Restructuring

This is the third post in our series on Judge Sontchi’s postpetition interest decision in Energy Futures Holdings, issued on October 30, 2015. Our first post in this series analyzed Judge Sontchi’s ruling that postpetition interest on an unsecured claim does not constitute a part of the unsecured claim itself. Our second post addressed the court’s use of the federal judgment rate as “the legal rate” under section 726(a)(5) of the Bankruptcy Code. In this post, we discuss the third component of the court’s ruling: that a chapter 11 plan need not provide postpetition interest to an unsecured class that has rejected the plan to cram it down under the absolute priority rule where equity is receiving a distribution, but it must provide the court the ability to order postpetition interest based on equitable considerations. 
In support of its argument that the unsecured noteholders were entitled to postpetition interest, the unsecured notes indenture trustee contended that the requirement of section 1129(b) of the Bankruptcy Code (the “cramdown provision”) that a plan be “fair and equitable” to a rejecting unsecured class includes the requirement that, where the debtor is solvent, such class receive postpetition interest. Specifically, the trustee asserted that postpetition interest on unsecured claims against a solvent debtor is an uncodified aspect of the “fair and equitable” requirement.
We have previously written about the uncodified aspects of the “fair and equitable” requirement for cramdown plans. In short, section 1129(b)(1) provides that a nonconsensual chapter 11 plan must be “fair and equitable”; section 1129(b)(2) provides that “the condition that a plan be fair and equitable with respect to a class includes [certain enumerated] requirements.” (emphasis added.) The use of the word “includes” rather than the word “means” has been interpreted by some courts to mean that there are aspects of the “fair and equitable” requirement that are not expressly set forth in the Bankruptcy Code. There is no general agreement, however, on what those uncodified aspects of the “fair and equitable” requirement might be.
Here, the indenture trustee asserted that postpetition interest on unsecured claims in a solvent-debtor case is required for a plan to be fair and equitable. The court rejected the trustee’s argument for two reasons. First, the court reasoned that the word “includes” applies to classes of secured claims and equity interests in the same way that it applies to classes of unsecured claims. Because the word “includes” applies to all three types of classes, any interpretation of it that would impose a special requirement applicable to only one type of class (unsecured claims) would not make sense.
Second, the court explained that there was no precedential caselaw holding that a plan must provide postpetition interest on unsecured claims to be fair and equitable. The court relied on, among other things, longstanding precedent from the Supreme Court of the United States, Consolidated Rock Products Co. v. Dubois, 312 U.S. 510 (1941) and Vanston Bondholders Protective Committee v. Green, 329 U.S. 15 (1946). Judge Sontchi stated: “[a]t most, [these cases] stand[] for the proposition . . . that it is ‘manifest that the touchstone of each decision on allowance of interest in bankruptcy, receivership and reorganization has been a balance of equities between creditor and creditor or between creditors and the debtors.” He further explained that more recent caselaw—a series of decisions from the Dow Corning bankruptcy, which also involved disputes over postpetition interest on unsecured claims against a solvent debtor—expressly deferred to the bankruptcy court’s weighing of equitable factors.
Based on the foregoing cases, the EFH court reasoned that “[a]t most, [the “fair and equitable” requirement] allows a court to weigh equitable considerations in deciding whether to award post-petition interest” to an unsecured class that rejects a plan. Under the court’s reasoning, a plan that is cramming down a class of unsecured claims but providing a distribution to equity need not provide postpetition interest on unsecured claims—but it must provide the court with the ability to award postpetition interest on those claims to the extent that equitable considerations warrant such an award. Judge Sontchi noted as an example that unsecured creditors may not be equitably entitled to postpetition interest where, among other situations, the “equity” that would be receiving a distribution is really a debtor parent company that would be distributing that value to its own creditors.  The court did not provide examples of equitable factors weighing in favor of an award of postpetition interest.
Accordingly, the EFH court held:

the plain meaning of section 1129(b)(2) does not require payment to unsecured creditors of post-petition interest when a junior class is receiving a distribution for a plan to be fair and equitable. Rather, the Court has the discretion to exercise its equitable power to require, among other things, the payment of post-petition interest, which may be at the contract rate or such other rate as the Court deems appropriate.

In the next and final post in this series, we will examine the fourth component of Judge Sontchi’s decision: an extended discussion of the meaning of claim impairment under the Bankruptcy Code and whether unsecured creditors are entitled to postpetition interest in order to be unimpaired.
Scott Bowling is an Associate at Weil Gotshal & Manges, LLP in New York.