December 14, 2007

In a potentially important recent decision, the Bankruptcy Court for the Southern District of New York allowed substantial post-petition and default interest for an over-secured lender, but capped the lender's interest claim by the 25% interest rate limit provided by New York State usury law.

In re Urban Communicators PCS Limited Partnership, et al., 2007 Bankr. LEXIS 4062 (Bankr. S.D.N.Y. Dec. 11, 2007) (Gerber, J.).

Facts

In 1993, Urban Communicators PCS Limited Partnership successfully bid to acquire certain licenses from the Federal Communications Commission ("FCC") and subsequently assigned its rights as successful bidder to Urban Comm-North Carolina, Inc. (together with its affiliates, "UC-NC").  UC-NC financed 10% of the down payment that it was required to make to the FCC with a loan of $8 million from Gabriel Capital L.P. ("Gabriel"), secured by all of UC-NC's personal property and certain equity interests.  In a subsequent restructuring, the base interest rate for the loan was set at 15% compounded quarterly and the default rate was set at 4% over the base rate (i.e., a total default rate of 19% per annum, compounded quarterly).

In October of 1998, UC-NC filed for chapter 11 relief and, during the pendency of its bankruptcy case, UC-NC found third-party purchasers for certain of the licenses.

Gabriel filed a secured claim in UC-NC's bankruptcy case seeking payment of the outstanding principal of its loan plus the 19% default interest compounded quarterly.

UC-NC disputed the claim and, in April 2005, the bankruptcy court ruled that Gabriel was an over-secured creditor and entitled to post-petition interest of at least the 15% non-default rate.  The court reserved decision as to whether Gabriel was entitled to incremental post-petition interest representing the default rate (i.e., 19%, compounded quarterly).

The Bankruptcy Court's Decision

After a review of the relevant documentation, the bankruptcy court held that the contractual default rate of interest was 19% for the post-default period, compounded quarterly.  According to the court's calculations, the interest rate payable to Gabriel would therefore be the simple interest equivalent of approximately 38% per annum.  The court recognized that Gabriel was entitled to post-petition interest up to the amount of its equity cushion pursuant to section 506(b) of the Bankruptcy Code and that Gabriel's cushion was likely sufficient to allow payment of the 38% effective contractual rate.  The court also recognized the "general rule" that post-petition interest should be awarded to over-secured creditors at the relevant contractual rate.  However, the court relied on U.S. Supreme Court and Second Circuit case law for the proposition that bankruptcy courts have the discretion to award lower rates when required by equitable considerations.  In the present case, the court noted that the 38% effective rate would be a "very high" rate of interest that "necessarily" required the court to "focus on usury considerations," both as a matter of state law and as a matter of equity.

The court determined that a portion of the loan was subject to the 25% interest rate limit provided by New York State usury law, while the rest - because of its principal amount - was not.  With respect to that portion of the loan subject to the New York statute, the court ruled that Gabriel could not recover more than New York's 25% cap, because the loan documentation was expressly subject to New York law.  However, the court ultimately relied on equitable considerations to subject the entire loan to a 25% cap, relying on New York's usury law as "embodying an important public policy in the State of New York, and providing a benchmark for the Court's exercise of equitable discretion."

Conclusion

The Urban Communicators decision is of significance to over-secured creditors claiming an entitlement to post-petition interest, in that the court allowed very substantial post-petition and default interest, but went beyond the otherwise-applicable contractual rate to cap the creditor's post-petition interest by the 25% rate provided by New York's usury law, even where at least a portion of the loan was expressly exempted from the statute's coverage.

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