Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca8-19-06025/USCOURTS-ca8-19-06025-0/pdf.json

Parties Involved:
Family Pharmacy
Appellee
Family Pharmacy of Strafford
Appellee
Family Pharmacy, Inc.
Appellee
Family Property Management
Appellee
HealthTAC Logistics
Appellee
JM Smith Corporation
Appellee
Smith Management Services
Appellee
The Bank of Missouri
Appellant

Document Text:

United States Bankruptcy Appellate Panel

For the Eighth Circuit

___________________________

No. 19-6025

___________________________

In re: Family Pharmacy, Inc.; Family Pharmacy of Missouri, LLC; HealthTAC

Logistics, LLC; Family Property Management, LLC; Family Pharmacy of

Strafford, Inc.

lllllllllllllllllllllDebtors

------------------------------

The Bank of Missouri

lllllllllllllllllllllCreditor - Appellant

v.

Family Pharmacy, Inc.; Family Pharmacy of Missouri, LLC; HealthTAC Logistics,

LLC; Family Property Management, LLC; Family Pharmacy of Strafford, Inc.

lllllllllllllllllllllDebtors - Appellees

JM Smith Corporation; Smith Management Services, LLC

lllllllllllllllllllllCreditors - Appellees

 ____________

Appeal from United States Bankruptcy Court

for the Western District of Missouri - Springfield

 ____________

 Submitted: February 19, 2020

Filed: March 19, 2020

____________

Appellate Case: 19-6025 Page: 1 Date Filed: 03/19/2020 Entry ID: 4893145
Before SALADINO, Chief Judge, SCHERMER and SHODEEN, Bankruptcy

Judges. 

____________

SALADINO, Chief Judge.

The Appellant, the Bank of Missouri (“BOM”), appeals the order of the

bankruptcy court denying its motion under 11 U.S.C. § 506(b) for allowance of

postpetition default interest. We have jurisdiction over this appeal. See 28 U.S.C.

§158(b). For the reasons that follow, we reverse and remand.

STANDARD OF REVIEW

On appeal from a final judgment, the appellate court reviews the bankruptcy

court's legal decision using a de novo standard and reviews factual findings for clear

error. Fix v. First State Bank of Roscoe, 559 F.3d 803, 808 (8th Cir. 2009). This case

primarily involvesreview of the bankruptcy court’s interpretation and application of

§ 506(b) under a de novo standard. See United States v. Brummels, 15 F.3d 769, 771

(8th Cir. 1994) (stating that standard of review for the lower court’s ‘‘application of

facts to the legal interpretation’’ of a statute is de novo ); Wegner v. Grunewaldt, 821

F.2d 1317, 1320 (8th Cir. 1987) (stating that reviewing court considers bankruptcy

court’s statutory constructions de novo). 

FACTUAL BACKGROUND

The facts are not disputed.

1

1The parties agreed to submit this matter to the court based on a joint

stipulation of facts and agreed admissibility of certain documents in addition to live

testimony from the BOM’sloan officer. Jt. Stip. of Facts & Agreement Related to the

(continued...)

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Appellate Case: 19-6025 Page: 2 Date Filed: 03/19/2020 Entry ID: 4893145
Debtor Family Pharmacy, Inc., and four related entities (collectively, the

“Debtors”) filed voluntary petitionsfor Chapter 11 relief on April 30, 2018. Debtors’

assets consisted primarily of inventory, equipment and real estate used in operating

pharmacies in southwest Missouri. Those assets were encumbered by three secured

creditors, in order of priority: The Bank of Missouri, owed approximately $11

million; Cardinal Health, $1 million, and J M Smith Corporation and Smith

Management Services, LLC (collectively, “Smith”), $18 million. 

Early in the case, Debtors and their creditors determined that the assets needed

to be sold at an auction sale free and clear of liens pursuant to 11 U.S.C. § 363. Smith,

the Debtors’ primary supplier, agreed to advance debtor in possession financing and

to serve as the so-called stalking horse bidder for the sale with an $8 million opening

bid. 

The court promptly entered orders approving Debtors’ interim and final

motions for use of debtor in possession financing and use of cash collateral, and

approving bid procedures for the sale. The auction drew substantial interest and on

August 8, 2018, the bankruptcy court entered its sale order approving Smith as the

purchaser with a final bid of $13,975,000. Under the terms of the sale order and

subsequentstipulations with various claimants, the sales proceeds (after variousfees

and closing costs) were disbursed to BOM and Cardinal Health, leaving excess sales

proceeds of approximately $556,040.59. 

Under its stipulation with the Debtors, BOM received $11,300,440.67, which

represented its full principal balance, estimated interest at the non-default rate set

forth in its loan contracts, certain fees and expenses, less its share of the broker’s fee

1

(...continued)

Admissibility of Certain Exhibits By and Between Debtors, J M Smith Corporation,

Smith Management Services, LLC, and the Bank of Missouri (ECF No. 328) (“Joint

Stipulation”). 

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Appellate Case: 19-6025 Page: 3 Date Filed: 03/19/2020 Entry ID: 4893145
for the sale. The parties reserved any issues as to BOM’s entitlement to additional

interest, fees or charges. BOM, as an oversecured creditor, later filed its motion under

11 U.S.C. § 506(b) seeking allowance of $18,271.19 in postpetition attorneys fees

plus $442,843.51 in interest calculated at an 18% default rate. The Debtors and Smith

jointly objected to BOM’s motion. Smith is owed approximately $16 million on

account of its undersecured secured claim.

At the hearing on the BOM’s motion, the Debtors and Smith agreed to

allowance of the BOM’s attorney fees, leaving only the default interest at issue.

BANKRUPTCY COURT DECISION

The bankruptcy court denied BOM's motion to enforce the default interest

provisions for two alternative reasons. First, the bankruptcy court held the default

interestrate constituted an unenforceable penalty under Missouri law. In so doing, the

bankruptcy court held that under Missouri law, courts refuse to enforce liquidated

damages clauses found to be improper penalties. Using this standard, the bankruptcy

court concluded thatBOM's default interestrate constituted an unenforceable penalty.

Second, and as an alternative holding, the bankruptcy court held that the default

interest rate could not be enforced based on "equitable considerations."

Before reaching its alternative holdings, the bankruptcy court briefly addressed

the issue of whether the default interest rate had even been triggered under the terms

of the contracts. The bankruptcy case was filed on April 30, 2018. The parties are in

agreement that on that date, the loans were not in default. Under the express terms of

the promissory notes, the next scheduled payments were due May 1, 2018. It is

undisputed that the debtors did not make those or any subsequent postpetition

payments. BOM argued that its default interest rate was automatically triggered when

the payments were not made on May 1. The Appellees argued that they were excused

from making postpetition payments absent a court order, and should not be held in

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Appellate Case: 19-6025 Page: 4 Date Filed: 03/19/2020 Entry ID: 4893145
default. Noting that the caselaw on the subject was “murky,” and due to its alternative

holdings, the bankruptcy court did not rule on the default issue. 

DISCUSSION

BOM assertsthree assignments of error by the bankruptcy court. First, it asserts

the court erred in finding the default interest rate under itsloan documents constituted

an unenforceable penalty under Missouri law. Specifically, BOM asserts that it was

erroneous to apply a liquidated damages vs. penalty analysis to a contractual rate of

interestset forth in a promissory note. Second, BOM asserts that it was erroneous for

the bankruptcy court to weigh “equitable considerations” under the plain language of

11 U.S.C.§ 506(b). Finally, even though the bankruptcy court declined to opine on

the issue, BOM argues that to the extent the bankruptcy court based its holding on a

lack of default or a lack of notice, that too is erroneous under the express language

of the loan documents. 

11 U.S.C.§ 506(b)

It is undisputed that BOM is entitled to “interest” on its claims. 11

U.S.C.§ 506(b) provides:

To the extent that an allowed secured claimissecured by property

the value of which, after recovery under subsection (c) of this section,

is greater than the amount of such claim, there shall be allowed to the

holder of such claim, interest on such claim, and any reasonable fees,

costs, or charges provided under the agreement or State statute under

which such claim arose. 

In United States v. Ron Pair Enterprises, Inc., 489 U.S. 235 (1989), the

Supreme Court held that § 506(b) allows all oversecured creditors, including those

holding nonconsensual liens, to recover postpetition interest on their claims. Id. at

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241. In doing so, the Supreme Court rejected the pre-Code practice of treating

consensual and nonconsensual liens differently, saying it could not discern “any

significant reason why Congress would have intended, or any policy reason would

compel, that the two types of secured claims be treated differently in allowing

postpetition interest.” Id. at 243. The Supreme Court concluded that this result was

mandated by the plain language of the statute and is “unqualified.” Id. at 241. 

However, the right of an oversecured creditor to recover “fees, costs and

charges” is qualified. Under the plain language of the statute, those recoveries are

allowed only if provided for in the parties’ agreement and only if the court determines

they are reasonable. Id. at 241-42. In holding that the right to interest was

“unqualified,” the Supreme Court wassaying that the qualifications applicable to the

right to recovery of fees, costs and charges under § 506(b) – that they must be

provided for in an agreement and must be reasonable – are not applicable to any

oversecured creditor’s entitlement to interest. 

Although the Ron Pair holding is clear that all oversecured creditors are

entitled to postpetition interest, the Supreme Court did not set the rate at which an

oversecured creditor is entitled to recover postpetition interest. Since Ron Pair, “most

courts have concluded that ‘postpetition interest should be computed at the rate

provided in the agreement, or other applicable law, under which the claim arose – the

so-called contract rate of interest.’’’ White v. Coors Distrib. Co. (In re White), 260

B.R. 870, 879 (B.A.P. 8th Cir. 2001) (citations omitted). In White, we affirmed the

bankruptcy court’s decision that an assignee of the original lender was entitled to

collect postpetition interest under Nebraska law and under § 506(b) at the 18% rate

specified in the contract. 

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Appellate Case: 19-6025 Page: 6 Date Filed: 03/19/2020 Entry ID: 4893145
The Contract Rate of Interest.

The bankruptcy court found that between July 21, 2014, and March 1, 2018,

BOM made eight loans to the Debtors. The individual promissory notes have

non-default interest rates ranging between 3.65% and 7.5%. Other than these

non-default interest rates and the maturity dates which vary from loan to loan, the

relevant terms of the notes are, for all practical purposes, identical. The notes provide

that “[u]pon default, including failure to pay upon final maturity, the interest rate on

this Note shall be increased to 18.000% per annum based on a year of 360 days.” A

“default” istriggered when the “Borrower failsto make any payment when due under

this Note.” These findings of the bankruptcy court are not challenged by any party to

this appeal. 

It is also undisputed that the Debtors were current on all of the loans on April

30, 2018, when they filed bankruptcy. The bankruptcy court record reflectsthat when

BOM originally filed its proofs of claimin the bankruptcy case, it referenced only the

non-default contractual rates of interest for each loan. In fact, based on the stalking

horse bid of $8,000,000.00 for the debtor’s assets, it appeared BOM was an

undersecured creditor. After the auction it became apparent that BOM was

oversecured and it began the process of claiming a right to default interest.

Default

Subsumed in all of BOM’s assignments of error on appeal are its assertionsthat

(i) the debtors became in default on the loans when they failed to make any of the

payments that became due on May 1, 2018, which was the day after bankruptcy

filing; and (ii) upon such default, the interest rate automatically increased to the

default rate of 18% per annum. However, as indicated, the bankruptcy court did not

opine on this issue. 

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Appellate Case: 19-6025 Page: 7 Date Filed: 03/19/2020 Entry ID: 4893145
Appellees do not disagree with BOM’s assertions about what the documents

say. However, they assert the bankruptcy court was correct in holding that the

presumption in favor of the contract rate of interest applies only if the rate is

enforceable under applicable non-bankruptcy law, and even then may be modified by

the bankruptcy court if equitable considerations so demand.

The issues on appeal are: (i) whether it was erroneous to apply a liquidated

damages vs. penalty analysisto a contractual rate of interest set forth in a promissory

note; and (ii) whether the bankruptcy court properly considered equitable factors in

denying the lender’s claim for default interest.

Applicability of Liquidated Damages vs. Penalty Analysis.

Section 502 of the Bankruptcy Code provides that the bankruptcy court shall

allow a claim‘‘except to the extent that — (1) such claimis unenforceable against the

debtor . . . under . . . applicable law[.]’’ 11 U.S.C. § 502(b)(1). The Supreme Court

in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 549

U.S. 443, 450 (2007), affirmed that “[c]reditors' entitlements in bankruptcy arise in

the first instance fromthe underlying substantive law creating the debtor's obligation,

subject to any qualifying or contrary provisions of the Bankruptcy Code.” Here, the

parties agree that the substantive law of the state of Missouri is applicable to the notes

at issue. 

The bankruptcy court found, and the parties do not dispute, that Missouri

statutory law permits parties to certain types of loans, such as those at issue here, “to

agree in writing to any rate of interest, fees, and other terms and conditions[.]” Mo.

Ann. Stat. § 408.035 (West) (emphasis added). The bankruptcy court then segued into

an analysis of liquidated damage provisions and penalty clauses, determining for

variousreasonsthat BOM’s default interestrate constituted an unenforceable penalty

under Missouri law. 

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Appellate Case: 19-6025 Page: 8 Date Filed: 03/19/2020 Entry ID: 4893145
The concepts of default interest and liquidated damages are often conflated, but

it isimportant to differentiate between the two. We explained the distinctionsin 1998

when ruling on a South Dakota employment agreement:

Although default interest and liquidated damages are similar in

concept, the differences between the two are readily discernible,

especially when applied to the factsin this case. When the term “default

interest” is used, “default” refers to an event in a debtor-creditor

relationship that triggers certain consequencestypically set out in a loan

document. One such consequence may be the escalation of the interest

rate on remaining indebtedness, hence the term “default interest.” In

contrast, “liquidated damage” usually refers to a specific sum of money

expressly stipulated as the amount of damages to be recovered for

breach by either party to an agreement. Stein v. Bruce, 366 S.W.2d 732,

735 (Mo. App. 1963).

Direct Transit, Inc. v. S. Dakota Governor’s Office of Econ. Dev. (In re Direct

Transit, Inc.), 226 B.R. 198, 201 (B.A.P. 8th Cir. 1998) (internal citations omitted). 

Direct Transit involved two economic development loans from the state,

memorialized by promissory notes and secured by real and personal property and a

letter of credit, and a separate agreement that Direct Transit would maintain business

operations in South Dakota – and, presumably, the employment of South Dakota

residents – for a period of eight years. The parties’ agreement contained express

language whereby Direct Transit would pay a specific sum to the state economic

development office if Direct Transit changed the nature of the project, relocated, or

ceased operations so that a loss of employment resulted. In ruling that the liquidated

damages provision was enforceable under South Dakota law and the Bankruptcy

Code, the Bankruptcy Appellate Panel noted that the terms of the employment

agreement and the terms of the promissory notes were separate, and Direct Transit

could have been in default on the promissory notes without incurring liability for

liquidated damages as long as it continued to operate in accordance with the

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employment agreement. “The liquidated damages provision became due for a

non-monetary breach of the contract rather than for a default under the terms of the

note. Therefore, the provision in question is a true liquidated damages provision and

not a default rate of interest.” Id.

Other courts have also found that default interest provisions are not subject to

a liquidated damages vs. penalty analysis. See In re 3MB, LLC, 609 B.R. 841, 848

(Bankr. E.D. Ca. 2019) (noting that default interest has long been allowed in

California without resorting to a liquidated damages analysis); In re 785 Partners

LLC, 470 B.R. 126, 131 (Bankr. S.D.N.Y. 2012) (citing with approval a New York

state court case holding that an agreement to pay interest at a higher rate after default

is an agreement to pay interest and not a penalty).

In contrast, a more recent Eighth Circuit case did review a default interest rate

using a liquidated damages analysis under Minnesota law. Bowles Sub Parcel A, LLC

v. Wells Fargo Bank, N.A. (In re Bowles Sub Parcel A, LLC), 792 F.3d 897 (8th Cir.

2015). However, a careful review of that opinion and its history reveals that it does

not stand for the proposition that a liquidated damages analysis should be applied to

default interest rates. Instead, the Eighth Circuit opinion does not address that issue

at all, indicating the court simply addressed the issues as presented by the parties.

Clarity can be found, however, in the opinion of the United States District Court that

preceded the Court of Appeals decision – Bowles Sub Parcel A, LLC v. Wells Fargo

Bank, N.A. (In re Bowles Sub Parcel A, LLC), 2013 WL 6500130 (D. Minn. Dec. 11,

2013). In that opinion, the District Court said:

Default interest clauses are distinguishable from liquidated damages

clauses because the latter provide for a fixed amount of damages in the

event of a breach, see In re Qwest's Wholesale Serv. Quality Standards,

702 N.W.2d 246, 262 (Minn. 2005), whereas default interest clauses

cause the interest rate on whatever indebtedness remains at the time of

default to escalate to a higher percentage, see In re Direct Transit, Inc.,

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226 B.R. 198, 201 (B.A.P. 8th Cir. 1998). In other words, the monetary

consequences of a default interest clause differ depending on when the

default occurs, while the same is not true of a typical liquidated damages

clause. Despite this slight difference, the Bankruptcy Court applied a

liquidated damages analysis to the default interest provision and the

parties do not contest that this is the appropriate analysis.

Id. at *4, n.3. 

In any event, the question that faced the bankruptcy court in the instant case is

whether a default interest rate would be subjected to a liquidated damages vs. penalty

analysis under Missouri law. The bankruptcy court found that it would. After

acknowledging that an 18% rate of interest is per se legal under Missouri law, the

bankruptcy court then engaged in an analysis of valid liquidated damage clauses

versus invalid penalty provisions. It noted that under the loan documents, default

occurs immediately upon a failure to pay and the default interest rate applies

immediately upon default and without notice. It also noted the loans had cross-default

provisions and that the spread between the default and non-default rates ranged from

10.5% to 14.5%. The bankruptcy court held that there was no evidence that such a

large spread was a “reasonable” prediction of the harm caused by a default. 

However, as BOM correctly points out, neither party was able to point to a

single case under Missouri law which applied a liquidated damages analysis to a

contractual interest rate set forth in a promissory note. As the bankruptcy court

correctly found, the default rate of interest in the BOM notes is a lawful rate of

interest under Missouri law. No Missouri cases have been presented to us to support

the proposition that an otherwise lawful interest rate can or should be denied or

reduced under such an analysis. 

Further, applying the liquidated damages analysis to a contractual interest rate

brings into play “reasonableness” factors that simply are not applicable to interest

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rates under 11 U.S.C.§ 506(b). In Ron Pair, the Supreme Court was clear that the

right to interest is “unqualified” by the reasonableness language that qualifies a

creditor’sright to fees, costs and charges. 489 U.S. at 241. Therefore, the bankruptcy

court erred in applying a liquidated damages analysis and ruling the default interest

rate was an unenforceable penalty. 

Equitable Considerations.

The bankruptcy court ruled in the alternative that “the equities of this case

under applicable federal bankruptcy law mandate disallowance of default interest” on

BOM’s claim. In reviewing equitable considerations, the bankruptcy court was

following what islikely the majority position since Ron Pair – “[w]hat emerges from

the post-Ron Pair decisions is a presumption in favor of the contract rate subject to

rebuttal based upon equitable considerations.” In re Terry Ltd. P’ship, 27 F.3d 241,

243 (7th Cir. 1994) (citations omitted). In its analysis, the bankruptcy court

considered such factors as the spread between the default and the non-default rates

and the fact that BOM did not begin to assert a claim to default interest until it

appeared that the auction would produce unexpected results. 

While we acknowledge that the bankruptcy court followed the majority rule in

applying equitable considerations to its analysis, we note that the Eighth Circuit has

not yet ruled on the issue. We also note that despite the temptation to look beyond the

statutory language to effect a resolution, the United States Supreme Court has

unequivocally expressed its preference for staying within the lines:

The task of resolving the dispute over the meaning of § 506(b)

begins where all such inquiries must begin: with the language of the

statute itself. Landreth Timber Co. v. Landreth, 471 U.S. 681, 685, 105

S. Ct. 2297, 2301, 85 L. Ed.2d 692 (1985). In this case it is also where

the inquiry should end, for where, as here, the statute'slanguage is plain,

“the sole function of the courts is to enforce it according to its terms.”

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Caminetti v. United States, 242 U.S. 470, 485, 37 S. Ct. 192, 194, 61 L.

Ed. 442 (1917).

Ron Pair, 489 U.S. at 241. 

The Supreme Court emphasized this later in the same opinion:

The plain meaning of legislation should be conclusive, except in

the "rare cases [in which] the literal application of a statute will produce

a result demonstrably at odds with the intentions of its drafters." Griffin

v. Oceanic Contractors, Inc., 458 U.S. 564, 571, 102 S. Ct. 3245, 3250,

73 L. Ed.2d 973 (1982). In such cases, the intention of the drafters,

rather than the strict language, controls. Ibid. It is clear that allowing

postpetition interest on nonconsensual oversecured liens does not

contravene the intent of the framers of the Code. Allowing such interest

does not conflict with any other section of the Code, or with any

important state or federal interest; nor is a contrary view suggested by

the legislative history.

Id. at 242-43. See also Law v. Siegel, 571 U.S. 415, 426 (2014) (“Marrama most

certainly did not endorse, even in dictum, the view that equitable considerations

permit a bankruptcy court to contravene express provisions of the Code.”); Travelers

Cas. & Sur. Co. of Am. v. Pac. Gas & Elec. Co., 549 U.S. 443, 452 (2007)

(“Consistent with our prior statements regarding creditors’ entitlements in

bankruptcy, we generally presume that claims enforceable under applicable state law

will be allowed in bankruptcy unless they are expressly disallowed.”) (internal

citation omitted); andNorwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988)

(“[W]hatever equitable powersremain in the bankruptcy courts must and can only be

exercised within the confines of the BankruptcyCode.”). More recently, the Supreme

Court has expressed a need to place limitations on judicial lawmaking – or federal

common law. Rodriguez v. Federal Deposit Insurance Corp., ___ U.S. ___, 140 S.

Ct. 713, 718 (2020).

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Of course, we recognize that the statute in this case does not define the rate of

interest to be applied. However, the affinity for weighing equitable concerns in

determining claims has strayed beyond the circumstances in which it is most useful

and into situations where the statute itself provides the answer in a more

straightforward and less time-consuming manner. Simply put, no section of the

Bankruptcy Code gives the bankruptcy court authority, equitable or otherwise, to

modify a contractual interest rate prior to plan confirmation. In this case, the

bankruptcy court need not have considered equitable factors in deciding the matter

at hand. 

As an oversecured creditor, BOM has an unqualified right to postpetition

interest under § 506(b), and that interest should be computed at the rate – default as

well as non-default – provided in the parties’ agreement, as long as those rates are

allowed under state law. White, 260 B.R. at 879. Here, the default rate of interest was

agreed to by the parties to the promissory notes and all parties agree it is a legal rate

under state law. There have not been any allegations of misconduct byBOM, whether

in the making of its loans or in the course of the bankruptcy case. Nor have the

appellants recited any basis for not enforcing the contract rate under Missouri law.

Accordingly, absent some compelling reason to the contrary, BOM should be

permitted to collect interest at that rate if the notes are in default. 

CONCLUSION

In summary, we make no decision as to whether and when the default interest

rates under the notes at issue were triggered under the facts of this case. Those

decisions are mixed questions of law and fact that are best left for the bankruptcy

court to decide in the first instance. Further, we endorse the view that post-Ron Pair,

the pre-confirmation interest rate to be applied under § 506(b) to an oversecured

creditor whose claim is evidenced by a promissory note or similar loan agreement is

the contract (both non-default and default) rate set forth in the note or loan agreement,

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to the extent enforceable under applicable law.2 Also, absentstate law to the contrary,

a liquidated damages vs. penalty analysis is not applicable and should not be applied

to a default interest rate set forth in a promissory note or similar loan agreement.

Finally, we follow the rule that equitable considerationsshould be used sparingly and

only in exceptional circumstances.

Accordingly, the decision of the bankruptcy court is reversed. Because the

issues of whether and when the loans became in default and subject to the default rate

of interest were not decided by the bankruptcy court, we will remand this case for a

determination of those issues, and further proceedings consistent with this opinion.

______________________________

2Of course, the rate may properly be modified post-confirmation though the

plan confirmation process.

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