It is generally well understood that an "oversecured" creditor is entitled to interest and, to the extent provided for under a loan agreement, related fees and charges as part of its secured claim in a bankruptcy case. Although section 506(b) of the Bankruptcy Code provides that fees, costs or charges allowed as part of a secured claim must be "reasonable," the provision does not expressly impose any restrictions on the amount or nature of interest allowable as part of a secured claim. A Bankruptcy Appellate Panel for the Eighth Circuit recently considered whether a secured creditor is entitled to contractual default-rate interest under section 506(b).
In In re Family Pharmacy, Inc., 614 B.R. 58 (B.A.P. 8th Cir. 2020), the panel reversed a bankruptcy court's order disallowing a secured creditor's claim for interest at the default rate under the parties' contract, using a penalty-type analysis generally applied to liquidated damages provisions. According to the panel, such an analysis cannot be applied to default interest provisions. The panel also held that the bankruptcy court erred when it held that the default interest rate was unenforceable based on "equitable considerations."
Secured Creditor's Right to Interest, Fees, Costs, or Charges
Whether a claim is secured or unsecured is determined in accordance with section 506(a) of the Bankruptcy Code, which provides that a creditor holds a secured claim to the extent of the value of the collateral securing its claim and an unsecured claim for any deficiency. If a creditor is "oversecured" because the creditor's collateral has a greater value than the face amount of the claim, section 506(b) provides that the creditor is entitled to receive, as part of its secured claim, "interest on [its] claim, and any reasonable fees, costs, or charges provided for under the agreement or State statute under which such claim arose." As noted by a leading commentator, "the entitlement provided by section 506(b) marks a significant exception to the general rule that claims are not entitled to accrue interest after the commencement of the [bankruptcy] case." Collier on Bankruptcy ("Collier") ¶ 506.04 (16th ed. 2020).
In United States v. Ron Pair Enterprises, Inc., 489 U.S. 235 (1989), the U.S. Supreme Court determined that section 506(b) applies to both consensual and nonconsensual liens and security interests. Prior to Ron Pair, some courts ruled that interest was not allowable under section 506(b) with respect to nonconsensual liens, reasoning that: (i) the reference to an "agreement" in the provision modified the entitlement to interest, suggesting that interest could be allowed only if there was an agreement providing for it; and (ii) because nonconsensual liens, such as tax liens, do not involve agreements, such liens must be excluded from the scope of section 506(b). See generally Collier at ¶ 506.04[a] (citing cases). According to the Court in Ron Pair, the reference to an "agreement" in section 506(b) modifies only the reference to "reasonable fees, costs, or charges," but not to "interest." An oversecured creditor has an "unqualified" right to such interest, the Court concluded, as long as it is entitled to such interest under a contract or applicable law.
Notably, the Court did not specify the rate of interest to which an oversecured creditor is entitled under section 506(b). Most lower courts have since concluded that the interest rate should be the rate provided in the contract, or other applicable law, under which the claim arose—i.e., the "contract rate" of interest. Collier at 506.04[b][i] (citing cases).
Although courts may disagree over the payment of contractual default-rate interest as part of an allowed secured claim, whether a claim based on another common contractual provision designed to compensate the non-defaulting party—a liquidated damages clause—is less controversial.
Enforceability of Liquidated Damages Claims in Bankruptcy
Section 502(b)(1) of the Bankruptcy Code provides that, if a party objects to a claim, the bankruptcy court shall allow it except to the extent that "such claim is unenforceable against the debtor and property of the debtor...
