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Introductory Note

On May 2, 2023, we issued a note entitled Make-Wholes in Bankruptcy: A General Primer (the “Primer”) that discussed what make-wholes are and how certain courts have interpreted them. In broad strokes, the Primer discussed recent developments related to whether make-wholes will be disallowed in bankruptcy as “unmatured interest” under § 502(b)(2) of the Bankruptcy Code; how disallowed make-wholes should be treated in those rare cases where a debtor is solvent; and whether debtors can avoid paying make-wholes if the debt is reinstated through a plan of reorganization pursuant to § 1124(2) of the Bankruptcy Code. We invite our readers to review the Primer for more background on make wholes.

As it relevant here, the Primer also highlighted a pending noteholder appeal before the U.S. Court of Appeals for Third Circuit (the “Third Circuit”) arising out of the chapter 11 cases of Hertz Corporation (“Hertz”). This note explores the noteholder appeal in detail. It starts by recapping the background of the litigation; it discusses the arguments presented appeal, including oral arguments that occurred on October 25, 2023; and it concludes with a few of our thoughts and takeaways.

Background on Noteholder/Hertz Litigation

At the height of the Covid pandemic, Hertz filed for chapter 11 in the U.S. Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) in May 2020. Hertz had several series of notes outstanding with a principal amount of approximately $2.8 bn (the “Notes,” and the holders of the Notes, the “Noteholders”). The interest rates on the Notes ranged from 5.5% to 7.125%, and Wells Fargo Bank N.A. (“WF”) and U.S. Bank, N.A. (“USB,” and with WF, the “Trustees”) served as indenture trustees on different series of the Notes. Some of the Notes also benefited from an “Applicable Premium” (referred to as a “make whole” throughout this note) if the Notes were redeemed prior to their stated maturities.

Hertz’s luck changed considerably over the ensuing year—vaccines became common, and travel started to resume. Hertz then underwent a successful auction and sales process in May 2021 that allowed Hertz to propose a plan of reorganization that would pay all creditors in full and return value to equity. The Bankruptcy Court confirmed Hertz’s chapter 11 plan in June 2021, and the plan went effective shortly thereafter.

As is critical to this dispute, the plan classified the Noteholders as unimpaired, which meant two critical things: Noteholders were not entitled to vote on the plan of reorganization, and they were not entitled to the substantive protections of the Bankruptcy Code related to “cramdown” when impaired creditors vote against a plan of reorganization. As for their treatment under the plan, the plan provided that Noteholders would receive (i) payment in full on the effective date of the plan, which included pre-bankruptcy interest at the contract rate in the Notes plus (ii) post-petition interest at the federal judgment rate (i.e., the average 1-year constant maturity Treasury yield, which was 0.15% at the time). Critically, the plan reserved the Noteholders’ right to seek declaratory relief after plan confirmation to obtain payment of any post-petition interest or make-whole premium, as applicable, they would be entitled to receive in order to be “unimpaired” under the Bankruptcy Code. This reservation of rights ensured that any litigation over the Noteholders’ post-petition entitlements would not jeopardize Hertz’s plan of reorganization process.

Shortly after the plan was confirmed, the Trustees commenced litigation seeking a $147 mn make-whole payment plus $125 mn in contractual interest (roughly $270 mn in total). In two separate decisions issued on December 22, 2021, and November 21, 2022, the Bankruptcy Court considered two primary issues and reached the following two conclusions:

  • First, the Bankruptcy Court considered whether the make whole on the Notes, which was triggered by the repayment of the Notes under Hertz’s plan, was the economic equivalent of “unmatured interest” that must be disallowed under § 502(b)(2) of the Bankruptcy Code. The Bankruptcy Court answered the question in the affirmative, holding that the make-whole was the equivalent of “unmatured interest” because the make-whole formula was based on accrued and unpaid interest and the present value of those interest payments. The Bankruptcy Court flatly rejected the argument that the premium was designed to compensate lenders for their reinvestment costs.
  • Second, the Bankruptcy Court considered whether the Noteholders were nonetheless entitled to post-petition interest under the so-called “solvent-debtor exception,” which is an exception to the prohibition on the payment of post-petition/unmatured interest. In broad strokes, this doctrine rests on the theory that it would be inequitable to permit the return of any funds to the debtor or equity without paying creditors the full benefit of their contractual bargain (such asa make-whole) or some other form of post-petition interest. On this issue, the Bankruptcy Court held that the “solvent-debtor exception” does exist under the Bankruptcy Code, but the court said it was limited to the payment of interest at the federal judgment rate (and not the contract rate between Hertz and the Noteholders). The Noteholders were therefore only entitled to interest at the federal judgment rate, which was considerably lower than the contract rate. On this point, the Bankruptcy Court recognized that its reasoning conflicted with recent decisions issued the Fifth Circuit in Ultra Petroleum and the Ninth Circuit in PG&E. (Our Primer discusses these decisions as well.)

In November 2022, the Bankruptcy Court certified an appeal of its decision directly to the Third Circuit (bypassing the Delaware District Court).

Arguments on Appeal

On appeal, the Trustees make a number of detailed and nuanced arguments articulating why the Noteholders are entitled to $270+ mn in post-petition interest/compensation. We distill the key arguments as follows:

  • First, the Trustees argue that the Bankruptcy Code’s provision that allows a debtor to classify creditors as unimpaired (thereby denying creditors the right to vote on a plan of reorganization) has been violated in this case. Specifically, § 1124(1) of the Bankruptcy Code (with emphasis added) provides that “a class of claims or interests is impaired under a plan unless, with respect to each claim or interest of such class, the plan— (1) leaves unaltered the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest.” The Trustees argue that § 1124(1) requires that Hertz pay the Noteholders post-petition interest at the contract rate and/or a make-whole, as applicable, because it would otherwise alter their legal, equitable and contractual rights.
  • Second, and relatedly, the Trustees argue that denying the Noteholders post-petition interest at the contract rate denies them of their equitable rights under § 1124(1) when a debtor—like Hertz—is wildly solvent and otherwise has the wherewithal to honor its contractual commitments. The Trustees cite to recent decision in Fifth and Ninth Circuits, which have recognized the so-called “solvent debtor exception.” The Trustees argue that § 1124(1) incorporates the meaning of the solvent debtor exception by preserving the Noteholders’ equitable rights.
  • Third, the Trustees argue that the Noteholders’ entitlement to post-petition interest at the contract rate is based in equity, and any limitation on that entitlement—like an entitlement that is limited to the federal judgment rate, like the Bankruptcy Court did in this case—misreads the Bankruptcy Code. The Trustee argue that the provisions of the Bankruptcy Code that limit payments to the federal judgment rate only apply to impaired (not unimpaired) creditors.
  • Fourth, the Trustees argue that make-whole in this case is not unmatured interest or its economic equivalent because it compensates investors who are otherwise forced to reinvest at potentially less advantageous market conditions. The Trustees argue that a make-whole is just compensation for the premature termination of a payment obligation. Just because future interest is an input variable in the calculation of a make whole premium, the Trustees argue, does not transform the obligation into one for unmatured interest. Indeed, the Trustees argue that a protection against prepayment in the form of a make-whole is, by itself, a valuable right in any lending arrangement. It follows that disallowing a make-whole unfairly puts two lenders that have different bargained-for credit protections in the same position post-bankruptcy.

Hertz, on the other hand, argues that the Third Circuit should affirm the Bankruptcy Court in all respects. Hertz makes number of detailed arguments, which we distill as follows:

  • First, Hertz argues that any impairment to the Noteholders is not being done by the plan of reorganization itself, which is what § 1124(1) otherwise proscribes (i.e., “the plan— (1) leaves unaltered…”). Rather, Hertz argues that the Noteholders’ claim for post-petition interest and/or a make whole has been altered by the Bankruptcy Code itself, which disallows unmatured interest under § 502(b). In other words, unimpaired creditors like the Noteholders are entitled to the full amount of their lawful claim—which they received under the Hertz plan—but their lawful claim had already been altered by the provision of the Bankruptcy Code that disallows unmatured interest. Because the plan pays the Noteholders everything their claim entitles them to as a matter of law, there is no impairment under § 1124(1). Stated even more succinctly, it is the Bankruptcy Code and not the plan of reorganization that is doing the impairing, which applies equally regardless of whether a debtor is solvent or insolvent.
  • Second, Hertz acknowledges that the solvent-debtor exception may have existed before the Bankruptcy Code was enacted in 1978, but Hertz argues that the Third Circuit should disregard it now because the exception was not incorporated into the Bankruptcy Code. To the extent the exception exists, Hertz argues that any claim for post-petition interest should be based on the text of the Bankruptcy Code, which provides for post-petition interest in solvent debtor cases at the “legal rate” of interest (or federal judgment rate).
  • Third, Hertz argues that the Bankruptcy Court correctly held that the component parts of the make whole at issue clearly show that it was the functional equivalent of unmatured interest.

Oral Arguments

The Third Circuit held oral argument on October 25, 2023. The panel was comprised of Circuit Judges Krause, Porter, and Ambro, and each judge showcased a strong grasp of the issues presented. The initial focus of the argument was on the intricacies of the make whole in this case, and the judges demonstrated an awareness of the potential nuanced distinctions between permissible make wholes and unmatured interest that must otherwise be disallowed. The panel then peppered lawyers for each side with thoughtful questions, and one panel member even stated that this this case raises very tough questions. The panel gave no indication on how or when it will render its decision.

Thoughts and Takeaways

This appeal raises tricky and nuanced issues in the area of bankruptcy law that have divided trial and appellate judges all over the country. We have no doubt that Judges Krause, Porter, and Ambro will similarly wrestle with these issues over the months ahead. We do offer a few thoughts and impressions.

The first is on the issue of whether make wholes are unmatured interested. As we explored in our make-whole Primer earlier this year, we note that most lower courts have historically concluded that make-wholes are akin to permissible liquidated damages or debts that are fully payable upon a bankruptcy filing and are not “unmatured interest” that must be disallowed under the Bankruptcy Code. We noted that this former majority rule appears to be trending in the other direction with cases like the Fifth Circuit’s decision in Ultra Petroleum and the Bankruptcy Court’s decision in this case.

Our gut feeling is that the trend will probably continue with courts finding that make wholes are unmatured interest. That being said, we were pleasantly surprised that the Third Circuit at oral argument demonstrated an acute appreciation for both the purpose of make wholes and that, depending on the facts and circumstances, make wholes may not invariably lead to disallowance as unmatured interest. Even so, the Third Circuit could affirm the Bankruptcy Court on this point and say that the question of whether the make whole was the economic equivalent of unmatured interest was a factual question, and that the Bankruptcy Court’s factual determinations should only be reversed for an abuse of discretion or for clear error. This would allow the Third Circuit to dodge the issue entirely, and it would not surprise us if the court did so here.

Beyond the make wholes, it is anyone’s guess how the Third Circuit will rule on the question of what post-petition interest rate applies to the Noteholders’ claim under the so-called solvent debtor exception. The issue has been considered by two federal appellate courts in the last couple of years—the first was by the Fifth Circuit in Ultra Petroleum, and the second was by the Ninth Circuit in PG&E. Each court found that the solvent debtor exception is alive and well, and that creditors of solvent debtors are entitled to the contract rate of interest in the post-petition period. Moreover, the U.S. Supreme Court recently denied certiorari review earlier this fall on both of those decisions. But the Ultra Petroleum and PG&E decisions were both decided by 2-1 votes over vigorous dissents, which demonstrates that there is no clear consensus among federal judges on this issue. Our sense is that the Third Circuit panel might be sympathetic to at least the economic position of the Noteholders in this case, but the panel gave no indication of which way it was leaning.

We will continue to follow this appeal and issue subsequent report(s) as appropriate, but as we noted in our Primer, the end result of this case could potentially be of diminished significance because solvent debtors are the rare exception in bankruptcy.


Mark Lightner, Esq.
Head of Special Situations Legal Research



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