United States: Equity Begets Flexibility: Valuing A Secured Creditor’s Claim In Bankruptcy And Allocating Post-Petition Interest

Last Updated: June 17 2014
Article by Eric R. Blythe and Kevin J. Walsh

The First Circuit Court of Appeals in In re SW Boston Hotel Venture, LLC, 2014 U.S. App. LEXIS 6768 (1st Cir. Apr. 11, 2014) recently ruled on a number of issues critical to valuing a secured claim in bankruptcy. Specifically, the court 1) endorsed the use of a “flexible approach” to value collateral under the circumstances of this case, 2) recognized that the date collateral should be valued is the lender’s burden to prove, and 3) confirmed that the pre-petition agreement’s default interest rate should generally be used to determine the post-petition interest rate. This case is of particular relevance to secured creditors that may be (or become) oversecured during a bankruptcy case.

In general, the Bankruptcy Code permits a secured creditor to receive unmatured interest on its claim during a bankruptcy case if and to the extent the claim is oversecured, i.e., that the value of the collateral securing the claim exceeds the amount of the claim. However, determining the amount of unmatured, post-petition interest can be complicated when the value of the collateral changes over the life of the case. Indeed, in SW Boston, the parties agreed that the secured creditor was oversecured for at least part of the bankruptcy proceeding and that the creditor was entitled to some amount of post-petition interest. Yet, the parties disagreed on how to determine oversecured status, when the creditor became oversecured and how to calculate the appropriate amount of interest.

Background

SW Boston Hotel Venture, LLC (“SW Boston”) developed a mixed-use property that would become the W Hotel (the “Hotel”) and Residences (the “Condos”) in Boston. SW Boston financed the project through the Prudential Insurance Company of America (“Prudential”), and Prudential received a mortgage and first priority security interest in SW Boston’s real and personal property, including the Hotel and Condos (collectively, the “SW Boston Collateral”). SW Boston completed the construction of the Hotel and Condos in October of 2009, but purchases and occupancy rates were lower than expected. Additionally, a number of the Hotel and Condo amenities – the restaurant, spa and bar – remained incomplete. In December 2009, the City of Boston (the “City”) provided additional funding to permit SW Boston to finish constructing the amenities; the City was secured by a junior lien on most of the collateral that secured the Prudential loan. Despite the additional funding, on April 28, 2010, SW Boston and four affiliated entities filed Chapter 11 bankruptcy petitions, which were followed on June 4 by three additional affiliated entities (collectively, the “Debtors”).

Four months into the bankruptcy case, Prudential filed a motion for relief from the automatic stay arguing that it lacked adequate protection (i.e., was undersecured) because the amount of its claim exceeded the value of the SW Boston Collateral (Prudential’s claim was approximately $154 million, exclusive of any post-petition interest or expenses). After a three-day hearing, the bankruptcy court found that Prudential was undersecured with respect to the Hotel and Condos (valued collectively at $153.6 million), but oversecured by an amount in excess of $19 million when accounting for Prudential’s entire collateral package, which included assets of the affiliated debtors as well. Accordingly, the court ruled that Prudential was adequately protected, and denied the lift-stay motion.

On May 24, 2011, the bankruptcy court approved the Debtors’ motion to sell the Hotel for $89.5 million. The proposed sale had several significant contingences to closing. Three days after approval of the Hotel sale motion, the Debtors filed their reorganization plan. The plan called for Prudential to be paid in full by March 2014 if the hotel sale closed, or after a more extended period if it did not. The plan further provided that Prudential would receive interest of 4.25% per annum after the plan became effective, but it made no provision for post-petition interest during the case and prior to the effective date of the plan. Prudential objected to the plan on multiple grounds. Relevant for this advisory, ten months after it had moved for relief from the stay by arguing it had an undersecured claim, Prudential moved for a determination that it was oversecured and therefore entitled to post-petition interest.

Flexible Valuation Approach

To address Prudential’s claim that it was oversecured, the First Circuit first considered whether to apply a flexible or single-valuation approach in determining the value of Prudential’s collateral. Acknowledging a circuit split on this issue, the court examined the two potential valuation methods. The “single-valuation” approach involves a determination of oversecured status at a fixed point in time (generally either the petition date or the confirmation date). The “flexible” approach allows the bankruptcy court discretion to determine the appropriate measuring date based on the circumstances of the case.

In this case, both the bankruptcy court and the bankruptcy appellate panel (“BAP”) had adopted the flexible approach, though their respective applications of the approach differed. The First Circuit agreed with the lower courts stating that “[t]he availability of a flexible approach strikes us as more likely to produce fair outcomes than allowing post-petition interest for the entire bankruptcy, or not at all, based on a rigidly defined one-shot vantage point.” However, the First Circuit refrained from mandating the flexible approach holding that, “at least in the circumstances presented here, a bankruptcy court may, in its discretion, adopt a flexible approach.” (emphasis added).

Date of Determination

The First Circuit then evaluated the appropriate measuring date, along the continuum of the petition date to the confirmation date, for determining oversecured status. The bankruptcy court had found that the Hotel sale price provided the best evidence of the Hotel’s value as of the sale date. However, given the significant contingencies in the sale agreement, the bankruptcy court concluded that the sale price was not reflective of the Hotel’s value at any earlier time in the case. The BAP agreed that the sale price was the best evidence of value, but concluded that the sale price established that Prudential was oversecured throughout the pendency of the bankruptcy proceedings.

The First Circuit noted that the burden of proof was on Prudential to establish when it became oversecured under the flexible approach. Prudential unsuccessfully argued that earlier valuations (e.g., in the Debtors’ schedules, or through prior adequate protection determinations) showed Prudential to be oversecured. Noting the valuation determinations that occurred during Prudential’s lift-stay motion, the First Circuit explained that earlier valuations for one purpose do not bind courts with regard to later valuations for some other purpose. In fact, the changing scenarios (Prudential’s declining claim as additional condos were sold, the Hotel and Condos’ increasing value as improvements were made) throughout the bankruptcy case showed these earlier valuations to be of questionable use. While the First Circuit noted that it was plausible that Prudential’s declining claim and the SW Boston Collateral’s increasing value may have crossed paths at some point before the Hotel sale date, Prudential had not carried its burden of proof in demonstrating that it was oversecured at any prior date. Thus, the First Circuit upheld the sale date as the date from which post-petition interest should accrue.

Computation of Interest

Finally, the First Circuit examined the type and rate of post-petition interest applicable to Prudential’s oversecured claim. To calculate post-petition interest rates, courts generally agree that where parties have contractually stated interest terms, those terms should presumptively apply so long as they are enforceable under state law, and equitable considerations do not dictate otherwise. The bankruptcy court and the BAP both held that Prudential was entitled to interest at 14.5% – the default rate specified in the parties’ agreement. The First Circuit noted that it was the Debtors’ burden of proof to rebut the presumption in favor of enforcing the contractual rate, and concluded that the Debtors failed to show that the default rate was grossly disproportionate to anticipated damages or otherwise unconscionable as to be unenforceable under Massachusetts law. Therefore the 14.5% rate applied.

As to whether interest should be calculated as simple or compounding, the First Circuit explained that compound interest is disfavored under Massachusetts law, and is generally not applicable absent an express agreement to the contrary. The parties’ agreement in this case defined “Applicable Interest Rate” as “9.50% per annum, compounding monthly,” (emphasis added) and the “Default Rate” as “a rate per annum equal to the lesser of (i) the maximum rate permitted by applicable law, or (ii) five percent (5%) above the Applicable Interest Rate.” The courts found the language of the agreement was unclear as to whether compound interest applied to the Default Rate. Importantly, Prudential failed to raise the issue at trial. Prudential only sought compound interest after the bankruptcy court ruled on the appropriate interest rate.

Upon review of the issue, the First Circuit was troubled by the fact that Prudential, “whether by inadvertence or in an attempt to sandbag the Debtors and mislead the bankruptcy court[,]” did not seek compound interest until after the bankruptcy court granted Prudential post-petition interest at the default rate. Accordingly, the First Circuit ruled that “[w]e do not believe that Prudential, having failed to give the bankruptcy court the opportunity to consider whether application of compound interest (even if the contract calls for it) would have been equitable, can now be heard to complain that the court abused its discretion (or even erred) in disallowing compounding.” Accordingly, and without deciding the issue on its merits, the First Circuit ruled that Prudential was not entitled to compound interest.

Conclusion

The First Circuit recognized equitable considerations in affirming use of the flexible approach in determining whether a claim is oversecured, leaving the issue to the discretion of the bankruptcy court but not mandating the approach as the only one available in the First Circuit. The court did not break from precedent when affirming the use of the contractually agreed default rate of interest as the applicable rate for post-petition interest. And, in the face of ambiguity, the court followed applicable nonbankruptcy law in determining that simple, rather than compound, interest would apply post-petition.

Secured lenders involved in bankruptcy cases must remain vigilant and diligently pursue their rights or risk losing them. Such lenders must be prepared to carry the burden of proof at all times when asserting a claim for post-petition interest, as any interest paid to a secured creditor means less cash available to pay to unsecured creditors. The lender needs to be prepared to prove the amount of the claim, the value of the collateral, the time when the value of the collateral should be determined and finally, if the claim is demonstrated to be oversecured, the amount and type of interest that should be applied to the claim.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Eric R. Blythe
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions