The Ninth Circuit Court of Appeals just joined the majority of circuits in enforcing a default interest rate despite a confirmed plan of reorganization calling to cure the default and roll back to the pre-default contract rate.
In reaching its decision the Ninth Circuit needed to revisit its 1988 decision in Great Western Bank & Trust v. Entz-White Lumber And Supply, Inc. which had held that “[Borrower/Debtor was] entitled to avoid all consequences of the default-including higher post-default interest rates.”
The Court needed to reconcile two clauses contained in section 1123 of the Bankruptcy Code.
1123 (a) provides: “Notwithstanding any otherwise applicable nonbankruptcy law, a plan shall–…(5) provide adequate means for the plan’s implementation, such as–…(G) curing or waiving of any default…”
However, 1123 (d) provides: “Notwithstanding subsection (a) of this section and sections 506(b), 1129(a)(7), and 1129(b) of this title, 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.”
The debtor was the operator of a hotel in Washington State and obtained a $2.75 million mortgage loan from Frontier Bank. The debtor failed to repay the loan when it matured and the bank, by its successor, imposed the default rate of interest and commenced a non-judicial foreclosure which was the catalyst for the voluntary Chapter 11 filing. The debtor then proposed a plan of reorganization that provided for a sale of the hotel as well as deeming the loan to be recast back to the pre-default contract interest rate. The dispute with the bank’s successor related to the amount of the bank’s secured claim – specifically its right to the default rate of interest.
The confirmed plan treated the bank as unimpaired, but the debtor argued that the pre-default interest rate should apply. The bank disagreed. The Bankruptcy Court ruled in favor of the debtor and the bank appealed. Inasmuch as it was clear that the case would ultimately reach the Circuit Court of Appeals, the Ninth Circuit certified the case negating the need to first appeal to the District Court. The Ninth Circuit stated:
In Entz-White we observed that the Bankruptcy Code did not define “cure.” …. We borrowed the Second Circuit’s definition: “A default is an event in the debtor-creditor relationship which triggers certain consequences. Curing a default commonly means taking care of the triggering event and returning to pre-default conditions. The consequences are thus nullified. This is the concept of ‘cure’ used throughout the Bankruptcy Code.” ….. We held that “the power to cure under the Bankruptcy Code authorizes a plan to nullify all consequences of default, including avoidance of default penalties such as higher interest.” …. As a result, a debtor whose plan proposed to cure a default would allow him to avoid having to pay a higher, post-default interest rate called for in the loan agreement.
Entz-White was decided in 1988. In 1994, Congress amended § 1123 to add subsection(d)… 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. Subsection (d) governs here because [Debtor’s] plan proposes to cure a default.
In rendering its decision the Ninth Circuit specifically noted that in adopting 1123(d),Congress specifically intended to overrule the decision of the United States Supreme Court in Rake v Wade (no connection to the famous Roe v Wade), which had held that
a Chapter 13 debtor who proposed to cure a default was required to pay interest on his arrearages to a secured creditor even if the underlying loan agreement did not provide for such interest. Congress viewed this as an untoward result that allowed for “interest on interest payments.”
The Court noted that its holding might appear difficult in light of the intent of the Bankruptcy Code to provide for a fresh start but was compelled by the clear intent of Congress. [One might note that in this case there was no fresh start in that it was a liquidating case and the windfall from the hoped for reduced interest payments would be used to pay administrative expenses and unsecured claims.] The dissent, however, felt that the bank had not met its burden that Congress’ clear intent was to reverse settled law.
The case stands for the premise that default rate interest cannot be rolled back by a plan of reorganization. As often is the case, the facts in this case are rare but one can envision a sympathetic judge trying to assist a reorganizing debtor by stepping down default interest rates against an objecting lender. This case, as well as similar holdings from other Circuits, should block such attempts.
Keep an eye out for more from me on this subject – either on these pages or in my in-print articles.