The Bank of Missouri v. Family Pharmacy, Inc.

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
____________

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 involves review 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’s loan officer. Jt. Stip. of Facts & Agreement Related to the
(continued...)
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Debtor Family Pharmacy, Inc., and four related entities (collectively, the
“Debtors”) filed voluntary petitions for 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
subsequent stipulations with various claimants, the sales proceeds (after various fees
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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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
interest rate 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 that BOM's default interest rate 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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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 asserts three assignments of error by the bankruptcy court. First, it asserts
the court erred in finding the default interest rate under its loan 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
interest set 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 claim is secured 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 was saying 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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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” is triggered when the “Borrower fails to 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 reflects that when
BOM originally filed its proofs of claim in 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 assertions that
(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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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 analysis to 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 claim is 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 from the 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
various reasons that BOM’s default interest rate constituted an unenforceable penalty
under Missouri law.
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The concepts of default interest and liquidated damages are often conflated, but
it is important to differentiate between the two. We explained the distinctions in 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 facts in this case. When the term “default
interest” is used, “default” refers to an event in a debtor-creditor
relationship that triggers certain consequences typically 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’s right 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 is likely 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's language 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); and Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988)
(“[W]hatever equitable powers remain in the bankruptcy courts must and can only be
exercised within the confines of the Bankruptcy Code.”). 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 by BOM, 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, absent state 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 considerations should 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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