In 1994, Congress amended the Bankruptcy Code to add section 1123(d), which provides that, if a chapter 11 plan proposes to "cure" a default under a contract, the cure amount must be determined in accordance with the underlying agreement and applicable nonbankruptcy law. Since then, a substantial majority of courts, including the U.S. Court of Appeals for the Eleventh Circuit, have held that such a cure amount must include any default-rate interest required under either the contract or applicable nonbankruptcy law.

Until this year, courts in the Ninth Circuit were outliers in this debate, adhering to a contrary approach articulated nearly three decades ago—well before the enactment of section 1123(d)—by the U.S. Court of Appeals for the Ninth Circuit in Great Western Bank & Trust v. Entz-White Lumber and Supply, Inc. (Entz-White Lumber and Supply, Inc.), 850 F.2d 1338 (9th Cir. 1988). In Entz-White, the Ninth Circuit held that the payment of default-rate interest is not required to cure and reinstate a defaulted secured debt under a chapter 11 plan because cure effectively nullifies all aspects of the default and rolls back the status quo to a time prior to its occurrence.

Despite the enactment of section 1123(d) and the weight of judicial authority in other circuits rejecting the Entz-White approach, Ninth Circuit courts, including the court of appeals, remained faithful to the Entz-White rule for 28 years, albeit sometimes reluctantly.

However, the primacy of Entz-White in the Ninth Circuit finally ended in 2016. In In re New Invs., Inc. (Pacifica L 51 LLC v. New Invs., Inc), 840 F.3d 1137 (9th Cir. 2016), a divided three-judge panel of the Ninth Circuit held that "Entz-White’s rule of allowing a curing debtor to avoid a contractual post-default interest rate in a loan agreement is no longer valid in light of § 1123(d)."

Cure and Reinstatement Under a Chapter 11 Plan

Upon the occurrence of an event of payment default under a loan agreement, the lender generally has the right to accelerate the loan and exercise its legal and contractual collection remedies. However, if the borrower files for chapter 11 protection, the lender must refrain from exercising such remedies unless it obtains relief from the automatic stay to do so. As long as the stay remains in place, the borrower as a chapter 11 debtor-in-possession can propose a plan that decelerates a defaulted loan, "cures" any defaults (with certain exceptions), and reinstates the original terms of the debt—in effect, "roll[ing] back the clock to the time before the default existed." MW Post Portfolio Fund Ltd. v. Norwest Bank Minn., N.A. (In re Onco Inv. Co.), 316 B.R. 163, 167 (Bankr. D. Del. 2004); see also 11 U.S.C. § 1123(a)(5)(G) (providing that a plan shall provide adequate means for its implementation, such as "curing or waiving of any default").

To the extent that its claim is not "impaired" under the terms of the proposed plan, the lender will be deemed to have accepted the plan and will not be entitled to vote on it. See 11 U.S.C. § 1126(f). Even though the lender is precluded from enforcing its contractual right of acceleration, the lender’s claim will be deemed unimpaired if the plan: (i) cures any defaults (other than defaults triggered by the bankruptcy filing or certain nonmonetary defaults, as specified in section 365(b)(2) of the Bankruptcy Code); (ii) reinstates the pre-default maturity of the debt; (iii) compensates the lender for any damages sustained due to reasonable reliance on its contractual or legal ability to accelerate the debt; (iv) compensates the lender for any actual pecuniary loss arising from the debtor’s failure to perform a nonmonetary obligation; and (v) does not "otherwise alter the legal, equitable, or contractual rights" of the lender. See 11 U.S.C. § 1124(2).

Prior to 1994, the Bankruptcy Code did not provide guidance as to the meaning of the term "cure," and courts were split as to whether payment of default-rate interest was required in order to cure a default. While most courts required payment of default-rate interest in this context, a minority of courts, including the Ninth Circuit in Entz-White, held that the payment of default-rate interest was not required because cure effectively nullifies all aspects of a default and reinstates the pre-default status quo. Accord Levy v. Forest Hills Assocs. (In re Forest Hills Assocs.), 40 B.R. 410 (Bankr. S.D.N.Y. 1984).

In 1994, however, lawmakers added section 1123(d) to the Bankruptcy Code, which provides that, notwithstanding the entitlement of oversecured creditors to collect postpetition interest under section 506(b), the "best interests" requirement of section 1129(a)(7), and the cramdown requirements of section 1129(b), "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."

Most courts have interpreted section 1123(d) as requiring the payment of default-rate interest as a condition of cure to the extent that it is required by the underlying agreement or applicable nonbankruptcy law. See, e.g., In re Moody Nat’l SHS Houston H, LLC, 426 B.R. 667, 672 (Bankr. S.D. Tex. 2010) ("To the extent that there was ambiguity as to how to cure a default when Entz-White was written, that ambiguity evaporated in 1994 when § 1123(d) was added" to the Bankruptcy Code); In re 1 Ashbury Court Partners, LLC, 2011 BL 396895 (Bankr. D. Kan. Oct. 5, 2011); In re General Growth Props., Inc., 451 B.R. 323 (Bankr. S.D.N.Y. 2011); In re Schatz, 426 B.R. 24 (Bankr. D.N.H. 2009).

However, this approach is not necessarily supported by the legislative history of section 1123(d). Section 1123(d) and companion provisions in chapter 12 and chapter 13 (sections 1222(d) and 1322(e)) were enacted to abrogate the U.S. Supreme Court’s decision in Rake v. Wade, 508 U.S. 464 (1993). In Rake, the Court held that, in order to cure a mortgage default under a chapter 13 plan, the mortgagee must be paid interest on the defaulted payments, including interest on interest, regardless of whether such interest was provided for in the agreement or under state law. Congress overruled the decision by enacting section 1123(d) because the ruling "had the effect of providing a windfall to secured creditors at the expense of unsecured creditors by forcing debtors to pay the bulk of their income to satisfy the secured creditors’ claims," which would include interest on interest, late charges, and other fees, "even where applicable law prohibits such interest and even when it was . . . not contemplated by either party in the original transaction." H.R. Rep. No. 103-835, at 55 (1994).

In light of this legislative history, some courts have argued that section 1123(d) should not be interpreted to require payment of default-rate interest, even where the contract provides for it. Additional support for this interpretation can arguably be found in: (i) section 365(b)(2), which was also added to the Bankruptcy Code in 1994 and provides that a "penalty rate" related to the debtor’s failure to perform nonmonetary obligations need not be satisfied to cure a default under an executory contract or an unexpired lease; and (ii) section 1124(2), which does not require the holder of a claim to be paid default-rate interest for the claim to be rendered unimpaired. In re Phoenix Bus. Park Ltd. P’ship, 257 B.R. 517, 522 (Bankr. D. Ariz. 2001) (construing the language of section 365(b)(2), which was adopted at the same time as section 1123(d), together with section 1124(2), and finding that "Entz-White remains good law in the Ninth Circuit" because "Congress did not legislatively overrule Entz-White" when it enacted section 1123(d)); accord Brody v. Geared Equity, LLC, 2014 BL 218335 (D. Ariz. Aug. 6, 2014); see also General Elec. Capital Corp. v. Future Media Productions, Inc., 536 F.3d 969 (9th Cir. 2008) (declining to rule that Entz-White was overruled by section 1123(d)).

In 2015, the Eleventh Circuit conclusively rejected the Entz-White approach in JPMCC 2006-LDP7 Miami Beach Lodging, LLC v. Sagamore Partners, Ltd. (In re Sagamore Partners, Ltd.), 620 Fed. Appx. 864, 2015 BL 280922 (11th Cir. Aug. 31, 2015). In Sagamore, the court ruled that "the clear mandate of § 1123 . . . allows a creditor to demand default-rate interest as a condition for reinstating [a defaulted] loan," to the extent that the loan agreement provided for the payment of interest at the default rate. The ruling created a circuit split in an area of bankruptcy jurisprudence that had long lain dormant and gone largely unnoticed.

New Investments Turns the Page

The Ninth Circuit finally abandoned Entz-White in New Investments, but not without dissent. In the case, the debtor’s chapter 11 plan proposed to cure a default on a commercial real estate loan by selling the property to a third party and using the proceeds of the sale to pay the outstanding amount of the loan at the pre-default interest rate. The secured lender objected, claiming that, under the terms of the note, it was entitled to be paid at the higher, post-default interest rate.

On a direct appeal of the bankruptcy court’s order confirming the plan over the lender’s objection, a divided three-judge panel of the Ninth Circuit reversed. The panel’s majority held that "§ 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."

According to the Ninth Circuit majority opinion, "By 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. . . . [and] [h]ere, that analysis requires the payment of post-default interest." This conclusion is "consistent with the intent of § 1123(d)," the court wrote, "because it holds the parties to the benefit of their bargain."

The Ninth Circuit accordingly reversed the bankruptcy court’s confirmation order and remanded the case below.

Dissenting Opinion

Circuit judge Marsha S. Berzon dissented, stating that "neither the text of the statute nor the legislative history of § 1123(d) support[s] the majority’s departure [from Entz-White]." According to Judge Berzon, "Nowhere did the 1994 amendments define ‘cure a default’ or suggest that this Circuit’s then-operative definition of ‘cure’ was incorrect." Furthermore, she noted, Congress focused on addressing an entirely different matter—the U.S. Supreme Court’s decision in Rake v. Wade—when it enacted section 1123(d).

"Far from repudiating Entz-White’s holding," Judge Berzon wrote, the legislative history of section 1123(d) "reiterated" the Entz-White approach, stating that "[i]t is [lawmakers’] 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" (citing H.R. Rep. No. 103-835, at 55 (1994)). According to her, the legislative history "thus indicates, at the very least, that the new provision was not meant sub silentio to enact a definition of ‘cure’ conflicting with that adopted in Entz-White."

Judge Berzon observed that "[t]he majority opinion errs in concluding otherwise, and, in doing so, wrongly imposes a severe penalty on debtors in New Investments’ situation."

Finally, Judge Berzon wrote that "the majority’s opinion mistakenly upsets this Circuit’s binding precedent . . . [because a] three judge panel of this Court is ‘bound by decisions of prior panels unless an en banc decision, Supreme Court decision or subsequent legislation undermines those decisions’ " (citation omitted).

Outlook

By finally aligning the Ninth Circuit with the majority view on the meaning of section 1123(d), New Investments creates uniformity and a greater degree of certainty regarding what is required to cure and reinstate a defaulted debt under a chapter 11 plan. The ruling is no doubt a welcome development for lenders—and an unwelcome one for borrowers faced with the more costly prospect of paying default-rate interest as a condition to obtaining confirmation of a chapter 11 plan.