Tag Archives: 105(a)

May 24, 2016

Default Interest Rates are Presumed Reasonable Under Sec. 506(b), and a Bankruptcy Court May Not Use the Fair and Equitable Language of Sec. 1129(b) to Conclude Otherwise

The Ninth Circuit BAP recently discussed on appeal the issue of whether a bankruptcy court may use the “fair and equitable” standard for confirmation in § 1129(b) to deny an oversecured creditor default interest on its claim to which it would otherwise be entitled under § 506(b). In Wells Fargo Bank, N.A. v. Beltway One Development Group, LLC (In re Beltway One Development Group, LLC), 547 B.R. 819 (9th Cir. BAP 2016), the Ninth Circuit BAP concluded that the fair and equitable standards for confirmation deal with treatment of an allowed claim post-confirmation, but that allowance of an oversecured claim is governed by § 506(b). The BAP held the bankruptcy court erred In using § 1129(b) to deny Wells Fargo default interest on its claim.

The facts in Beltway One were straightforward. The value of the bank’s collateral exceeded the amount the bank was owed. The debtor’s plan, however, provided that the bank would not be entitled to any default interest on its claim, and treated the claim by modifying its terms and providing for payment amortized over 30 years. The plan further provided that any pre-effective date defaults would be deemed to have been cured. The debtor’s argument was that the default was “cured” because it was paid with a new loan; therefore, under the Ninth Circuit’s decision in Great Western Bank & Trust v. Entz-White Lumber and Supply, Inc. (In re Entz-White Lumber and Supply, Inc.), 850 F.2d 1338 (9th Cir. 1988), the default had been cured and the bank was not entitled to default interest during the pendency of the case. Wells Fargo opposed confirmation, asserting the plan did not meet the “fair and equitable” test under § 1129(b)(1). The bankruptcy court agreed with the debtor, concluding the new loan under the plan “paid” the debt within the meaning of Entz-White, and confirmed the plan.

The BAP reversed. The BAP noted a major factual difference between the Beltway One plan and the Entz-White plan in that the debtor in Entz-White­ actually cured the defaults on its secured creditor’s debt by paying the debt in full on the effective date of the plan, whereas Beltway One merely restructured the terms of its secured debt with Wells Fargo. Consequently, the BAP concluded Entz-White was not applicable to the present case. The BAP stated that determining post-petition interest on an oversecured claim under § 506(b) “is an issue separate and distinct from the fair and equitable test for plan confirmation under § 1129(b). The BAP held that determination of interest on an oversecured debt is a claim issue, not a confirmation issue.

This holding did not end the inquiry, however. The BAP also concluded that entitlement to default interest during the pendency of the case “is not automatic but may be allowed upon demonstrating that it meets certain requirements.” The BAP stated that the determination is accompanied with a presumption that the contract’s default interest rate is reasonable unless the debtor introduces evidence that it is not. The BAP based its conclusion on the Ninth Circuit’s decision in Gen. Elec. Capital Corp. v. Future Media Prods., Inc. (In re Future Media), 536 F. 3d 969 (9th Cir.), amended 547 F.3d 956 (9th Cir. 2008), which held that, if Entz-White does not apply, then the bankruptcy court must evaluate the viability of the contractual default interest rate by using applicable “substantive law creating the debtor’s obligation, subject to any qualifying or contrary provisions of the Bankruptcy Code.” In other words, the bankruptcy court should apply a presumption of allowability for the contract default interest rate, provided the rate is not unenforceable under applicable non-bankruptcy law. The creditor enjoys a presumption that the contracted for rate is reasonable, and the debtor bears the burden of demonstrating it is not, or that the rate is not enforceable under applicable non-bankruptcy law.

October 13, 2015

Tenth Circuit Holds that U.S. Supreme Court Decisions in Law v. Siegel and Travelers Casualty v. Pacific Gas & Electric do no Change Established Tenth Circuit Law on Recharacterization of Debt to Equity

Recently, the Tenth Circuit considered a case involving the question of whether the U.S. Supreme Court’s decisions in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 549 U.S. 443 (2007) and in Law v. Siegel, 134 S. Ct. 1188 (2014) affected established Tenth Circuit precedent that a bankruptcy court’s authority to recharacterize debt as equity arises under 11 U.S.C. § 105(a).  In its decision in Redmond v. Jenkins, et al (In re Alternate Fuels, Inc.), 789 F.3d 1139 (10th Cir. 2015), the Tenth Circuit held that neither Supreme Court decision eliminated a bankruptcy court’s authority under § 105(a) to recharacterize debt as equity.  In so ruling, the Tenth Circuit reiterated the continued application of its decision in In re Hedged-Invsetments Assocs., Inc., 380 F.3d 1292 (10th Cir. 2004) and its factors for determining when debt should be recharacterized as equity.

In Hedged-Investments, the Tenth Circuit held that recharacterization of debt as equity involves a mixed question of law and fact which a bankruptcy court addresses pursuant to its general equitable powers under § 105(a) of the Bankruptcy Code.  In recharacterizing debt as equity, a court “effectively ignores the label attached to the transaction at issue and instead recognizes its true substance.”  In re Hedged-Investments, 380 F.3d at 1297.  In Alternate Fuels, the appellant/creditor argued that the U.S. Supreme Court’s decisions in Travelers Casualty and Law v. Siegel eliminated a bankruptcy court’s ability to recharacterize debt under § 105(a), leaving a court to do so only under § 502(b).   The appellant urged the court to follow the conclusions of the Fifth Circuit in In re Lothian Oil, Inc., 650 F.3d 539 (5th Cir. 2011) and the Ninth Circuit in In re Fitness Holdings Int’l, Inc., 714 F.3d 1141 (9th Cir. 2013), both of which rejected reliance on § 105(a) as a source of authority to recharacterize debt.  The Tenth Circuit declined and instead reiterated its conclusions in In re Hedged-Investments.  First, the Tenth Circuit noted that the Supreme Court did not expressly overrule Hedged-Investments in either opinion, nor did either opinion mention—much less deal with—recharactierization of debt.  The Tenth Circuit stated that disallowance of claims and recharacterization of debt require different inquiries and serve different functions.  In fact, the court noted that a claim can be allowed under § 502 and still recharacterized as equity as appropriate under the court’s equitable powers of § 105(a).  The court held that disallowance is appropriate where the claimant has not right of recovery against the debtor, whereas recharacterization is not an inquiry into the enforceability of the claim but rather an inquiry into the nature of the transaction between the claimant and the debtor. 

For these reasons, the Tenth Circuit held that courts continue to have equitable power under § 105(a) to recharacterize debt as equity.

March 5, 2014

SCOTUS Tells the Ninth Circuit to Follow the Law: Section 105(a) Is Not a Means to Contravene Other Provisions of the Bankruptcy Code

Stephen Law filed a chapter 7 petition in California.  His only valuable asset was his home, which he scheduled at a value of $363,348.  Washington Mutual Bank held a lien against the home to secure a loan in the amount of $156,929.  Law asserted a homestead exemption under California law of $75,000.  In order to prevent the bankruptcy trustee from selling his home, Law fabricated a second lien against his home which consumed his entire equity, and obtained the cooperation of a Chinese national named Lili Lin to assert that she was actually owed money by the debtor.  The bankruptcy trustee brought an adversary proceeding to avoid the lien, an action which Law and Lin vigorously opposed.  In what some might call a poor financial decision, the bankruptcy trustee incurred $500,000 in legal fees overcoming Law’s fraudulent misrepresentations regarding his $363,000 home.  The bankruptcy court approved a surcharge of the debtor’s $75,000 homestead exemption to pay a portion of the trustee’s legal fees, a holding which was affirmed by the Ninth Circuit BAP and the Ninth Circuit.

The Supreme Court reversed in its opinion in Law v. Siegel, 2014 WL 813702 (March 4, 2014).  The Supreme Court held that neither 11 U.S.C. § 105(a) nor the bankruptcy court’s inherent powers provided a basis for a bankruptcy court to contravene the express language of § 522 of the Bankruptcy Code allowing debtors to claim exemptions in certain assets. In addressing § 105(a), the Court stated  “A bankruptcy court has statutory authority to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of” the Bankruptcy Code. . . But in exercising those statutory and inherent powers, a bankruptcy court may not contravene specific statutory provisions,” and that “It is hornbook law that § 105(a) ‘does not allow the bankruptcy court to override explicit mandates of other sections of the Bankruptcy Code.’” (citing 2 Collier on Bankruptcy ¶ 105.01[2], p. 105-6 (16th ed. 2013).  Consequently, because § 105(a) confers on bankruptcy courts the authority to “carry out” the provisions of the Bankruptcy Code, “it is quite impossible to do that by taking action that the Code prohibits.” 

The Court also rejected the trustee’s argument that the surcharge did not contravene § 522 of the Code.  The trustee argued that a bankruptcy court has equitable power to deny an exemption in response to a debtor’s misconduct.  The Court first held that the trustee’s failure to object to the debtor’s homestead objection within the time required by the Code prevented him from challenging the exemption through seeking a surcharge.  In addition, the Court held that the plain language of § 522 prevented the surcharge.  Section 522(b) provides that the debtor may exempt property, and the Court interpreted this provision as vesting the debtor, not the bankruptcy court, with the discretion on whether the exemption can be claimed.  Section 522 contains various bases on which an exemption can be limited or disallowed, some of which relate to misconduct by the debtor.  The Court held that § 522’s “meticulous—not to say mind-numbingly detailed” list of restrictions and limitations on a debtor’s right to assert an exemption “confirms that courts are not authorized to create additional exceptions.”  Consequently, the debtor’s misconduct in fabricating a lien was not grounds to deny his exemption.

Finally, the Court held that its prior decision in Marrama v. Citizens Bank, 549 U.S. 365 (2007) did not require a different result.  The Court explained its decision in Marrama as one where a chapter 7 debtor could be denied his statutory right to convert his bankruptcy case to a chapter 13 proceeding because his bad faith conduct prevented him from qualifying for relief under chapter 13, and should not be read as providing bankruptcy courts with an equitable right to take action which contravenes the express provisions of the Bankruptcy Code.