If a creditor obtains a pre-petition judgment on a debt that is later declared nondischargeable, the creditor is entitled to post-judgment interest at the state rate throughout, according to the Ninth Circuit Bankruptcy Appellate Panel.
A company executive abruptly quit and opened a competing business, appropriating his former employer’s employees, clients and mailing lists. The employer sued in state court and won a judgment for several million dollars. The executive filed a chapter 11 petition on entry of the state court judgment.
The employer sued in bankruptcy court for a declaration that the judgment was nondischargeable. After trial, the bankruptcy court ruled that the judgment was nondischargeable as a willful and malicious injury to property under Section 523(a)(6).
The bankruptcy court allowed post-judgment interest at the state rate until the employer filed the dischargeability complaint. The bankruptcy court allowed no post-judgment interest over the three years when the adversary proceeding was pending. The bankruptcy court allowed post-judgment interest at the federal rate after entry of the nondischargeability judgment.
Not satisfied with the interest allowed by the bankruptcy court, the employer appealed and won when the BAP handed down its decision on April 17, written by Bankruptcy Judge Robert J. Faris of Honolulu. He applied the de novo standard of review to the allowance of post-judgment interest.
The distinction between the state and federal rates was important because the state statute grants post-judgment interest at 10%. The federal rate, based on one-year Treasury bills, is “dramatically” lower, Judge Faris said.
Judge Faris noted distinctions between the applicable state and federal laws on interest. Post-judgment interest is mandatory under state law, while federal courts have discretion to impose prejudgment interest based on the equities of the case, he said.
Judge Faris said that the bankruptcy court properly awarded post-judgment interest at the state rate for the time before the creditor filed the dischargeability complaint.
With regard to the time periods after the creditor initiated the dischargeability adversary proceeding, Judge Faris cited a principle from U.S. Supreme Court authority that “interest is an ‘integral part’ of a nondischargeable debt.”
Judge Faris therefore ruled it was error to cut off the state rate during the pendency of the adversary proceeding because Section 523(a)(6) “does not permit the court to relieve the debtor of some of the interest that is an integral part of a nondischargeable debt . . . because the bankruptcy court thinks that the state interest rate is too high.”
Based on the same logic, Judge Faris held that it was error to allow interest at the lower federal rate after entry of the nondischargeability judgment because “interest on a nondischargeable judgment should continue to accrue at the state rate, even after the bankruptcy court determines the nondischargeability of the debt.” He conceded, however, that some courts have held otherwise.
The federal rate did not apply, Judge Faris said, because the nondischargeability judgment was not a new money judgment under federal law. “It simply determined that the state court judgment was not dischargeable. As such, the bankruptcy court lacked authority to override the state court’s award of interest.”
Judge Faris said the result would have been different had there been no judgment before bankruptcy. In that case, the bankruptcy judge would have determined “both the existence of the debt and its dischargeability,” making the federal rate applicable to both pre- and post-judgment interest.