In two recent decisions in the General Growth Properties, Inc., et al. chapter 11 cases, the United States Bankruptcy Court for the Southern District of New York upheld certain loan provisions which provided for an automatic event of default and imposition of a default rate of interest upon the commencement of a bankruptcy case, and held that certain creditors were entitled to receive postpetition interest at the contractual default rate.  General Growth Properties, Inc. and its affiliated debtors own, develop, and operate regional shopping malls across the United States.

On June 16, 2011, Judge Allan L. Gropper ruled that a secured creditor of GGP Limited Partnership ("GGPLP") was entitled to postpetition default interest on a note reinstated pursuant to GGPLP's confirmed chapter 11 plan of reorganization because (i) an ipso facto provision in the note was effective to trigger application of the note's default rate of interest, (ii) section 506(b) of the Bankruptcy Code entitles an oversecured creditor to postpetition interest and GGPLP failed to rebut the presumption in favor of applying the contractual default rate, and (iii) equitable considerations otherwise warranted payment of interest at the contractual default rate.  See In re General Growth Props., Inc., 451 B.R. 323 (Bankr. S.D.N.Y. 2011) ("GGP I ").

A month later, Judge Gropper held that secured lenders to GGPLP and certain of its affiliated debtors ("GGP") were entitled to payment of postpetition default interest on loans that matured during the pendency of the chapter 11 cases, upon concluding that an ipso facto clause in the credit agreement was enforceable and automatically triggered application of the credit agreement's default rate of interest, and GGP had failed to rebut the presumption in favor of applying the contractual default rate for purposes of section 506(b) of the Bankruptcy Code.  See In re General Growth Props., Inc., No. 09-11977 (ALG), 2011 WL 2974305 (Bankr. S.D.N.Y. July 20, 2011) ("GGP II ").

The GGP I decision provides greater clarity in the Southern District of New York regarding the appropriate rate of interest to apply when reinstating debt pursuant to section 1124(2) of the Bankruptcy Code.  Additionally, both GGP I and GGP II serve as an example of courts' increased willingness to enforce private contractual arrangements imposing default interest rates when the debtor is solvent and equitable considerations otherwise justify imposition of the default rate.  However, the impact of the decisions may be limited, given that most debtors are insolvent and payment of postpetition default interest likely would harm general unsecured creditors or impair the "fresh start" intended by chapter 11 of the Bankruptcy Code.

GGP I - Background

In February 2008, the New York State Common Retirement Fund ("CRF") and GGPLP entered into a promissory note pursuant to which CRF extended a loan of $254 million to GGPLP in connection with GGP's investment in a joint venture.  The note matures in February 2013 and is secured by a pledge of GGPLP's shares in the joint venture.  Pursuant to the note, GGPLP promised to pay CRF the outstanding principal amount upon maturity and to make quarterly interest payments.  The note provides, among other things, that the voluntary commencement of a bankruptcy case constitutes an event of default.  Further, in contrast to other events of default under the note, an event of default premised on the commencement of a voluntary bankruptcy case by GGPLP occurs automatically and without any requirement that CRF "call" the default by providing notice to any party.  Significantly, upon the occurrence of an event of default, the note entitles CRF to a 3% increase in the rate of interest owed on the outstanding principal balance of the note for a total interest rate of 8.95% per annum.  Prior to April 16, 2009, GGPLP's chapter 11 petition date, the note was not in default.

Pursuant to its chapter 11 plan, GGPLP proposed to cure its default on the note by reinstating the principal amount of the note and paying the accrued interest due to CRF from the petition date through the effective date of the plan at the non-default rate of 5.95%.  CRF objected to GGPLP's proposed plan, arguing that GGPLP was required to pay accrued interest at the default rate of 8.95% in order to reinstate the note.

GGPLP and CRF agreed to defer resolution of CRF's objection until after GGP's emergence from bankruptcy.  The Bankruptcy Court confirmed GGPLP's plan in October 2010, and the plan became effective several weeks later in November 2010.  On the effective date, consistent with the plan, GGPLP reinstated the note and paid CRF approximately $25 million in cash to compensate CRF for certain professional fees and postpetition interest at the non-default rate.  Following this payment, the amount in dispute between GGPLP and CRF was approximately $11.5 million (i.e., the difference between the accrued interest calculated at the non-default rate versus the default rate).  In connection with the hearing on CRF's objection, the parties stipulated to certain facts.  Pursuant to the stipulation of facts, GGPLP acknowledged that the default rate under the note, as a stand alone figure, was not disproportionately higher than the non-default rate under the note, and that GGPLP was solvent.     

GGP I - Analysis

The Bankruptcy Court began its analysis by stating that section 502(b)(2) of the Bankruptcy Code ordinarily disallows postpetition interest, and noting that the Supreme Court has recognized this principle as "'[t]he general rule in bankruptcy and in equity receivership' because the delay of the case is 'a delay necessitated by law if the courts are properly to preserve the estate for the benefit of all interests involved.'"1  The Court went on to note that the general rule established by section 502(b)(2) of the Bankruptcy Code is subject to two exceptions - one statutory and one court-created.

The statutory exception, codified in section 506(b) of the Bankruptcy Code, provides that "[t]o the extent that an allowed secured claim is secured by property the value of which . . . is greater than the amount of such claim, there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement . . . under which such claim arose."2  Thus, although section 506(b) of the Bankruptcy Code provides that an oversecured creditor is entitled to postpetition interest, it does not specify an interest rate.  However, courts in the Second Circuit have interpreted section 506(b) of the Bankruptcy Code as creating a rebuttable presumption in favor of granting an oversecured creditor interest at the rate specified in the contract, subject to equitable considerations.

Judge Gropper then addressed the court-created exception to the general rule of section 502(b)(2) of the Bankruptcy Code, which is based upon the principle that before there is a return to equity in a reorganization case, creditors should receive interest as compensation for the delay of the bankruptcy process.  This court-created exception is memorialized in a Second Circuit decision, Ruskin v. Griffiths.3   In Ruskin, the relevant agreement provided that upon the occurrence of an event of default, including the commencement of a bankruptcy case, the noteholders could accelerate the entire unpaid amount of the notes upon notice to the debtor.  Upon determining that that the noteholders had provided such notice to the debtor, the Second Circuit required the debtor to pay the default rate of interest to the noteholders, concluding that it would have been inequitable to deny the noteholders' contractual right to interest at the default rate where the debtor was solvent and the interest rate was not a penalty.4

Having established the general framework regarding the payment of postpetition interest, the Court then addressed the specific facts of GGP I, recognizing that CRF's right to receive postpetition interest derived from GGP's reinstatement of the note under section 1124(2) of the Bankruptcy Code.  In connection with confirmation of a plan, section 1124(2) of the Bankruptcy Code permits a debtor to reinstate debt and reverse any contractual or legal acceleration of such debt by curing all existing defaults and reinstating the maturity of the debt, without altering the legal, equitable, or contractual rights of the debt holder.5  Notably, the Bankruptcy Code is silent with respect to whether curing a default under section 1124(2) requires a debtor to pay accrued interest at the contractual non-default rate or the contractual default rate.

A body of case law, including several decisions from the Southern District of New York, has developed to address this silence, however, as observed by Judge Gropper, there is conflicting authority regarding the appropriate rate of interest to apply for purposes of curing a default under section 1124(2) of the Bankruptcy Code.  Older decisions on the issue have held that a holder of reinstated debt is entitled only to interest at the non-default rate because reinstatement erases all effects of a default, including the contractual right to interest at a default rate.6

Several more recent decisions, however, have rejected such an expansive reading of section 1124(2), and questioned the continued viability of the older decisions in light of the addition of section 1123(d) to the Bankruptcy Code in 1994.7  Section 1123(d) of the Bankruptcy Code provides that "[n]otwithstanding  subsection (a) of this section [mandatory chapter 11 plan provisions] and sections 506(b) [postpetition interest for oversecured creditors],  1129(a)(7) [best interest test], and 1129(b) [cramdown], 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."8

GGPLP urged the Court to adopt the reasoning of the older decisions on section 1124(2) of the Bankruptcy Code.  However, the Court declined to do so, concluding instead that resolution of the apparent conflict in the section 1124(2) case law was unnecessary "because section 1123(d) certainly does not preclude the payment of default interest - under the facts of [GGP I] section 1123(d) points to its payment 'in accordance with the underlying agreement and applicable nonbankruptcy law'".  Further, the Court determined that, "[i]n any event, the instant matter falls squarely within the reasoning of Ruskin v. Griffiths and its progeny", which "calls for the payment of default interest by a solvent debtor to effect the cure and reinstatement of debt, absent factors that would make such payment inequitable."9

In applying Ruskin to the facts of GGP I, the Court found that none of the factors typically justifying the nullification of a default rate were present, noting that (i) GGPLP had stipulated that, as a stand alone rate, the default rate of 8.95% was not a penalty, (ii) GGPLP had not alleged any misconduct by CRF, and (iii) payment of default interest would neither inflict harm on unsecured creditors nor impair GGPLP's fresh start because GGPLP was "exceedingly" solvent when it emerged from bankruptcy.10  As additional support for application of the default rate, the Court noted that enforcement of the default rate provisions of the note was consistent with an important policy consideration identified by the Ruskin Court - namely, that "if creditors could not rely on the courts to enforce default interest rate clauses, creditors would have 'to anticipate a possible loss in the value of the loan due to his debtor's bankruptcy or reorganization, [and a lender] would need to exact a higher uniform interest rate for the full life of the loan,' unnecessarily increasing the cost of credit for all borrowers."11

Moreover, the Court found that payment of interest at the default rate also was consistent with "the increasing reluctance of courts in [the Second Circuit] and other circuits, in construing . . . § 506(b) [of the Bankruptcy Code] . . . , to modify private contractual arrangements imposing default interest rates except where: (i) there has been creditor misconduct; (ii) application of the contractual interest rate would cause harm to the unsecured creditors; (iii) the contractual interest rate constitutes a penalty; or (iv) its application would impair the debtor's fresh start."  As previously noted by the Court, all of these facts were notably absent in GGP I.  Additionally, the Court emphasized that courts' reluctance to interfere with default interest rate provisions in private contracts "is particularly evident in cases where the debtor proves to be solvent" - as was unquestionably the case with GGPLP.12  Thus, on these facts, no reason existed to disturb the presumption favoring payment of the contract rate of interest - the default rate - to CRF.13

The Court dispensed with GGPLP's other arguments in favor of application of the non-default contract rate.  Specifically, the Court rejected GGPLP's assertion that section 1123(d) of the Bankruptcy Code was enacted solely to remedy Rake v. Wade, a case which construed section 1322 of the Bankruptcy Code and held that the statute required compound interest to be paid by a debtor defaulting on its mortgage, notwithstanding applicable state law.14  GGPLP argued that Congress' express purpose in enacting section 1123(d) "was to ensure 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 Court did not agree with GGPLP's interpretation of section 1123(d), finding instead that section 1123(d) is a chapter 11 provision, and the plain terms of the section is far broader than necessary if the 1994 amendment's only purpose was to overturn Rake, a chapter 13 case.15

The Court also rejected GGPLP's assertion that the clause of the note providing for the automatic imposition of the default rate upon commencement of a bankruptcy case by GGPLP constituted an invalid ipso facto clause.16  As an initial matter, the Court noted that whether a bankruptcy default clause should be treated as an invalid ipso facto clause depends on whether the contract at issue is an executory contract or unexpired lease.  GGPLP, however, did not attempt to argue that the note was an executory contract or unexpired lease, but rather contended that ipso facto clauses are generally disfavored and should not be enforceable even when contained in a non-executory contract.  While acknowledging that courts have declined to enforce ipso facto clauses in instances where enforcement of the clause would impede a debtor's ability to enjoy a "fresh start", the Bankruptcy Court found that such clauses are only per se invalid in the Second Circuit when contained in an executory contract or unexpired lease.  Furthermore, as the Court previously noted, there were no concerns as to GGPLP's ability to enjoy a "fresh start", as GGPLP was highly solvent, had confirmed a plan, and emerged from bankruptcy several months prior.17

Accordingly, the Court held that CRF was entitled to postpetition interest on its claim from the petition date through the effective date at the contractual default rate.18

GGP II - Background

In February 2006, certain banks and other financial institutions ("Lenders") entered into a credit agreement with GGP pursuant to which the Lenders made a series of secured loans to GGP.  The loans matured in February 2010 and were secured by equity pledges of GGP.  Similar to the note in GGP I, the credit agreement provided that the filing of voluntary chapter 11 petitions constituted an automatic event of default, and resulted in the automatic acceleration of the loans and the imposition of the contractual default rate without the need for any further action by the administrative agent or the Lenders.

Beginning in March 2009, GGP failed to make certain interest payments on the loans.  GGP's failure to make interest payments constituted potential events of default under the credit agreement, but did not automatically accelerate the loans.  Shortly thereafter, GGP and the Lenders entered into two forbearance and waiver agreements, pursuant to which the Lenders agreed not to accelerate the loans for the duration of the agreements.  On March 15, 2009, the forbearance and waiver agreements expired in accordance with their terms.  On April 14, 2009, counsel for the administrative agent sought comments from GGP's counsel on a draft letter which, if issued in final form, would have accelerated by loans.  However, the draft letter was never finalized, and approximately 36 hours later, GGP commenced its chapter 11 cases.

Pursuant to its chapter 11 plan, GGP proposed to render the Lenders' secured claims "unimpaired" pursuant to section 1124 of the Bankruptcy Code by paying the Lenders (i) the total outstanding principal balance of the loans, (ii) accrued prepetition and postpetition interest at the contractual non-default rate, and (iii) certain amounts owing with respect to letters of credit and other related fees and expenses.  The administrative agent, on behalf of the Lenders, objected to GGP's proposed plan, arguing that GGP was required to pay postpetition interest at the contractual default rate, which was 2% greater than the contractual non-default rate, in order to render the Lenders' secured claims unimpaired.  

As in GGP I, the administrative agent agreed to defer resolution of its objection until after GGP's emergence from bankruptcy.  On the effective date, consistent with the plan, GGP paid the Lenders (i) approximately $2.58 billion on account of the outstanding principal balance of the loans, (ii) approximately $143.3 billion on account of accrued prepetition and postpetition interest at the contractual non-default rate, and (iii) approximately $14.5 million on account of certain obligations with respect to letters of credit and other related fees and expenses.  Payment of these amounts reduced the amount in dispute to approximately $85.6 million to $87.4 million plus interest at the per diem rate of $12,573 after February 17, 2011.

In connection with the hearing on the administrative agent's objection, GGP stipulated that the default rate under the credit agreement, as a stand alone figure, was not disproportionately higher than the non-default rate under the credit agreement, and that GGP was solvent.  Further, there was no dispute that the Lenders were oversecured.

GGP II - Analysis

Judge Gropper briefly summarized his prior holding in GGP I, and noted the similarity between the dispute in GGP I and GGP II.  The Court went on to clarify that, unlike the note at issue in GGP I, the loans under the credit agreement had matured during the pendency of the bankruptcy cases, and therefore, could not be reinstated.  Accordingly, those portions of the GGP I decision addressing whether a solvent debtor must pay default interest in order to reinstate a debt, were not applicable to GGP II.  However, the Court concluded that the remainder of the GGP I decision controlled the resolution of the issue presented in GGP II - and accordingly, "[n]o extended discussion [was] required with respect to the applicability of the presumption in favor of enforcing the default interest rate agreed by the parties where the creditor is oversecured, the rate is both reasonable and not a penalty and, most importantly, the debtor is solvent.19

GGP's primary argument in GGP II was that the Lenders were not entitled to postpetition interest at the default rate because the loans were never properly accelerated.  While GGP acknowledged that the credit agreement provided for an automatic event of default (and a corresponding automatic acceleration of the loans and imposition of the contractual default rate) upon the commencement of a bankruptcy case, GGP argued that because the Lenders could have, but did not, accelerate the loans prepetition, the loans could not be accelerated without postpetition, affirmative action by the administrative agent - which was barred by the automatic stay.

Citing to GGP I, the Court rejected GGP's interpretation of the credit agreement, reiterating that Congress did not expressly invalidate ipso facto clauses except in executory contracts and unexpired leases, and the equitable justifications that many courts had found for invalidating default interest rates were notably absent.  Additionally, the Court observed that:

This case is a good example of the reasons for enforcing reasonable contractual provisions in loan agreements that automatically impose a default interest rate upon a bankruptcy filing.  Failure to enforce such clauses would deter lenders from withholding a notice of acceleration, where the notice would trigger cross defaults and force the borrower  into an unnecessary insolvency proceeding . . . there can be no dispute that efforts were made to avoid creditor action that might have forced [GGP] into an unnecessary, freefall bankruptcy case, eliminating the possibility of an out-of-court workout.  [GGP] would penalize the [Lenders] for attempting to negotiate a potential resolution, but neither the [c]redit [a]greement nor the Bankruptcy Code provide such a penalty.  

Accordingly, the Bankruptcy Court held that the ipso facto provision of the credit agreement was effective to accelerate the loans and trigger the default interest rate without the need for any affirmative action by the administrative agent.20

Having found that the ipso facto provision was enforceable in the chapter 11 cases, the Court then addressed whether the contractual default rate was the appropriate rate to apply for purposes of calculating the postpetition interest due to the Lenders.  The Court referred to its decision in GGP I, for the proposition that section 506(b) of the Bankruptcy Code requires payment of postpetition interest to oversecured creditors, and a rebuttable presumption exists in favor of paying such interest at the contractual rate.  Further, Judge Gropper again noted courts' reluctance to modify default rate provisions in private contracts when the debtor is solvent and equitable considerations otherwise warrant imposition of the default rate.

As in GGP I, the Court found that none of the factors that typically have justified application of an interest rate lower than the contractual default rate were present in GGP II.  Specifically, the Court noted that GGP had stipulated that the default rate was not a penalty, GGP had not alleged any misconduct by the Lenders, and payment of the default rate would neither inflict harm on unsecured creditors nor impair GGP's "fresh start" because GGP was "exceedingly" solvent when it emerged from bankruptcy.21

Thus, the Court held that the Lenders were entitled to postpetition interest at the default rate set forth in the credit agreement.22