Default Interest: What Does the Plan of Reorganization Say?

UMB Bank, N.A. v Linn Energy L.L.C. (In re Linn Energy, L.L.C.), 927 F.3d 350 (5th Cir. 2019) –

A lenders’ agent sought a court order directing payment of postpetition default interest, contending that this was required by the terms of a confirmed plan of reorganization. The bankruptcy court denied the motion; the district court affirmed; and the lenders’ agent appealed to the Fifth Circuit.

The lender group included over 40 financial institutions that extended billions of dollars in credit prepetition pursuant to a credit agreement. The credit agreement provided that after an event of default outstanding loans would accrue interest at 2% above the applicable base rate.

During the bankruptcy the court entered a cash collateral order that required the debtors to make adequate protection payments “in an amount equal to accrued and unpaid prepetition or postpetition interest calculated at the non-default rate.” The administrative agent for the lenders reserved but did not assert the right to adequate protection payments at the default rate. Later at least three of the lenders submitted proofs of claim that expressly listed claims for the additional interest at the default rate as provided in the credit agreement.

Against this background, the court focused on two provisions in the plan of reorganization.

Article III.B.3(b) provided:

Notwithstanding any other provision of this Plan to the contrary, on the Effective Date, the LINN Lender Claims are Allowed as fully Secured Claims under section 506(b) of the Bankruptcy Code having first lien priority in the amount of $1.939 billion on account of unpaid principal, plus unpaid interest, fees, other expenses, and other obligations arising under or in connection with the LINN Lender Claims, or as set forth in the LINN Credit Agreement other Loan Documents (as defined in the LINN Credit Agreement), in each case, not subject either in whole or in part to off-set, disallowance or avoidance under chapter 5 of the Bankruptcy Code or otherwise, or any legal, contractual, or equitable theory for claims . …

Article VI.F, which was captioned “No Postpetition or Default Interest on Claims,” provided:

Unless otherwise specifically provided for in the Plan or the Confirmation Order, and notwithstanding any documents that govern the LINN Debtors’ prepetition funded indebtedness to the contrary, (a) postpetition and/or default interest shall not accrue or be paid on any Claims and (b) no Holder of a Claim shall be entitled to: (i) interest accruing on or after the Petition Date on any such Claim; or (ii) interest at the contract default rate, as applicable.

As the court put it, the “obvious question” was whether the first provision authorized default interest or did the second provision barred it. In other words, did the first provision “specifically provide” for default interest? Both parties insisted that the plan was unambiguous, so there was no reason to look beyond the language of the plan.

The debtors argued that neither the plan nor the confirmation order “specifically” provided for postpetition or default interest. The lenders responded that the provision barring default interest was explicitly subordinated to other provisions of the plan, and the provision regarding payment of their claims allowed the claims as fully secured, and the plan used a term (LINN Lender Claims) that was defined as the claims set forth in the proof of claim.

The court noted that the arguments were not frivolous, and agreed that the plan was unambiguous. So, it looked solely to the language in the plan. The court concluded that there was a clear prohibition on payment of default interest unless otherwise “specifically provided,” and there were no provisions in the plan or confirmation order specifically providing for default interest.

The court was influenced by the fact that the cash collateral order only required payments at the nondefault rate, which was never contested by the lenders. It also determined that the lenders’ interpretation would render meaningless the language that prohibited claims for default interest arising under “any documents that govern [Linn’s] prepetition funded indebtedness.” Finally, it rejected incorporating the terms of the proofs of claim into the plan by reference by application of state contract law (which required that the contract language make it clear that the purpose of the reference was to incorporate the referenced material into the contract rather than just to acknowledge that the material was relevant).

Accordingly, the court affirmed the lower court decisions.

Over $31 million of additional interest was at issue. While the lenders had a good argument, given the stakes it is a little surprising that they did not insist on an affirmative statement that they were entitled to default interest notwithstanding the contrary plan provision. Of course, this may have been a deliberate negotiating strategy based on a concern that insisting on further clarification could backfire resulting in a clarification that default interest was indeed barred?

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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