GECC v. Future Media Productions Inc.
9th Circuit Case # 07-55694
Second Amendment October 24, 2008; Amended August 7, 2008; originally filed July 3, 2008
(On direct appeal from the bankruptcy court under BAPCPA's new subsection 28 U.S.C. § 158(d)(2), providing for discretionary appellate jurisdiction over non-final orders of the bankruptcy court upon proper certification of that court or of all parties.)
The Ninth Circuit considered here whether an oversecured creditor, GECC, was entitled to its pre-default or rather its higher default rate of interest under § 506(b), which provides that such creditor “shall be allowed . . . interest . . . provided for under the agreement or State statute under which such claim arose.” The difference between the two rates of interest was only 2%, but since the debt at issue was nearly $6 million, about $165,000 of interest differential was at issue.
The Court's decision turned on whether or not this case was distinguishable from Ninth Circuit precedent as established in In re Entz-White Lumber and Supply, Inc., 850 F.2d 1338 (9th Cir. 1988), and whether that precedent and this case were affected by last year's U.S. Supreme Court opinion in Travelers Cas. & Sur. Co. of Am. v. Pac. Gas & Elec. Co., 127 S. Ct. 1199 (2007).
The Ninth Circuit distinguished this case from Entz-White, by restricting that precedent to "the rule that an oversecured creditor was not entitled to interest at the default rate when its claim was paid in full pursuant to the terms of a Chapter 11 plan." This is the so-called per se rule against using a default interest rate. Here to the contrary, GECC's claim was NOT paid off through the Chapter 11 plan but rather "as a result of a series of asset sales outside of a Chapter 11 plan." Therefore the Court held that the per se rule against use of the default interest rate was not applicable here, and remanded to the bankruptcy court "to decide whether the default rate should apply under the rule adopted by the majority of federal courts . . . : The bankruptcy court should apply a presumption of allowability for the contracted for default rate, 'provided that the rate is not unenforceable under applicable nonbankruptcy law'."
The Ninth Circuit also held that this "majority rule" is consistent with the Travelers Supreme Court opinion (which specifically addressed creditors' attorney fees), but Entz-White is not overturned by Travelers either. Let me explain.
The Essential Facts
Future Media owed a substantial commercial loan to GECC, secured by a first priority security interest on substantially all of Future Media's assets. The loan's terms included a default interest rate: a 2% increase in the rate if Future Media defaulted on loan payments. Future did default, which triggered the interest rate increase. Future Media then filed a liquidating Chapter 11 case, having "executed an agency agreement to sell its assets in an auction." It immediately arranged to enter into a "cash collateral" agreement with GECC--allowing it to use cash, which was collateral on the GECC debt, for winding down its business and preparing for the auction. The cash collateral agreement was delayed by objections from unsecured creditors, including an objection about GECC's right to impose the higher default interest rate (thereby reducing what was available to unsecured creditors from the liquidating auction). An amended cash collateral agreement was entered into allowing the default interest rate issue to be decided separately. On a subsequent motion raising that issue, the bankruptcy court decided that GECC was only entitled to the lower pre-default interest rate pursuant to the Entz-White opinion, and GECC appealed.
The Ninth Circuit's Rationale
In Travelers the Supreme Court said that “[c]reditors’ entitlements in bankruptcy arise in the first instance from the underlying substantive law creating the debtor’s obligation, subject to any qualifying or contrary provisions of the Bankruptcy Code.” The Ninth Circuit said that the facts in Entz-White fit within such a "qualifying or contrary provision" of the Code, but the present case did not. In Entz-White the specific issue was whether a creditor's claim was considered "impaired" for purposes of voting on a Chapter 11 plan, which it is not if the debtor "cures" any pre- or post-petition defaults. And since the Code permits "cures" under § 1124(2)(A) to negate all consequences of default including the imposition of a default interest rate, the debtor was permitted to avoid this higher rate "to cure a default to render it unimpaired for voting on a Chapter 11 plan." In the present case in contast, "GECC's oversecured claim was paid through a sale of assets governed by § 363, outside the context of a Chapter 11 plan" and so "the facts of Entz-White are distinguishable, and thus our per se rule from that case is inapplicable." "Because the Bankruptcy Code does not provide a 'qualifying or contrary provision' to the underlying substantive law here [as now required by Travelers], the bankruptcy court's extension of Entz-White to the loan agreement's default rate was error." Instead The Ninth Circuit remanded to the bankruptcy court to apply the federal majority rule as quoted above.
Applicability to Chapter 13?
This Future Media case and Entz-White are both Chapter 11 cases, referring to sections of the Code which are unique to Chapter 11. But are their holdings also applicable to Chapter 13 cases? Are Chapter 13 oversecured creditors, whose claims are after all also covered by § 506(b), entitled to their default interest rate, and do the same rules specified above govern this question? To quote a controversial remark by a former Presidential candidate now President-elect, that question is "above my pay grade" at least for purposes of this Bulletin. My suspicion is that fully secured creditors paid through a Chapter 13 plan, such as a vehicle loan paid in full through the plan, are not entitled to a default interest rate but a creditor not being paid through the Plan, such as a current home mortgage, is entitled to default interest. But I could very well be wrong. I would appreciate comments from any readers who know.
Note that although Travelers was also a Chapter 11 case, the Supreme Court's overturning of the 9th Circuit's Fobian rule on creditor's attorney fees does apply to Chapter 13 since it involves interpretation of §502(b) of the Code, applicable to all Chapters. Please see my earlier Bulletin on Travelers entitled: Reminder about U.S. Supreme Ct's Reversal of 9th Circuit's Fobian Rule on Creditors' Atty Fees: Fees Recoverable Even on Issues Peculiar to B'cy Law
(On direct appeal from the bankruptcy court under BAPCPA's new subsection 28 U.S.C. § 158(d)(2), providing for discretionary appellate jurisdiction over non-final orders of the bankruptcy court upon proper certification of that court or of all parties.)
The Ninth Circuit considered here whether an oversecured creditor, GECC, was entitled to its pre-default or rather its higher default rate of interest under § 506(b), which provides that such creditor “shall be allowed . . . interest . . . provided for under the agreement or State statute under which such claim arose.” The difference between the two rates of interest was only 2%, but since the debt at issue was nearly $6 million, about $165,000 of interest differential was at issue.
The Court's decision turned on whether or not this case was distinguishable from Ninth Circuit precedent as established in In re Entz-White Lumber and Supply, Inc., 850 F.2d 1338 (9th Cir. 1988), and whether that precedent and this case were affected by last year's U.S. Supreme Court opinion in Travelers Cas. & Sur. Co. of Am. v. Pac. Gas & Elec. Co., 127 S. Ct. 1199 (2007).
The Ninth Circuit distinguished this case from Entz-White, by restricting that precedent to "the rule that an oversecured creditor was not entitled to interest at the default rate when its claim was paid in full pursuant to the terms of a Chapter 11 plan." This is the so-called per se rule against using a default interest rate. Here to the contrary, GECC's claim was NOT paid off through the Chapter 11 plan but rather "as a result of a series of asset sales outside of a Chapter 11 plan." Therefore the Court held that the per se rule against use of the default interest rate was not applicable here, and remanded to the bankruptcy court "to decide whether the default rate should apply under the rule adopted by the majority of federal courts . . . : The bankruptcy court should apply a presumption of allowability for the contracted for default rate, 'provided that the rate is not unenforceable under applicable nonbankruptcy law'."
The Ninth Circuit also held that this "majority rule" is consistent with the Travelers Supreme Court opinion (which specifically addressed creditors' attorney fees), but Entz-White is not overturned by Travelers either. Let me explain.
The Essential Facts
Future Media owed a substantial commercial loan to GECC, secured by a first priority security interest on substantially all of Future Media's assets. The loan's terms included a default interest rate: a 2% increase in the rate if Future Media defaulted on loan payments. Future did default, which triggered the interest rate increase. Future Media then filed a liquidating Chapter 11 case, having "executed an agency agreement to sell its assets in an auction." It immediately arranged to enter into a "cash collateral" agreement with GECC--allowing it to use cash, which was collateral on the GECC debt, for winding down its business and preparing for the auction. The cash collateral agreement was delayed by objections from unsecured creditors, including an objection about GECC's right to impose the higher default interest rate (thereby reducing what was available to unsecured creditors from the liquidating auction). An amended cash collateral agreement was entered into allowing the default interest rate issue to be decided separately. On a subsequent motion raising that issue, the bankruptcy court decided that GECC was only entitled to the lower pre-default interest rate pursuant to the Entz-White opinion, and GECC appealed.
The Ninth Circuit's Rationale
In Travelers the Supreme Court said that “[c]reditors’ entitlements in bankruptcy arise in the first instance from the underlying substantive law creating the debtor’s obligation, subject to any qualifying or contrary provisions of the Bankruptcy Code.” The Ninth Circuit said that the facts in Entz-White fit within such a "qualifying or contrary provision" of the Code, but the present case did not. In Entz-White the specific issue was whether a creditor's claim was considered "impaired" for purposes of voting on a Chapter 11 plan, which it is not if the debtor "cures" any pre- or post-petition defaults. And since the Code permits "cures" under § 1124(2)(A) to negate all consequences of default including the imposition of a default interest rate, the debtor was permitted to avoid this higher rate "to cure a default to render it unimpaired for voting on a Chapter 11 plan." In the present case in contast, "GECC's oversecured claim was paid through a sale of assets governed by § 363, outside the context of a Chapter 11 plan" and so "the facts of Entz-White are distinguishable, and thus our per se rule from that case is inapplicable." "Because the Bankruptcy Code does not provide a 'qualifying or contrary provision' to the underlying substantive law here [as now required by Travelers], the bankruptcy court's extension of Entz-White to the loan agreement's default rate was error." Instead The Ninth Circuit remanded to the bankruptcy court to apply the federal majority rule as quoted above.
Applicability to Chapter 13?
This Future Media case and Entz-White are both Chapter 11 cases, referring to sections of the Code which are unique to Chapter 11. But are their holdings also applicable to Chapter 13 cases? Are Chapter 13 oversecured creditors, whose claims are after all also covered by § 506(b), entitled to their default interest rate, and do the same rules specified above govern this question? To quote a controversial remark by a former Presidential candidate now President-elect, that question is "above my pay grade" at least for purposes of this Bulletin. My suspicion is that fully secured creditors paid through a Chapter 13 plan, such as a vehicle loan paid in full through the plan, are not entitled to a default interest rate but a creditor not being paid through the Plan, such as a current home mortgage, is entitled to default interest. But I could very well be wrong. I would appreciate comments from any readers who know.
Note that although Travelers was also a Chapter 11 case, the Supreme Court's overturning of the 9th Circuit's Fobian rule on creditor's attorney fees does apply to Chapter 13 since it involves interpretation of §502(b) of the Code, applicable to all Chapters. Please see my earlier Bulletin on Travelers entitled: Reminder about U.S. Supreme Ct's Reversal of 9th Circuit's Fobian Rule on Creditors' Atty Fees: Fees Recoverable Even on Issues Peculiar to B'cy Law
by: Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com
Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.
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