Chapter 11 bankruptcies find the debtor generally to be insolvent, but not always.
Occasionally, a debtor will emerge from the bankruptcy process as a solvent entity, and in those situations, Bankruptcy Code §726(a)(5) may entitle creditors of the debtor’s estate to post-petition “interest at the legal rate from the date of filing the petition.”
In other words, the Bankruptcy Code affords creditors an opportunity to recoup the time-value for the lost use of the debtor’s assets.
Significantly, the term “legal rate” is undefined in both the Bankruptcy Code and its legislative history. Accordingly, the courts have been forced to supply meaning to this nebulous term. Fortunately, they were not writing on a blank slate—analogous provisions contained elsewhere in the United States Code provided valuable guidance.
Practically speaking, a majority of courts embrace the statutory post-judgment interest rate contained in 28 U.S.C. § 1961(a) as supplying the “legal rate” for post-petition interest. But, it is not the sole rule; there are other arguments to be offered.
[Editor’s Note: For more on legal rate, please read How Much Can I Add to My Claim? (says Lender) How Much Liquidity Will I Have? (says Reorganizing Debtor): On the Payment of Post-Petition Interest.]
On its face, Section 1961(a) explicitly defines post-judgment interest rates, and provides in pertinent part, “[s]uch interest shall be calculated from the date of the entry of the judgment, at a rate equal to the weekly average 1-year constant maturity Treasury yield, as published by the Board of Governors of the Federal Reserve System, for the calendar week preceding the date of the judgment.”
During periods of low inflation and low interest rates, the federal statutory interest rate is a relative pittance. To put things in context, the 1-year Treasury rate last topped 3% more than a decade ago. According to the latest available data, the average 1-year rate recently only climbed over 2% this past January and are still under 2.7% as of October 22, 2018,  which, from the vantage point of a creditor, is likely to be insufficient.
Against this backdrop, economic incentive exists for an unsecured creditor to advance alternative definitions for “legal rate” if by so doing they can obtain a return greater than the federal post-judgment rate.
To effect this outcome, unsecured creditors have sought to rely upon a minority of courts that have read the term “legal rate” to incorporate the pertinent contractual rate of interest that would otherwise have governed the relationship between the debtor and its creditor. Indeed, this may even translate to interest being calculated at a contractual default rate.
[Editor’s Note: For more lower court rulings, please see Judge Cox Clarifies Creditor Post-Petition Interest Rates.]
As one court explained, “When a debtor is solvent, then, the presumption is that a bankruptcy court’s role is merely to enforce the contractual rights of the parties, and the role that equitable principles play in the allocation of competing interest is significantly reduced.” Yet, even under this rationale, in those instances in which the pertinent contract lacked an interest rate, the parties must look to Section 1961 and the Federal Reserve for the applicable rate.
To be sure, the contractual argument has run into legal headwinds and been rejected on at least three separate grounds.
First, there is the language of the statute. By its terms, “section 726(a)(5) states that interest on unsecured claims shall be paid at the legal rate as opposed to a legal rate or the contract rate.”
Second, the payment of post-judgment interest is procedural by nature and dictated by federal law rather than state law.”
Third, “the use of the federal judgment rate promotes two important bankruptcy goals: fairness among creditors and administrative efficiency.”
That said, one other conceivable “legal rate” of interest might be the statutory rate of interest codified in state laws. For example, Section 5004 of New York’s Civil Practice Law & Rules contains a 9% statutory interest rate. That approach, however, looms as potentially more problematic than the contractual model for determining the legal rate as it lacks textual basis. Indeed, during a period of record low federal post-judgment interest rates, turning to state legal rates would confer an unintended and unimagined windfall to an unsecured creditor.
[Editor’s Note: For more information, please see Cash Collateral and DIP Loan Contests.]
Although the issue of what constitutes the “legal rate” in a solvent debtor bankruptcy case remains unresolved, a majority of bankruptcy courts, including those sitting in Delaware and New York, look to the federal post-judgment interest rate as a definitional source. Attempts to get beyond 28 U.S.C. § 1961(a) suffer from being at odds with the plain text of Section 726(a) of the Bankruptcy Code, and the primacy of federal law in bankruptcy cases.
A member of Otterbourg P.C., Melanie served for 14 years as a U.S. Chief Bankruptcy Judge in the Eastern District of New York before returning to private practice in 2007. Before the bench, she was a commercial/securities litigator at Sullivan & Cromwell and Milbank Tweed. She is a Fellow of the American College of Bankruptcy…
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