Shearman & Sterling achieved a victory for client Citibank in a case of first impression from the Bankruptcy Court for the Southern District of New York (Judge Martin Glenn), which awarded Citibank, an oversecured creditor in the ResCap chapter 11 cases, postpetition interest at the contractual default rate, as well as attorney’s fees, even though unsecured creditors were not receiving payment in full on their claims.
Citibank was repaid its principal and non-default interest when ResCap sold the assets constituting Citibank’s collateral as part of a sale of substantially all of ResCap’s assets, but refused to pay accrued default rate interest. After Shearman & Sterling, on behalf of Citibank, filed a motion for payment of default interest, the Liquidating Trust that was appointed under ResCap’s confirmed chapter 11 plan of reorganization took the position that Citibank was not entitled to default interest as a matter of equity because (i) payment of such interest would be harmful to unsecured creditors who were only receiving between 9%-36% on their allowed claims, and (ii) Citibank allegedly was never at risk of not getting repaid on its loan. The Liquidating Trust also argued that Citibank should not be paid its legal fees for pursuing default interest, despite a requirement in the loan documents that the borrower reimburse Citibank for its reasonable legal fees. Although courts in the Second Circuit traditionally have applied an equitable test in determining whether an oversecured creditor is entitled to default interest at the contractual rate, no case ever expressly ruled upon whether or to what extent a debtor’s insolvency precluded a claim for default interest. Notably, no reported decisions in the Second Circuit had ever awarded default interest in a case where unsecured creditors were not being paid in full. The Bankruptcy Court, however, rejected the notion that there was a “bright line test” and held that, under the facts, Citibank was entitled to the payment of default interest as well as payment of Citibank’s legal fees. The decision is an important precedent for secured lenders because virtually all debtors in the bankruptcy context are insolvent.