A Cure By Any Other Name

Under Section 1123(d) of the Bankruptcy Code, enacted in 1994, the answer is found in the rights afforded the lender in the underlying loan documents and applicable state law. In relevant part, Section 1123(d) states 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.” Courts have generally agreed that this language is straightforward, but this general agreement has not led to a consensus on meaning.

Prior to 1994, debtors were afforded more flexibility in proposing cures, and courts were afforded more latitude in considering them. Before 1994, the Bankruptcy Code contained no specific definition of cure, and courts looked for guidance to Section 1124 and its categorical explications of the characteristics of an impaired claim. A seminal and oft-cited pre-1994 case is In re Entz-White Lumber & Supply, Inc., 850 F.2d 1338, 1340 (9th Cir. 1988). The U.S. Court of Appeals for the Ninth Circuit cocluded at that time that Section 1124 allowed a debtor to bypass contractual provisions extending additional relief to a creditor in the event of a default. As a result, a cure of a lender's default returns the parties to the “status quo ante” ' in other words, the lender loses any contractual right to recover interest at the default rate as a condition to cure. See also In re Madison Hotel Assocs., 749 F.2d 410 (7th Cir.1984).

Amendments to the Bankruptcy Code can occur after years of deliberation and study (e.g., BAPCPA in 2005), or in reaction to a particular decision. Section 1123(d) was the latter. Congress enacted Section 1123(d) as a “cure” for the Supreme Court's decision in Rake v. Wade, 508 U.S. 464 (1993), in which the court held that the Bankruptcy Code entitles oversecured creditors to interest on arrearages of home-mortgage payments under a Chapter 13 plan, notwithstanding state law to the contrary and the lack of a provision requiring such interest in the underlying agreement. The House Judiciary Committee Report for the amendment stated:

This section will have the effect of overruling the decision of the Supreme Court in Rake v. Wade [508 U.S. 464], 113 S.Ct. 2187 [124 L.Ed.2d 424] (1993) ' . Notwithstanding State law, this case has 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. This had the effect of giving secured creditors interest on interest payments, and interest on the late charges and other fees, even where applicable laws prohibit[ ] such interest and even when it was something that was not contemplated by either party in the original transaction ' . 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.

H.R.Rep. No. 103-835, at 55 (1994), 1994 U.S.C.C.A.N. 3340, 3364 (emphasis added).

It is not a stretch to read Congress' stated intent, in drafting Section 1123(d), as including the preservation of the approach taken by courts such as Entz-White prior to the amendment ' to preserve the “status quo ante.” However, for many courts, Section 1123(d) was a sea change ' lenders were no longer forced to return to pre-default status as a condition to cure; lenders were now entitled to the continued benefits of the default provisions of their loan documents as a condition to cure.

The Courts' Interpretation

A partial survey of lower court decisions over the past decade suggests that most courts view Section 1123(d) as requiring courts to honor provisions in the underlying agreements or state law that provide for higher default-rate interest and late fees. See, e.g., In re Southland Corp., 160 F.3d 1054, 1059 n. 6 (5th Cir.1998) (the bankruptcy amendments enacted in 1994 “arguably rejected the Entz-White denial of contractual default interest rates”); In re 1 Ashbury Court Partners, L.L.C., at *4 (Bankr. D. Kan. Oct. 5, 2011) (Section 1123(d) “was enacted in 1994 for the specific purpose of clarifying ' that cure and reinstatement required more than simply rolling back the clock as some courts had held”); In re Moody Nat'l SHS Hous. 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 [prior to 1994], that ambiguity evaporated in 1994 when ' 1123(d) was added”); In re K & J Properties, Inc., 338 B.R. 450, 461 (Bankr.D.Colo.2005) (under Section 1123(d), a plan may require as a cure the inclusion of enforceable, accrued default interest).

Sagamore Partners

The most recent significant decision on this topic was issued in August, 2015, by the U.S. Court of Appeals for the Eleventh Circuit in In re Sagamore Partners, Ltd., 620 Fed. Appx. 864 (2015). In Sagamore, the debtor, a hotel operator, proposed a cure and maintenance plan in which the lender was returned to pre-default status. The plan was confirmed. The bankruptcy court concluded, in relevant part, that the lender had elected late fees in lieu of default interest prior to the bankruptcy case and thus was stuck with its election of remedies. The lender appealed, on grounds that it had not waived its right to default interest and was entitled to default rate interest under Section 1123(d) as a condition to cure. The district court agreed with the ruling that the lender had effectively elected late fees over default interest and therefore waived any right to default interest in cure. On further appeal, the Eleventh Circuit overturned, finding the bankruptcy court had clearly erred on two grounds.

First, the bankruptcy court erred in concluding that the lender elected late fees as its initial remedy. The lender's billing system had automatically added late fees to the debtor's account when the debtor became delinquent. The lender later filed an enforcement suit seeking both late fees and default interest as its remedies. The bankruptcy court held that the lender's initial pursuit of late fees (even if the result of blind automation on lender's part) was an election. The Eleventh Circuit panel concluded that lender's assertion in its suit of both remedies was sufficient to preserve those rights. Eventually, the lender relinquished pursuit of late fees and sought only default interest.

Having concluded that the lender clearly preserved a right to default interest, the Sagamore court addressed the debtor's argument that, as a matter of law, the lender was not entitled to default interest as a condition to cure. The debtor relied upon a long line of cases from the Ninth Circuit ' Entz-White and its progeny ' to argue that the loan should be returned to its pre-default status. In passing, the circuit panel noted that Section 1123(d) was not ambiguous and therefore, under existing Supreme Court precedent, “there was no reason to resort to legislative history.” In sum, the lender was entitled to default interest. As the lender had dropped its claim for late fees, the court concluded that it did not need to address whether a lender could be entitled to both late fees and default interest to cure, but did note that, under Florida law, both remedies may be pursued concurrently to adjudication. In the Eleventh Circuit (in Florida, anyway), a lender may be entitled to both remedies as a cure under Section 1123(d).

Analysis

The debtor's attempt to convince the Eleventh Circuit panel that it should follow the Ninth Circuit illustrates the small gulf that divides the treatment afforded lenders between these two jurisdictions. In the Ninth Circuit, Entz-White and its progeny remain good law, and debtors seeking to justify a cure that includes neither default interest nor late charges can rely for precedent and factual examples on a line of decisions that both pre-date and post-date the 1994 amendment.

Interestingly, certain lower courts in the Ninth Circuit have followed pre-1994 precedent without reference to Section 1123(d). See, e.g., In re Sylmar Plaza, L.P., 314 F.3d 1070, 1075 (9th Cir.2002); In re Udhus, 218 B.R. 513, 518 (9th Cir. BAP 1998). Others more expressly follow Entz-White by attempting to reconcile the language of Section 1123(d) with existing Ninth Circuit precedent. A notable decision in this vein is In re Phoenix Business Park Ltd. Partnership, 257 B.R. 517 (Bankr. D. Ariz. 2001).

The court concluded that the 1994 amendments did not overturn prior Ninth Circuit precedent by reviewing Section 365(b)(2)(D), a section added to the Bankruptcy Code at the same time as Section 1123(d). A claim is unimpaired under Section 1124(2)(A) if a plan cures any defaults associated with the claim, but Section 1124(2)(A) provides that a plan need not cure defaults “of a kind specified in ' 365(b)(2)” ' including “any penalty rate or penalty provision relating to a default arising from any failure by the debtor to perform nonmonetary obligations under [an] executory contract or unexpired lease.” Section 365(b)(2)(D). The Phoenix Business Park court looked to Ninth Circuit decisions precedent suggesting that the phrase “any penalty rate” in that section of Section 365(d)(2) stood alone and was not modified by the rest of the provision ' in other words, a plan need not cure a default by paying “any penalty rate” (i.e., the default rate) ' period. The court then concluded that charging monthly late fees of $1,056.00 plus a default rate of 24% ' against a contract rate of 10.75% ' was a penalty rate and that a cure did not require payment of these fees and charges.

The Phoenix Business Park court also relied on the legislative history of Section 1123(d) and concluded that Congress intended only to address the narrow issue raised in Rake v. Wade ' namely, the payment of interest on arrearages in consumer mortgage payments ' and not to revisit existing law and practice in the area of Chapter 11 cures. The court concluded that the legislative history indicates that past precedent holding that payment of default-rate interest is not required to cure remains good law. A later lower court decision in the Ninth Circuit closely followed similar reasoning. See In re Zamani, 390 B.R. 680, 687 (Bankr.N.D.Cal.2008).

Conclusion

While this remains an emerging area of law with little circuit level guidance, there is one clear moral: If you are a lender facing a cure fight, you are far better off in the Eleventh Circuit than the Ninth Circuit. Beyond that, there appears to be a small but emerging body of law at the bankruptcy court level ' outside the Ninth Circuit ' that is consistent with the reasoning of Sagamore. The Ninth Circuit, as it is wont to do, is once again marching to its own drummer.

Mark S. Melickian is a partner at Sugar Felsenthal Grais & Hammer LLP in Chicago. His practice focuses on creditor-side representations in Chapter 11 commercial bankruptcy cases, although his experience also includes debtors and other interested parties in commercial bankruptcy and out of court insolvency matters. He can be reached at [email protected].