Siding with the minority on an issue where the courts are split, the Eighth Circuit Bankruptcy Appellate Panel reversed the bankruptcy court and held that equitable factors may not be considered to disallow the default rate of interest to an oversecured creditor under Section 506(b).
The Unexpectedly Successful Auction
The chapter 11 debtor was forced to sell its pharmacy business. It wasn’t looking good. There were three secured creditors with claims of $11 million, $1 million and $16 million, in order of priority. The stalking horse bidder at the Section 363 sale was only offering $8 million — not enough to pay off the first lien.
The first-lien debt was current on filing. There were no payments to the senior lender after filing because the interim and final cash collateral orders did not call for any. The nondefault contract interest rates on the tranches owing to the first-lien lender ranged between 3.65% and 7.5%. The contractual default rate was 18%.
The auction was unexpectedly successful, with a final bid of almost $14 million, or enough to pay the first lien in full at the nondefault contract rate. The sale proceeds would also pay the second lien in full.
After paying the second-lien lender and the senior lender’s counsel fees, there was a surplus of about $550,000 that would be available for the third-lien lender. The first-lien lender, however, made a claim for more than $440,000 in post-petition interest at the 18% default rate specified in the note.
The bankruptcy court denied the claim for default interest, concluding that the default rate was an unenforceable penalty under Missouri law. Alternatively, the bankruptcy court ruled that equitable considerations permitted the disallowances of default interest. To read ABI’s report on the bankruptcy court’s opinion, click here.
The BAP’s Reversal
The senior lender appealed and won in a March 19 opinion for the BAP by Bankruptcy Judge Thomas L. Saladino of Omaha, Neb. His opinion made two holdings, both grounded on Section 506(b).
To the extent a creditor is oversecured, the section provides that “there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided under the agreement or State statute under which such claim arose.”
Judge Saladino began with Ron Pair, the premier Supreme Court decision on the plain-meaning doctrine of statutory interpretation. U.S. v. Ron Pair Enterprises Inc., 489 U.S. 235 (1989). He characterized the opinion as holding that “all oversecured creditors are entitled to postpetition interest,” regardless of whether the lien is consensual or nonconsensual.
Ron Pair did not prescribe the allowable rate of interest, but “most courts” have decided that postpetition interest should be computed at the contract rate, Judge Saladino said.
Turning to the issues on appeal, Judge Saladino first addressed the lower court’s conclusion that the 18% default interest rate was an unenforceable penalty under Missouri law.
There were no Missouri cases applying a liquidated damages analysis to allowance of a contractual rate of interest. Furthermore, 18% is a legal rate under Missouri law, Judge Saladino said.
Next, Judge Saladino said that Ron Pair “was clear” that the reasonableness qualification in Section 506(b) only applies to fees, costs and charges, but not to the allowance of interest. He therefore held that “the bankruptcy court erred in applying a liquidated damages analysis and ruling the default interest rate was an unenforceable penalty.”
Judge Saladino turned to the bankruptcy court’s alternative holding: Equitable considerations — such as the large spread between the nondefault and the default rate — permitted disallowance of the default rate. In that regard, the bankruptcy court had said that the Second, Third, Fifth, Seventh and Ninth Circuits hold that equitable factors may be considered.
Conceding that the bankruptcy court’s decision “likely” represented “the majority position since Ron Pair,” Judge Saladin observed, however, that the Eighth Circuit had not taken a position.
Following the teachings of Law v. Siegel, 571 U.S. 415 (2014), Judge Saladino ruled that “no section of the Bankruptcy Code gives the bankruptcy court authority, equitable or otherwise, to modify a contractual interest rate prior to plan confirmation.”
He therefore held that interest must be computed at the default rate, “as long as [the default rate is] allowed under state law.”
Judge Saladino remanded for the bankruptcy court to decide whether the default rate was automatically invoked by the payment default after filing, or perhaps waived by the senior lender.
Siding with the minority on an issue where the courts are split, the Eighth Circuit Bankruptcy Appellate Panel reversed the bankruptcy court and held that equitable factors may not be considered to disallow the default rate of interest to an oversecured creditor under Section 506(b).
The Unexpectedly Successful Auction
The chapter 11 debtor was forced to sell its pharmacy business. It wasn’t looking good. There were three secured creditors with claims of $11 million, $1 million and $16 million, in order of priority. The stalking horse bidder at the Section 363 sale was only offering $8 million — not enough to pay off the first lien.
The first-lien debt was current on filing. There were no payments to the senior lender after filing because the interim and final cash collateral orders did not call for any. The nondefault contract interest rates on the tranches owing to the first-lien lender ranged between 3.65% and 7.5%. The contractual default rate was 18%.
The auction was unexpectedly successful, with a final bid of almost $14 million, or enough to pay the first lien in full at the nondefault contract rate. The sale proceeds would also pay the second lien in full.
After paying the second-lien lender and the senior lender’s counsel fees, there was a surplus of about $550,000 that would be available for the third-lien lender. The first-lien lender, however, made a claim for more than $440,000 in post-petition interest at the 18% default rate specified in the note.