To “cure and reinstate its loan under a plan of reorganization,” Bankruptcy Judge Philip Bentley of New York held that “the Debtor must pay default interest and fees to the extent required by its loan agreement and New York law.”
In his July 31 decision, Judge Bentley said that three sections of the Bankruptcy Code “bear directly on the issue,” Sections 1123(d), 1124(2)(A) and 365(b)(2)(D). He found that “only a handful of decisions have even mentioned all three of these provisions.” Moreover, he said that caselaw in the Second Circuit and elsewhere “provides little help in resolving the difficult statutory construction issues facing the Court.”
Since “none of these decisions rest on a thorough analysis of the three operative Bankruptcy Code sections and how they intersect,” Judge Bentley undertook his “own analysis.”
Payment Defaults on a Large Mortgage
The debtor owned a 50-story hotel in Manhattan subject to a $137 million, 10-year standing mortgage at 5.259% annual interest. Before bankruptcy, the debtor committed a payment default. The lenders accelerated, kicking in default interest at five percentage points above the contract rate.
The debtor filed a chapter 11 petition before the lenders could install a receiver. The lenders filed a secured claim for $179 million, including almost $18 million in default-rate interest plus more than $2 million in fees.
The debtor was aiming to preserve the below-market 5.259% mortgage, but without paying default interest and fees. So, the debtor filed a chapter 11 plan asserting the right to cure and assume the mortgage, but without paying about $20 million in default interest and fees.
Rather than test the debtor’s theory at confirmation, the parties agreed to have Judge Bentley resolve the question beforehand.
The Three Questions
Judge Bentley identified three questions:
1. Should the court apply the “plain terms” of Section 1123(d) to require payment of all cure amounts required by the contract and nonbankruptcy law?
2. Does the carveout for cures in Section 365(b)(2)(D) apply to loan agreements or only to executory contracts and unexpired leases?
3. Should the cure carveout in Section 365(b)(2)(D) apply to all “penalty rates” or only to penalties triggered by non-monetary defaults?
The debtor won the first two but lost on the third. Curing and reinstating the mortgage will require paying default interest and fees.
The First Two Questions
In their current form, Judge Bentley said that Sections 1123(d), 1124(2)(A) and 365(b)(2)(D) “were not part of the Bankruptcy Code when it was enacted in 1978. Instead, each provision was added or amended by one or both of the omnibus bankruptcy reform statutes that Congress passed in 1994 and 2005, and the congressional purposes underlying these amendments are not always discernable.”
Judge Bentley said that the “cure requirements for reinstatement and assumption w[ere] straightforward until 1994, when the passage of the Bankruptcy Reform Act threw a wrench into the works.” The legislation’s amendments to both Sections 365(b) and 1123 “have confounded courts ever since,” he said.
Before the Reform Act, Judge Bentley said that Second Circuit authority could be read to mean that a plan could deaccelerate and reinstate a defaulted debt. However, he said that the amendments “materially changed” the statute. Now, he said that “§ 1123(d) mandates the payment of default interest to the extent required by the parties’ contract and permitted by non-bankruptcy law.”
Judge Bentley analyzed whether Sections 1124(2)(A) and 365(b)(2)(D) created an exception to the plain language in Section 1123(d). He said that Section 1124(2)(A) “sets forth a conflicting, and equally unambiguous, directive: to de-accelerate defaulted debt and render it unimpaired, the debtor need not cure ‘a default of a kind specified in § 365(b)(2) of this title or of a kind that section 365(b)(2) expressly does not require to be cured.’” [Emphasis in original.]
Judge Bentley handed the debtor a first, interim victory when he concluded that “the carve-out created by § 1124(2)’s incorporation of § 365(b)(2)(D) must be treated as an exception to § 1123(d)’s otherwise absolute mandate.”
Judge Bentley gave the debtor a second victory when he adopted “the more natural reading of § 1124(2)(A): that it excuses defaults arising under loan agreements, so long as the defaults are ‘of a kind’ addressed by § 365(b)(2) — that is, ipso facto defaults, and failures to satisfy penalty rates and penalty provisions relating to non-monetary defaults.”
The Third Question
The debtor lost on the third and final question dealing with the scope of Section 365(b)(2)(D). The subsection exempts from the cure requirements “the satisfaction of any penalty rate or penalty provision relating to a default arising from any failure by the debtor to perform nonmonetary obligations under the executory contract or unexpired lease.”
The question is this: Does the exemption apply to “any penalty rate” or only to penalty rates resulting from failure to perform nonmonetary obligations?
In the case before Judge Bentley, the penalty rate resulted from breach of a monetary obligation. Therefore, the debtor would win only if Judge Bentley were to interpret the exception as applying to “any penalty rate.”
Judge Bentley found the answer in “conventions of ordinary speech” and in the “interpretative canon known as the series-qualifier canon, which provides that, when a series of nouns are followed by a modifying clause, that clause modifies every noun in the series, not just the last.” Consequently, he held that the “section excused cure only of penalty provisions, and not also of the underlying defaults.”
To “cure and reinstate its loan under a plan of reorganization,” Judge Bentley held that “the Debtor must pay default interest and fees to the extent required by its loan agreement and New York law.”
Observations
This report does not do justice to Judge Bentley’s meticulous, 40-page opinion. An adequate discussion would be twice the length of his opinion. Anyone facing a similar question should read the opinion in full text.
Judge Bentley’s opinion also contains extensive discussion of an article by Prof. Ralph Brubaker, who reached a different conclusion that would award victory to the debtor. See Ralph Brubaker, Default Rates of Interest and Cure of a Defaulted Debt in a Chapter 11 Plan of Reorganization (Part II): Entz-White and the “Penalty Rate” Amendments (“Default Rates of Interest, Part II”), 37 Bankr. L. Letter No. 1 (2017).
Prof. Brubaker’s article also must be read in full to appreciate the complexity of the question and the professor’s different point of view.
Question
Does the same rule apply to loans where the lender has not accelerated or kicked in the default rate before bankruptcy?
To “cure and reinstate its loan under a plan of reorganization,” Bankruptcy Judge Philip Bentley of New York held that “the Debtor must pay default interest and fees to the extent required by its loan agreement and New York law.”
In his July 31 decision, Judge Bentley said that three sections of the Bankruptcy Code “bear directly on the issue,” Sections 1123(d), 1124(2)(A) and 365(b)(2)(D). He found that “only a handful of decisions have even mentioned all three of these provisions.” Moreover, he said that caselaw in the Second Circuit and elsewhere “provides little help in resolving the difficult statutory construction issues facing the Court.”
Since “none of these decisions rest on a thorough analysis of the three operative Bankruptcy Code sections and how they intersect,” Judge Bentley undertook his “own analysis.”