The additional “default interest” owed when a borrower defaults under a loan agreement is a technical but highly critical part of any lending arrangement. This important “default interest” was the subject of a recent Ninth Circuit decision in which the Circuit made a nearly 180 degree u-turn away from its prior precedent. Earlier this month in a case called In re New Investments, Inc. the Ninth Circuit adopted a new rule which may significantly constrain the ability of distressed companies to reorganize by restructuring their debt.
In that case, two members of a three judge Ninth Circuit panel reversed a bankruptcy court’s decision, and ruled that the chapter 11 debtor could not cure a default under its loan agreement by paying only the contractual pre-default interest but instead must pay interest at the higher post-default rate. This ruling is contrary to the Circuit’s prior decision in In re Entz-White Lumber & Supply, Inc. 850 F. 2d 1138 (9th Cir. 1988), and represents a dramatic shift in the Bankruptcy Code’s balance of power away from debtors and towards secured creditors. The decision makes it much more difficult for a debtor to cure a loan default as part of a plan of reorganization.
In 1988, in the Entz- White decision, the Ninth Circuit held that a debtor who proposes to cure a loan default through a plan of reorganization is entitled to avoid all consequences of the default including higher post-default interest rates. At that time, the Court acknowledged that under the Bankruptcy Code, a plan of reorganization “shall provide adequate means for the plan’s implementation, such as curing or waiving of any default.” The Court recognized that there was no definition of “cure” in the Bankruptcy Code, and adopted the following definition, which had been used by the Second Circuit: