East West Bank v. Altadena Lincoln Crossing, LLC

598 B.R. 633

EAST WEST BANK, Appellant,

v.ALTADENA LINCOLN CROSSING, LLC, Appellee.

Case No. 2:18-CV-08738-JLS

Bank. Case No. 2:17-bk-14276-BB

United States District Court, C.D. California.

Signed March 6, 2019

Anastasia Elizabeth Bessey, Lois Moonitz Jacobs, Kralik and Jacobs LLP, Pasadena, CA, Timothy Towery Coates, Greines Martin Stein and Richland LLP, Los Angeles, CA, for Appellant.

Gregory M. Salvato, Joseph I. Boufadel, Salvato Law Offices, Los Angeles, CA, for Appellee.

ORDER REVERSING BANKRUPTCY COURT ORDER

ORDER REMANDING ACTION TO BANKRUPTCY COURT

Josephine L. Staton, United States District Judge

This matter arises out of an appeal of an order of the Bankruptcy Court. Appellant East West Bank ("EWB") appeals the Bankruptcy Court's order disallowing its claim for default interest against the Debtor-Appellee Altadena Lincoln Crossing, LLC ("Altadena"). More specifically, EWB appeals the Bankruptcy Court's Order Regarding Debtor's Objections to Secured Creditor East West Bank's Proof of Claim Nos. 9 and 11 ("Order re Objections"), which expressly incorporates the Bankruptcy Court's Findings of Fact and Conclusions of Law ("Findings" or "Conclusions"). (BK Docs. 564 & 643.)¹

Altadena took out a loan from EWB to finance a construction project but was unable to repay the loan upon maturity. Nonpayment triggered a default interest rate provision and led to a series of forbearance agreements between the parties over the course of eight years. After EWB refused to renew the last forbearance agreement, Altadena filed for bankruptcy. At issue in the present appeal is whether the default interest rate provision is enforceable under California law. The Bankruptcy Court concluded it was not. On appeal, this Court disagrees.

Therefore, as set forth herein, the Court REVERSES the Bankruptcy Court's Order and REMANDS this action for further proceedings consistent with this opinion.

I. FACTUAL BACKGROUND

The Bankruptcy Court made findings regarding loan formation and regarding contractual arrangements made by the parties when Altadena was unable to repay its loan at its maturity date. The Bankruptcy Court's Findings of Fact are not contested.

Negotiations regarding the loan occurred over a period of months, during which time Altadena was represented by counsel. (Findings at 2.) During the negotiations, the parties did not discuss the default interest rate provision, and the rate established in this provision remained the same throughout the term of the loan. (Id. at 2-3.) The rate was chosen based on EWB's practice to use this rate. (Id. at 4.) Altadena and both parties' experts agreed that the 5% default interest rate was within the range of default interest rates commonly charged in the relevant industry during the relevant time period. (Id. )

Beginning in 2005, in two separate transactions,² EWB loaned Altadena $ 26 million³ and $ 2.5 million for a construction project. (EOR 225 & 319.) The loans were secured by deeds of trust on the property under construction. (See, e.g. , EOR 193-207 & 295-310.) In the original loan agreements, the larger loan provided for an annual interest rate of 1% over the prime lending rate, with an increase to 6% in the event of Altadena's default, and the smaller loan provided for an annual interest rate of 5% over prime with an increase to 10% upon default. This represented a default interest rate for each loan of 5%. (Findings at 4.) The loans eventually matured in 2009,⁴ but Altadena failed to pay the principal. (EOR 248.)

From August 2008 through February 2016, the parties entered into a series of forbearance agreements, extending the maturity date of the larger loan. (Findings at 5.) When negotiating the first forbearance agreement, Altadena complained that the default rate was too high, but it nevertheless agreed to its application by executing the forbearance agreement. (Id. at 5-6.) In the forbearance agreements, Altadena acknowledged the amounts then due, including the then-accrued default interest. (Id. ) Altadena also agreed to release any known or unknown claims against EWB, agreed that interest would continue to accrue at the default interest rate, and agreed to a provision that EWB would forgive all default interest if Altadena paid the loan in full by the maturity dates specified in the agreement ("the forgiveness provision"). (Id. at 6.) This latter provision was included at Altadena's insistence and is found in twelve of the thirteen forbearance agreements. (Id. )

In return, EWB agreed not to exercise its right to foreclose on the property. (See, e.g. , EOR 254-55.) The parties' final agreement also expressly stated that it was made in reliance on Altadena's representation that a sale of the property was imminent. (EOR 252.) However, the loan was not fully repaid as agreed, and EWB commenced foreclosure proceedings with the filing of Notices of Default and Elections to Sell Under Deed of Trust. (EOR 1197-1202 & 1204-08.) Thereafter, on April 7, 2017, Altadena filed a petition in bankruptcy. (EOR 143-62; BK Doc. 1.)

II. BANKRUPTCY COURT PROCEEDINGS

In its Schedule D to the Petition, Altadena listed EWB as a secured creditor with claims collateralized by the Project. (EOR 155.) On August 8, 2017, EWB filed Proof of Claim Nos. 9 and 11, together with supporting exhibits. (EOR 163-335, BK Claims 9-1 & 11-1.) On October 16, 2017, Altadena filed Objections to Claim Nos. 9 and 11. (BK Docs. 269 & 271.) Thereafter, from November 15, 2017 to March 28, 2018, EWB and Altadena filed volumes of other documents in support of the Claims or the Objections, including declarations, requests for judicial notice, expert reports, evidence, objections to evidence and memoranda of law. (See generally EOR 163-3095.)

On May 23, May 24, and June 20, 2018, the Bankruptcy Court held an evidentiary hearing. The Bankruptcy Court ruled on a number of evidentiary objections in an order dated May 24, 2018. (BK Doc. 530.) On July 3, 2018, the Bankruptcy Court issued its Findings of Fact and Conclusions of Law Resolving (In Part) Debtor's Objections to Claims 9 and 11, which is the subject of this appeal. (BK Doc. 564.) EWB moved to amend the Bankruptcy Court's Order re Objections and, after briefing by the parties and a hearing on the matter on August 8, 2018, the Bankruptcy Court denied EWB's Motion to Amend. (BK Doc. 608.) The Bankruptcy Court also held a further hearing on September 13, 2018 regarding the parties' cross-motions for attorney fees and costs. (See BK Doc. 643.)

On October 2, 2018, the Bankruptcy Court issued its Order Regarding Debtor's Objections to Secured Creditor East West Bank's Proof of Claim Nos. 9 and 11 ("Order re Objections"), which is the subject of the present appeal. (BK Doc. 643.) As to Claim 9, the Order re Objections disallowed EWB's claim for default interest, but allowed EWB's claims for the principal amount of the loan, pre-and post-petition non-default interest, late charges, foreclosure fees, a number of other fees, and legal fees unrelated to the claim objection litigation. (BK Doc. 643 at 2-3.) Consistent with its ruling regarding Claim 9, the Order re Objections disallowed Claim 11 in its entirety because the balance remaining on Claim 11 was less than the default interest associated with it. (Id. at 3.) The Bankruptcy Court awarded legal fees to Altadena related to its Objections to the Claims. (Id. at 3.)

III. BANKRUPTCY COURT'S CONCLUSIONS OF LAW

The Bankruptcy Court's legal conclusions address the enforceability of contractual default interest rates. Those conclusions are summarized in this section.

The Bankruptcy Court first noted that contractual default interest rates should be enforced in bankruptcy, unless the default interest provision is not enforceable under applicable non-bankruptcy law. (Conclusions at 11 (citing General Electric Capital Corp. v. Future Media Productions, Inc. , 547 F.3d 956, 961 (9th Cir. 2008) ).) California Civil Code § 1671(b) states that "a provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made." See Cal. Civ. Code § 1671(b). As the party challenging the default interest provision, Altadena bears the burden of proving the default interest provision is unreasonable. (Conclusions at 11.)

The Bankruptcy Court next analyzed whether Altadena had met its burden, noting that "[a] liquidated damages clause will generally be considered unreasonable, and hence unenforceable under section 1671(b), if it bears no reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach" at the time the contract was made. (Conclusions at 11 (quoting Ridgley v. Topa Thrift & Loan Ass'n , 17 Cal.4th 970, 977, 73 Cal.Rptr.2d 378, 953 P.2d 484 (1998) ).) The liquidated damages amount "must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained." (Conclusions at 12 (quoting Garrett v. Coast & Southern Fed. Sav. & Loan Ass'n , 9 Cal. 3d 731, 739, 108 Cal.Rptr. 845, 511 P.2d 1197 (Cal. 1973) ).) Because the parties used an industry standard or customary rate rather than engaging in an individualized "reasonable endeavor ... to estimate a fair average compensation for any loss that might be suffered by EWB in the event of a default," the Bankruptcy Court concluded that Altadena had established invalidity of the default interest provision pursuant to § 1671(b). (Conclusions at 15.)

The Bankruptcy Court also rejected EWB's argument that the diminution in value of the loan (in a secondary market) was a reasonable measure of potential damages in the event of default. (Conclusions at 15-16 ("The magnitude of the default interest to be charged as liquidated damages in the event of default could only be characterized as reasonable ... if the Court...