In re Sagamore Partners, Ltd: Eleventh Circuit Holds That a Creditor May Demand Default-rate Interest as a Condition for Reinstating Loan

Practical Law Legal Update 7-618-1053 (Approx. 5 pages)

In re Sagamore Partners, Ltd: Eleventh Circuit Holds That a Creditor May Demand Default-rate Interest as a Condition for Reinstating Loan

by Practical Law Bankruptcy & Restructuring and Practical Law Finance

Background

Sagamore Partners, Ltd. (Debtor) owns the Sagamore Hotel (Hotel). In 2006, Arbor Commercial Mortgage, LLC (Arbor) loaned the Debtor $31.5 million to refinance the Hotel. The details of the loan are set out in a promissory note and a related loan agreement (Agreement), both of which Arbor assigned to JPMCC 2006-LDP7 Miami Beach Lodging, LLC (Secured Lender).

The loan agreement required the Debtor to make interest-only payments of 6.54% per year until 2016, when all outstanding amounts would come due. However, the Agreement required the Debtor to pay a default-rate interest of 11.54% in the "Event of Default." An "Event of Default" would occur if the Debtor missed "any regularly scheduled payment with respect to any portion of the Debt when due." The Agreement stated that any "required or permitted" notice to the Debtor must be addressed to the Debtor's Florida address with a copy sent to the Debtor's New York counsel. The parties agreed that the Agreement did not require the Secured Lender to provide a notice of default.

Beginning in August 2009, the Debtor stopped making its payments. In September 2009, the Secured Lender sent a letter to the Debtor, but not to its New York counsel, declaring that the Debtor was in default. In November 2009, the Secured Lender sent a letter to the Debtor and its New York counsel accelerating the obligation to repay the loan. On the Debtor's failure to cure the default, the Secured Lender commenced a foreclosure action in state court in December 2009. The Debtor filed for bankruptcy on October 6, 2011.

In February 2012, the Secured Lender filed a proof of claim demanding interest from July 11, 2009, default interest, late charges, costs, attorneys' fees, expenses and all other charges and amounts accruing and imposed under the loan documents. In response, the Debtor filed a plan of reorganization in which it sought to cure and nullify the consequences of the alleged default by paying the accrued pre-default-rate interest. The Secured Lender objected that the plan did not allow for default-rate interest and the bankruptcy court rejected the plan.

The Debtor filed an amended plan, along with an objection to the Secured Lender's proof of claim in which it argued that it did not owe default-rate interest, because the Secured Lender demanded late fees and a creditor is not entitled to both default-rate interest and late fees. The plan proposed a fund that would contain all of the funds required to reinstate the indebtedness, in the amount determined by the court, and on the terms and conditions imposed by the court.

Outcome

The Eleventh Circuit held that:

A creditor may demand default-rate interest as a condition to reinstating the original terms of a loan. Under section 1123(d) of the Bankruptcy Code, to cure a default under a prepetition loan, a debtor must cure in accordance with the terms of the underlying agreement and applicable nonbankruptcy law.
The bankruptcy court's and district court's conclusion that the lender waived its right to default-rate interest by demanding late fees was based on clearly erroneous findings.
The faulty notice of default was legally irrelevant, because no notice of default was required.

Permissibility of Default-rate Interest

The Eleventh Circuit rejected the Debtor's argument that, even if the Secured Lender preserved its claim to default-rate interest, bankruptcy law does not allow the Secured Lender to demand default-rate interest as a condition to reinstating the original terms of the loan. The Eleventh Circuit noted that the Debtor's argument relied primarily on case law issued before the 1994 amendments to the Bankruptcy Code, and the corresponding legislative history for those amendments. The 1994 amendments provided the previously missing definition of the term "cure" in section 1123, providing that the amount necessary to cure a debtor's default is determined in accordance with the underlying contract or agreement, if that document complies with relevant nonbankruptcy law. Before the 1994 amendments, courts looked to section 1124, which governs whether a claim can be treated as unimpaired under a plan, for guidance. Courts read section 1124 as allowing a debtor to cure defaults without paying default interest owed under the loan documents.

The Eleventh Circuit also discussed the tension between section 1123(d) and section 1124 of the Bankruptcy Code. To resolve the tension between section 1123(d) and section 1124, the Eleventh Circuit noted that the tension "merely demonstrates that the Bankruptcy Code does not precisely equate curing a default [for the purposes of reinstating a loan] with unimpairment of a claim." The Court therefore held that the "clear mandate" of section 1123 allows a creditor to demand default-rate interest as a condition for reinstating the loan.

The Eleventh Circuit held that the current iteration of the Bankruptcy Code requires a debtor to cure its default in accordance with the underlying contract or agreement, if that document complies with relevant nonbankruptcy law. Therefore, because the Debtor's loan documents required the payment of default-rate interest and those provisions comply with Florida law, the Debtor must pay default-rate interest to cure its default.

Waiver of Late Fees

The Eleventh Circuit then held that the bankruptcy court and district court clearly erred in finding that the Secured Lender chose late fees over default-rate interest. Rather, the Eleventh Circuit held that the record clearly demonstrates that the Secured Lender first demanded both default-rate interest and late fees and later withdrew the claim to late fees. After the Debtor objected to the Secured Lender's request for both default-rate interest and late fees, the Secured Lender expressly and clearly waived its claim to all late fees "for any time period for which the Court allows default rate interest."

The Eleventh Circuit held that the Secured Lender properly preserved its claim to default-rate interest and waived any claim to late fees. However, it declined to address whether a creditor could ever demand both default-rate interest and late fees.

Sufficiency of the Notice of Default

Finally, the Eleventh Circuit held that the faulty notice of default was legally irrelevant, because no notice of default was required. In other words, the Agreement did not require the Debtor to provide any notice of default and "expressly waived" any notice not explicitly called for by the Agreement or applicable law.

Practical Implications

This case clarifies that in the Eleventh Circuit, the reinstatement of a loan under a Chapter 11 plan requires the debtor to pay accrued default-rate interest in accordance with the underlying agreement and applicable nonbankruptcy law. However, despite the "clear mandate" of section 1123, other courts disagree and have ruled that the pre-default contract rate is the appropriate interest rate, even if the agreement provides for a higher default interest rate (see Platinum Capital, Inc. v. Sylmar Plaza, L.P. (In re Sylmar Plaza, L.P.), 314 F.3d 1070, 1075 (9th Cir. 2002)). These courts reasoned that by curing a default, a debtor is entitled to avoid all consequences of the default, including paying higher post-default interest rates.

For more information on reinstatement, see Practice Note, Reinstatement of Prepetition Loans in Bankruptcy.

In re Sagamore Partners, Ltd: Eleventh Circuit Holds That a Creditor May Demand Default-rate Interest as a Condition for Reinstating Loan | Practical Law