Ch. 11 Debtors Must Pay Default Interest Rates, 9th Cir. Says

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By Daniel Gill

Nov. 7 — A Chapter 11 reorganization plan can’t eliminate a loan’s contractual default interest rate, a split Ninth Circuit panel ruled Nov. 4 ( Pacifica L 51 LLC v. New Invs., Inc. (In re New Invs., Inc.) , 2016 BL 368939, 9th Cir., No. 13-36194, 11/4/16 ).

Circuit Judge Mary H. Murguia wrote that Section 1123(d) of the Bankruptcy Code, enacted in 1994, invalidated prior caselaw, In re Entz-White Lumber and Supply, Inc., 850 F.2d 1338 (9th Cir. 1988), which 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.”

Professor Dan Schechter, Loyola Law School, Los Angeles, told Bloomberg BNA Nov. 7 that he expects that the decision will make it much harder for Chapter 11 debtors to confirm a plan. “It will be much more expensive to cure defaults, since so many loan agreements provide for higher interest rates on defaults,” he said.

Chapter 11 allows companies (or individuals) to enjoy protections from creditors while they seek to reorganize their debt or liquidate pursuant to a plan which must be approved by the bankruptcy court.

The court explained that under Entz-White, a debtor in Chapter 11 could avoid contractual default penalties, such as an increased interest rate, by curing the default under the plan. That rule is voided, however, by 11 U.S.C. §1123(d), the court said.

That section provides 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.”

“The plain language of §1123(d) compels the holding that a debtor cannot nullify a preexisting obligation in a loan agreement to pay post-default interest solely by proposing a cure,” the court said.

Berzon’s Dissent

Dissenting, Circuit Judge Marsha S. Berzon noted that the legislative history behind Section 1123(d) indicates that the statute was created specifically as a response to the Supreme Court’s decision in Rake v. Wade, 508 U.S. 464 (U.S. 1993) which “held that an over secured creditor was entitled to pre- and post-confirmation interest on mortgage arrearages paid to cure a default under a Chapter 13 plan.”

Judge Berzon said that the legislative history of the 1994 Code amendment made clear that the statute was intended to undo this result, which could provide a windfall to secured creditors by giving them more than they bargained for with the debtor (i.e., interest on arrearages).

She argued that the House Report on the amendment in fact supported Entz-White’s holdings, quoting this language: “It is the Committee’s intention that a cure pursuant to a plan should operate to put the debtor in the same position as if the default had never occurred.”

The dissent says that “the majority’s opinion mistakenly upset this Circuit’s binding precedent.”

Prof. Schechter told Bloomberg BNA that he would be shocked if the debtors don’t seek en banc review of this decision, based on the quality of the dissent. He also noted surprise that the issue hasn’t come before other circuit courts since the 1994 amendments were enacted.

Circuit Judge Susan P. Graber joined in the decision.

Dillon E. Jackson and Terrance J. Keenan, Faster Pepper PLLC, Seattle, represented the creditor, Pacifica L 51, LLC.

The debtor, New Investments, Inc. was represented by Lawrence K. Engel, Bellevue, Wash.

To contact the reporter on this story: Daniel Gill in Washington at dgill@bna.com

To contact the editor responsible for this story: Jay Horowitz at JHorowitz@bna.com

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