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Ninth Circuit Holds that a Solvent Debtor Must Pay Postpetition Interest at the Federal Judgment Rate

Lemmer, Elisa

(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 such circumstances.


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.”


Conclusion

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 (2000).
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. BAP 1998).
In re Schoeneberg, 156 B.R. 963 (Bankr. W.D. Tex. 1993).
   
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