section 1124(3) to require that unimpaired creditors receive their contract rate of interest, in addition to payment in full of their allowed claims; or (ii) amending section 502(b)(2) to provide that unmatured interest is disallowed "except in the case of a solvent debtor." Id. at 797. Yet it did neither.  

The bankruptcy court wrote that "after consideration of the cases cited by the parties, the express language of the Bankruptcy Code, and its Legislative History, the Court is convinced that the solvent debtor exception survived passage of the Bankruptcy Code only to a limited extent." Id. at 800 (emphasis added). It explained that the Bankruptcy Code expressly codified the solvent-debtor exception in section 506(b) as to oversecured creditors and in sections 1129(a)(7) and 726(a)(5) as to unsecured creditors. The court further noted that: (i) although sections 1129(a)(7) and 726(a)(5) currently apply only to unsecured creditors impaired by a chapter 11 plan, they applied to all unsecured creditors—impaired and unimpaired—when the Bankruptcy Code was originally enacted; and (ii) when Congress amended the Bankruptcy Code in 1984 to limit the scope of section 1129(a)(7) to impaired classes, "it was motivated by the desire to require voting only by impaired creditors, rather than by a desire to assure that unimpaired creditors get their contract rate of interest." Id. 

The bankruptcy court also determined that neither the Bankruptcy Code nor its legislative history expressly states that unimpaired creditors are entitled to their contract rate of interest "or even to more than impaired creditors in the case of a solvent debtor." Id. Instead, it wrote, the legislative history "provides strong evidence Congress intended that unimpaired creditors in a solvent chapter 11 debtor case should receive post-petition interest only in accordance with sections 1129(a)(7) and 726(a)(5)." Id. Moreover, the court reasoned, the legislative history to the repeal of section 1124(3) suggests that lawmakers believed that there was no legitimate reason in a solvent-debtor chapter 11 case to distinguish between impaired and unimpaired unsecured creditors who are receiving full payment of their claims in cash under a plan. As a consequence, it ruled, "both should receive the same treatment: payment of their allowed claim plus post-petition interest at the federal judgment rate in accordance with section 726(a)(5)." Id. 

The bankruptcy court accordingly held that the 26/28 Noteholders failed to state a plausible claim that the debtors were obligated to pay pendency interest on the 26/28 Notes at the rate specified in the indenture rather than at the federal judgment rate. 

The 26/28 Noteholders and the debtors subsequently filed summary judgment motions on the issue of whether the make-whole premium payable on the 26/28 Notes was unmatured interest, or its economic equivalent, within the meaning of section 502(b)(2). The 26/28 Noteholders, based on the intervening court decisions in PG&E and Ultra Petroleum, also moved for reconsideration of the court's ruling that the noteholders were entitled only to the federal judgment rate of interest, rather than their contract rate, for any pendency interest due on their claims. In a November 21, 2022, opinion, the bankruptcy court granted the debtors' motion for summary judgment, finding that the make-whole premium was the economic equivalent of unmatured interest and must be disallowed under section 502(b)(2). The court denied the motion for reconsideration but certified a direct appeal of its ruling to the Third Circuit. See In re The Hertz Corp., Adv. Proc. No. 21-50995 (MFW), 2022 BL 426983, 2022 Bankr. Lexis 3358 (Bankr. D. Del. Nov. 21, 2022), aff'd in part and rev'd in part, No. 23-1169 (3d Cir. Sept. 10, 2024).  

The Third Circuit's Ruling 

A divided three-judge panel of the Third Circuit affirmed the ruling in part, and denied it in part. 

Writing for the majority, U.S. Circuit Judge Thomas L. Ambro agreed with the bankruptcy court that the 26/28 Noteholders' claim for make-whole premiums "must be disallowed under § 502(b)(2), for they fit both the dictionary definition of interest and are its economic equivalent." Hertz, 2024 WL 4730512, at *2. However, he concluded, based primarily upon the absolute priority rule, the 26/28 Noteholders had a right to receive the make-whole premiums as well as pendency interest at the contract rate because Hertz was solvent.  

According to Judge Ambro, Hertz simply could not "use the Bankruptcy Code to force the Noteholders to give up nine figures of contractually valid interest and spend that money on a massive dividend to the Stockholders" in keeping with more than century-old Supreme Court precedent holding that stockholders are not entitled to any distribution until creditors are paid in full. Id. at *8 (citing Chi., Rock Island & Pac, R.R. v. Howard, 74 U.S. 392, 409-10 (1868)). Permitting the debtors to do so, Judge Ambro emphasized, would violate the U.S. Supreme Court's ruling in Czyzewski v. Jevic Holding Corp., 580 U.S. 451, 455 (2017), prohibiting final distributions in a chapter 11 case that "deviate from the basic priority rules … the Code establishes for final distributions of estate value in business bankruptcies." 

Based on relevant precedent, the Third Circuit majority concluded that "the Bankruptcy Code entitles every creditor—not just the dissenting impaired creditors who can invoke § 1129(b)—to treatment consistent with the absolute priority rule absent a clear statement to the contrary." Id. at *11 (citation and footnote omitted). Accordingly, Judge Ambro reasoned, "the Noteholders' right to treatment consistent with absolute priority must be honored to leave them unimpaired." Id. at *12. He explained that lawmakers' decision to reuse the language "fair and equitable" from pre-Bankruptcy Code law in section 1129(b)(2) and the provision's use of the word "includes" was intended to incorporate the pre-Code common law absolute priority rule into the current statute. Id. at *13. That common law and jurisprudence applying it, Judge Ambro wrote, "required solvent debtors to pay contract rate interest before making distributions to equity." Id. (citing cases). 

Even so, the Third Circuit majority noted that "compelling equitable considerations" might warrant the payment of pendency interest at a rate other than the contract rate, such as where the estate was not sufficiently solvent to pay every unsecured creditor the full amount of its contractual interest. Id. at *14. 

According to Judge Ambro, if the plan only had to pay 26/28 Noteholders pendency interest at the federal judgment rate, they would recover less than objecting impaired creditors, thereby violating the basic premise that unimpaired "creditors cannot be treated any worse than impaired creditors, who at least get a vote." Id. (citation and internal quotation marks omitted). 

U.S. Circuit Judge David. J. Porter concurred in part and dissented in part. He agreed with the majority's conclusions, except with respect to the payment of the make-whole premium and pendency contract-rate interest. Largely echoing the dissenting opinions in Ultra Petroleum and PG&E, Judge Porter wrote that: (i) treatment consistent with the absolute priority rule is not one of the rights "protected" by section 1124(1); and (ii) even if it were a protected right, the 26/28 Noteholders' claims were nevertheless unimpaired because those rights were altered not by the debtors' chapter 11 plan but by section 502(b) of the Bankruptcy Code, which expressly disallows any claim for pendency interest. Id. at **16–19. 

Outlook 

On September 25, 2024, the Third Circuit vacated its ruling. On November 6, 2024, the court filed an amended opinion that added certain footnotes but did not substantively alter its original opinion. The Third Circuit also denied the debtors' petition for rehearing en banc.  

With Hertz, no fewer than six federal courts of appeals have now determined that the solvent-debtor exception is alive and well and requires a solvent debtor to pay pendency interest to unsecured creditors to render their claims unimpaired under a chapter 11 plan. In the absence of a circuit split on the question, and having repeatedly declined to review circuit court decisions involving the issue, the U.S. Supreme Court is unlikely to weigh in on any remaining controversy regarding it among bankruptcy and appellate courts.  

The ramifications of Hertz and other similar recent rulings may be significant in large chapter 11 cases where the potential obligation to pay millions of dollars in pendency interest on unsecured claims may significantly impact a debtor's ability to confirm a plan. However, despite several recent high-profile bankruptcy cases involving solvent debtors, such cases remain relatively infrequent, so the impact of these rulings may be limited. 

Key takeaways from the ruling include: 

• If a make-whole premium payable under a debt instrument upon default is either definitionally or the economic equivalent of interest, the claim will be disallowed in the obligor's bankruptcy case as unmatured interest under section 502(b)(2) of the Bankruptcy Code.
• However, to render the claims of unsecured creditors entitled to an otherwise disallowed make-whole premium unimpaired under a chapter 11 plan, the plan must pay the creditors postpetition interest at the contract rate, unless equitable considerations warrant paying a different rate, as well as the make-whole premium amount. 

The requirements expressly set forth in section 1129(b)(2) for the "fair and equitable" treatment of an impaired dissenting creditor under a cram-down chapter 11 plan are not exclusive. Other requirements, such as the pre-Bankruptcy Code common law absolute priority rule, may also apply.