‘Unimpairment’ under Chapter 11: more than just a non-word | Morgana Lewis

It starts with an awkward bite. Outside of a bankruptcy filing, is “unimpairment” even a word? (No, according to Merriam-Webster.) In Chapter 11, it’s much more: a trend.

Do you want to refinance your bonds at a lower cost? Are you an otherwise sound and solvent company forced into bankruptcy by a massive fire (PG&E), persistently low commodity prices (Ultra Petroleum) or a pandemic (Hertz, whose airport leasing business has closed in 2020 due to COVID-19)?

Or do you simply prefer to increase the value of your share by lowering your coupon?

Chapter 11 allows debtors to reorganize without paying their debts in full, through a form of creditor democracy backed by rules allowing disgruntled creditors to oppose plans that unfairly confer value on junior stakeholders.

For many years Section 1124 was a sleepy corner of this Chapter. It allows the debtor to impose its plan on a class of creditors without a vote, provided that the claims of the class are “unaffected” by the plan.

In a new trend, debtors are arguing that they can consider “unimpaired” bondholders whose interest rates have been cut to the bone on the filing date and whose prepayment premiums are eliminated in the plan. Argument assembles three sections of code[1] to reduce the “allowed” claim of this group, then remove the disallowed part.[2]

Circuit decisions in Ultra Petroleum and PG&E are expected soon. Suppose the trend wins – so what? What would prevent any debtor whose business can survive the bankruptcy process from using Chapter 11 to refinance at lower rates?

Some proponents of the trend have pointed to a court’s “bad faith” removal power under Section 1112, but that standard is, to put it politely, vague. And while circuit courts bless integrity, it’s hard to see how a debtor using Section 1124 to cut interest rates on their debt differs from a taxpayer exploiting a loophole in that other code.

Debtors will argue that it cannot be “bad faith” to exploit a legal right. Creditors may wonder what happened to their coupon.

[1] Sections 1124(1) (describing whether a debt is modified by the plan), 502(b)(2) (excluding unexpired interest of the “permitted debt”) and 726(a)(5) (directing the payment of interest at the “legal rate” within the framework of the distribution cascade in the cases of chapter 7).

[2] Morgan Lewis represents bondholders who argue that this argument is contrary to law and common sense.

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Anne G. Cash