If a debtor can pay all the money it promised to pay, should it be required to do so, despite having filed for bankruptcy? Three federal courts of appeals have said yes, but there was a dissent in each case, and the Supreme Court of the United States has shown a tentative interest in the issue.
Earlier this summer, the Court asked the U.S. Solicitor General’s Office to weigh in on the pending petition for a writ of certiorari in Hertz Corp. v. Wells Fargo Bank N.A., No. 24-1062, which presents the question stated above. In slightly more technical terms, the petition asks whether creditors of solvent bankruptcy debtors can recover post-petition interest at the contract rate. The question is also sometimes phrased as whether there is a “solvent debtor exception” to certain provisions of the Bankruptcy Code.
The U.S. Court of Appeals for the Third Circuit ruled in favor of Hertz’s noteholders. In re Hertz Corp., 120 F.4th 1181 (3d Cir. 2024). Although the Bankruptcy Code disallows claims for unmatured interest, the panel majority held that principles of absolute priority required Hertz to pay its noteholders more than $250 million in unmatured interest because it was solvent and had already distributed four times that much to its shareholders. That result, the majority explained, was dictated by long-standing common-law principles of absolute priority that had been incorporated into the Code and Supreme Court precedent barring debtors from using “backdoor” maneuvers to evade the absolute priority rule. Judge David Porter dissented in relevant part.
The majority’s conclusion was consistent with recent decisions of the Fifth and Ninth Circuits, which likewise required solvent debtors to pay claims for unmatured interest. In re Ultra Petroleum Corp., 51 F.4th 138 (5th Cir. 2022), cert. denied, 143 S. Ct. 2495 (2023); In re PG&E Corp., 46 F.4th 1047 (9th Cir. 2022), cert. denied, 143 S. Ct. 2492 (2023). HSF Kramer’s predecessor firm argued the winning side in Ultra and defeated the certiorari petition filed in that case by the same counsel now seeking certiorari in Hertz.
Factual Background
In May 2020, famous rental car company Hertz, crippled by the COVID pandemic’s impact on its industry, filed for Chapter 11 bankruptcy. As the economy recovered, however, Hertz regained its footing and became solvent again. It emerged from bankruptcy via a plan that purported to leave all its creditors “unimpaired.”
Specifically, the plan paid off all of Hertz’s prepetition debt without interest. But it did not pay the noteholders the more than $250 million in make-whole premiums owed under the notes. That money — and much more — was instead distributed to Hertz’s stockholders.
The noteholders objected. The U.S. Bankruptcy Court in Delaware ruled for Hertz. It concluded that the make-whole premiums were claims for unmatured interest that are barred by the Bankruptcy Code. The bankruptcy court certified its decision for direct appeal.
The Panel Opinion
The Third Circuit reversed. The panel unanimously concluded that the make-whole payments were claims for unmatured interest, which the Bankruptcy Code disallows unless an exception applies.
Hertz nevertheless had to pay those premiums, two of the three judges concluded, because it was solvent and had distributed four times that amount to its shareholders. According to Judge Thomas Ambro, writing for the majority, a failure to pay the noteholders would violate the absolute priority rule, which had arisen in common law and had been incorporated into the code in relevant part.
As the majority put it, the absolute priority rule “requires creditors’ obligations be paid in full before owners, with junior rights to the business, take anything at all.” The majority read the Supreme Court’s decision in Czyzewski v. Jevic Holding Corp., 580 U.S. 451 (2017), as holding that the principle of absolute priority applies in every context under the Code. Accordingly, the majority concluded that “every creditor — not just the dissenting creditors who can invoke” the Code’s “cramdown” provisions — has a right to be treated “consistent with absolute priority absent a clear statement to the contrary.” The rule of absolute priority prevented Hertz from — in the majority’s words — using “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.”
The majority noted that the Fifth Circuit in Ultra and the Ninth Circuit in PG&E had reached the same conclusion, if not necessarily by the exact same reasoning. Those cases also involved “solvent debtors who sought to save immense amounts by paying … interest at the federal judgment rate instead of the higher rates applicable outside bankruptcy.” Both courts concluded by 2-1 votes “that pre-Code practice required solvent debtors [to] pay contract rate interest, and decided that the enacted Bankruptcy Code did not clearly reject that tradition.”
The majority perceived some tension between a portion of its analysis and the Second Circuit’s discussion in In re LATAM Airlines Grp. S.A., 55 F.4th 377, 388, 388–89 (2d Cir. 2022). (LATAM, like Ultra, was argued and won by HSF Kramer’s predecessor firm.) But Judge Ambro’s majority opinion noted that Hertz never cited LATAM, and LATAM did not address the Supreme Court’s decision in Jevic or deal with the specific language of the Code, which controlled the majority’s analysis. In any event, the relevant discussion in LATAM was dicta because the debtor there was insolvent.
Judge Porter’s Dissent
Judge Porter dissented on the solvent debtor issue. As Judge Porter saw it, the absolute priority rule is a procedural protection, not a substantive “right to payment” or “right to an equitable remedy for breach of performance if such breach gives rise to a right to payment” that is protected by Section 101(5) of the Bankruptcy Code.
Judge Porter also disagreed with other aspects of the majority opinion. In his view, Jevic is inapposite because the bankruptcy court there acted without express authorization in the Code and violated the codified absolute priority rule. Judge Porter acknowledged that his view could result in a seemingly unfair outcome, but he concluded that the court was bound to enforce the express terms of the Code “regardless of such policy considerations.”
Hertz’s Petition for Certiorari
Hertz presents the case as one of textualism. It accuses the Third Circuit of concluding that an uncodified pre-Code version of the absolute priority rule trumps the Code’s clear text. For Hertz, Section 502(b)(2)’s disallowance of unmatured interest is the beginning and the end of this case.
Hertz further contends that the panel mistakenly read the pre-Code absolute priority rule into Section 1129’s “cramdown” provision, which by its own terms applies only to “impaired” creditors — a class that Hertz argues does not include its noteholders. Hertz also notes that the Supreme Court has already recognized that the Bankruptcy Code “does not codify any authoritative pre-Code version of the absolute priority rule.” Bank of Am. Nat’l Tr. & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434, 448 (1999). (The winning oral argument in 203 N. LaSalle also was presented by a lawyer who is now at HSF Kramer.)
Hertz argues that the Supreme Court should grant certiorari to resolve a conflict with the Second Circuit’s opinion in LATAM. Moreover, it argues that the Third Circuit exacerbated “disarray in the lower courts” by relying on absolute priority principles that were not discussed in either Ultra or PG&E.
The Noteholders’ Response
The noteholders have opposed Hertz’s certiorari petition. Interestingly, the noteholders defend the Third Circuit’s judgment on grounds slightly different from those in the majority opinion. The noteholders appeal extensively to Section 1124(1) of the Bankruptcy Code, which treats a class of creditors as impaired unless the plan leaves unaltered their legal, equitable or contractual rights. The noteholders argue that the solvent debtor principle is an equitable right protected by Section 1124(1). That principle, they explain, is an outgrowth of the absolute priority rule with a centuries-long history in American and English bankruptcy practice. Nothing in the Code expressly overrides that principle, they argue, so the Third Circuit correctly applied “[t]he normal rule of statutory construction…that if Congress intends for legislation to change the interpretation of a judicially created concept, it makes that intent specific.” Midlantic Nat’l Bank v. New Jersey Dep’t of Env’t Prot., 474 U.S. 494, 501 (1986).
CVSG
Those hoping that the Supreme Court will ultimately decide to review the Third Circuit’s decision received some tentative encouragement when the Court invited the Solicitor General to file a brief expressing the views of the United States on the Hertz petition. The Court calls for the views of the Solicitor General on cases where the United States is a non-party a handful of times per Term in a process colloquially known as “CVSG” (Call for the Views of the Solicitor General). A CVSG reflects that the Justices have at least some interest in a case.
The Court’s decision to issue a CVSG correlates, empirically, with an increased likelihood that the Court will grant certiorari (although correlation is not necessarily causation). A study from 2009 estimated that a CVSG raises the likelihood of certiorari being granted from 0.9% to 34%. From 1998 to 2004, the Court granted 31 cases out of 91 with CVSG orders. And the Court accepts the SG’s recommendation about 80% of the time. Hence, the mere issuance of the CVSG order is significant for the Hertz petition.
Key Takeaways
Until recently, concerns about the solvent debtor exception have been largely absent from the discussion about where to file for bankruptcy. And it may remain that way no matter what happens in Hertz because, for most debtors, the odds of returning to solvency during the bankruptcy are slim. As the Fifth Circuit colorfully put it in the first of its two decisions in Ultra Petroleum, solvent debtors in bankruptcy are “as rare as the proverbial rich man who manages to enter the Kingdom of Heaven.”
For debtors that do become solvent again, however, the location of the bankruptcy may matter immensely. Some of the nation’s most popular venues for mega bankruptcy cases — including the District of Delaware and the Southern District of Texas — are within circuits that have now endorsed the solvent debtor exception. And as Hertz demonstrates, this is no small question — it can determine whether hundreds of millions of dollars must go to creditors or can be distributed to equity.
Other circuits have not directly weighed in on the question. And the court overseeing the other most popular venue for large Chapter 11s — the Southern District of New York — has arguably looked the other way in dicta.
Litigating those matters successfully will require the assistance of experienced counsel who can distill and persuasively argue the competing and complicated issues of statutory interpretation, common-law practice, and equitable considerations raised by these cases.
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