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Creditors of LATAM Airlines Seek Supreme Court Review of Second Circuit’s Decision Denying Post-Petition InterestMarch 24, 2023
On Friday, March 17, 2023, creditors in the LATAM Airlines bankruptcy cases filed a cert. petition with the US Supreme Court seeking review of the Second Circuit’s affirmance of the confirmation of LATAM Airlines’ chapter 11 plan. The cert. petition presents a question that comes up regularly in chapter 11 cases: Is an unsecured claim “unimpaired” by a plan if the claim’s treatment does not include post-petition interest? The issue is important both for creditor recoveries (as it may allow equity-holders to recover before creditors are truly made whole) and because unimpaired creditors cannot vote to reject a chapter 11 plan.
The Circuit held that a creditor can be treated as unimpaired in a plan under Bankruptcy Code section 1124(1) (which defines when a claim is impaired) even though unsecured creditors are not receiving interest to which they are contractually entitled. This is because section 1124(1) tests whether any impairment is caused by a chapter 11 plan, not by “modifications [to creditor rights] which occur by operation of the Code.” In the Second Circuit’s view, because section 502(b)(2) disallows unsecured creditors from receiving “unmatured interest,” a plan that provides that treatment for creditors does not itself “impair” the claim; the Bankruptcy Code is doing the impairment. The Second Circuit further held that the unsecured creditors had no “equitable” right to post-petition interest under the so-called “solvent debtor exception,” rejecting the idea that such an equitable principle applies whenever a chapter 11 plan returns value to the debtor’s owners.
The Petitioners argue the Second Circuit’s decision was wrong for two reasons. First, as the Debtors’ chapter 11 plan classified these claims as unimpaired, the claimants argue that section 1124(1) required the plan to “leav[e] unaltered” their “legal, equitable, and contractual rights to which [their] claim[s] . . . entitl[e] them.” 11 U.S.C. § 1124(1). This cannot mean that such plan could withhold post-petition interest the Debtors owe (nearly $150 million), while passing surplus value (of roughly $2 billion) to the Debtors’ equity-holders. Petitioners assert that the Second Circuit’s decision is at odds with the Sixth Circuit’s decision in In re Monclova Care Center, Inc., 59 F. App’x 660 (6th Cir. 2003), in which the court determined that the Internal Revenue Services’ claim against a debtor would be impaired under section 1124(1) unless the IRS received post-petition interest, a holding which was further endorsed by the Third Circuit in In re PPI Enterprises (U.S.), Inc., 324 F.3d 197 (3d Cir. 2003).
Second, the claimants argue the Second Circuit’s decision creates a circuit split over whether an unimpaired creditor has a right to be made whole before equity-holders receive a windfall. According to the claimants, both the Ninth and Fifth Circuits recognize a creditor’s equitable right to be paid in full, including post-petition interest, before a debtor helps itself to assets leftover after repaying the principal, which is commonly referred to as the solvent-debtor exception. See In re PG&E Corp., 46 F.4th 1047, 1053-1064 (9th Cir. 2022), petition for cert. pending, No. 22-733 (filed Feb. 2, 2023); In re Ultra Petroleum Corp., 51 F.4th 138, 157-160 (5th Cir. 2022), petition for cert. pending, No. 22-772 (filed Feb. 13, 2023). While the bankruptcy court specifically held that LATAM Airlines was insolvent, the claimants take the position that under the Ninth and Fifth Circuit’s approach, a solvent or insolvent debtor impairs its creditors when it proposes a plan that keeps for its equity-holders the value of accrued interest it is not paying unsecured creditors.
Responses to the certiorari petition are due April 17, 2023, and we will continue to monitor and report back on further developments.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Peter Friedman, an O’Melveny partner licensed to practice law in the District of Columbia, Illinois, and New York, Daniel S. Shamah, an O’Melveny partner licensed to practice law in New York, Laura Smith, an O’Melveny counsel licensed to practice law in Texas, and Emma Persson, an O'Melveny associate licensed to practice law in Texas, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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