Delaware Bankruptcy Court Addresses When, if Ever, Unsecured Creditors are Entitled to Postpetition Interest in Chapter 11 (Part 1)

The law governing postpetition interest in bankruptcy remains unsettled despite having been subjected to more than 100 years of debate in the federal courts. On October 30, 2015, Judge Sontchi of the Bankruptcy Court for the District of Delaware weighed in on postpetition interest issues as they have arisen in the Energy Futures Holdings chapter 11 cases – specifically, when unsecured creditors are entitled to receive postpetition interest under a chapter 11 plan. 
Judge Sontchi rendered his postpetition interest decision in the context of a claim objection. Prior to bankruptcy, Energy Future Intermediate Holding Company LLC and EFIH Finance Inc. issued $1.4 billion in certain unsecured notes. The notes indenture expressly provided that noteholders were entitled to contract-rate postpetition interest. After the debtors commenced their chapter 11 cases, the indenture trustee for the notes filed a proof of claim asserting an entitlement to, among other things, a make-whole and postpetition interest at the notes’ contract rate. The debtors objected to the portion of the trustee’s claim seeking postpetition interest and the make-whole.  The court granted both of the debtors’ claim objections, addressing the make-whole in a separate decision.
The court’s postpetition interest analysis comprises four main components, each of which warrants careful consideration and will be discussed in a separate Blog entry. The first section of the decision is discussed below.
Postpetition interest is not a constituent part of an unsecured claim.
The indenture trustee asserted that postpetititon interest was part of the allowed unsecured claim arising from the notes. The court disagreed, holding that the plain language of section 502(b)(2) of the Bankruptcy Code eliminates postpetition interest from unsecured claims. The court based its conclusion on the plain language of two sections of the Bankruptcy Code.
First, the court reasoned that section 502(b)(2) of the Bankruptcy Code elimintates postpetition interest from unsecured claims. Section 502(b)(2) provides that a claim in bankruptcy is not allowable “to the extent that such claim is for unmatured interest.” This is, in fact, the general rule in bankruptcy, though there are many exceptions to it—the most notable being that section 506(b) of the Bankruptcy Code expressly makes postpetition interest on an oversecured claim a constituent part of the claim to the extent of the claim’s oversecurity. The EFH court did not address section 506(b) in this context, presumably because section 506(b) does not govern the allowance of postpetition interest on unsecured claims.
Second, the court reasoned that the text of section 726(a) of the Bankruptcy Code implies that the Code distinguishes between unsecured claims and postpetition interest on unsecured claims. Specifically, section 726(a) establishes six payment priorities in chapter 7 cases. Allowed unsecured claims are the second priority, while postpetition interest on unsecured claims is the fifth priority. The EFH court reasoned:

The distinction in section 726(a)(2) and (a)(5) between the allowed amount of the claim and post-petition interest on the allowed claim, respectively, supports the plain meaning interpretation of section 502(b)(2), i.e., an allowed unsecured claim cannot include post-petition interest. Otherwise, the distinction between payment under the 2nd and 5th priorities of the allowed claim and interest on the allowed claim, respectively, would be meaningless.

The court also remarked: “As one court has noted, there is a distinction between the payment of interest on an allowed claim as opposed to as an allowed claim.” (Emphasis in original.) Although this proposition in the decision was uncited, the court appears to be alluding to In re Dow Corning Corporation, 244 B.R. 678 (Bankr. E.D. Mich. 1999). In Dow Corning—itself an exhaustive decision on postpetition interest—Chief Judge Arthur Spector of the Bankruptcy Court for the Eastern District of Michigan reasoned:

Properly understood, then, interest under § 726(a)(5) is paid on an allowed claim (as stated in the statute itself), rather than as an allowed claim. And since § 502(b)(2) speaks only to claim allowance, there is no tension between that statute and § 726(a)(5).

Id. at 685. Accordingly, the EFH court held that postpetition interest on an unsecured claim is not a constituent part of the claim.
As we will explore in the next part of this series, the fact that an unsecured creditor’s allowed claim does not include postpetition interest is not the end of the story.  Judge Sontchi also explored whether postpetition interest must ever be paid to unsecured creditors to confirm a plan.
Judge Sontchi’s EFH decision is thorough and carefully reasoned, and we look forward to discussing the remaining three sections of it in upcoming posts on the Weil Bankruptcy Blog.
Scott Bowling is an Associate at Weil Gotshal & Manges, LLP in New York.