Payment of Postpetition Interest in Chapter 11 and Chapter 13 Plans
Some creditors are not entitled to postpetition interest on their claims. For example, general unsecured creditors typically don’t get postpetition interest pursuant to 11 U.S.C. § 502(b)(2).
Other creditors are entitled to postpetition interest.
I. Interest On Unsecured Priority Taxes
A. Chapter 11
For example, in Chapter 11 taxing authorities are entitled to postpetition interest on their unsecured priority claims. See, e.g., § 1129(a)(9)(c), IRM 126.96.36.199.1.3(6)., and IRS pub. 908 at pages 26-27.
B. Chapter 13
However, the IRS is not entitled to postpetition interest on unsecured priority claims in Chapter 13, unless the debtor has sufficient disposable income to pay the interest. 11 U.S.C. § 1322(b)(1) and IRM 188.8.131.52.1.3(5).
II. Default Interest On A Prepetition Arrearage
When a Chapter 11 or Chapter 13 plan proposes to cure a prepetition default, the creditor is entitled to postpetition interest on the default if the underlying note contains a default provision that includes default interest. See 11 U.S.C. § 1123(d), In re New Investments, Inc., 840 F. 3d 1137 (9th Cir. 2016), and 11 U.S.C. § 1322(e). This relatively new requirement states that the terms of curing the default must be “determined in accordance with the underlying agreement and applicable nonbankruptcy law.” Therefore, if the note provides for default interest, then the creditor gets interest on interest at the default interest rate in the contract.
III. Interest On An Over Secured Creditor’s Claim
Over secured creditors are entitled to postpetition interest. 11 U.S.C. § 506(b). At what interest rate? Just make something up?
The classical starting place is the Supremes’ holding in Till v. SCS Credit Corp., 541 U.S. 465 (2004). The Court held that the reason for choosing the correct interest rate in an objective manner is “to ensure that an objective economic analysis would suggest the debtor’s interest payments will adequately compensate all such creditors for the time value of their money and the risk of default.” Till, at 477. According to the Court, the correct method for determining the interest is the formula approach.
Taking its cue from ordinary lending practices, the approach begins by looking to the national prime rate, reported daily in the press, which reflects the financial market’s estimate of the amount a commercial bank should charge a creditworthy commercial borrower to compensate for the opportunity costs of the loan, the risk of inflation, and the relatively slight risk of default. Because bankrupt debtors typically pose a greater risk of nonpayment than solvent commercial borrowers, the approach then requires a bankruptcy court to adjust the prime rate accordingly.
Till, at 478-479 (emphasis added).
According to the Ninth Circuit BAP:
[A] bankruptcy court should apply the market rate of interest where there exists an efficient market. And, when no efficient market exists for a Chapter 11 debtor, then the Bankruptcy Court should employ the formula approach endorsed by the Till plurality.
That sounds great. Unfortunately, the Till holding is quite vague in determining the size of the addition to the prime rate to account for the higher risk associated with a debtor in bankruptcy.
In an attempt to make things more precise, our own Judge Albert — building on Pacific First Bank v. Boulders on the River, Inc. (In re Boulders on the River, Inc.), 164 B.R. 99, 105 (B.A.P. 9th Cir. 1994) — provided a multi-tiered approach in In re North Valley Mall, 432 B.R. 825 (Bankr. C.D. Cal. 2010). He divided the loan into three pieces — tranches — and assigned different interest rates to the tranches. He applied the lowest rate to part of the loan, then a higher rate to the next part, and a higher rate still to the last part. Each rate was determined according to the relative market risk associated with the corresponding portion of the loan.
Who bears the burden of proving the correct interest rates? The creditor. See, e.g., In re Tapang, 540 B.R. 701, 702 (Bankr. N.D. Cal. 2015) (“Creditor bears the burden of proof on the appropriate risk factors to be applied under the formula approach set forth in Till.”)
Unfortunately, this sort of analysis requires expert testimony, which can be quite expensive. Therefore, if the debtor is an individual, the litigation cost could be prohibitive.
The post Payment of Postpetition Interest in Chapter 11 and Chapter 13 Plans appeared first on Southern California Bankruptcy Law Blog.