The Ninth Circuit held on July 3, 2008, that an oversecured creditor’s claim for payment was entitled to a “presumption in favor of the loan agreement’s default rate (an additional 2% interest), subject only to reduction based upon any equities involved.” General Elec. Capt’l Corp. v. Future Media Productions, Inc., 2008 WL2610459, *2 (9th Cir. 7/3/08). Reversing the lower courts, the Court of Appeals held that the bankruptcy court had improperly applied a questionable Ninth Circuit precedent when denying the lender a default rate of interest. Id., at *4. Accordingly, the court remanded the dispute to the bankruptcy court “to decide whether the default rate should apply under the rule adopted by the majority of federal courts.” Id.

Facts

The parties had entered into a secured loan agreement in 2004 providing for a 2% per year additional rate of interest after default. The loan agreement, governed by New York law, also required the borrower to pay attorneys’ fees and related costs in any subsequent dispute relating to the loan agreement.

The borrower filed a Chapter 11 petition in early 2006. After a payment dispute with the debtor and the creditors’ committee during the early stages of the reorganization case, the parties agreed to an interim solution permitting the lender to be paid in full with interest at the default rate plus all reimbursable expenses. Id., at *2. The creditors’ committee later sought the return of the default rate of interest, totaling approximately $164,995.

The Lower Courts: No Default Interest

The bankruptcy court held that the lender “was not entitled to the default rate of interest” and “was not entitled to attorneys’ fees or costs.” Id. In ordering the return of the default rate and other fees, the bankruptcy court relied on In re Entz-White Lumber and Supply, Inc., 850 F.2d 1338 (9th Cir. 1988) (held, oversecured creditor not entitled to interest at default rate when claim paid in full pursuant to terms of Chapter 11 plan). Here, however, the bankruptcy court, affirmed by the district court, extended the Entz-White rule “to a claim that was paid in full as a result of a series of asset sales outside of the Chapter 11 plan.” Id., at *3 (emphasis in original).

Ninth Circuit: Default Interest Presumptively Valid

The Court of Appeals disagreed with the lower courts, holding that the bankruptcy court had improperly extended the holding of Entz-White beyond the Chapter 11 plan context. Id. Relying on the Supreme Court’s holding in Travelers Cas. & Sur. Co. of Am. v. Pac. Gas & Elec. Co., 127 S. Ct. 1199, 1204 -1205 (2007), the Ninth Circuit found that the “default rate should be enforced, subject only to the substantive law governing the loan agreement, unless a provision of the Bankruptcy Code provides otherwise.” Id., at *3. When the court handed down Entz-White, it reasoned, a specific provision of the Code (§ 1124(2)(A)) authorized a plan to nullify default penalties. Id. In this case, however, “there was never any question of whether the debtor needed to cure a default” under a Chapter 11 plan, for the lender’s “oversecured claim was paid through a sale of assets…outside the context of the Chapter 11 plan.” Id. (emphasis in original).

The court remanded the dispute to the bankruptcy court “to decide whether the default rate should apply under the rule adopted by the majority of [other] federal courts [i.e.,]: The bankruptcy court should apply a presumption of allowability for the contracted for default rate, ‘provided that the rate is not unenforceable under applicable non-bankruptcy law.’” Id., at *4, citing 4 Collier, Bankruptcy, ¶ 506.04[2][b][ii] (15th rev. ed. 1996); In re Laymon, 958 F.2d 72, 75 (5th Cir. 1992) (held, “…contract provides the rate of post-petition interest” on oversecured creditor’s claim, subject to examination of equities); In re Terry Ltd. Partnership, 27 F.3d 241, 243 (7th Cir. 1994) (“presumption in favor of the contract rate subject to rebuttal based on equitable considerations”). See also In re Urban Communicators PCS Limited Partnership, 2007 Bankr. LEXIS 4062 (Bankr. S.D.N.Y. 12/11/07) (oversecured lender received post-petition interest on full amount of secured claim at default rate in lender’s contract (19%) plus compound (PIK) interest up to aggregate rate of 25% (maximum rate allowable under New York usury laws), citing equities of case to limit interest award).