The Ninth Circuit Court of Appeals recently issued a decision in Pacifica L 51, LLC v. New Investments, Inc. (In re New Investments, Inc.) (16 C.D.O.S. 11723, Nov. 4, 2016), which held that a secured creditor can collect default interest in connection with a cure under a chapter 11 plan, thereby rendering void the long-established rule under Great W. Bank & Tr. v. Entz-White Lumber & Supply, Inc. (In re Entz-White Lumber & Supply, Inc.), 850 F. 2d 1338 (9th Cir. 1988).

Facts and Procedural History

The New Investments debtor borrowed $3,045,760.51 from Pacifica L 51, LLC’s (“Pacifica”) predecessor-in-interest to purchase a hotel property. The loan was evidenced by a promissory note and secured by a deed of trust. The promissory note provided for an 8-percent contract rate of interest and a 13-percent default rate of interest. The debtor defaulted under the promissory note in 2009, and Pacifica commenced non-judicial foreclosure proceedings. The debtor then filed its chapter 11 voluntary petition in the Western District of Washington to stay the foreclosure proceedings.

The debtor filed its chapter 11 plan, which proposed a sale of the hotel property with the proceeds of sale paying the amounts due to Pacifica under the promissory note in full at the pre-default contract rate of interest. Pacifica objected to the confirmation of the plan. The bankruptcy court overruled Pacifica’s objection and confirmed the plan authorizing the sale of the hotel property for $6,890,000, with $2,830,877.28 being paid to Pacifica to cure the amounts due and owing at the pre-default contract rate of interest. Pacifica appealed to the Ninth Circuit Court of Appeals, and the Ninth Circuit reversed and remanded for further proceedings.

The Holding

The Ninth Circuit reversed the bankruptcy court’s decision and held that the plain language of Section 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.” The Ninth Circuit noted that “[b]y its terms § 1123(d) tells us to look to the promissory note and Washington law to determine what amount New Investments must pay to cure its default.” Because the promissory note allowed for a higher post-default rate of interest and applicable Washington law permitted and required payment of the higher rate of interest to cure, the Ninth Circuit held that “Pacifica is entitled to receive payment of the loan at the post-default interest rate.”

In arriving at its decision, the Ninth Circuit analyzed the interplay between the Entz-White decision, which was issued in 1988, and 11 U.S.C. Section 1123(d), which was enacted in 1994. While the Entz-White rule is 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,” the Ninth Circuit noted that Congress subsequently amended Section 1123 to add subsection (d), which provides: “[n]otwithstanding 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 non-bankruptcy law.” See 11 U.S.C. § 1123(d).

Commentary

The New Investments decision vastly changes the landscape for secured creditors in the Ninth Circuit, particularly during the plan negotiation and plan confirmation process. While it likely comes as a surprise to many practitioners in the Ninth Circuit given that the Entz-White rule has been challenged over the years and has been strictly followed by the bankruptcy courts, the New Investments decision is consistent with how the courts in the other circuits treat the allowance of default interest when a cure is proposed under a chapter 11 plan. New Investments essentially takes a powerful tool away from debtors and places secured creditors that find themselves in the Ninth Circuit on equal footing with treatment of default interest by the bankruptcy courts in other circuits.