In re Direct Transit, Inc., BAP No. 98-6039NI.
| Decision Date | 26 October 1998 |
| Docket Number | BAP No. 98-6039NI. |
| Citation | 226 BR 198 |
| Parties | In re DIRECT TRANSIT, INC., an Iowa Corporation, Debtor. DIRECT TRANSIT, INC., an Iowa Corporation, Appellant, v. SOUTH DAKOTA GOVERNOR'S OFFICE OF ECONOMIC DEVELOPMENT, Appellee. |
| Court | U.S. Bankruptcy Appellate Panel, Eighth Circuit |
John R. Weiss, Chicago, IL, for Appellant.
Roger Wilgers Damgaard, Sioux Falls, SD, for Appellee.
Before KOGER, Chief Judge, SCHERMER and MIXON,1 Bankruptcy Judges.
The Debtor, Direct Transit, Inc. ("Direct Transit"), appeals an order of the bankruptcy court2 allowing the inclusion of liquidated damage in the calculation of a secured claim filed by the South Dakota Governor's Office of Economic Development ("GOED"). We affirm.
I
The parties do not dispute the facts in this case, which they submitted to the bankruptcy court by stipulation. The State of South Dakota has established an incentive program to stimulate economic development in the state referred to as the "Revolving Economic Development and Initiative Fund" (REDI). GOED administers the fund, the mission of which is to invest taxpayer dollars to create new primary jobs and quality job opportunities for South Dakotans through low interest loans to qualified applicants. Between 1989 and 1996 more than 10,000 primary jobs were created with the use of REDI funds.
GOED lent REDI funds to Direct Transit under two loan packages. Loan Package # 91-05-A in 1992 was for the sum of $200,000.00 at 3% interest, and Loan Package # 94-21-A in 1995 was for the sum of $500,000.00 at 2% interest. A promissory note memorialized each loan. To secure the two loans, GOED took a mortgage on Direct Transit's new headquarters, a security interest in the personal property located there, and a $450,000.00 demand letter of credit. The mortgage and security interests were properly perfected.
In addition to the loan packages, the parties entered into separate employment agreements. These agreements specified, among other things, that the applicant must maintain its business operation in South Dakota for eight years from the date of the agreement without the loss to South Dakota of "the employment created by the project." (App. to Appellant's Brief at 26, 37.) Although the employment agreements were binding for a term of eight years, the promissory notes were amortized over a shorter, five-year period in equal monthly installments.
Each employment agreement contained a provision that if the borrower ceased operation within eight years from the date of the agreement, the borrower agreed to pay liquidated damages. The agreement fixed liquidated damages as the difference between the interest rate in the note and an interest rate that the parties agreed was the current commercial rate, 10% in 1992 and 8% in 1995. This increased interest rate was to be applied not only prospectively against all outstanding balances at the time of the breach, but also retroactively, to all outstanding principal since the inception of the loan.
Competent legal counsel represented both Direct Transit and GOED at the time the employment agreements were signed. The parties negotiated extensively regarding the terms of the agreements, and the officers who signed the agreements on behalf of Direct Transit are experienced businessmen.
Direct Transit filed for relief under the provisions of chapter 11 of the Bankruptcy Code on October 21, 1996. The parties have stipulated that Direct Transit breached the employment agreement on April 8, 1997. GOED's claim is fully secured, including that disputed portion of the claim for liquidated damages. Unsecured creditors in this case will receive less than a 100% dividend. A distribution to equity security holders is unlikely.
The amount of liquidated damages, measured by the difference in the contract rate of interest and the market rate of interest, is $104,851.00. GOED's secured claim, if all liquidated damages are allowed, is calculated as follows:
Principal $171,909.97
Interest through 2/15/98 $ 15,032.80
Liquidated Employment Damage $104,851.00
___________
TOTAL: $291,793.77
Per Diem on Principal $ 54.16
Balance only on and after
February 15, 1998
II.
Direct Transit filed a timely notice of appeal, and neither party elected to submit the appeal to the District Court. Therefore, this panel has jurisdiction pursuant to 28 U.S.C. § 158(a)(1); 28 U.S.C. § 158(b)(6); and 28 U.S.C. § 158(c).
III.
The issue is whether the liquidated damage provision of the employment agreements is enforceable under South Dakota law and properly included in the secured claim of GOED pursuant to 11 U.S.C. § 506(b). Because the issue is a question of law, we review the bankruptcy court's ruling de novo. First Nat'l Bank of Olathe v. Pontow, 111 F.3d 604, 609 (8th Cir.1997); Van Der Heide v. La Barge (In re Van Der Heide), 219 B.R. 830, 833 (8th Cir. BAP 1998).
IV.
As a basis for reversal Direct Transit argues two points. The first argument is that, despite its characterization as liquidated damages, the disputed portion of the claim results from a default interest rate retroactively applied and is, therefore, not allowable. The second argument is that even if the claim includes liquidated damages rather than default interest, it is unenforceable under South Dakota law because the amount of liquidated damages is "vastly disproportionate to the injury from the breach and, thus, unreasonable and unenforceable." (Appellant's Brief at 5.)
V.
The Bankruptcy Code provides that an over-secured creditor may claim principal and interest due on the date the petition is filed, as well as post-petition interest and "any reasonable fees, costs or charges provided for under the agreement under which such claim arose." 11 U.S.C. § 506(b) (1994). The parties stipulated that Direct Transit is over-secured to the full extent of the amount of the claim, including the disputed charge for liquidated damages, and that if the liquidated damages claim is allowable, it is a properly perfected secured claim.
We hold that the term of the employment contract in question is a true liquidated damages provision, that it is enforceable under South Dakota law, and that it is a reasonable charge and properly allowable as part of GOED'S secured claim pursuant to 11 U.S.C. § 506(b).
Direct Transit first argues that the liquidated damage provision in each employment agreement is a default rate of interest that is unenforceable because such interest cannot be retroactively applied. In determining whether to enforce default interest terms, some courts view such increases as a species of liquidated damages rather than distinguishing between the two. See, e.g., In re Timberline Property Dev., Inc., 136 B.R. 382, 385-86 (Bankr.D.N.J.1992) (); Foss v. Boardwalk Partners (In re Boardwalk Partners), 171 B.R. 87, 92 (Bankr.D.Ariz.1994) ().
Although default interest and liquidated damages are similar in concept, the differences between the two are readily discernible, especially when applied to the facts in this case. When the term "default interest" is used, "default" refers to an event in a debtor-creditor relationship that triggers certain consequences typically set out in a loan document. Citybank v. Udhus (In re Udhus), 218 B.R. 513, 515 (9th Cir. BAP 1998) (citing In re Entz-White Lumber & Supply, Inc., 850 F.2d 1338 (9th Cir.1988)). One such consequence may be the escalation of the interest rate on remaining indebtedness, hence the term "default interest." See, e.g., Fischer Enter., Inc. v. Geremia (In re Kalian), 178 B.R. 308 (Bankr.D.R.I.1995) (); Connecticut Gen. Life Ins. Co. v. Schaumburg Hotel Owner Ltd. Partnership (In re Schaumburg Hotel Owner Ltd. Partnership), 97 B.R. 943 (Bankr. N.D.Ill.1989) (); In re W.S.Sheppley & Co., 62 B.R. 271 (Bankr.N.D.Iowa 1986) (). In contrast, "liquidated damage" usually refers to a specific sum of money expressly stipulated as the amount of damages to be recovered for breach by either party to an agreement. Stein v. Bruce, 366 S.W.2d 732, 735 (Mo.App.1963).
Here, the calculation for liquidated damages is located in each Agreement Relating to Employment but not in the promissory notes or other loan documents where provisions for default interest rates typically are found. The disputed increase in interest is labeled "liquidated damages," and the parties expressly agreed that Direct Transit would pay GOED a specific sum in the event of breach of the Loan Authorization. Under this agreement, the specified liquidated damages are only due if Direct Transit changed the nature of the project, relocated, or ceased operations so that a loss of employment resulted. Other than the contract rates of interest of 3% and 2%, the only interest rate referred to by the two promissory notes is interest on past-due payments. Direct Transit could have been in default under the terms of the notes without being liable for liquidated damages if Direct Transit continued to operate consistent with the Agreements Related to Employment.
The liquidated damages provision became due for a non-monetary breach of the contract rather than for a default under the terms of the note. Therefore, the provision in question is a true liquidated damages provision and not...
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