1st Circuit Limits Secured Lender’s Right to Post-Petition Interest by Applying Flexible Standard

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In an important decision for lenders, the 1st Circuit Court of Appeals recently decided In re SW Boston Hotel Venture LLC, holding that a bankruptcy court was right to give a lender a claim for post-petition interest beginning on the date of the sale of its collateral rather than the commencement date of the debtor’s bankruptcy case. This case serves as a guide for lenders regarding their entitlement to post-bankruptcy interest, and importantly, it provides a precedent for lenders to obtain post-petition interest, even when they happen to be undersecured on the date of the filing of the petition.

Post-petition interest is not generally allowed after the filing of a bankruptcy petition under section 502(b)(2) of the Bankruptcy Code. There is an exception, however, for oversecured creditors, who, under section 506(b) of the Bankruptcy Code, are entitled to post-petition interest up to the value of their collateral. The statute does not state when or how to determine whether a creditor is oversecured, which was the genesis of the dispute described in SW Boston Hotel Venture LLC.

Prudential Insurance agreed to provide up to $192.2 million in financing to build a 235-room hotel, a condominium complex, and related retail space. After making the loan, the borrower, SW Boston, together with several of its affiliates, filed for bankruptcy.

Prudential promptly asked for relief from the automatic stay, arguing that it was undersecured. The bankruptcy court denied the motion. Even though Prudential was marginally undersecured with respect to collateral owned by the primary debtor, Prudential was deemed adequately protected by its interests in other property.

SW Boston then proceeded with a sale of the property. The sale price was higher than the value used by the bankruptcy court to determine, in the context of the earlier stay relief motion, that Prudential was marginally undersecured. Accordingly, Prudential filed a claim seeking post-petition interest going back to the beginning of the bankruptcy case on the basis that the sale revealed Prudential was, in fact, oversecured.

The bankruptcy court decided that Prudential was entitled to post-petition interest, but only beginning on the date of the sale of the property, and not beginning on the date of the commencement of the bankruptcy case. The parties appealed, and the bankruptcy appellate panel reversed, finding Prudential should receive interest from the bankruptcy petition date. The parties appealed again, which prompted the 1st Circuit to issue its decision.

The parties agreed that Prudential was oversecured at some point during the bankruptcy proceedings. They disagreed about when Prudential was oversecured, and what date should be used to determine whether Prudential was oversecured for purposes of deciding Prudential’s right to interest under section 506(b).

There is a split of authority under section 506(b). Some courts, including the 11th Circuit Court of Appeals, have held that a creditor’s allowed secured claim for post-petition interest is limited to the amount that the creditor was oversecured by at the time of the filing of the bankruptcy case. Other courts take a more flexible approach, which they believe is appropriate because section 506(b) does not define the measuring date for purposes of post-petition interest. Those courts sometimes note that section 506(a) says the value of collateral will be determined “in light of the purpose of the valuation and of the proposed disposition or use of the property,” which is not a rigid standard.

The 1st Circuit decided that the flexible approach was a better one. It is more likely to avoid inequitable results. Under the “petition date” approach, if a creditor was undersecured on the petition date, but its collateral increased in value just a day after the petition, the creditor nevertheless would receive no interest at all. On the other hand, if the measuring date was the date of plan confirmation (a position Prudential advocated), then a creditor might be undersecured throughout the bankruptcy case, become oversecured just a day or two before confirmation, and then be deemed entitled to post-petition interest for the entire duration of the case, including periods when it was obviously undersecured.

In this case, it was not clear that Prudential was oversecured at any time prior to the sale. The debtor continued to make improvements to the property. The final sale price probably reflected that work. The 1st Circuit observed it would be unfair for a debtor and other parties to fund continued construction, only for all the benefits of that investment to be captured by another creditor.

The 1st Circuit addressed several other interesting issues along the way. Among other things, it decided that the bankruptcy court’s determination of value—made in the context of the stay relief motion filed by Prudential—was not binding on the bankruptcy court in the later proceedings to decide the nature and extent of Prudential’s claim. Values may change during the course of the bankruptcy case, and values determined for purposes of one kind of motion, such as stay relief, are not necessarily binding for other kinds of motions, such as those to decide an entitlement to post-petition interest.

The 1st Circuit’s decision is significant for lenders because it demonstrates that a lender’s right to post-petition interest may change during the course of the bankruptcy case. Lenders should not simply assume that they are not entitled to interest just because they happen to be undersecured on the petition date. Values may fluctuate during the course of the case, and lenders should remain alert to opportunities to seek post-petition interest based on increased valuations.

 

Topics:  Commercial Bankruptcy, Hotels, Secured Lenders

Published In: Bankruptcy Updates, Civil Procedure Updates, Civil Remedies Updates, General Business Updates, Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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