In In re Flatbush Rho Mezz LLC, the U.S. Bankruptcy Court for the Southern District of New York allowed a secured creditor to be paid the entirety of a $5 million bond based on a loan with 24% default rate interest that continued to accrue interest during the pendency of an appeal. 

Background of the Dispute

One of the three debtors, 85 Flatbush RHO Mezz LLC ("Mezz"), acquired a mixed-use property “with a hotel component” in Brooklyn, New York.

To purchase the property, the two other debtors obtained a loan that was secured by a mortgage on the property. This loan was eventually sold to TH Holdco ("the Senior Lender").

Separately, Mezz obtained a loan from 85 Flatbush Mezz LLC ("Mezz Lender") that was secured by Mezz’s interests in the two other debtors. 

During the debtors’ bankruptcy cases, Senior Lender filed its own chapter 11 plan, which provided for Senior Lender to acquire the property via a $92 million credit bid and $2 million of new money.

The bankruptcy court confirmed the Senior Lender’s plan over the objections of the Mezz Lender and the debtors. In particular, Mezz Lender objected to Senior Lender voting Mezz Lender's claim and accepting the plan, which Senior Lender was permitted to do under the terms of an intercreditor agreement between Mezz Lender and Senior Lender. In so ruling, the bankruptcy court found that the intercreditor agreement was binding on Mezz Lender. 

Mezz Lender’s Appeal to the District Court 

Following confirmation of the Senior Lender’s plan, the debtors and Mezz Lender appealed and Mezz Lender sought—and obtained—a stay pending appeal. The district court conditioned the stay on Mezz Lender filing a $5 million bond in favor of the Senior Lender. Mezz Lender subsequently obtained the bond.

Thereafter, the district court affirmed the bankruptcy court’s confirmation order, which “effectively terminated the stay pending appeal and allowed [Senior Lender] to close on its credit bid in November 2022.”

The Dispute Over Payment of the $5 Million Bond

Following the closing on the sale of the property, Senior Lender requested that Mezz Lender pay the bond to Senior Lender as the successful party on the appeal and which sustained damage during the appeal. Mezz Lender contested Senior Lender’s claim on the bond in its entirety and directed the bond company not to pay any claim on the bond. The issue of payment on the bond was raised to the bankruptcy court. 

The bankruptcy court observed: “Given the District Court's affirmance of the Confirmation Order, the Mezz Lender is required to compensate [Senior Lender] under the Bond for any losses sustained by [Senior Lender] by virtue of the unsuccessful appeal. The issue before the Court today is the amount of such compensable losses.”

The Parties’ Competing Positions

Senior Lender asserted it was entitled to the bond money based on “six possible categories of damages,” which included: (1) default interest; (2) lost hotel and residential profits; (3) repair and maintenance costs; (4) attorneys' fees; (5) real estate taxes; and (6) a lapsed liquor license. 

The bankruptcy court only addressed the first two categories in its decision.

Default Rate Interest

The bankruptcy court observed that Senior Lender’s “position is straightforward:” it contended that it was entitled to default interest that accrued during the appeal. The Senior Lender quantified the per diem default interest to be approximately $58,800, totaling $5,645,000 for the entire appeal period. 

The bankruptcy court agreed with Senior Lender, finding upon the district court granting a stay of the confirmation order, Mezz Lender maintained its rights while the appeal was pending “but so did [Senior Lender].” Senior Lender’s credit bid “did not become effective until the appeal was resolved and the confirmation order became final.” Thus, until that occurred, “[Senior Lender’s] claim remained open and it continued to accrue whatever interest to which it was entitled.”

The bankruptcy court also decided that, as to Senior Lender’s entitlement to continuing interest, “that issue was decided by the Court, who explicitly concluded at the confirmation hearing that [Senior Lender] was entitled to interest on its claim.” 

As to the rate of post-petition interest under 11 U.S.C. § 506(b), the bankruptcy court found that “there is a strong presumption that the ‘contract rate’ will apply under Section 506(b), subject to limited equitable considerations.” There, the default interest rate was 24%. Given the bankruptcy court had already approved this rate of interest in the previously entered cash collateral order, the bankruptcy court ruled that it “[would] not stray from that approach and [found] that [Senior Lender’s] claim for postpetition interest at the default rate is valid.”

Accordingly, the bankruptcy court awarded Senior Lender default interest in the amount of $5.6 million.

Lost Profits

The bankruptcy court observed that, “[a]lthough the amount of default interest is sufficient by itself to justify the payment of the entire $5 million Bond to [Senior Lender], [Senior Lender] is entitled to the full amount of the Bond based on other damages in the record.”

Specifically, as “[Senior Lender’s] counsel correctly framed the issue, the ‘stay resulted in 96 days delay of [Senior Lender] getting possession of its collateral, and overall a 96-day delay in them operating and profiting off of [P]roperty over the lifetime of their ownership of that [P]roperty.”

The bankruptcy court found that Senior Lender’s lost profit evidence “to be credible and persuasive on how to quantify such delay” and that Mezz Lender “did not provide any evidence to rebut the showing of delay damages by [Senior Lender] or offer its own calculation of such damages.”

Conclusion

Flatbush Rho Mezz LLC is a reminder that parties will likely be held to contractual default interest rate and intercreditor rights and obligations that they agree upon. In particular, this case indicates that there is a strong presumption in favor of enforcing a lender’s contractual default rate interest. This case is also a reminder that default rate interest will likely continue to accrue during the pendency of an appeal. Finally, the case is also a reminder of the importance of negotiating appropriate intercreditor agreements as courts will likely enforce them according to their terms.