Document Type
Research Memorandum
Publication Date
2012
Abstract
(Excerpt)
Although secured creditors use default interest rates to protect their security interest throughout the bankruptcy process, courts are not required to enforce those contractual provisions. Secured creditors can legitimately use default interest rates to provide an offset for the “costs and delay of the bankruptcy process.” Equitable considerations may require judicial nullification of default interest rates. Inequitable default interest rates directly contradict the policy goals of bankruptcy. The difficulty in determining the reasonableness of default interest rates results from competing policy interests within bankruptcy. Courts favor enforcing contractual obligations and preserving rights inside of bankruptcy, as they would have existed outside of bankruptcy. However, courts also value protecting a debtor’s “fresh start” and the interest of all creditors within the bankruptcy process. For these reasons, it is important to understand the different justifications courts have used to enforce, or nullify, default interest rates.
Courts have analyzed several factors to determine whether it is equitable to enforce a default interest rate under section 506(b) of the Bankruptcy Code. In In re General Growth Properties Inc., the Bankruptcy Court for the Southern District of New York enforced a default interest rate that was 3% higher than the contractual interest rate. The bankruptcy court determined that the debtor failed to produce persuasive evidence that enforcement of the default interest rate would produce an inequitable result. The bankruptcy court noted that GGP was a solvent debtor, and the default interest rate would not impair GGP’s “fresh start. The bankruptcy court also placed a distinct value in enforcing the “expressly bargained for result” between the parties. As a policy matter, it was further recognized that default interest rates help debtors attain loans with lower interest, because“[I]f a creditor had to anticipate a possible loss in the value of the loan due to his debtor's bankruptcy or reorganization, he would need to exact a higher uniform interest rate for the full life of the loan.”