To jack up the interest rate on tax claims, the Tennessee legislature tried to outsmart the bankruptcy court but failed, for reasons the Sixth Circuit explained.
The state statute called for 12% interest on delinquent taxes plus a 6% “penalty.” A Tennessee bankruptcy court disallowed a claim for the 6% penalty, because the Bankruptcy Code generally does not allow penalties.
The Tennessee legislature responded by adding a new subsection declaring that the assessment of penalties “constitutes the assessment of interest” with regard to “any claim in a bankruptcy proceeding.”
Problem solved, right?
Wrong. Upholding the bankruptcy court, the Bankruptcy Appellate Panel held that the additional 6% interest was not pursuant to nonbankruptcy law and was therefore not allowable. The Sixth Circuit affirmed in a Feb. 23 opinion by Circuit Judge Jane B. Stranch.
The outcome turned on Section 511, which in substance says that the interest rate on tax claims “shall be the rate determined under applicable nonbankruptcy law.”
Judge Stranch rejected Tennessee’s argument that “nonbankruptcy law” means any law other than the Bankruptcy Code.
Instead, Judge Stranch adopted the First Circuit’s approach from Bank of New England Corp. that the term “nonbankruptcy law leaves no room for state legislatures or state courts to create special rules pertaining strictly and solely to bankruptcy matters.”
Adding her own gloss to the First Circuit holding, Judge Stranch said that “Congress authorized states to pass laws applicable to bankruptcy proceedings as long as those laws are generally applicable, not specifically targeted at bankruptcy proceedings.”
Judge Stranch therefore said that the proper reading of “nonbankruptcy law” means “any law that is not aimed solely at bankruptcy proceedings.” She said that Congress granted the states authority “to set generally applicable interest rates but not interest rates specific to bankruptcy proceedings.”
Although the state’s approach “may lend initial clarity,” Judge Stranch said it would require courts to decide whether the state violated the Supremacy Clause by enacting a bankruptcy law. Focusing on the Bankruptcy Code, standing alone, “avoids unnecessary adjudication of constitutional issues,” Judge Stranch said.
Without explaining why the result is different, Judge Stranch acknowledged Sixth Circuit authority allowing states to enact bankruptcy-specific exemptions without preemption by federal law.