Connecticut District Court Rules That Oversecured Creditor Was Not Entitled to Postpetition Default Interest Until Unsecured Creditors Were Paid In Full

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Section 506(b) of the Bankruptcy Code allows secured creditors to receive post-bankruptcy or postpetition interest, also known as pendency interest, when the value of their collateral exceeds the amount they are owed.  However, there is no provision in section 506(b) or elsewhere in the Bankruptcy Code which specifies the rate of interest to which such oversecured creditors are entitled.  Although many courts award pendency interest at the contract rate, oversecured creditors are not necessarily entitled to interest at that rate, In re Milham, 141 F.3d 420, 423 (2d Cir. 1998) and, when the contract provides for an increased rate of interest after default, there may be equitable considerations which would preclude recovery at that higher rate.

In O’Brien v. President’s Holdings, LLC, No. 13cv625 (JBA) (D. Conn. Feb. 10, 2014), the District Court, on appeal from the Bankruptcy Court’s ruling that an oversecured creditor was entitled to post-bankruptcy default interest at the rate of 24%, even though it appeared that unsecured creditors would not be paid in full in the bankruptcy case, held that a bankruptcy court has the discretion to reduce default interest when the bankruptcy estate is insolvent, i.e., if unsecured creditors would not be paid in full if the default interest was paid to the secured creditor.

In particular, the District Court ruled that based on equitable considerations, default interest to an oversecured creditor should be reduced to the highest amount that would still allow payment in full to the debtor’s unsecured creditors.  The District Court found further support for such a reduction based upon the large spread between the non-default rate of 6.25% and the 24% default rate, as well as the magnitude of the default rate.

Although the District Court did not expressly say so, its ruling appears to be a fairly absolute one, i.e., postpetition default interest to an overesecured creditor in bankruptcy should be reduced up to the point where the bankruptcy estate is no longer insolvent

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