Weil, Gotshal & Manges LLP
Ninth Circuit Holds that a Solvent Debtor Must Pay Postpetition Interest at the Federal Judgment Rate
(June 2002, Bankruptcy Bulletin)
By Elisa R. Lemmer
In Onink v. Cardelucci (In re Cardelucci), the United States Court of Appeals
for the Ninth Circuit determined that the federal judgment rate is the
applicable rate of postpetition interest payable on a claim held by an
unsecured creditor in the chapter 11 case of a solvent debtor. Cardelucci
is the first circuit court case to address and decide this issue.
Statutory and Historical Background
To confirm a plan of reorganization, a debtor (or other plan proponent)
must meet the requirements of section 1129 of the Bankruptcy Code. Among
other requirements, a plan must satisfy the “best interest of creditors”
or “liquidation” test set forth in section 1129(a)(7). Section
1129(a)(7)(A) provides that each creditor entitled to vote on a plan must
either accept the plan or receive no less under the plan than the creditor
would receive if the debtor were liquidated under chapter 7.
Section 726(a) of the Bankruptcy Code, which governs the priorities of
distribution in a liquidation, provides in subsection (5) that, after all
prepetition allowed claims have been paid in full, an unsecured creditor
is entitled to “payment of interest at the legal rate from the date of
the filing of the petition” before any of the remaining assets are distributable
to the debtor. Accordingly, to satisfy the “best interest of creditors”
test, a solvent debtor will be required to pay a dissenting unsecured creditor
postpetition interest at the “legal rate.” This requirement does
not apply to postpetition interest payable to secured creditors, whose
right to postpetition interest is governed under a different section of
the Bankruptcy Code.
The term “legal rate” is not defined in the Bankruptcy Code and, therefore,
has been left for judicial determination. Prior to Cardelucci, some
bankruptcy courts held that the phrase “interest at the legal rate” refers
to the federal judgment rate provided by section 1961(a) of title 28 of
the United States Code. The federal judgment rate is calculated according
to the weekly average of the one-year constant maturity Treasury yield,
as published weekly by the Board of Governors of the Federal Reserve System.
Other bankruptcy courts, however, have held that the “legal rate”
is the contract rate, if one exists, or a state statutory rate, if there
is no contract, and have applied the federal judgment rate only in the
absence of a contract or state statutory rate.
Thus, the applicable postpetition interest payable on the claim of an unsecured
creditor remains unsettled across jurisdictions. For example, the
bankruptcy court in In re Dow Corning Corporation undertook a thorough
review of existing case law on the issue and concluded that the phrase
“interest at the legal rate” refers to the federal judgment rate. By
contrast, the bankruptcy court in In re Schoeneberg refused to apply the
federal judgment rate even in the absence of a contract or special state
statutory rate, holding that the state judgment rate would apply under
The inconsistent interpretations of the term “legal rate” have not only
resulted in disparate awards of postpetition interest in various jurisdictions,
but also have resulted in disparate treatment of creditors within the same
circuit. The Ninth Circuit specifically encountered this problem
in the late 1990s when two decisions, one issued by the Ninth Circuit Bankruptcy
Appellate Panel (the “B.A.P.”) and the other issued by the District of
New Mexico, directly contradicted each other. In 1998, in Beguelin
v. Volcano Vision, Inc. (In re Beguelin), the B.A.P. held that postpetition
interest should be payable at the federal judgment rate to promote ease
of administration of a debtor’s bankruptcy case.
One month later, the District of New Mexico in In re Carter rejected the
Beguelin holding and criticized the Beguelin court for overlooking what
the Carter court apparently considered to be a negative byproduct of awarding
postpetition interest at the federal judgment rate — a windfall to the
debtor comprised of the remaining assets. The Carter court refused
to award postpetition interest at the federal judgment rate and, instead,
held that the applicable interest rate would be that provided pursuant
to any applicable contract or underlying judgment.
In 1999, the Ninth Circuit came close to resolving the matter in In re
Shoen when it stated in dicta that if the debtor in that case were solvent,
postpetition interest at the federal judgment rate would be awarded.
The dichotomy within the Ninth Circuit illustrates the bankruptcy courts’
struggle to interpret the phrase “interest at the legal rate.” The
inconsistent interpretations appear to reflect conflicting policy concerns:
on the one hand, to promote ease of administration as well as equitable
treatment of all unsecured creditors and, on the other hand, to prevent
a windfall to the debtor. The problem has been compounded further
by the paucity of appellate level decisions directly discussing the issue.
Factual Background of the Cardelucci Case
In Cardelucci, the debtor, Samuel Cardelucci, owned and operated various
rubbish companies in California. In January of 1993, a California
state court found that Cardelucci had engaged in predatory pricing and,
as a result, was liable to Marsha and Willem Onink for unfair trade practices.
The state court entered a judgment in favor of the Oninks, which
included interest at the state statutory rate applicable to judgments.
Shortly after entry of the state court judgment, Cardelucci filed a voluntary
petition for relief under chapter 11 of the Bankruptcy Code. The
Oninks’ state court judgment became an unsecured claim in Cardelucci’s
bankruptcy case. Cardelucci’s plan of reorganization provided for
payment of the Oninks’ claim in full with postpetition interest at a rate
to be determined according to the Bankruptcy Code.
It was acknowledged that Cardelucci’s chapter 11 estate was solvent and,
therefore, unsecured creditors would be entitled to payment of postpetition
interest at the “legal rate.” However, the parties disputed the
applicable interest rate. Cardelucci contended that the “legal rate”
was the federal judgment rate, which was calculated at 3.5%; the Oninks
argued that the appropriate “legal rate” was California’s state statutory
rate, which was calculated at 10%. The bankruptcy court agreed with
Cardelucci and held that the federal judgment rate, rather than the state
law rate, applied. The district court affirmed the bankruptcy court’s
ruling. The Oninks appealed to the Ninth Circuit arguing, among other
things, that an award of postpetition interest at the federal judgment
rate would violate their substantive due process rights.
The Ninth Circuit’s Holding
The Ninth Circuit rejected the Oninks’ arguments, holding that the phrase
“interest at the legal rate” refers to the federal judgment rate. Recognizing
the disparate previous bankruptcy court decisions and the lack of legislative
history on the meaning of the phrase “interest at the legal rate,” the
Ninth Circuit relied on a textual interpretation of the phrase, as well
as principles of equity, in reaching its conclusion.
The Ninth Circuit found that the principles of statutory interpretation
supported the conclusion that Congress intended the phrase “interest at
the legal rate” to refer to the federal judgment rate and noted that Congress
had replaced the originally proposed language “interest on claims allowed”
with “interest at the legal rate.” The Ninth Circuit also focused
on the choice of the definite article “the,” as opposed to the indefinitearticle “a” or “an,” to support its conclusion that Congress intended
a single, specific rate to be used in calculating postpetition interest.
Uniformity within federal law and ease of administration of claims were
also cited as reasons for applying the federal judgment rate to calculate
postpetition interest. The Ninth Circuit noted that the award of
postpetition interest on a claim in bankruptcy is analogous to an award
of postjudgment interest on a federal judgment. Accordingly, the
Ninth Circuit concluded that a holder of an allowed claim in bankruptcy
should be entitled to an award of interest pursuant to a rate provided
in a federal statute.
Applying a single, easily determinable rate to all claims for postpetition
interest, said the Ninth Circuit, guarantees fair and equitable treatment
of all unsecured creditors. Citing the B.A.P.’s rationale in Beguelin,
the Ninth Circuit noted that use of the federal judgment rate in calculating
postpetition interest is the most judicially efficient and practical way
of distributing the estate’s assets. If varying interest rates were
applied, the process of calculating the postpetition award would become
cumbersome and overwhelming.
The Ninth Circuit acknowledged that, in some cases, calculating postpetition
interest using varying interest rates (e.g., the rates stated in each creditor’s
contract) would not be a cumbersome or difficult task. Moreover,
the Ninth Circuit noted that, in those cases, the debtor might receive
a windfall if the lower federal judgment rate (as opposed to a contract
rate or another rate of interest) were applied. However, the Ninth
Circuit refused to carve out an exception to the application of the federal
judgment rate in calculating postpetition interest, noting that “interest
at the legal rate” is a definite phrase with a specific meaning that could
not be adjusted depending on the circumstances of each bankruptcy case.
Finally, the Ninth Circuit rejected the Oninks’ substantive due process
argument, remarking that even if the Oninks had a substantive right to
postpetition interest, applying the federal judgment rate to all claims
is “rationally related to the legitimate interests in efficiency, fairness,
predictability, and uniformity within the bankruptcy system.”
As the first court of appeals case to determine the applicable rate of
postpetition interest, the Cardelucci decision is significant because it
squarely addresses, and attempts to reconcile, the competing considerations
often cited by bankruptcy courts in determining the meaning of “interest
at the legal rate” in section 726(a)(5). While recognizing that,
in certain circumstances, an award of postpetition interest at the federal
judgment rate could result in a windfall for the debtor, the Ninth Circuit
nevertheless has held that section 726(a)(5) mandates application of the
federal judgment interest rate for the calculation of postpetition interest.
Thus, the Cardelucci decision creates a much needed bright line rule
for calculating postpetition interest which, accordingly, becomes the rate
of interest necessary to satisfy the “best interest of creditors” test.
It remains to be seen whether courts outside the Ninth Circuit will follow
Cardelucci and its rationale.
Onink v. Cardelucci (In re Cardelucci), 285 F.3d 1231 (9th Cir. 2002).
In re Shoen, 176 F.3d 1150 (9th Cir. 1999), cert. denied, 528 U.S. 1075
In re Dow Corning Corp., 237 B.R. 380 (Bankr. E.D. Mich. 1999).
In re Carter, 220 B.R. 411 (D. N.M. 1998).
Beguelin v. Volcano Vision, Inc. (In re Beguelin), 220 B.R. 94 (9th Cir.
In re Schoeneberg, 156 B.R. 963 (Bankr. W.D. Tex. 1993).