In re Residential Capital, LLC, 508 B.R. 851 (Bankr. S.D.N.Y. 2014) –
An oversecured creditor claimed post-petition interest at the contract default rate. The debtors and the post-confirmation liquidating trust objected, arguing that the lender should be limited to the non-default rate.
Generally a lender is not entitled to post-petition interest. However, under Section 506(b) of the Bankruptcy Code an oversecured creditor is entitled to its claim together with post-petition interest and "any reasonable fees, costs or charges provided under the agreement under which such claim arose" up to the value of its collateral. The court identified the guiding principles for determining the interest rate: (1) there is a rebuttable presumption that the contract default rate applies, and (2) the court has limited discretion, to be used "sparingly," to modify that rate.
The lender had provided a revolving credit facility that was amended ten times to extend the maturity date and make other changes. The original commitment was for $700 million. By the time of the last amendment, the commitment was reduced from $300 million to $158 million.
The lender received an extension fee in connection with each extension. The last amendment extended the maturity date by two months. At that time the parties understood that the debtors were preparing for bankruptcy and the loans would probably not be repaid at maturity. Given the increased risk, the lender's extension fee was $3.16 million, and the non-default interest rate was increased to LIBOR plus 8½% (from LIBOR plus 6%.) The default rate remained the non-default rate plus 4%.
The court order at the beginning of the bankruptcy case that approved the debtors' use of the lender's cash collateral included a finding that the lender was oversecured; and accordingly it was entitled to interest and fees on the outstanding obligations in accordance with the prepetition agreement. The court order required the debtors to pay interest at the non-default rate during the case.
In connection with a sale of debtor assets securing the revolving credit facility, the debtors were required to apply a portion of the sale proceeds to the debt. The debtors contended they should pay the principal and interest at the non-default rate, while the lender contended that they should pay accrued interest at the default rate. By the time the court was ready to rule on the dispute, the lender claimed that the difference between default and non-default interest was ~$5 million.
The lender cited a Supreme Court case (Travelers) for the proposition that "a creditor's rights in bankruptcy derive from the substantive law creating those rights, subject to 'qualifying or contrary provisions of the Bankruptcy Code.'" It also cited a 1st Circuit case holding that enforcement of the contract rate was consistent with this general premise.
In response, the trust argued that courts have denied post-petition interest at the contract default rate on equitable grounds. It contended that the rebuttable presumption in favor of this rate was overcome because the debtors were insolvent, so additional payments to the lender would harm the unsecured creditors. However, the trust did not argue that there was any misconduct, that the debtors' "fresh start" would be impaired, or that the contract default rate was an unenforceable penalty.
While acknowledging that solvency was an important factor, the court declined to find that the contract rate should automatically be reduced when the debtor is insolvent. It commented that a bright-line rule would likely increase the cost of credit, and debtors might fare worse because the higher risk would be reflected in a higher rate of interest for the full life of the loan. However, the court was willing to consider equitable factors.
In this case the court noted that it was not clear that every dollar paid to the lender was one dollar less for the unsecured creditors, since the ongoing financing (which extended post-petition) allowed the debtors to continue as a going concern which maximized the amount realized for creditors. In addition, while declining to characterize $5 million as "miniscule" (as argued by the lender), the court did acknowledge that payment of the default rate would reduce the assets available for creditors by roughly 0.2%. This reduction was not sufficient to overcome the rebuttable presumption.
As is typically the case, the loan documents provided that a bankruptcy filing was an event of default. Although this is not invalid as impermissible ipso facto clause (as is the case in the context of executory contracts), this type of clause is generally disfavored. After considering the equities, the court declined to approve default interest based solely on the bankruptcy filing, but instead allowed default interest only after the loan maturity date.
Since the bankruptcy was filed on May 14 and the loan matured on May 30, the court's distinction between the "technical default" of a bankruptcy filing and a default "in a more meaningful sense later by failing to pay [the lender] at the maturity date," doesn't appear to be particularly significant. Perhaps the court was signaling its views for future cases.
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