The Cure: Eleventh Circuit Entitles Lender to Default-Rate Interest

Contributed by Alana Katz.
We have previously discussed default-rate interest and late fees in connection with a secured creditor’s claim.  Can a secured creditor choose to waive one in favor of the other if both are not available?  And when is a secured creditor entitled to default-rate interest in the first place? Recently, in In re Sagamore Partners, the Eleventh Circuit weighed in on these issues. 
This case involved a dispute over whether a secured lender was entitled to default-rate interest when the debtor sought to reinstate, under its chapter 11 plan, a loan that was in default for years prior to the bankruptcy filing.  In addition to arguing that a lender whose loan is reinstated under a chapter 11 plan is never entitled to default-rate interest, the debtor also argued, among other things, that because the lender in that case already demanded late fees, it could not also receive default-rate interest.  The lender countered that it was entitled to default-rate interest (a much larger amount than the late fees in that situation), because it agreed to waive all late fees for any time period for which the court would allow default-rate interest.
The bankruptcy court ruled in favor of the debtor, holding that the lender failed to assert a proper demand for default-rate interest due to insufficient notice of default to the debtor and, having asserted entitlement to late fees, the lender could not recover default-rate interest in any case.  The district court reversed the bankruptcy court’s decision regarding insufficient notice, stating that a default occurred under the loan documents regardless of any failure to notify the debtor.  The district court did, however, affirm the bankruptcy court’s conclusion that the lender waived default-rate interest due to its demand of late fees.
Default-Rate Interest
On appeal, the Eleventh Circuit rejected the debtor’s argument that bankruptcy law does not allow a creditor to demand default-rate interest as a condition to reinstating the original terms of the loan.  The Eleventh Circuit noted that this argument relied solely on case law prior to the 1994 amendments to the Bankruptcy Code.  Under the current version of section 1123(d) of the Bankruptcy Code, the court noted that in order to cure a default under a prepetition loan, the debtor must cure in accordance with the terms of the underlying agreement and applicable non-bankruptcy law.
The court noted the tension between section 1123(d) and section 1124(2) of the Bankruptcy Code.  Some courts had interpreted section 1124, which governs whether a secured creditor’s claim can be treated as unimpaired under a plan, as allowing a debtor to cure defaults without paying default interest owed under the loan documents.  This is arguably in contrast to section 1123(d), which seems to require the payment of outstanding default-rate interest, if called for in the underlying documents and consistent with state law, to cure any default and reinstate the loan.  The court stated that this tension merely demonstrates that the Bankruptcy Code does not equate curing a default for reinstatement of a loan with unimpairment of a claim.  The court, agreeing with the bankruptcy court’s decision, held that the mandate of section 1123 controls, and requires a debtor to pay outstanding default-rate interest as a condition for reinstating the loan.
Accordingly, because the underlying loan documents provided for default-rate interest, the debtor could not cure its default without paying such rate.  Additionally, the court noted that the requirement to pay default-rate interest in the underlying documents complied with applicable state law.  As such, if the debtor wanted to cure the default and reinstate the loan, it had to pay default-rate interest.
Waiver of Late Fees
The Eleventh Circuit further held that the bankruptcy court and district courts’ findings that the lender waived its right to default-rate interest by demanding late fees were based on clearly erroneous findings.  Rather, the record clearly demonstrated that even though the lender first demanded both default-rate interest and late fees, the lender explicitly withdrew its claim for late fees for any period in which the court would allow default-rate interest.
The court also noted that relevant state law provides that all consistent remedies may be pursued concurrently to final adjudication, so long as a party does not actually received satisfaction of its claim.   Because at the time the lender waived its claim for late fees, its claims had not been finally adjudicated, the lender was entitled to default-rate interest.  The court declined to address whether a creditor could ever demand both late fees and default rate interest.
Finally, the court addressed the bankruptcy court’s finding that the lender could not receive default-rate interest due to improper notice of default to the debtor.  Both the district court and the circuit court held that such faulty notice was legally irrelevant, because the underlying loan documents did not require the lender to give notice of default to the debtor.
The Eleventh Circuit concluded that the wording of section 1123(d) provides a clear mandate that allows a creditor to demand default-rate interest as a condition for reinstating the loan, if the underlying documents so provide.  The court specifically did not address the issues of whether the lender could receive attorneys’ fees and costs and the timing for a debtor having to provide default-rate interest to a lender to cure its default.  We will keep you posted on any developments in these areas.