Lender Entitled to Grid as Well as Default Interest as Part of Allowed Secured Claim Where Debtor Provided Inaccurate Financial Information

During the six years since the Sarbanes-Oxley reforms were implemented in 2002, the heightened accountability of corporate fiduciaries has made restatements of public-company SEC filings and indictments of corporate fiduciaries routine fodder for business and financial headlines. The financially devastating and sometimes criminal consequences of such revisionism for the companies and their fiduciaries have been highly visible. Less attention, however, has been devoted to the impact that forensic accounting may have on the company’s obligations to its creditors. A New York district court recently had an opportunity to examine this issue. In Bank of Nova Scotia v. Adelphia Communications Corp. (In re Adelphia Communications Corp.), the district court reversed a bankruptcy court order excluding from the allowed amount of a secured claim “grid” interest to which the lenders would have been entitled under their loan agreement had the debtors provided them with accurate financial information.

Determining the Allowed Amount of Secured Claims in Bankruptcy

Debts and other obligations, secured or otherwise, are generally classified as “claims” in the Bankruptcy Code. This means that a secured obligation may give rise to both a secured claim, to the extent of the value of the property securing it, and an unsecured claim, to the extent of any deficiency in the collateral value. In accordance with section 506(a) of the Bankruptcy Code, the value of the debtor’s interest in assets securing a debt determines whether the debt gives rise to an allowed secured claim, an allowed unsecured claim, or both.

If a creditor turns out to be “oversecured” because its collateral value exceeds the face amount of the underlying debt (including interest, fees, and other charges), section 506(b) provides that it may recover interest and related costs as part of its allowed secured claim:

To the extent that an allowed secured claim is secured by property the value of which, after any recovery under subsection (c) of this section, 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 or State statute under which such claim arose.

Although this provision expressly refers to “interest on such claim . . . provided for under the [underlying] agreement or State statute,” it does not specify whether any distinction should be made between ordinary and default-rate interest. Most courts, consistent with the Supreme Court’s 1989 ruling in United States v. Ron Pair Enterprises, Inc., have allowed (or at least recognized a presumption of allowability for) default interest provided in a contract as part of a secured creditor’s claim, provided the rate is not unenforceable under applicable nonbankruptcy law. Whether an allowed secured claim should include both default interest and pre-default interest that would have been payable to a secured lender had the debtor accurately reported its financial condition was the subject of the district court’s ruling in Adelphia.


Before filing for chapter 11 protection in New York in June 2002, Adelphia Communications Corporation and its affiliates (collectively, “Adelphia”), once the nation’s fifth-largest cable services company with 5.7 million subscribers in more than 31 states, entered into credit agreements with certain lenders. Under the credit agreements, Adelphia was obligated to pay nondefault, or “grid,” interest that varied according to the company’s financial performance (as specified in a grid included within agreements). The grid interest, which increased with Adelphia’s leverage ratio, was determined in accordance with financial statements delivered periodically by Adelphia to the lenders’ administrative agents. Delivery of inaccurate financial information would constitute a breach of Adelphia’s covenant under the credit agreements to provide an accurate assessment of its financial health and would thus trigger an event of default. In the event of a default, the agreements provided that interest would accrue on Adelphia’s outstanding obligations at the specified default rate.

In their proofs of claim against Adelphia, the agent banks asserted fully secured claims based upon the credit agreements. After two of Adelphia’s officers were later convicted of various crimes, including bank fraud, the agent banks amended their claims to include retroactive payment of the additional grid interest to which the lenders would have been entitled (approximately $187 million) had they been provided with accurate financial-performance information. Adelphia objected to the amended claims, contending that the sole remedy under the credit agreements in the event of a covenant violation was payment of default interest.

The bankruptcy court agreed with Adelphia, ruling that the credit agreements did not provide for the payment of retroactive grid interest as a consequence of the company’s delivery of false financial statements to the lenders. According to bankruptcy judge Robert E. Gerber, the lenders’ exclusive remedy under the credit agreements was default interest. He also ruled that Adelphia was not required to establish a reserve for the payment of grid interest claims in its chapter 11 plan.

The ruling was important because the lenders, in connection with debtor-in-possession financing provided to Adelphia, had agreed to waive any claim for default interest arising from pre-petition defaults. Without such a waiver, the amount of default interest would have significantly exceeded the amount of the lenders’ claims for additional grid interest. Judge Gerber also rejected the lenders’ claims for additional grid interest based on tort theories of fraud or misrepresentation. According to Judge Gerber, although tort claims could have given rise to an unsecured liability, they could not be a component of the lenders’ allowed secured claims under section 506(b). He also held that the tort claims at issue did not give rise to damages for the lenders’ expectancy for additional grid interest, but only compensatory damages for the lenders’ actual out-of-pocket loss, which Judge Gerber equated to the outstanding principal amount. Because the lenders’ claims were to be paid in full under Adelphia’s chapter 11 plan, the judge reasoned, they would not suffer any compensable damages. Some of the agent banks appealed the ruling to the district court.

The District Court’s Ruling

The United States District Court for the Southern District of New York reversed. District judge John G. Koeltl embarked upon his analysis by noting that there was no dispute that Adelphia was obligated under the credit agreements to provide accurate financial information and that grid interest was calculated on the basis of the information. Addressing the lenders’ remedies for Adelphia’s failure to comply, Judge Koeltl concluded that although the credit agreements provided for payment of default interest upon the occurrence of a default, the agreements did not specifically express an intention for default interest to be the exclusive remedy. Instead, Judge Koeltl determined, the lenders were entitled to recover standard expectancy damages arising from Adelphia’s breach of the credit agreements. The credit agreements, he explained, actually indicated that the lenders had remedies other than default interest. For example, the lenders expressly retained the right to pursue “damages, other monetary relief, injunctive relief or any other remedy at law or equity against the [b]orrower . . . by reason of fraud, [or] knowing or willful breach of representations and warranties.” The credit agreements also included “no-waiver” clauses, which precluded any waiver of the lenders’ right to collect nondefault interest at the appropriate rate, even though they exercised their right to collect default interest.

Based upon his analysis, district judge Koeltl reversed the bankruptcy court’s determination that retroactive grid interest was not a component of the lenders’ allowed secured claim under section 506(b). However, the judge remanded the case to the bankruptcy court to consider whether the lenders had waived any claim to grid interest in connection with the court’s approval of debtor-in-possession financing for Adelphia.


Adelphia is undoubtedly a positive development for any lender whose loan agreement incorporates interest calculated according to a grid determined by leverage or other financial-performance indicia, but the fact that it came only after reversal on appeal should be a clear warning to lenders. According to Judge Koeltl’s approach, an oversecured creditor’s allowed secured claim should include any interest shortfall resulting from financial-reporting mistakes or misrepresentations that are later discovered, provided the loan agreement does not limit the lender’s remedy to default interest payable upon default. The real lesson of Adelphia lurks in this proviso. A lender intent upon preserving the integrity of its loan must ensure that loan documentation expressly and unambiguously spells out the lender’s entire panoply of remedies.


Bank of Nova Scotia v. Adelphia Communications Corp. (In re Adelphia Communications Corp.), 2008 WL 3919198 (S.D.N.Y. Aug. 22, 2008).

United States v. Ron Pair Enterprises, Inc., 489 U.S. 235 (1989).