United States: Secured Creditors Are Rejoicing Over The Ninth Circuit's Decision Overruling Costly Precedent

Secured creditors are rejoicing over the recent decision of the United States Court of Appeals for the Ninth Circuit holding that a creditor is entitled to collect default interest at the rate provided in the loan documents where the debtor's chapter 11 plan proposes to cure the pre-bankruptcy default.Pacifica L 51, LLC v. New Investment, (In re New Investments, Inc.) (16 C.D.O.S. 11723, Nov. 4, 2016). In so holding, the Ninth Circuit overruled In re Entz-White Lumber & Supply, Inc., 850 F.2d 1338 (9th Cir. 1988) and joined the majority of other circuits limiting a debtor's ability to avoid paying default interest.

In In re New Investments, Inc., the debtor obtain a roughly $3 million loan from Pacifica L 51, LLC's to purchase a hotel. The loan documents provided for an interest rate of 8 percent and in the event of default, the interest rate would increase by 5 percent. Under the authority of the Ninth Circuit precedent Entz-White, the debtors proposed a plan to sell the hotel property and use the resulting proceeds to pay the outstanding amount of the loan at the pre-default interest rate. The lender objected, arguing the 1994 amendments to the Bankruptcy Code required the debtor to comply with all default cure provisions of the loan documents.

In In re Entz-White Lumber, the Ninth Circuit established that when a debtor cures a default under a plan of reorganization, the debtor is entitled to avoid all consequences of default that are provided in the loan documents, "including avoidance of default penalties such as higher interest." Essentially, this allowed the debtor to return to pre-default conditions at the expense of the creditor's contracted for default remedies. Subsequent to Entz-White the Bankruptcy Code was amended in 1994 with the addition of Section 1123(d), providing that "if it is proposed in a plan to cure a default the amount necessary to cure the default shall be determined in accordance with the underlying agreement and applicable nonbankruptcy law."

In light of the 1994 amendment, the Ninth Circuit in In re New Investments, Inc., held that the creditor was entitled to receive the benefit of his bargain and obtain interest at the default rate based on the plain language of Section 1123(d) and the legislative history. Thus, the court held that "Subsection § 1123(d) renders void Entz-White's rule that a debtor who proposes to cure a default may avoid a higher, post-default interest rate in a loan agreement." Instead where, as in In re New Investments, Inc., the underlying agreement and "applicable nonbankruptcy law" "respectively require and permit repayment at a higher, postdefault interest rate," the Bankruptcy Code requires that the parties are limited to "the benefit of their contractual bargain."

Judge Marsha Berzon strongly dissented to this decision and found instead that the addition to the Bankruptcy Code was intended to overrule the Supreme Court decision in Rake v. Wade, 508 U.S. 464 (U.S. 1993) that allowed an "over secured creditor [to receive] ... pre- and post- confirmation interest on mortgage arrearages paid to cure a default under a Chapter 13 plan." Based upon her understanding of the legislative history, the purpose of the Bankruptcy Code is to return debtor's to its pre-default position when a default is cured as part of a plan of reorganization.

The debtors may decide to appeal the decision and seek en banc review because of the split panel; however, this is unlikely since the outcome is consistent with other circuits. Assuming the decision withstands a possible appeal, debtors will find it more difficult to cure loan defaults in the context of a chapter 11 plan given the predominance of default interest rate provisions in loan agreements. While this decision changes the rules for secured creditors and debtors in the Ninth Circuit, overruling Entz-White is consistent with the majority of other circuits that have dealt with the issue of contractual default interest when a debtor seeks to cure a default under Chapter 11.1


1 See In re Gen. Growth Props., Inc ., 451 B.R. 323, 327-28 (Bankr. S.D.N.Y. 2011) (allowing the payment of post-petition default interest at the contractual default rate); see also In re Route One W. Windsor Ltd. Pshp., 225 B.R. 76 (Bankr. D.N.J. 1998) (noting the Third Circuit's presumption in favor of the contractual terms and allowing a creditor to recover default interest); see also In re Johnson, Nos. 04-09864-8-JRL, 04-09168-8-JRL, 2005 Bankr. LEXIS 3569, at *9 (U.S. Bankr. E.D.N.C. Oct. 31, 2005) ("adopt[ing] the majority view and [] presume[ing that] the terms of the contract apply" and allowing the creditor to recover default interest); and see In JPMCC 2006-LDP7 Miami Beach Lodging, LLC v. Sagamore Partners, Ltd. (In re Sagamore Partners, Ltd.), 2015 BL 280922 (11th Cir. Aug. 31, 2015) (allowing secured lender to recover interest at the contractual default rate as part of the debtor's chapter 11 plan to cure its default).

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