UPDATED RULING FROM THE FIFTH CIRCUIT IN 2022 DISCUSSED HERE. In a much-anticipated decision issued on October 26, the Bankruptcy Court for the Southern District of Texas awarded make-whole premiums and post-petition interest (i.e., interest accruing after the bankruptcy filing) to certain noteholders in the Ultra Petroleum bankruptcy case. Specifically, the court concluded: (1) make-whole premiums do not constitute the economic equivalent of unmatured interest and are thus not disallowed claims under the Bankruptcy Code; and (2) pursuant to the solvent-debtor exception, creditors of a solvent debtor are entitled to post-petition interest on their claims at the applicable contractual rate, not the federal judgment rate.
This case stems from exceptional facts where a rise in commodity prices enabled the debtor (a natural gas exploration and production company) to propose and confirm a chapter 11 plan of reorganization that purported to pay all its creditors in full, with the debtor’s pre-bankruptcy equity holders receiving any residual value.
Although the debtor argued that its plan paid all creditors in full (i.e., left them unimpaired), the plan provided that certain noteholders would not receive a make-whole premium that was provided for in the applicable notes. Moreover, the plan paid post-petition interest at the federal judgment rate. The noteholders objected and argued that in order for the noteholders’ claims to be deemed unimpaired the make-whole premium must be paid and post-petition interest must be paid at the rate provided for in the notes (including the default rate). On September 21, 2017, the Bankruptcy Court found in favor of the noteholders and ruled that payment of the contractually-required make-whole premium and the post-petition interest at the default rate was required to render claims unimpaired—even if the Bankruptcy Code otherwise disallows such claims. However, on direct appeal, the Fifth Circuit subsequently held that a claim is not impaired simply because a plan fails to pay amounts that are disallowed under the Bankruptcy Code. Accordingly, the Fifth Circuit remanded the case to the Bankruptcy Court to determine:
1. Whether make-whole premiums constitute “unmatured interest” and are thus disallowed under Section 502(b)(2) of the Bankruptcy Code; and
2. Whether the solvent-debtor exception is still valid, and if so, whether it entitles noteholders to post-petition interest at contractual default rates.
Section 502(b)(2) of the Bankruptcy Code disallows claims for “unmatured interest.” And certain case law has interpreted this provision to also preclude claims that constitute the economic equivalent of unmatured interest. Judge Isgur, writing for the Bankruptcy Court, relied on a three-step analysis to hold that the make-whole premium from the indenture did not constitute interest, unmatured interest, or its economic equivalent for purposes of disallowance of the related claim under Section 502(b)(2)—instead, applying New York law, the court found that a make-whole premium is simply liquidated damages.
First, the court relied on the dictionary definition of interest and a consistent line of cases finding interest to represent “a cost associated with the use or forbearance of another’s money …. normally expressed as a percentage accruing over time.” In contrast, the make-whole premium was designed to “compensate a Noteholder for deprivation of the ‘right to maintain its investment in the Notes free from repayment.’”
Second, the Bankruptcy Court found unmatured interest is simply “interest that has not accrued or been earned as of a reference date.” Since the make-whole premium by definition did not constitute interest, Judge Isgur reasoned that it could likewise not constitute unmatured interest. And because the notes did not accelerate before the petition date (as acceleration was triggered by the filing), “the Make-Whole Amount’s status under § 502(b)(2) is determined without reference to the acceleration clause.”
Third, Judge Isgur found that the make-whole premium is not the “economic equivalent” of unmatured interest. Unlike interest which accrues over time, the make-whole premium is akin to liquidated damages: a “one-time charge” fixing noteholders’ damages “for the cost of reinvesting in a less favorable market.” Consequently, the mere reference to interest rates in the discounted cash flow formula used to calculate the make-whole premium does not render it the economic equivalent of unmatured interest, but rather ensures that “the high-water mark of damages a lender may suffer when a loan is paid off ahead of schedule is equal to the expected interest lost.”
Taken together, Judge Isgur concluded that these findings obviated the need to determine whether liquidated damages and unmatured interest are mutually exclusive, such that the make-whole premiums could conceivably constitute both liquidated damages under New York law and unmatured interest under the Bankruptcy Code. Therefore, Judge Isgur found the make-whole premium was an allowed claim, undisturbed by the disallowance of claims for the economic equivalent of unmatured interest under Section 502(b)(2).
SOLVENT-DEBTOR EXCEPTION AND DEFAULT RATES
As to the second issue, Judge Isgur found the solvent-debtor exception survived the adoption of the Bankruptcy Code in 1978 and thus entitled noteholders to post-petition interest at the contractual default rates rather than the federal judgment rate. This finding was based on review of related legislative history and interpretation of equitable and statutory interpretation principles underlying the Bankruptcy Code.
The solvent-debtor exception is rooted in the simple principle that a debtor “with the means to pay his debts in full should be required to do so.” The exception “is triggered when one concrete fact exists: the estate’s assets exceed its liabilities”—with the effect of requiring debtors pay creditors “the post-petition interest to which they are legally or contractually entitled” to classify such claims as unimpaired under Section 1124(1) of the Bankruptcy Code (“leaves unaltered the legal, equitable, and contractual rights…”)
In that regard, Judge Isgur found the noteholders were entitled to post-petition interest at the default rate rather than judgment rate because to hold otherwise would (i) alter the equitable rights of the unimpaired creditors to have their contractual rights fully enforced in contravention of unimpairment under Section 1124(1); (ii) leave unimpaired creditors in less advantageous position than impaired creditors also entitled to receive interest at the federal judgment rate, as the impaired creditors would have the right to vote on debtor’s plan; and (iii) contravene the fundamental policy underlying the solvent-debtor exception that a “debtor cannot walk away from bankruptcy with a windfall while creditors walk away with depleted pockets.”
For now, lenders in the Fifth Circuit can take some comfort—at least in the unusual context of a chapter 11 plan proposed by a solvent debtor—that they’ll be entitled to recover make-whole premiums and post-petition default interest. In light of a likely appeal of the Bankruptcy Court’s decision, which is in large part consistent with its original ruling that was appealed, we will continue to monitor this important issue and circulate further updates as they become available.
 The phrase make-whole premiums is generally understood to reference a provision in a loan agreement or indenture that requires a borrower to pay the lender a premium for any loan payment made by the borrower prior to maturity, compensating the lender for interest payments it would have received if the debt had not been prepaid.
 In re Ultra Petroleum Corp., No. 16-32202, slip op. (Bankr. S.D. Tex. Oct. 26, 2020), ECF No. 1874.
 For previous K&S publications discussing this case, please see (i) Client Alert, Fifth Circuit Vacates Bankruptcy Court’s Order Requiring Payment of Make-Whole Premium and Interest in Ultra Petroleum Bankruptcy, KING & SPALDING LLP (Jan. 22, 2019), https://www.kslaw.com/news-and-insights/fifth-circuit-vacates-bankruptcy-courts-order-requiring-payment-of-make-whole-premium-and-interest-in-ultra-petroleum-bankruptcy; and (ii) Matthew Warren & Sarah Primrose, The Ultra Effect: Litigating Make-Whole Premiums and Post-Petition Interest, 35(10) REV. OF BANKING & FIN. SERVS. 133 (Oct. 2019).
 See In re Ultra Petroleum Corp., 575 B.R. 361 (Bankr. S.D. Tex. 2017).
 See In re Ultra Petroleum Corp., 913 F.3d 533, 538 (5th Cir. 2019).
 In re Ultra Petroleum Corp., No. 16-32202, ECF No. 1874 at 12.
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 Id. at 9.
 Id. at 27– 28.
 Id. at 36.
 Id. at 41–42.