In re Family Pharmacy, Inc.
| Decision Date | 05 August 2019 |
| Docket Number | Case No. 18-60521 |
| Citation | 605 B.R. 900 |
| Parties | IN RE: FAMILY PHARMACY, INC., et al., Debtors. |
| Court | U.S. Bankruptcy Court — Western District of Missouri |
Mark T. Benedict, John Joseph Cruciani, Michael D. Fielding, Christopher C. Miles, Husch Blackwell Sanders LLP, Kansas City, MO, for Debtors.
The issue in this case is whether the debtors and a junior lender have met their burden of rebutting a senior lender's claim to postpetition default interest1 under its loan documents and applicable Missouri and federal bankruptcy law. For the reasons set forth below, the court finds and concludes they have.2
This matter concerns the allowance or disallowance of The Bank of Missouri's claims against the bankruptcy estate and is therefore a statutorily core proceeding under 28 U.S.C. § 157(b)(2)(B). Specifically, because this proceeding involves a determination of the Bank's entitlement to default interest on claims to be paid from estate assets, it "falls squarely into the category of matters that ‘necessarily be resolved in the claims allowance process.’ "3 Therefore, this court has the authority to enter a final judgment or order in this matter.4
The facts are not disputed.5
Debtor Family Pharmacy, Inc. and four related entities6 (collectively, the "Debtors") filed voluntary petitions for chapter 11 relief on April 30, 2018. Debtors' assets, consisting primarily of inventory, equipment and real estate used in operating pharmacies in southwest Missouri, were encumbered by three secured creditors, in order of priority: The Bank of Missouri, owed approximately $11 million; Cardinal Health, $1 million, and J M Smith Corp., $18 million. From the inception, all parties7 agreed that the assets needed to be sold at a § 3638 auction sale. Smith, the Debtors' primary supplier, agreed to advance debtor-in-possession ("DIP") financing9 and to serve as the so-called stalking horse bidder for the sale with an $8 million opening bid.
The court entered orders authorizing the DIP financing with Smith, approving Debtors' interim and final motions for use of DIP financing and use of cash collateral, and approving bid procedures for the sale.10 After a robust auction, the court in early August 2018 – some three months after the case was filed – approved Smith as the final bidder with a cash bid of $13,975,000.11 Under the terms of the order approving the sale, the principal claims of the Bank12 and Cardinal Health and other fees and closing costs were paid at closing, leaving sales proceeds of approximately $556,040.59.13
The Bank, as an oversecured creditor, then filed its motion under § 506(b) seeking allowance of $18,271.19 in postpetition attorneys fees plus $442,843.51 in interest calculated at an 18% default rate.14 The Debtors and Smith15 jointly objected to the Bank's motion. The parties stipulated that Smith is owed approximately $16 million on account of its undersecured secured claim.16
At the hearing on the Bank's motion, the Debtors and Smith agreed to allowance of the Bank's attorney fees, leaving only the default interest at issue. Additional findings of fact will be made below.
As a general rule, interest ceases to accrue on prepetition debts once a bankruptcy filing occurs.17 This rule is codified in § 502(b)(2) of the Bankruptcy Code, which disallows a claim for "unmatured interest."18 As the Eighth Circuit has explained, 19
The Bankruptcy Code provides, however, an exception to the general rule for oversecured creditors. Section 506(b) provides:
To the extent that an allowed secured claim is secured by property the value of which after recovery under subsection (c) of this section, is greater than the amount of such claim, there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided under the agreement or State statute under which such claim arose.20
This section authorizes an oversecured creditor, such as The Bank of Missouri here, to recover postpetition interest and reasonable attorney fees on its claims.21
In United States v. Ron Pair Enterprises, Inc. , the Supreme Court held that § 506(b) allows oversecured creditors to recover "fees, costs and charges" – such as attorney fees – only if provided for in the parties' agreement and only if the court determines they are reasonable. In contrast, recovery of postpetition interest by oversecured creditors is "unqualified."22 Although the right of oversecured creditors to postpetition interest is "unqualified," the Supreme Court did not set the rate at which an oversecured creditor is entitled to recover postpetition interest.23 When the debtor-creditor relationship is governed by contract, as is the case here, most courts presumptively apply the contract rate of interest under § 506(b),24 although – as discussed more fully below – the contract rate must be enforceable under state law, and many courts also consider equitable factors in their § 506(b) analysis.25 In addition, most courts have at least recognized a presumption of allowability of default rates of interest, provided, again, that the rate is enforceable under applicable nonbankruptcy law.26
The parties agree that the Bank is an oversecured creditor to the extent of the remaining sales proceeds pursuant to § 506(b). The parties also agree that the Bank's various loan documents provide for nondefault contract interest of between 3.65 – 7.5%27 and a default rate of 18% and are subject to applicable Missouri law. The parties even agree that the Debtors were current on all loans to the Bank as of the date of filing.28 Where the parties disagree, however, is (1) whether the Debtors were in default postpetition; and (2) if so, whether application of an 18% default rate under the circumstances of this case should be disallowed as either a penalty or for equitable reasons under Missouri or federal bankruptcy law. There are no Eighth Circuit cases on point.29
The court makes additional findings with respect to whether the Debtors were in default as follows:
Between July 21, 2014 and March 1, 2018, the Bank of Missouri made eight loans to the Debtors.30 The individual promissory notes have non-default interest rates ranging between 3.65 – 7.5%.31 Other than these non-default interest rates and the maturity dates which vary from loan to loan, the relevant terms of the notes are, for all practical purposes, identical. They provide that "[u]pon default, including failure to pay upon final maturity, the interest rate on this Note shall be increased to 18.000% per annum based on a year of 360 days...." A "default" as relevant here is in turn triggered when the "Borrower fails to make any payment when due under this Note." Importantly, the notes contain no right to cure for a payment default.
The notes also contain a standard acceleration clause providing that the Bank "may" declare the entire unpaid principal balance due "upon default," in addition to a so-called ipso facto clause under which insolvency or bankruptcy constitutes an event of default. The notes provide that they are to be construed in accordance with Missouri law and contain cross-default and cross-collateralization provisions. Payments on each of the notes were due on the first of each month.
As noted previously, the Debtors were current on all the Bank's loans when they filed bankruptcy on April 30, 2018. The loan payments on most of the loans were due under the terms of the various notes the next day, May 1.32 Except for a payment on one small vehicle loan (which the Debtor's chief reorganizing officer testified was made to the Bank in error), the Debtors did not make the May 1 or subsequent regular monthly payments. The Bank did not, however, send a notice of default or otherwise send notice of acceleration when the Debtors failed to make the postpetition payments, and otherwise made no claim for default interest until just before the auction sale was set to occur, several months later.
The Bank argues that under the plain terms of its loan documents, the Debtors defaulted when they failed to make loan payments, even when those payments became due postpetition. The Debtors and Smith vehemently disagree; they argue that the Debtors were prevented by the filing from making loan payments such that any payment default should be excused and that the ipso facto clause is not enforceable.33 They point out that the Bank did not send a notice of payment default or even accelerate. The Bank retorts that nothing in the Bankruptcy Code or case authorities prevents a debtor in bankruptcy from continuing to make payments to creditors; that it did not have to affirmatively accelerate to trigger default; and that the cases so requiring34 are distinguishable based on the terms of the loan documents in those cases.
Surprisingly, the case law is murky. The court found cases for the broad proposition that some (but not all) ipso facto clauses are not enforceable in bankruptcy35 as well as for the proposition that bankruptcy effectuates an acceleration (and perhaps a default).36 Many of the cases are distinguishable based on differences in the terms of the loan documents, the applicable state law, or precedential circuit decisions, and whether the...
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