Has the Make-Whole Been Plugged? The Fifth Circuit’s Latest Opinion in Ultra Petroleum

Background: Make-Whole Amounts and the Ultra Decisions

Most credit agreements include a contractual make-whole amount due upon acceleration or prepayment of the loan. Typically, these provisions are designed to provide lenders with the present value of future interest payments that would come due over the life of the loan, thus making the lender whole by providing it with its expected return. In bankruptcy cases, a key question for courts has been whether these make-whole amounts constitute “unmatured interest” — disallowed under Section 502(b)(2) of the Bankruptcy Code — or whether such make-whole amounts are recoverable as liquidated damages.

In Ultra, the debtors proposed a plan that paid lenders all outstanding principal and accrued prepetition interest at the contract rate but included no distribution for the contractual make-whole amount.² The debtors argued that because the plan paid creditors all they were entitled to under the Bankruptcy Code, the lenders were “unimpaired.” The lenders and other creditors objected, arguing that the plan impaired their legal and contractual rights by failing to also pay the make-whole amount. Judge Marvin Isgur agreed, concluding that creditors are impaired unless paid the full amounts allowed under applicable non-bankruptcy law (which in this case included all payment rights under the actual contracts, including the make-wholes). 

Reversing the bankruptcy court, the Fifth Circuit held, “Where a plan refuses to pay funds disallowed by the Code, the Code — not the plan — is doing the impairing.”³ The Fifth Circuit then remanded the case to Judge Isgur to determine whether the Code disallowed the make-whole amount and the contractual default interest rate. On remand, the bankruptcy court again ruled in favor of the creditors, holding that (1) the make-whole amount constituted liquidated damages rather than “unmatured interest” or its “economic equivalent” and was thus not disallowed under Section 502(b)(2), and (2) the historically rooted solvent debtor exception, which predates the Bankruptcy Code, entitles creditors to postpetition interest at the contractual default rate rather than the federal judgment rate.⁴ The debtors once again appealed.

Ultra II Decision

In this latest decision, a divided Fifth Circuit affirmed the bankruptcy court, holding that while “the Bankruptcy Code disallows a Make-Whole Amount as the economic equivalent of unmatured interest,” the solvent debtor exception survived enactment of the Bankruptcy Code and overrides Section 502(b)(2), and when the solvent-debtor exception applies, interest will be owed at the contractual default rate and not the federal judgment rate.

With respect to make-whole analysis, the Fifth Circuit took a sweeping approach, holding that “a make-whole amount is nothing more than a lender’s unmatured interest, rendered in today’s dollars.”⁵ Make-wholes are precisely the “economic equivalent of unmatured interest” and should be disallowed by Section 502(b)(2) of the Code and existing circuit precedent. Deviating from the bankruptcy court’s analysis, the Fifth Circuit emphasized that make-whole amounts designed to provide a lender with all future unmatured interest payments expressed in today’s dollars should be disallowed under Section 502(b)(2) regardless of how the creditors or courts labeled such amounts. In reaching this conclusion, the Fifth Circuit recognized that other courts have characterized certain make-whole amounts as liquidated damages provisions or something other than unmatured interest. Going so far as to illustrate a “fake-whole” calculation, the Fifth Circuit described such a characterization as failing to acknowledge “economic reality” and elevating form over substance, explaining, “[w]hether the claim also happens to be denominated ‘liquidated damages’ is beside the point. Like interest masquerading as ‘principal,’ interest labeled as ‘liquidated damages’ is still interest.”⁶

The Fifth Circuit then held, however, that the solvent debtor exception survived the enactment of the Bankruptcy Code and trumped Section 502(b)(2) in the case of a solvent debtor. Despite the unambiguous language in Section 502(b)(2), which the dissent highlights, the majority reasoned that the “Code’s general bar on claims for unmatured interest does not specifically address the solvent-debtor scenario,” which had traditionally been excepted from such rule under prior versions of the Bankruptcy Act and historic English law. Accordingly, the Fifth Circuit reasoned that this pre-Code doctrine remained good law, operating to suspend Section 502(b)(2)’s disallowance of make-whole amounts in the case of a solvent debtor, provided such claimed amount is valid under applicable state law. To summarize, “when a debtor is able to pay its valid contractual debts, traditional doctrine says it should — bankruptcy rules notwithstanding.”⁷

Finally, the Fifth Circuit turned to postpetition interest, holding that the “legal rate” referenced in Section 726(a)(5) sets only the floor for what an impaired (and by implication, unimpaired) creditor receives in a cramdown scenario. Without deciding whether the “legal rate” is the Federal Judgment Rate, the Fifth Circuit reasoned that “the Code does not preclude unimpaired creditors from receiving default-rate post-petition interest in excess of the Federal Judgment Rate” in a solvent debtor case. Thus, the Fifth Circuit concluded the lenders had an equitable right to their contractual default rate on postpetition interest in this case.⁸

Takeaways From Ultra II and Remaining Unresolved Issues

The Ultra II decision leaves borrowers and lenders with a handful of key takeaways. 

First, in cases where the debtor is insolvent, make-whole amounts may be disallowed in the Fifth Circuit. The Fifth Circuit held that regardless of how the parties might draft a particular provision, the bar on unmatured interest would apply regardless of how the payment might be labeled. The Fifth Circuit concluded that (1) the make-whole amount is both liquidated damages and the “economic equivalent of unmatured interest” and therefore disallowed, and (2) “a make-whole amount contractually triggered by a bankruptcy petition cannot antedate that same bankruptcy petition” and thus cannot mature prior to filing.⁹ Notably, the Fifth Circuit left open the possibility of lenders’ receiving payment of make-whole premiums as true liquidated damages in the future, although it emphasized that such damages must be tied to anticipated transaction costs and not unmatured interest.

Second, the Fifth Circuit’s analysis does not appear to limit itself to only unsecured creditor claims. Although the Ultra II decision dealt with make-whole amounts owed to unsecured creditors, the language of the opinion was firm: Make-whole amounts are disallowed under Section 502(b)(2). While secured creditors may argue that these amounts are “reasonable fees, costs, or charges” permissible under Section 506(b), the Fifth Circuit’s emphasis and underlying basis for disallowing make-whole amounts still threatens the viability of such a claim, absent a solvent debtor.

Finally, given the financial importance of both the make-whole issue and the solvent debtor exception, as well as a circuit split on the interpretation of make-wholes as liquidated damages, Supreme Court guidance on these important matters would be welcome to settle these issues with finality. 

¹ Ultra Petroleum Corp. v. Ad Hoc Comm. of OpCo Unsecured Creditors (In re Ultra Petroleum Corp.), No. 21-20008, --- F.4th ---, 2022 WL 8025329, at *1 (Oct. 14, 2022) (Ultra II).
² 575 B.R. 361, 366–75 (Bankr. S.D. Tex. 2017).
³ See In re Ultra Petroleum Corp., 943 F.3d 758, 760, 765 (5th Cir. 2019). 
⁴ In re Ultra Petroleum Corp., 624 B.R. 178, 191–204 (Bankr. S.D. Tex. 2020).
⁵ Ultra II, 2022 WL 8025329, at *4, 6–8.
⁶ Id. at *6.
⁷ Id. at *8.
⁸ Notably, the dissent maintains that the solvent debtor exception did not survive adoption of the Bankruptcy Code. 
⁹ Id. at *5, 7