Eleventh Circuit Weighs In on Section 1123(d): Reinstatement of Defaulted Loan Agreement Under Chapter 11 Plan Requires Payment of Default-Rate Interest
In 1994, Congress amended the Bankruptcy Code to, among other things, 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 majority of courts have held that such a cure amount must include any default-rate interest required under either the contract or applicable nonbankruptcy law. A ruling recently handed down by the U.S. Court of Appeals for the Eleventh Circuit endorses this view. In JPMCC 2006-LDP7 Miami Beach Lodging, LLC v. Sagamore Partners, Ltd. (In re Sagamore Partners, Ltd.), 2015 BL 280922 (11th Cir. Aug. 31, 2015), the Eleventh Circuit ruled in favor of a secured lender demanding payment of default-rate interest as a condition of curing the debtor’s default and reinstating the original terms of the loan agreement through a chapter 11 plan and reversed the determination of the bankruptcy and district courts below that the lender had waived its entitlement to such default-rate interest.
Reinstatement and Cure 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. Assuming that the stay remains in place, the borrower as chapter 11 debtor in possession may propose a plan which decelerates the 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 qualifies as unimpaired 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 define 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 order to cure defaults and reinstate an obligation under a plan, a minority of courts held that the payment of default-rate interest was not required because cure effectively nullifies all aspects of a default and rolls back the status quo to a time prior to its occurrence. See, e.g., Great Western Bank & Trust v. Entz-White Lumber and Supply, Inc. (Entz-White Lumber and Supply, Inc.), 850 F.2d 1338 (9th Cir. 1988); 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 post-petition 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.” 11 U.S.C. § 1123(d). Most courts have interpreted section 1123(d) as requiring 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).
This result is not necessarily supported by the legislative history of section 1123(d), however. Section 1123(d) and a companion provision in chapter 13, section 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 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)); 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)). As discussed below, the Eleventh Circuit conclusively rejected this line of argument in Sagamore Partners.
Sagamore Partners, Ltd. (“Sagamore”) is the owner of the Sagamore Hotel in Miami Beach, Florida. In 2006, Arbor Commercial Mortgage, LLC (“Arbor”) loaned Sagamore $31.5 million to refinance its hotel indebtedness. The loan agreement provided that, in the event of default, Sagamore would be required to pay default-rate interest at the rate of 11.54 percent per annum.
After Sagamore stopped making payments on the loan in 2009, Arbor’s assignee—JPMCC 2006-LDP7 Miami Beach Lodging, LLC (“JPMCC”)—sent a notice of default to Sagamore, but not its New York counsel, as required under the loan agreement. Shortly afterward, JPMCC notified Sagamore’s New York lawyers that it was accelerating the loan.
JPMCC commenced a foreclosure action in state court in December 2009. In its complaint, JPMCC demanded, among other things, both default-rate interest and late fees. In its internal records, the servicer of the Sagamore loan recorded accruing charges for late fees, but not default-rate interest.
Sagamore filed for chapter 11 protection on October 6, 2011, in the Southern District of Florida. JPMCC filed a proof of claim for $31.5 million, plus pre-default interest, default-rate interest, late fees, costs, attorneys’ fees, and other charges due under the loan agreement. In response to Sagamore’s objection that JPMCC could not claim both default-rate interest and late fees, JPMCC waived its claim to all late fees “for any time period for which the Court allows default rate interest.”
Sagamore’s chapter 11 plan proposed to reinstate the maturity of the loan and to cure and “nullify all consequences of any alleged default” by, among other things, payment of accrued interest at the nondefault rate.
Initially, the bankruptcy court ruled that the proposed plan was not confirmable because it did not provide for the payment of default-rate interest to JPMCC. Persuaded by the reasoning of courts which have concluded that Entz-White was abrogated by section 1123(d), the court held that: (i) section 1123(a)(5)(G) “governs the permissible contours of a plan of reorganization and serves as the authority for curing or waiving a default”; (ii) the cure amount is determined by section 1123(d), which reverts to the underlying agreement and applicable nonbankruptcy law; and (iii) section 1124(2) governs whether a secured creditor’s claim can be treated as unimpaired but does not supplant section 1123(d). However, in its decision, the court noted that “[i]f the Debtor can establish . . . that any default may be excused, or that default interest is not otherwise due in accordance with the underlying agreement and/or applicable non-bankruptcy law, then the issue of entitlement to default interest is moot.” In re Sagamore Partners, Ltd., No. 11-37867-BKC-AJC (Bankr. S.D. Fla. July 10, 2012) (memorandum order at p. 10) [Doc. No. 213].
After Sagamore filed an amended plan, the bankruptcy court ruled that JPMCC’s notice of default was defective and “all that flowed from the Defective Notice is improper,” including the acceleration letter; the foreclosure proceeding; and JPMCC’s efforts to charge default-rate interest, attorneys’ fees, and other charges. In the alternative, the bankruptcy court found that JPMCC failed to demand default-rate interest and waived any right to such interest by opting to collect late fees.
On appeal, the district court ruled that an event of default occurred despite insufficient notice and remanded the case to the bankruptcy court for a determination of whether JPMCC was entitled to an award of attorneys’ fees and costs. However, the district court affirmed the bankruptcy court’s ruling that JPMCC waived its right to default-rate interest. JPMCC appealed to the Eleventh Circuit.
The Eleventh Circuit’s Ruling
The Eleventh Circuit acknowledged that “the requirements for reinstating the terms of a loan under § 1123 may appear to be in some tension with the framework for determining when parties have the right to vote on a debtor’s reorganization plan.” Even so, the court noted that “[i]t does not allow us to ignore the clear mandate of § 1123 that allows a creditor to demand default-rate interest as a condition for reinstating the loan.” Because the loan agreement required the payment of default-rate interest and the provision complied with Florida law, the Eleventh Circuit ruled, Sagamore must pay default-rate interest to cure its default.
The Eleventh Circuit faulted the bankruptcy court’s conclusion that JPMCC waived its right to default-rate interest by failing to timely demand such interest and by electing to collect late fees instead. According to the Eleventh Circuit, the record clearly demonstrated that JPMCC consistently demanded default-rate interest and withdrew its claim for late fees to the extent that it could not collect both default-rate interest and late fees. Moreover, the court noted, claims for late fees and default-rate interest are consistent remedies that may be pursued concurrently under Florida law, so long as a party does not receive “satisfaction of the claim by one remedy.”
Accordingly, the Eleventh Circuit reversed the ruling below denying JPMCC’s claim for default-rate interest. It affirmed the ruling that Sagamore’s chapter 11 plan was feasible and remanded the case for certain additional findings, including determinations as to whether JPMCC was entitled to attorneys’ fees and costs as part of its secured claim and the timing of Sagamore’s obligation to pay the default-rate-interest amount.
With Sagamore Partners, the Eleventh Circuit has joined the majority camp in concluding that section 1123(d) requires the payment of default-rate interest as a condition to curing a default under a loan agreement which is to be reinstated under a plan, provided that the obligation to pay default-rate interest is contained in the underlying loan agreement or authorized under applicable nonbankruptcy law. The decision underscores the fact that courts in the Ninth Circuit are outliers on this issue and are likely to remain so unless and until the Ninth Circuit Court of Appeals expressly rules that Entz-White is no longer good law. The ruling may also serve as a reminder to lenders to be clear and consistent in enforcing their post-default rights if they wish to avoid claims that they waived the right to collect default-rate interest authorized under a loan agreement or applicable law.
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