The United States Court of Appeals for the Fifth Circuit issued a
ruling on Oct. 14, 2022 regarding the treatment of make-whole premiums in bankruptcy. The
court held that claims for payment of a make-whole premium are the
economic equivalent of unmatured interest and therefore disallowed
under section 502(b)(2) of the Bankruptcy Code — unless the
“solvent debtor exception” applies.
The “solvent debtor exception” is an equitable exception in bankruptcy to
the general rule that disallows unmatured interest from accruing
post-petition. One of the issues in this case was whether this exception
survived the enactment of the Bankruptcy Code, which did not expressly
The Fifth Circuit’s decision arises out of the Ultra Petroleum Corp. bankruptcy case pending in the U.S. Bankruptcy Court for the Southern
District of Texas and follows several years of litigation. This is the
first circuit-level decision on this issue and deviates significantly from
prior bankruptcy court decisions that viewed make-whole premiums as
recoverable liquidated damages that should be treated differently than
Ultra Petroleum Corp. and its affiliates filed for bankruptcy protection in 2016
but became solvent during the case due to an increase in crude oil prices.
As a result, the debtors were able to propose a chapter 11 plan that
purported to pay their creditors in full, including certain unsecured
noteholders. While the chapter 11 plan treated the noteholders as
unimpaired (i.e., did not alter their contractual rights), it did not
provide for payment of the noteholders’ claim for a make-whole premium. The
debtors’ rationale was that, because section 502(b)(2) of the Bankruptcy
Code disallows claims for “unmatured interest,” the claim based on the
make-whole premium (which in the debtors’ view was the economic equivalent
of unmatured interest) should be disallowed.
The noteholders objected to this proposed plan treatment and argued that
they are impaired if the plan does not provide for payment of the
make-whole premium. The Bankruptcy Court agreed, but the Fifth Circuit (in
its prior decision on appeal) did not. The Fifth Circuit ruled that if the
make-whole premium can be disallowed as unmatured interest under section
502(b)(2), then it is the Bankruptcy Code rather than the chapter 11 plan
that is impairing the noteholders. The case was then remanded to the
bankruptcy court for a determination as to whether the make-whole premium
must be disallowed under the Bankruptcy Code. On remand, the bankruptcy
court determined that the make-whole premium was not the equivalent of
unmatured interest because it did not compensate the noteholders for the
use or forbearance of their money but, instead, the make-whole premium
compensated the noteholders only for a breach of a promise to use the
money, and therefore, was better characterized as liquidated damages.
The Fifth Circuit Ruling
On appeal, the Fifth Circuit disagreed, holding that a make-whole premium
does in fact compensate creditors for the use or forbearance of money —
specifically, the future use of their money. In the Fifth Circuit’s view,
make-whole premiums are “nothing more than a lender’s unmatured interest,
rendered in today’s dollars,” regardless of whether the parties
characterized them as liquidated damages in the loan documents.
Essentially, the court held that a make-whole premium constitutes both liquidated damages and the economic equivalent of unmatured
interest. The Fifth Circuit left open the possibility that lenders could
receive make-whole premiums as true liquidated damages in the future, but
only if those damages are not tied to unmatured interest.
However, the Fifth Circuit held that even though make-whole premiums
typically should be disallowed as unmatured interest under section
502(b)(2), in the Ultra case, the make-whole premium nevertheless
was payable under the “solvent debtor exception,” which overrides section
502(b)(2). The Fifth Circuit disagreed with the debtors’ argument that the
solvent debtor exception, which predates the Bankruptcy Code, had been
abrogated in 1978 when Congress enacted the Bankruptcy Code without
expressly building in the exception. The Fifth Circuit further held that,
where the solvent debtor exception applies, post-petition interest must be
paid at the contract rate rather than at the federal judgment rate. This
ruling is in accord with the Ninth Circuit’s August 2022 decision in In re PG&E Corp., 46 F.4th 1047 (9th Cir. 2022).
There are several key takeaways from the Fifth Circuit’s decision:
Except in the very rare instance where the debtor is solvent,
make-whole premiums may now be disallowed in bankruptcy in the Fifth
Circuit, which includes the Bankruptcy Court for the Southern District
of Texas — one of the most popular bankruptcy courts in the country for
corporate chapter 11 filings.
- The Fifth Circuit was clear that labeling the make-whole premium as
liquidated damages in the loan documents would not change the outcome
where, in substance, the make-whole premium is the economic equivalent of
- The Fifth Circuit’s opinion was much less clear with respect to the
circumstances under which a make-whole premium may be allowable. In dicta,
the court suggested that make-whole premiums potentially could be allowed
as liquidated damages if tied to anticipated transaction costs, though the
nature and extent of permissible costs remains to be determined. It also
may be the case that a flat prepayment fee would be acceptable, or possibly
a fee based on timing benchmarks and/or a percentage of outstanding
- As a result of this uncertainty, litigation over the allowability of
make-whole premiums likely will expand as lenders seek to find ways around
the opinion in Ultra Petroleum.
- Nothing in the court’s decision limits its applicability to unsecured
claims, and thus, make-whole premiums due to secured creditors are likewise
at risk of disallowance.
If there are any questions about the topics addressed in this alert, please
contact Mark Freedlander or Frank Guadagnino.