Corinne Ball

On Jan. 19, 2019, the U.S. Court of Appeals for the Fifth Circuit held that contractual make-whole damages claims arising out of a bankruptcy filing should be characterized as claims for “unmatured interest” within the meaning of §502(b)(2) of the Bankruptcy Code and therefore disallowed. Ultra Petroleum et al. v. Ad Hoc Comm. of Unsecured Creditors of Ultra Res. (In re Ultra Petroleum), 913 F.3d 533 (5th Cir. 2019) (Ultra Petroleum). Facing the unusual fact of a solvent debtor, the court also held that claims for post-petition interest on unsecured debts in a solvent case are unlikely to be calculated with reference to contractual default rates, though it ultimately remanded to the bankruptcy court for such determination.

In Ultra Petroleum, the question presented was whether a class of claims was unimpaired if such class’s contractual rights to make-whole damages were not honored in a reorganization plan. The reasoning distinguished between “plan impairment” and “Code impairment.” The court affirmed that a creditor is not impaired by a plan of reorganization when such plan simply incorporates the Bankruptcy Code’s disallowance provisions because the Bankruptcy Code and not the plan is doing the impairment. The plan in question provided a return to equity enhanced by the savings achieved through the plan’s failure to pay the make-whole amount. The determination that the creditor class was nevertheless unimpaired also influenced the analysis of a creditor’s right to post-petition interest in a solvent case. Solvent debtors are unusual but surprisingly the reasoning of the case and its holding on make-whole damages are not limited to that rare circumstance. Indeed, the ruling on make-whole payments should benefit equity and junior classes in Chapter 11 cases commenced in the Fifth Circuit.

Factual Background

Ultra Petroleum is an oil and gas exploration and production company. Between 2008 and 2010, Ultra Petroleum’s subsidiary Ultra Resources issued unsecured notes of approximately $1.46 billion to various noteholders. Under the note agreement, which was governed by New York law, Ultra Resources had the right to prepay the notes at 100 percent of principal plus make-whole damages, based on a specified formula. An event of default under the agreement included a bankruptcy filing. In 2011, Ultra Resources borrowed another $999 million under a revolving credit facility. The unsecured notes and the revolving credit facility were guaranteed by Ultra Petroleum. Due to a precipitous and unanticipated decline in the price of crude oil between 2014 and 2016, Ultra Petroleum became insolvent and filed a voluntary bankruptcy petition in the U.S. Bankruptcy Court for the Southern District of Texas on April 29, 2016.

During the pendency of the bankruptcy proceedings, however, crude oil prices recovered substantially, and the debtors became solvent once again. Consequently, the debtors proposed a plan of reorganization that would pay class 4 creditors (i.e., those holding claims under the unsecured notes and the revolving credit facility) in full. Specifically, the plan of reorganization proposed paying in full the outstanding principal on the unsecured notes and the revolving credit facility, pre-petition interest a rate of 0.1 percent, and post-petition interest at the federal judgment rate. In other words, the plan did not provide for the payment of (1) make-whole damages due under the note agreement, or (2) post-petition interest due at the contractual default interest rate on the unsecured notes, the revolving credit facility as well as on the make-whole damages. The plan nonetheless treated the creditors as unimpaired within the meaning of §1124(1) of the Bankruptcy Code, and thus not entitled to vote on the plan. All voting classes accepted the plan. (Section 1124 provides in substance that, unless a creditor consents, its claim is impaired under a plan unless: (1) the plan “leaves unaltered the legal, equitable, and contractual rights to which such claim … entitles [the creditor]”; or (2) reinstates the maturity of the claim after curing any monetary defaults and compensating the creditor for any reliance damages.) The holders of class 4 claims challenged confirmation.

Specifically, the creditors contested non-payment of the $201 million in make-whole damages contractually provided for under the note agreement in the event of default (the Make-Whole Amount) as well as $186 million in contractual post-petition interest arising under the unsecured notes, the revolving credit facility and the Make-Whole Amount itself. The debtors responded that the contractual Make-Whole Amount amounted to unmatured interest within the meaning of §506(b)(2) of the Bankruptcy Code, and alternatively, that the Make-Whole Amount was an unenforceable penalty under New York law. While the creditors and the debtors agreed at plan confirmation that the creditors were entitled to post-petition interest, they disagreed on the applicable rate to render the noteholders unimpaired. The debtors argued for the federal judgment rate, while the creditors argued for their higher contractual default rate.

The creditors and the debtors agreed to defer resolution the issue of whether the creditors were unimpaired until after plan confirmation under the condition that the debtors segregate sufficient cash to pay the disputed amounts.

The Opinions

The Bankruptcy Court’s Opinion. The bankruptcy court disagreed with the debtors and held that New York law permitted the creditors to recover the Make-Whole Amount as a liquidated damages provision rather than rejecting it as an unenforceable penalty. In re Ultra Petroleum, 575 B.R. 361, 370 (Bankr. S.D. Tex. 2017). The bankruptcy court rejected the debtors’ arguments that the Make-Whole Amount was “conspicuously disproportionate to foreseeable losses at the time the parties entered” into the note agreement.

The bankruptcy court also held that debtors’ Chapter 11 plan impaired the creditors’ claims because the plan failed to provide for the payment of the Make-Whole Amount and post-petition default-rate interest. The court rejected the debtors’ position that, because the Make-Whole Amount represented “unmatured interest” and was not allowable under §502(b)(2) of the Bankruptcy Code, the plan left the noteholders’ rights under the Bankruptcy Code unaltered, and the noteholders’ claims were therefore unimpaired under §1124(1) of the Bankruptcy Code.

In support of their position, the debtors had relied on the Third Circuit’s holding in In re PPI Enters. (U.S.), 324 F.3d 197 (3d Cir. 2003) (PPI). In PPI, the Third Circuit ruled that a plan proposing to pay a landlord’s lease rejection claim in an amount equal to the cap on future rent claims set forth in §502(b)(6) left the landlord’s claim unimpaired. Instead of focusing on the disallowance provisions of the Bankruptcy Code, the bankruptcy court focused on state law and the effect of confirming the proposed plan, notably a discharge of the debtors’ otherwise enforceable liability for the unpaid Make-Whole Amount. Hence the bankruptcy court concluded that the plan impaired the noteholders’ claims unless the plan provided for the payment of the Make-Whole Amount in full.

The debtors appealed the bankruptcy court’s ruling directly to the Fifth Circuit rather than the district court because the case raised important and unsettled questions of law.

The Fifth Circuit’s Opinion. On appeal, the Fifth Circuit (1) reversed the bankruptcy court holding that the debtors’ plan impaired the unsecured noteholders’ claims; and (2) vacated and remanded for reconsideration determinations by the bankruptcy court. The Fifth Circuit first analyzed the Make-Whole Amount and the question of impairment, and then turned to the question of post-petition interest.

The Fifth Circuit observed that the bankruptcy court “never decided whether the Code disallows the make-whole amount as ‘unmatured interest’ under section 502(b)(2).” The Fifth Circuit determined that the bankruptcy court improperly focused on whether the unsecured noteholders’ claims were enforceable under state law when the proper inquiry was whether those claims were allowable under the Bankruptcy Code.

First, the Fifth Circuit concluded—in keeping with the majority of applicable case law—that a plan’s incorporation of the Bankruptcy Code’s disallowance provisions did not render the noteholders’ claim impaired. The Fifth Circuit clarified that “a creditor’s claim outside of bankruptcy is not the relevant barometer for impairment; we must examine whether the plan itself is a source of limitation on a creditor’s legal, equitable, or contractual rights … . Where a plan refuses to pay funds disallowed by the Code, the Code—not the plan—is doing the impairing.” Because the Bankruptcy Code limits damages under section 502(b)(6), the Code—and not the plan—was impairing the creditor’s rights, and thus the “creditor’s claim outside of bankruptcy [was no longer] the relevant barometer for impairment.” Id. at 540 (citing In re PPI Enters. (U.S.), 324 F.3d 197, 201-02).

Turning to the question of post-petition interest, the Fifth Circuit built on its analysis of impairment. The debtors argued that the “best interest” requirement of Chapter 11, which sets as a minimum for every creditor that it receive at least what it would receive under a Chapter 7 liquidation, in effect incorporated the federal judgment rate because §726 required payment of such interest prior to providing a return to equity. The Fifth Circuit determined that, if a class of claims was unimpaired, the statutory analysis for providing the federal judgment rate of interest failed because the “best interest” test only applied to impaired claims. Hence the Fifth Circuit evaluated alternative support for payment of post-petition interest, including an in-depth analysis of whether the historic “solvent debtor” rule survived enactment of the Bankruptcy Code. While its analysis suggested that the rule did not survive, the Fifth Circuit nevertheless was clear that some post-petition interest was appropriate.

Although it ultimately remanded such issues to the bankruptcy court for reconsideration, the Fifth Circuit held that: (1) claims for make-whole payments triggered upon the bankruptcy filing of a debtor should be characterized as claims for the economic equivalent of “unmatured interest” and thus disallowed pursuant to section 502(b)(2) of the Bankruptcy Code, irrespective of their enforceability under state law; and (2) payment of post-petition interest by a solvent debtor is not determined by a creditors’ contract because post-petition interest is not part of the creditor’s allowed claim, but instead relies upon the court’s use of its equity powers in light of the debtor’s solvency. But see In re 1111 Myrtle Ave. Grp., No. 15-12454 (MKV) (Bankr. S.D.N.Y. Feb. 14, 2019), ECF No. 171 (applying, in a solvent debtor case arising under Chapter 11, the contractual interest rate to a post-petition interest claim).

The Fifth Circuit’s direction that the enforceability of the creditors’ claims under the relevant credit documents and under state law was not the relevant determinant represents a clear departure from recent conflicting circuit-level decisions in MPM Silicones and Energy Future Holdings in the Second and Third Circuits, respectively. Indeed, its reliance upon the court’s inherent “equity power” also represents a departure from recent trends. See Czyzewski v. Jevic Holding, 137 S. Ct. 973 (2017).


Generally, bankruptcy law defers to otherwise applicable law in assessing claims. There is no doubt that make-whole provisions and similar yield protections are enforceable under New York law. Although the Second Circuit affirmed denial of a make-whole claim, the reasoning in the Second Circuit stands in sharp contrast to the Fifth Circuit. The Second Circuit relied upon state law and clear drafting as the predicate for allowance of a make-whole claim. Although the Fifth Circuit’s holding in Ultra Petroleum occurred under the rare circumstance of a clearly solvent debtor, its analysis of the Make-Whole Amount has wider application. The make-whole provision was described by the Ultra Petroleum court as “walk[ing], talk[ing], and act[ing] like unmatured interest.” Such analysis appears to equate lender compensation tied to protecting yield regardless of characterization as unmatured interest. As such, better drafting of the make-whole provision is likely not the answer.

In all events for distressed investors, Ultra Petroleum will impact the assessment of the “fulcrum” or controlling security or position in a company that has a Chapter 11 case pending in or has the ability to seek Chapter 11 relief in the Fifth Circuit. Significantly, the ruling in Ultra Petroleum has the potential to reallocate value as among creditors. To the extent that the bulk of creditors are lenders and noteholders, perhaps the impact can be controlled through intercreditor agreements. If, however, there are pension, employee, landlord, vendor and similar general creditors, the potential to reallocate value from debtholders asserting make-whole claims to such general creditors remains. Lenders will seek compensation and will continue to seek the benefit of their bargain, but at least in the Fifth Circuit will have to do so on an another basis. Certainly to the extent that waivers and amendments to funded debt obligations are the prelude to a Chapter 11 filing, there may be opportunity to impose alternate value options. Perhaps there will be increased rates or fees for borrowers with access to the Fifth Circuit? There may even be serious discussion of involuntary cases being commenced outside the Fifth Circuit.

In the final analysis, however, one must wonder whether debtors will often have the ability to satisfy their post-petition lenders, obtain the support of or otherwise satisfy their prepetition secured creditors and still render their unsecured debtholders unimpaired when bankrupt. While it is true that insolvency is not a requirement for seeking relief under Chapter 11, one must wonder—although theoretically possible—will a debtor attempt to avoid its funded debt obligations through a retreat into a bankruptcy in the Fifth Circuit? Will such a case be subject to dismissal as a bad faith filing? It remains to be seen whether avoiding make-whole obligations will be a venue consideration.

Corinne Ball is a partner at Jones Day.