Post-Bankruptcy Interest on Oversecured Debt: How Much Can You Get?

CRE Finance World, Winter 2013

Post-Bankruptcy Interest on Oversecured Debt: How Much Can You Get? The Chapter 11 of Boston’s “W” Hotel and Residences Highlights One of the Challenges Stuart A. Laven, Jr. Lenders Face with Aggressive Borrowers, Even When There is Equity in the Property Coplan & Aronoff LLPBenesch Friedlander A technical questions concerning your right to receive law. The bankruptcy court didn’t buy this argument, and, on appeal,Default Interest as a “Penalty” and the General GrowthProperties TestThe debtors’ opposition to the 14.5% rate was based on an argumentthat the rate was an inequitable “penalty” under Massachusettss a portfolio lender or special servicer, if you are“blessed” enough to find yourself in a borrower Chapter11 bankruptcy with a property that isn’t painfully underwater, you may be confronted with a series of rather post-petition interest on your mortgage. The baseline answer is neither did the First Circuit B.A.P., who noted a well developed straightforward enough: oversecured mortgage lenders are allowed legal presumption in favor of using the contract rate. to charge and receive post-bankruptcy interest under Bankruptcy Code section 506(b). But the Bankruptcy Code doesn’t say anything But that doesn’t mean the debtors were totally out of school. Rather, about the specifics of what the permissible interest rate is, or over the “penalty” argument was one of four criteria derived from a what period of time it can accrue. And as was illuminated in an checklist developed in the General Growth Properties Chapter October 2012 decision1 from the First Circuit’s Bankruptcy Appellate 11 for assessing whether the presumption in favor of using the Panel (B.A.P.) in the Chapter 11 of Boston’s “W” Hotel and Residences contract default rate should be overcome in the name of “equity.” project, these grey areas can give aggressive borrowers a window In a 2011 decision in that case, the Southern District of New York of opportunity to challenge even the most iron-clad default provisions considered these factors:2 in commercial mortgages. • Whether there has been any “creditor misconduct”; In the SW Boston Hotel Venture, LLC Chapter 11, the debtor- developers of the “W” project challenged senior mortgagee •Whether application of the contract rate would “cause harm Prudential Insurance Co. on (among other things) the allowable to unsecured creditors”; rate of post-petition interest on Prudential’s senior mortgage. Prudential originally financed development of the mixed-use •Whether the contract rate constitutes a “penalty”; and property with a $192 million construction loan secured by a first mortgage and backstopped by a $17.3 million letter of credit. •Whether application of the contract rate would “impair the debtor’s fresh start.” In the course of a lift-stay fight shortly after the April 2010 bankruptcy filing (which Prudential lost), the bankruptcy court In SW Boston, three out of these four factors came off the table valued the property at $168 million. Following Prudential’s draw quickly because the debtors’ plan proposed a 100% distribution to on the letter of credit and some interim debt service, Prudential’s unsecured creditors (i.e., the debtors were flush enough that they outstanding mortgage debt stood at $154 million. With the valuation really couldn’t complain about default interest “impairing their fresh comfortably exceeding Prudential’s claim, Prudential sought start” or “causing harm” to unsecureds). bankruptcy court approval to charge interest at the mortgage’s stated 14.5% default rate. The debtors opposed the 14.5% rate, But the “penalty” argument had some traction — enough to garner and in parallel, sought confirmation of a plan of reorganization that the attention of the B.A.P. in its analysis. Significantly, the B.A.P.’s proposed to pay Prudential only 4.5% interest while the debtors determination that the contract default rate was not an unfair sold off their remaining condo inventory and gradually retired the “penalty” turned on the word of a Prudential loan officer, who outstanding principal. testified that the 14.5% rate was consistent with the default rates CRE Finance World Winter 2013 64


CRE Finance World, Winter 2013
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