In a case sure to attract attention from the circuit court and perhaps from the Supreme Court, the Sixth Circuit Bankruptcy Appellate Panel held that a state legislature cannot adopt a statute imposing an interest rate on tax claims exclusively for bankruptcies.
The case decided on April 26 is the latest installment in an ongoing struggle between the bankruptcy court in Tennessee and the state’s legislature. So far, the bankruptcy court is coming out on top.
For delinquent tax claims, Tennessee’s statute calls for a 12% interest rate and a 6% “penalty.” In a case called In re Gift, the bankruptcy court held in 2012 that the 6% penalty must be disallowed under Section 506(b), thus leaving taxing authorities with 12% interest on secured tax claims.
The legislature responded to Gift by adding a new subdivision to the statute, which provides, “for the purposes of any claim in a bankruptcy proceeding,” that the penalty on delinquent taxes “constitutes the assessment of interest.”
In a case after the amendment, the chapter 13 debtor proposed a plan with 12% interest on delinquent taxes. The bankruptcy judge dismissed the taxing authority’s objection, ruling that the amended statute and its attempted imposition of 18% interest violated the Supremacy Clause of the Constitution.
On appeal to the three-judge BAP, Bankruptcy Judge Tracey N. Wise reached the same result but without resorting to the constitutional issue. To reason that 12% was the proper rate, Judge Wise focused on Section 511(a), which says that the interest rate on a tax claim “shall be determined under applicable nonbankruptcy law.”
The BAP said that the statutory amendment effectively imposing an 18% interest rate solely in bankruptcies does not qualify as a “nonbankruptcy law” under Section 511 and therefore must be disregarded.
The ticklish part of the opinion concerns the question of whether all statutes aside from the Bankruptcy Code are nonbankruptcy laws. In other words, can some state statutes qualify as bankruptcy laws?
Judge Wise held that some state statutes can be bankruptcy laws. She pointed to the Sixth Circuit’s Schafer decision allowing bankruptcy-specific state exemptions for the proposition that states can enact bankruptcy laws in “appropriate circumstances.” In the case of exemptions, Schafer held in 2012 that state legislation was specifically permitted by Congress.
Judge Wise adopted the First Circuit’s 2004 Bank of New England opinion, which held that Section 510(a) does not allow states to adopt bankruptcy-specific statutes governing subordination. She said that the same principle applies to Section 511.
Given the “plain meaning” of the statute, Judge Wise held that the Tennessee law on interest rates in bankruptcies is a bankruptcy law that cannot be invoked under Section 511. Consequently, the proper interest rate was 12%, since the 6% penalty was not allowed.