Default Interest Rates Apply to Section 363 Sales

By: Caitlin Cline

St. John's Law Student

American Bankruptcy Institute Law Review Staff

 

Drawing a distinction between Chapter 11 plans and section 363 sales, the Ninth Circuit Court of Appeals held in General Electric Capital Corp. v. Future Media Productions, Inc.

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that when an oversecured creditor is paid off through a section 363 sale, it is entitled to enforce a default interest rate provision and is not limited to the pre-default rate.  In contrast, if payment is made through a confirmed plan, the debtor may “cure” the default under section 1124 and avoid the default interest rate.

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In Future Media, the loan agreement between GECC and Future Media provided for a 2% post-default increase in the interest rate.  After an event of default, the loan began to bear interest at the default rate.  Future Media filed for Chapter 11 and conducted a section 363 sale, the proceeds of which were used to pay GECC in full.  The Creditors Committee challenged GECC’s right to default interest and the bankruptcy court, relying on In re Entz-White Lumber and Supply, Inc.,

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concluded that GECC was not entitled to interest at the post-default rate.

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Entz-White involved a Chapter 11 plan where the debtor had “cured” the default under section 1124.

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 The Ninth Circuit held that the oversecured creditor was not entitled to interest at the default rate because, “[b]y curing the default,” the court stated, “Entz-White is entitled to avoid all consequences of the default – including the higher post-default interest rates.”

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  The Future Media court distinguished Entz-White, asserting that because the Entz-White creditor’s claim was paid in full pursuant to the terms of a confirmed Chapter 11 plan, rather than an asset sale, the per se rule of Entz-White was inapplicable.

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  The situations are different because section 1124 allows the debtor to “cure” defaults under a Chapter 11 plan and no similar provision appears in section 363 for pre-plan sales.

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  After finding that Entz-White did not control the analysis, the Court followed the approach adopted by the majority of federal courts where there is a presumption that the default rate applies unless it is unenforceable under applicable non-bankruptcy law.

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  This presumption can be rebutted based on equitable considerations.

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The Future Media decision has added a cost that must be balanced against the potential benefit of the section 363 sale as a means for avoiding the delays and uncertainties of the Chapter 11 plan confirmation process.

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  Additionally, Future Media abrogates the holdings in In re 433 South Beverly Drive

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and In re Casa Blanca Project Lenders, L.P.

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that the Entz-White rule against default interest applies to sales outside of a Chapter 11 plan.

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  The Future Media court declined to follow those decisions because they incorrectly transposed the concept of “cure” from sections 1124 and 365 into section 363, which does not mention “cure.”

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