Finding a "cure:" How Much Interest Is Enough for a Chapter 11 Cure?

• Publication year: 2017

Finding a "Cure:" How Much Interest Is Enough for a Chapter 11 Cure?

Jacob Dean

FINDING A "CURE": HOW MUCH INTEREST IS ENOUGH FOR A CHAPTER 11 CURE?

Abstract

Default-rate interest can quickly and easily amount to millions of dollars. In a chapter 11 bankruptcy proceeding, default-rate interest can jeopardize a plan's chances at confirmation. As one commentator described, "[i]n a bankruptcy case, interest is the tail of the dog, but it is a long tail and it wags a lot."¹ Default-rate interest—interest triggered by breach of a contractual obligation—implicates both a determination of claim's status and the claim's ultimate confirmation. In August 2015, a panel of judges on the Eleventh Circuit ruled on the matter, creating a circuit split for a brief time until a Ninth Circuit panel addressed the question in 2016. Last year, the Ninth Circuit eliminated the split. While the Eleventh Circuit three-judge panel was unanimous, the Ninth Circuit decision split two-to-one, with a fiery dissent. The Ninth Circuit decision also reversed a previous decision by another panel. All circuits agree the plain language of the Bankruptcy Reform Act of 1994, an amendment Congress added in 1994 to overrule a Supreme Court case, allows for collection of default interest. The circuits previously disagreed, however, whether Congress intended a requirement for "cure" to be payment of interest at the default rate. This Comment explains why both panels are incorrect.

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Introduction

An August 2015 decision by the Eleventh Circuit briefly created a circuit split on an issue of importance to many debtors in chapter 11 bankruptcy.² The split concerns whether, under § 1123 of the Bankruptcy Code ("Code"), a debtor who has defaulted on a loan must pay interest at the contractual default rate to cure the default.³ The Eleventh Circuit ultimately held in the affirmative and ruled for the creditors, joining several other circuits.⁴ In contrast, federal courts within the Ninth Circuit, most notable among them the Bankruptcy Appellate Panel for the Ninth Circuit, had, until November 2016, continued to construe the statute consistent with their previous holdings issued before the Bankruptcy Reform Act of 1994.⁵ The Ninth Circuit's recent decision resolved the split but did not assuage concerns that the holding of both courts is incorrect. Disputes and disagreements regarding statutory construction, the importance (or lack thereof) of congressional intent, and general Code interpretation are at the core of this issue.

This Comment will argue the Eleventh Circuit's interpretation frustrates Congress's pro-debtor amendment and creates unnecessary tension within the Code. While the Ninth Circuit joined the Eleventh Circuit in demanding default-rate interest to satisfy a cure, a judge on the panel dissented. Her dissent offers a cogent explanation for the majority's error.

First, this Comment will explore the broader purpose of chapter 11 bankruptcy and fully explain the two most relevant statutory provisions. Following the introduction, this Comment will proceed in three parts by (1) detailing the recent Eleventh and Ninth Circuit cases; (2) surveying jurisprudence both before and after the seminal Code amendments in 1994; and

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(3) exploring Congress's motivation for enacting the Bankruptcy Reform Act of 1994. Next, this Comment will discuss and analyze the differing approaches taken by the circuit courts. Finally, a proposed hybrid approach—as well as a call for Congress to clarify its intent—will be offered.

A. Purpose of Chapter 11 Bankruptcy

As the Eleventh Circuit has stated, the "ultimate goal of Chapter 11 is to marshall [sic] [] resources to provide the best possible opportunity for a successful rehabilitation which will ultimately redound to the benefit of all creditors."⁶ One of the primary benefits of a chapter 11 bankruptcy is permitting a business to continue operations so as to not disrupt the economic fabric of the community.⁷ Indeed, protecting the business and ensuring its continued operation and survival is in the best interest of both the creditor(s) and the public generally.⁸ Not only does protecting the business ensure its viability, but it also increases the likelihood of creditors receiving more on debts owed. To effectuate that goal, obtaining confirmation of a reorganization plan is imperative,⁹ and the Code delegates "broad equitable powers" to courts "to balance the interests of the affected parties" to successfully confirm a reorganization plan.¹⁰

Figure 1, below, displays the various Code provisions and their applicability and importance to understanding the circuit split. The following

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discussion details a summary of the existing Code and several of its pertinent intricacies.

1. Impaired Versus Unimpaired Creditors Under § 1124

Determining which claims or classes of claims are impaired and unimpaired is important for the viability of a reorganization plan.¹¹ Impaired creditors under chapter 11 have a right to vote on whether to accept a reorganization plan; unimpaired creditors, however, do not have this right.¹² Unimpaired creditors are "conclusively presumed to have accepted the plan."¹³ Section 1124 describes two exceptions in which a class of claims or interest is considered unimpaired.¹⁴ In the first exception, a claim is considered unimpaired if the plan "leaves unaltered the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest."¹⁵ Under the second exception, a claim is considered unimpaired if a creditor receives accelerated payment of claim or interest and the default is "cured," among other requirements.¹⁶

By objecting, an impaired creditor can prevent or substantially thwart a reorganization plan from being approved by the court, especially when there is only one creditor.¹⁷ To determine if a claim or interest is impaired, one must examine § 1124 of the Code, which states that:

[A] class of claims or interests is impaired under a plan unless, with respect to each claim or interest of such class, the plan—

(1) leaves unaltered the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest; or

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(2) notwithstanding any contractual provision or applicable law that entitles the holder of such claim or interest to demand or receive accelerated payment of such claim or interest after the occurrence of a default—

(A) cures any such default that occurred before or after the commencement of the case under this title, other than a default of a kind specified in section 365(b)(2) of this title or of a kind that section 365(b)(2) expressly does not require to be cured;
B) reinstates the maturity of such claim or interest as such maturity existed before such default;
(C) compensates the holder of such claim or interest for any damages incurred as a result of any reasonable reliance by such holder on such contractual provision or such applicable law;
(D) if such claim or such interest arises from any failure to perform a nonmonetary obligation, other than a default arising from failure to operate a nonresidential real property lease subject to section 365(b)(1)(A), compensates the holder of such claim or such interest (other than the debtor or an insider) for any actual pecuniary loss incurred by such holder as a result of such failure; and
(E) does not otherwise alter the legal, equitable, or contractual rights to which such claim or interest entitles the holder of such claim or interest.¹⁸

This provision provides debtors with two alternatives in which otherwise impaired claims can be considered unimpaired. The second alternative, in § 1124(2), provides for five additional requirements (other than the requirements found in § 1124(2)(A)) that a debtor must satisfy to render a claim unimpaired.¹⁹ Each of these additional requirements renders the creditor whole in some way and ensures the claims retain "all of their prepetition legal, equitable, and contractual rights against the debtor."²⁰ The legislative history behind the amendments sheds light on this provision. As the Senate Report on the Bankruptcy Reform Act of 1994 ("the Act") noted, a "claim or interest is

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unimpaired by curing the effect of a default and reinstating the original terms of an obligation."²¹

2. Contents of a Plan: Requirements and Options under § 1123

Section 1123(a) prescribes the requirements for what a chapter 11 bankruptcy plan must include.²² One requirement is that the plan "provide adequate means for the plan's implementation, such as . . . curing or waiving [] any default."²³ Section 1123(b) sets forth optional elements of what a plan "may" do, subject to § 1123(a).²⁴ Subsection (c) applies to an individual debtor's property exempted under § 522.²⁵ Section 1123 did not contain any reference to "cure" until Congress passed the Act. Under the Act, Congress amended § 1123, adding subsection (d) to require that any cure accord with the underlying contract and nonbankrupty law.²⁶

In 1994, in an effort to expressly overrule a Supreme Court case, Rake v. Wade,²⁷ Congress prescribed how a plan may "cure" a default and importantly, included the same definition of "cure" in three sections: §§ 1123, 1222, and 13 22.²⁸ The definition provides:

Notwithstanding subsection (a) of this section and sections 506(b), 1129(a)(7), and 1129(b) of this title, if it is proposed in a plan to cure a default the amount necessary to cure the default shall be determined in accordance with the underlying agreement and applicable nonbankruptcy law.²⁹

Notably (and confusingly), Congress did not include the same language in § 1124 to define cure. Creditors, seizing on the new definition, sought to apply

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the § 1123 definition to the § 1124(2)(A) context, arguing that defaults should be cured consistent with the "underlying agreement and applicable nonbankrupcty law."³⁰ In doing so...