In Pacifica L 51 LLC v. New Investments, Inc. (In re New Investments, Inc.), 840 F.3d 1137 (9th Cir. 2016), the Ninth Circuit Court of Appeals held that Section 1123(d) of the Bankruptcy Code provides that a cure amount may include a post-default rate of interest if the underlying loan documents and applicable non-bankruptcy law provide for the payment of post-default rate interest upon a default.
Prior to the petition date, New Investments, Inc. (New Investments) obtained a loan to purchase a hotel property in the State of Washington. The loan was secured by a deed of trust, which provided for a rate of interest of eight percent per year. The loan further provided that, in the event of a default, the interest rate would increase by five percent.
New Investments eventually defaulted on the loan, and when the lender commenced non-judicial foreclosure proceedings, New Investments filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. New Investments submitted a plan of reorganization that provided for the cure of the default 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 lender objected to the plan on the grounds that, under the applicable loan documents, the lender was entitled to the higher, post-default interest rate. The bankruptcy court confirmed New Investments’ plan over the lender’s objection and the lender appealed. Anticipating the appeal, the bankruptcy court also ordered some of the sale proceeds to be set aside for a disputed claim reserve.
The Ninth Circuit began its analysis with a review of its prior decision in Entz-White, which was decided in 1988 and prior to the enactment of Section 1123(d). In Entz-White, the appellate court noted that the term “cure” was not defined by the bankruptcy code and adopted the definition used by the Second Circuit, which provided that curing a default meant taking care of the triggering event and returning to pre-default conditions. Based upon this definition of cure, the Ninth Circuit ruled in Entz-White that “a debtor whose plan proposes to cure a default would allow him to avoid having to pay a higher, post-default interest rate called for in the loan agreement.”
In light of Section 1123(d), the Ninth Circuit decided that its prior decision in Entz-White was void. Section 1123(d) provides that if a debtor proposes to cure a default, “the amount necessary to cure the default shall be determined in the accordance with the underlying agreement and applicable nonbankruptcy law.” 11 U.S.C. §1123(d). The court noted that the plain and unambiguous language of Section 1123(d) “compels the holding that a debtor cannot nullify a preexisting obligation in a loan agreement to pay post-default interest solely by proposing a cure.”
As a result of the instruction provided by Section 1123(d), the Ninth Circuit then looked to the underlying loan documents and applicable non-bankruptcy law. The court determined that the loan documents expressly provided for a higher rate of interest upon default, and Washington state law permitted the charging of a higher rate of interest upon a default if provided for in the underlying loan documents. Accordingly, New Investments was required to pay the post-default rate of interest in the cure amount.
The Ninth Circuit went on to find that the holding would not change even if the Court determined that Section 1123(d) was ambiguous because the legislative history did not dictate a different outcome. The legislative history for Section 1123(d) revealed it was Congress’ intent to limit the secured creditor’s recovery to the benefit of the original bargain and prevent a court contrived windfall on the creditor’s behalf. The Ninth Circuit also noted that the fact that the intent of Section 1123(d) was to limit a secured creditor’s recovery did not change its analysis because the effect of a statute’s text is not limited to the original purpose for which it was enacted. Requiring a debtor to pay a default rate of interest “is further consistent with the intent of Section 1123(d) because it holds the parties to the benefit of their bargain.” According to the Ninth Circuit, Section 1123(d) affects how a debtor is to return to pre-default conditions, which may include paying a post-default rate of interest if that is what is provided for in the loan documents.
The court also noted that this interpretation of Section 1123(d) was consistent with the requirement of Section 1124(2)(E), which permits a debtor to cure a default but cannot otherwise alter the legal, equitable or contractual rights of the creditor. The lender had contracted for the right to higher rate of interest upon default, and New Investments could not alter that right.
This case has significant consequences for both debtors and secured creditors. The decision is clearly beneficial for secured lenders, who will be able to recover the full benefit of their pre-petition bargain with the debtor should the debtor choose to cure and reinstate the loan. Going forward, debtors will have to take into account the higher cure costs when determining whether to cure and reinstate a loan through a plan of reorganization.