Postdefault Interest Rates in Bankruptcy

This Article shows that as Bankruptcy Code section 506(b) is currently written, postdefault interest rates are prohibited when the default is an “ipso facto event”—a filing for bankruptcy or insolvency as the event of a default. Yet some courts have insisted on postdefault interest in situations reinstating a loan agreement and have been ignoring restrictions on pendency interest to permit oversecured creditors from obtaining penalty rates of interest. This Article argues that those holdings violate section 506(b) and Supreme Court precedent. It begins with an analysis of ipso facto defaults, showing that the Bankruptcy Code prohibits ipso facto clauses even in nonexecutory contracts. The Article then examines regular monetary defaults. Noting that the Supreme Court only allows compensatory market rates to oversecured creditors, high default interest rates will never be a proxy for the market rate as they constitute penalties. Similarly, the Article argues that the “cure” of loan agreements allowed by reorganization chapters is a compensatory concept, also requiring the market rate of interest. Finally, the Article concludes by arguing that the Bankruptcy Code applies to solvent and insolvent debtors, and thus ipso facto clauses are prohibited and section 506(b) requires compensatory, not punitive, rates even in solvent bankruptcy cases.

The full text of this Article is available to download as a PDF.