Cite as: Keith M. Lundin, Lundin On Chapter 13, § 83.4, at ¶ ____, LundinOnChapter13.com (last visited __________).
With respect to contracts entered into after October 22, 1994, § 1322(e) provides that the amount necessary to cure default “shall be determined in accordance with the underlying agreement and applicable nonbankruptcy law.”1
Typically, “applicable nonbankruptcy law” will be the state law “applicable” to the contract. This may be the state law specified in the contract. It could be the law of the state where the property is located for a real estate mortgage. It could also be the state law for the state in which the bankruptcy court sits when choice-of-law rules don’t point elsewhere.
“Nonbankruptcy law” may not be state law in some curing-default contexts. A federally guaranteed home loan or student loan contract may have “applicable” federal law that fixes or affects interest rates. Nothing in § 1322(e) limits “nonbankruptcy law” to state law.2
The “underlying agreement” may also require some interpretation. There may be several interest rates in the contract, including a “default” rate. Bankruptcy decisions in other contexts discussing default rates of interest will be relevant when the higher default rate in the underlying agreement is argued as the curing-default rate under § 1322(e).3
When § 1322(e) is applicable, if interest is allowed by the agreement and not prohibited by nonbankruptcy law, the rate of interest necessary to cure default should be determined by the contract.4 When interest was required but no rate of interest was specified in the note or deed of trust, one bankruptcy court looked to the interest rate under state law on “monies after they become due and payable on written contracts” to cure default through a Chapter 13 plan.5
When the contract provides for interest on “principal” and there are unpaid installments that include both principal and interest, curing default under § 1322(e) will only require interest on the principal portion of unpaid installments (if not prohibited by nonbankruptcy law). When the contract more broadly allows interest on unpaid installments, the effect can be to require the debtor to pay interest on the interest portion of an unpaid prepetition installment. If state law prohibits “interest on interest,” then § 1322(e) will prohibit recovery of interest on the interest portion of unpaid installments.
When state law does not prohibit interest on interest, but state law does regulate the maximum rate of interest that can be recovered on the contract, different questions arise. How does applicable nonbankruptcy law calculate the actual or effective rate of interest when the contract requires interest on the interest already included in an unpaid installment? If “interest on interest” multiplies the effective rate on arrearages cured through the plan, a state usury limitation may be in play.
When the interest rate in the contract and the rate allowed by nonbankruptcy law conflict—for example, if the contract produces a curing-default rate that exceeds a state usury limit—the conjunctive “and” in § 1322(e)6 will prohibit use of the contract rate. State law may then have more to say about the permitted rate of interest to cure default. Some states simply cap the permitted rate of interest when a contract requires an illegal rate. Other states prohibit the recovery of any interest when a contract contains a rate in excess of the maximum allowed rate. The incorporation of nonbankruptcy law in § 1322(e) could produce some very interesting interest rate cases as Chapter 13 lawyers dig into the documents and become more familiar with state interest rate limitations.
1 11 U.S.C. § 1322(e). See § 135.1 [ Section 1322(e): Contracts after October 22, 1994 ] § 83.2 Section 1322(e): Contracts after October 22, 1994.
2 See Patterson v. Shumate, 504 U.S. 753, 758, 112 S. Ct. 2242, 2246, 119 L. Ed. 2d 519 (1992) (“Nothing in § 541 suggests that the phrase ‘applicable nonbankruptcy law’ refers . . . exclusively to state law. The text contains no limitation on ‘applicable nonbankruptcy law’ relating to the source of the law.”).
3 See, e.g., Beal Bank v. Crystal Props., Ltd., L.P. (In re Crystal Props., Ltd., L.P.), 268 F.3d 743 (9th Cir. 2001) (Default interest rate required lender to give notice of acceleration.); Bradford v. Cozier (In re Laymon), 958 F.2d 72, 75 (5th Cir.) (Determination of which default interest rate applies under § 506(b) “must be decided by examining the equities involved in this bankruptcy proceeding.”), cert. denied, 506 U.S. 917, 113 S. Ct. 328, 121 L. Ed. 2d 247 (1992); Great Western Bank & Trust v. Entz-White Lumber & Supply, Inc. (In re Entz-White Lumber & Supply, Inc.), 850 F.2d 1338 (9th Cir. 1988) (Chapter 11 debtor could cure debt that matured prepetition by payment in full at confirmation and avoid default interest that had accrued since the default.); In re Phoenix Bus. Park Ltd. P’ship, 257 B.R. 517, 521 (B.A.P. 9th Cir. 2001) (“[A] debtor need pay interest only at the contract rate, and not the default rate, and need not pay late charges in order to effectuate a cure under section 1124(2).”).
4 See, e.g., In re Trabal, 254 B.R. 99 (D.N.J. 2000) (Mortgage holder is entitled to interest on advances at the contract rate of 8.625% because advances for attorney’s fees and taxes are added to the principal and bear interest at the contract rate. New Jersey law permits interest at the contract rate so long as the rate in the original agreement is not usurious.).
5 In re Koster, 294 B.R. 737 (Bankr. E.D. Mo. 2003).
6 See § 135.1 [ Section 1322(e): Contracts after October 22, 1994 ] § 83.2 Section 1322(e): Contracts after October 22, 1994.