In early November, the Ninth Circuit held in In re New Investments, Inc. that a debtor was required to “cure” defaults to an agreement using a post-default interest rate, overturning its prior, decades-old decision In re Entz-White Lumber & Supply, Inc., which had held that a debtor could cure agreements at pre-default interest rates.
New Investments, Inc. (“New Investments”) borrowed approximately $3 million from Pacific L 51, LLC (“Pacifica”) to purchase hotel property. The loan accrued interest at a five percent rate which would increase to thirteen percent after an event of default. New Investments defaulted in 2009 and filed for chapter 11 relief thereafter. In the bankruptcy case, New Investments’ plan of reorganization proposed to “cure” the default under the loan agreement by selling the hotel property and using the proceeds to pay Pacifica at the pre-default interest rate of eight percent. Pacifica objected to the plan by arguing that it was entitled to the higher post-default interest rate of thirteen percent.
The bankruptcy court confirmed New Investments’ plan over Pacifica’s objection and Pacifica timely appealed directly to the Ninth Circuit Court of Appeals.
Ninth Circuit Requires Post-Default Interest
In a 2-1 decision, the Ninth Circuit held that New Investments’ plan was required to “cure” a default in accordance with the post-default terms in the underlying loan agreement. The Ninth Circuit previously held in Entz-White that “the power to cure under the Bankruptcy Code authorizes a plan to nullify all consequences of default, including avoidance of default penalties such as higher interest.” However, since Entz-White was decided in 1988, Congress in 1994 added subsection 1123(d) of the Bankruptcy Code which requires 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.”
The Ninth Circuit held that the plan language of section 1123(d) prohibited a debtor from nullifying the terms of an agreement that provided for post-default interest solely by proposing a cure. The court noted that “curing” included not only paying any past due amounts, but also included late charges, attorney’s fees, or other costs provided in the underlying loan agreement. Essentially, the creditor is entitled to “the benefit of its bargain” – no less and no more. Because Pacifica was entitled to post-default interest on the entire loan (and not just the past due portion) under the underlying agreement, the court held that New Investment was required to “cure” the default by paying the post-default interest rate to satisfy section 1123(d) of the Bankruptcy Code.
In a forceful dissent, Judge Berzon of the Ninth Circuit argued that the ruling of Entz-White, that “‘curing a default’ means ‘returning to pre-default conditions,’ such that any consequences of the default [including the requirement to pay default rate interest] are ‘nullified,’” remains good law and was not changed by the enactment section 1123(d). Rather, a “cure” as applied in the Bankruptcy Code was to put a debtor in the same position as if the default never occurred. Consequently, section 1123(d) explained the “how” to cure a default (i.e., by looking at the underlying agreement and applicable nonbankruptcy law), but did not specify the “where” in the underlying agreement that would apply to cure. If the default never occurred, then no default interest rate could apply, meaning that the underlying agreement’s pre-default interest rate should apply. She argued that stare decisis required the court to apply Entz-White given that there was no “clear indication that Congress intended . . . a departure . . . from this Court’s past practice.”
The Ninth Circuit’s majority decision in In re New Investments brings it in line with the majority of other bankruptcy courts and at least one circuit court that have similarly held that creditors are entitled to a “cure” using post-default interest rates. Given the importance of the decision, the 2-1 voting outcome, and its impact to debtors and creditors alike, it would not be surprising if the decision were reheard en banc with a full panel of the Ninth Circuit’s judges. Until then, the debtors looking to “cure” contracts through a plan of reorganization should be mindful that the costs could be much higher than anticipated.
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