Federal Judgment Rate vs. Contract Rate: The Debate Continues

In the recent case of Calita Elston Robinson,[1] the U.S. Bankruptcy Court for the Northern District of Georgia addressed the issue of what the “interest at the legal rate” means under § 726(a)(5) of the Bankruptcy Code. In particular, the court addressed the issue of whether the appropriate interest rate for unsecured creditors in a solvent bankruptcy case should be at the federal judgment rate or the particular rate specified in the creditor’s contract with the debtor (i.e., the contract rate).

Recognizing a split of authority, the Robinson court first examined the two leading cases that have espoused the opposing views. The Robinson court noted that In re Cardelucci[2] is the leading case interpreting § 726(a)(5) to require that interest be paid at the federal judgment rate. In Cardelucci, the U.S. Court of Appeals for the Ninth Circuit opined that § 726(a)(5) of the Bankruptcy Code requires interest to be paid at the federal judgment rate for the following reasons: (1) Congress chose the more specific language of “interest at the legal rate” instead of the more general, originally proposed language of “interest on claims allowed” and the chosen language used the more definite “the” instead of an indefinite “a” or “an,” thereby indicating Congressional intent for an interest rate derived from a common, single source, that being the federal statute awarding interest on judgments; (2) the federal judgment rate is consistent with the general rule that post-petition interest is procedural in nature and, therefore, dictated by federal law, entitling a creditor to an award of interest pursuant to a federal statute; (3) a single, uniform rate is equitable to all unsecured creditors and ensures that no single creditor receives a disproportionate share of assets; and (4) trustees should not be burdened by having to determine and calculate the appropriate rate for each individual unsecured creditor.[3]

The Robinson court then addressed the countervailing point of view, set forth most recently in In re Dvorkin Holdings LLC.[4] In Dvorkin, the court found that “the Bankruptcy Code does not mandate payment of interest at the federal judgment rate when there is a surplus in the estate and that in such a case there is a presumption that post-petition interest should be paid pursuant to the terms of the contract.”[5]

As noted by the Robinson court, the Dvorkin court relied on a pre-Bankruptcy Code U.S. Supreme Court case, Vanston Bondholders Protective Committee v. Green,[6] wherein the Supreme Court utilized “‘a balance of the equities’ test to determine that it would be an inappropriate windfall to the debtor if money was returned to the debtor because creditors were deprived of their bargain for contractual interest.”[7] The Robinson court also noted the Dvorkin court’s reliance on a House Committee Report from 1994. As noted by the Robinson court, the Committee Report dealt with an amendment to § 1124 of the Bankruptcy Code concerning impairment of claims and the ability of creditors voting to accept or reject a chapter 11 plan. As observed by the Robinson court, “the Committee Report stated that in order for a Chapter 11 plan involving a solvent estate to be ‘fair and equitable’ as required under Section 1129(b)(2) with respect to a class of impaired, nonaccepting unsecured claims, those claims had to be paid in full, including with post-petition interest, before equityholders could participate in any recovery.”[8]

The Robinson court further noted the Committee Report’s conclusion that a “class of claims would be impaired and entitled to vote unless the class of claims was paid the full principal amount of their claims plus post-petition interest. Consequently, the Code was amended to delete Section 1124(3), which could be read to the contrary.”[9] However, according to the Robinson court, because the Dvorkin court determined that Congress intended for pre-Code practice to continue in the context of chapter 11 plan confirmation, the Dvorkin court relied on pre-Code case law that held that interest at the contract rate would be appropriate. Ultimately, as noted by the Robinson court, the Dvorkin court found that it would be “fundamentally unfair to require a creditor to accept a lower interest rate than he bargained for” in solvent cases.[10]

After analyzing § 727(a)(5) and the Cardelucci and Dvorkin decisions, the Robinson court found that the Cardelucci decision was “the better-reasoned case and that the federal judgment rate is the correct rate to apply based on the phrase ‘interest at the legal rate.’”[11] Rejecting the Dvorkin decision’s rationale, the Robinson court opined that Congress “adequately express[ed] its intention to have the interest rate found in the federal statute apply by choosing the more specific language of ‘interest at the legal rate’ instead of the more general, originally proposed language of ‘interest on claims allowed.’”[12]

In further support of its decision, the Robinson court observed that use of the federal judgment rate “is consistent with the general rule that post-petition interest is procedural in nature and dictated by federal law, and is equitable to all creditors because unsecured claims are allowed in an amount as of the petition date and should be treated equally thereafter with respect to the distribution of estate assets regardless of the parties’ pre-petition bargain.”[13] Furthermore, the Robinson court found that the federal judgment rate is the better rate to use, especially after considering § 502(b)(2) of the Bankruptcy Code, which disallows un- matured, post-petition interest for unsecured claims. Indeed, § 502(b)(2) specifically states that unmatured interest on an unsecured claim is not part of the allowed claim. Based on this interpretation of §§ 502(b)(2) and 726(a)(5), the Robinson court found that the correct application of these two sections was to treat the unsecured creditor as having “obtained a federal court judgment against the debtor on the day of the ling

of the petition on which it would receive interest at the federal judgment rate.”[14]
Finally, the Robinson court found that Dvorkin’s contractual-rate approach is also inconsistent with the

Supreme Court’s decision in Till v. SES Creditor Corp.[15] According to the Robinson court, the Till Court “specifically rejected the contract-rate approach in favor of a prime plus rate of interest, albeit for purposes of cramdown in a Chapter 13 case, but the principles supporting that decision are relevant to the matter before this Court [i.e., the appropriate interest rate].”[16] As noted by the Robinson court, as the Till Court was “not concerned with the debtor getting a perceived windfall in the event the prime plus interest rate was lower than the contract rate so that the debtor was permitted to retain the lender’s collateral while arguably depriving the creditor of its bargained-for interest rate, it would seem that Dvorkin’s concern about that issue with respect to the payment of interest on unsecured claims is neither warranted nor consistent with the statutory scheme found in the Bankruptcy Code.”[17] Furthermore, the Robinson court highlighted the Till Court’s concern that the contract-rate approach “violated the principles of equal treatment of creditors” as arguably various unsecured creditors would have different contractual rates of interest, thereby violating one of the premises of the Bankruptcy Code, namely like treatment of similarly situated creditors.

The Robinson court found that the Dvorkin decision was also contrary to the Supreme Court’s decision in Law v. Siegel,[18] wherein the Supreme Court specifically held that “bankruptcy courts [are prohibited] from using their equitable powers to create a remedy contrary to the existing statutory scheme.”[19] According to the Robinson court, the Dvorkin court was “clearly troubled by the apparent windfall the [solvent] debtor would receive in that case if the federal judgment rate of interest was applied so it resorted to equitable principles to prevent that result.”[20] However, the Robinson court found that by drafting §§ 502 and 726 of the Bankruptcy Code the way it did, “‘Congress balanced the difficult choices’ and ‘it is not for courts to alter the balance struck by the statute.’”[21] Accordingly, the Robinson court found that it was not appropriate for a bankruptcy court to “weigh equitable considerations to post its own result contrary to the statutory scheme.”[22] As a result, the court found that the federal judgment rate was the better rate to apply.

It seems like every year the debate concerning federal judgment rate versus contractual rate continues to be addressed by the courts. With the recent Robinson decision, the debate continues.