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As required by underlying loan agreement, debtor could cure default only by making plan payments at higher post-default interest rate.
Pacifica L 51, LLC v New Invs., Inc. (In re New Invs., Inc.) (9th Cir 2016) 840 F3d 1137
New Investments borrowed approximately $3 million from Pacifica’s predecessor in interest to purchase a hotel property. The note, which was secured by a deed of trust, provided for interest at 8 percent. The note also explicitly provided that the interest rate would increase to 13 percent if New Investments were to default. New Investments defaulted in 2009 and subsequently filed for Chapter 11 bankruptcy. Its reorganization plan proposed to cure the default by selling the property to a third party and using the proceeds to pay the outstanding amount at the pre-default 8 percent rate. Pacifica objected on grounds that it was entitled to the 13 percent post-default rate under the terms of the note. The bankruptcy court confirmed New Investments’ plan and authorized the sale of the hotel. Pacifica timely appealed.
The Ninth Circuit reversed, holding that New Investments was required to cure its default under the express terms of the loan agreement. In 1988, the Ninth Circuit had previously held that a debtor’s plan of reorganization could include a provision authorizing the debtor to remedy a default and return to pre-default conditions under 11 USC §1123. Great W. Bank & Trust v Entz-White Lumber & Supply, Inc. (In re Entz-White Lumber & Supply, Inc.) (1988) 850 F2d 1338. In 1994, however, Congress added 11 USC §1123(d) to provide that “the amount necessary to cure default shall be determined in accordance with the underlying agreement and applicable nonbankruptcy law.” Examining both the plain language of the amendment and its legislative history, the court concluded that 11 USC §1123(d) no longer permitted a debtor to nullify a preexisting contractual obligation to pay post-default interest simply by proposing a cure, and thus superseded the Entz-White rule. Applying common law contract principles here, the note expressly provided that the interest rate would increase to 13 percent on default. Accordingly, New Investments was required to make payments at the higher post-default rate to effectuate a cure.
THE EDITOR’S TAKE: This court’s decision that the enactment of §1123(d) of the Bankruptcy Reform Act of 1994—that the amount necessary to cure a default is to be determined “in accordance with the underlying agreement and the applicable bankruptcy law”—means that a creditor can now demand the higher, default interest rate specified in its promissory note as long as it is permitted by state law. This conclusion is contrary to the court’s earlier Entz-White decision (In re Entz-White Lumber & Supply, Inc. (1988) 850 F2d 1338) and means that now a bankruptcy judge must look at both what the loan documents say and what state law says to determine whether the original interest rate or a higher default rate applies. Of course, if the note itself does not include a default interest provision (or if there is such a clause but it has not been triggered by the events that occurred), there is no need to look at that state law.
In this case, that state law came in from Washington, whose statute permits reinstatement on payment of “the entire amount then due under the terms of the deed of trust and the obligation secured thereby.” This looks pretty similar to CC §2924c (“may pay ... the entire amount due ... with respect to all amounts of principal [and] interest ... that are in default ... under the terms of the deed of trust and the obligation secured thereby ... and thereby cure the default” (a very incomplete quote from our statute)). I don’t read either statute to expressly approve of a higher default interest rate, but the Ninth Circuit panel seems to have done so with regard to the Washington provision, and therefore would probably also do so for California’s.
There is the risk of running afoul of our state supreme court decision in Garrett v Coast & S. Fed. Sav. & Loan Ass’n (1973) 9 C3d 731, superseded by statute as stated in Walker v Countrywide Home Loans, Inc. (2002) 98 CA4th 1158, reported at 25 CEB RPLR 199 (Sept. 2002)—which invalidated a provision that called for “additional interest at the rate of two (2%) per cent per annum on the unpaid principal balance” following a default—although that consequence is generally avoided by decent drafting.
Lenders will cheer and borrowers will weep about this, but the split between the majority and dissenting judges in the New Inv. decision means the fight may not be over. There is an ongoing fight within the bankruptcy bar over which side is correct—a matter too technical for most of us real estate attorneys to understand. Compare the positions taken in 36 Am Bankr Inst J 16 (Jan. 2017) and in 36 Bankruptcy Law Letter No. 12 (Dec. 2016) (Thompson Reuters). Stay tuned.—Roger Bernhardt
39 Real Property Law Reporter 34 (Cal CEB Jan. 2017), © The Regents of the University of California, reprinted with permission of CEB.