In a split decision, the Ninth Circuit held that the addition of Section 1123(d) to the Bankruptcy Code in 1994 legislatively overruled the appeals court’s 1988 decision in Entz-White. Unless the November 4 opinion is set aside on en banc review, debtors in the Ninth Circuit henceforth must pay interest at the default rate to cure a default.
Interpreting a statute designed to lower a debtor’s interest burden, the majority increased interest cost, although in line with the underlying mortgage.
In dissent, Circuit Judge Marsha S. Berzon argued that neither the text nor the legislative history accompanying Section 1123(d) showed a clear congressional intent to overrule Entz-White.
The Facts of the Case
The case involved a corporate debtor that had defaulted on a mortgage calling for the interest rate to increase five percentage points after default. The bankruptcy judge confirmed the chapter 11 plan allowing the debtor to sell the property and pay off the mortgage at the lower non-default interest rate.
The bankruptcy judge required the debtor to escrow almost $800,000 to protect the lender in case an appellate court were to require paying the default rate.
At the request of both parties, the Ninth Circuit allowed a direct appeal, overstepping an intermediate appeal to the district court or the Bankruptcy Appellate Panel.
Entz-White, Rake and the Addition of Section 1123(d)
Although Section 1123(a)(5)(G) allows a plan to cure a default on secured debt, the Ninth Circuit noted in Entz-White that nothing in the Bankruptcy Code defines what it means to cure a default. In that case, the appeals court held that curing entitles a debtor to “avoid all the consequences of the default including the higher post-default interest rate.” Entz-White therefore allowed a debtor to cure a default by paying arrears at the lower non-default rate.
Five years later, in Rake v. Wade, the Supreme Court held in 1993 that curing a default required a chapter 13 debtor to pay interest on arrears even if the underlying documents did not. For the stated purpose of overruling Rake v. Wade, Congress adopted Section 1123(d) in 1994 to bar creditors from collecting interest on interest. The House Report said that the new section would “limit the secured creditor to the benefit of the initial bargain with no court contrived windfall.”
Thus, Section 1123(d) was intended by Congress to give debtors a lighter burden in curing defaults. To achieve the intended result, Section 1123(d) says that the “amount necessary to cure the default shall be determined in accordance with the underlying agreement and applicable nonbankruptcy law” when a plan proposes to cure a default.
The appeal decided on Friday called on the Ninth Circuit to apply the statute to a situation Congress may not have had in mind when it adopted Section 1123(d).
The Majority Opinion
In the majority opinion for herself and Circuit Judge Susan P. Graber, Circuit Judge Mary H. Murguia held that Congress legislatively overruled Entz-White by adopting Section 1123(d).
Judge Murguia observed that state law permitted the mortgage to impose higher interest after default. Therefore, she said, the plain language of the statute “cannot nullify a preexisting obligation in a loan agreement to pay post-default interest solely by proposing a cure.”
Even if the statute were ambiguous, the result would be the same, Judge Murguia said, because the intent of the amendment was to hold “the parties to the benefit of their bargain.” She added that the “fact that Congress had a particular purpose in mind when enacting a statute does not limit the effect of the statute’s text.”
The Dissent
Dissenting, Judge Berzon said that neither the statutory text nor the legislative history shows a congressional intent to overrule Entz-White. She cited the Supreme Court’s decision in Hamilton v. Lanning for the proposition that the Bankruptcy Code should not be read to “erode past bankruptcy practice absent a clear indication that Congress intended such a departure.”
Judge Berzon said that the text and legislative history both “support the continuing validity of Entz-White.” She said that Section 1123(d) prescribes “which materials the parties may consult in determining how to cure a default.”
The amendment, Judge Berzon said, was designed to address “an entirely separate matter” and was not intended to “impose a severe penalty” on a debtor. She said the amendment was designed to prevent secured creditors from receiving a “windfall.”
Since Congress still has not defined what it means to cure a default, Judge Berzon said that stare decisis should have obligated the panel to follow Entz-White absent an en banc decision overturning the 1988 decision.