When unsecured creditors are entitled to interest payments in bankruptcy and at what rate they are to be paid is an often confusing topic. First, unsecured creditors will often file a proof of claim with the bankruptcy clerk with supporting documentation to validate the amount it is owed by the debtor. Some unsecured creditors will inappropriately file a claim that includes post-petition interest that continually accrues post-petition. Unsecured creditors’ are only entitled to file claims that equal the amount of principal and accrued fees and interest due under the unsecured notes “as of the date of the filing of the petition.” [note]See In re W.R. Grace & Co., 475 B.R. 34, 159 (D. Del. 2012) (Section 502(b)(2)[/note]. This does not include any post-petition interest. “It is well-established that when a debtor files for bankruptcy, the accrual of interest on its loans is suspended, and any subsequent claims brought by unsecured creditors for the amount of this “unmatured interest” is prohibited under § 502(b) of the Bankruptcy Code.”).”[note]In re Energy Future Holdings Corp., 540 B.R. 109 (Bankr. Del. 2015).[/note] But in the context of Chapter 11 plan confirmation, unsecured creditors can be entitled to interest payment on their claims. The question is: At what interest rate does the debtor have to pay its unsecured creditors to confirm its Plan?
Interest Rates to Unsecured Creditors and Chapter 11 Plan Confirmation
Confirming a Chapter 11 plan is rife with obstacles and pitfalls that must be overcome to successfully reorganize a business. Section 1129 of the Bankruptcy Code lays out the requirements for plan confirmation. In fact, in most Georgia bankruptcy courts, even if no creditors object, the Chapter 11 attorney for the plan proponent (almost always the debtor, but other entities can file competing plans after the debtor’s 120 day exclusivity period) must go through a “checklist” of sorts where he must proffer the proponent’s testimony that each of the confirmation requirements of Section 1129 have been met. It literally involves going down the list of requirements and stating that the plan complies with each requirement.
Chapter 11 plans can either impair a class of claims or leave them unimpaired. If a class of claims is left unimpaired, it means that the debtor is “leaving unaltered the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest.”[note]11 U.S.C. 1124(1).[/note] One of the requirements to confirm a plan is to get one impaired class of creditors to vote in favor of the plan.[note]11 U.S.C. 1129(a)(10).[/note] Unsecured creditors are often lumped into one or two classes of claims to be treated similarly, and obtaining their approval is a large hurdle to overcome to get past the absolute priority rule – a rule providing that a Chapter 11 plan is “fair and equitable” regarding a dissenting class of unsecured claims (absolute priority rule only applies to unsecured claims) if the plan provides that each holder of a claim in such class is effectively paid in full, or that a dissenting class of unsecured creditors is assured that no junior claimants will receive any distribution from under the plan until their claims are paid in full.[note]11 U.S.C. 1129(b)(2)(B).[/note] This means that the equity security holders, or owners, of a Chapter 11 debtor can’t retain ownership of their company if any class of impaired unsecured creditors votes to reject the plan.[note]Id.[/note]
Are Unsecured Creditors Entitled to Receive Interest in the First Place?
But what if the unsecured creditors, as a class, vote to accept the plan, but there are a few unsecured claimants within that class that vote to reject the plan and object to confirmation based on the rate of interest they are receiving on their claims under the plan?
Section 1129(a)(7) provides that in order for a plan to be confirmed, each unsecured claim holder who rejects the plan (even if the class the claimant belongs to accepts the plan) “will receive or retain under the plan on account of such claim . . . property of a value, as of the effective date of the plan, that is not less than the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7 of this title on such date.” This is often referred to as the “liquidation test” or “best interest of creditors test.” In a nutshell, this means that creditors must receive under the Chapter 11 plan as much as they would receive in a hypothetical Chapter 7 liquidation where all debtor’s assets are sold and the proceeds distributed to creditors. In simplistic terms, if an unsecured creditor rejects the plan, regardless of whether the class as a whole accepts the plan, the rejecting creditor must receive a distribution under the Plan in an amount at least equal to a hypothetical distribution in a Chapter 7.
This is important because section 726 of the code governs distribution of property of the estate under this hypothetical Chapter 7, and 726(a)(5) states that the fifth priority is “payment of interest at the legal rate from the date of the filing of the petition, on any [unsecured] claim . . .”[note]11 U.S.C. 726(a)(5).[/note]
What this section means is that if under a hypothetical Chapter 7, the rejecting unsecured creditor would receive a distribution, that creditor is entitled to receive interest on its payments under the Chapter 11 Plan. If the creditor would receive no distribution under the hypothetical Chapter 7, then the creditor is not entitled to receive interest on its claim under the Chapter 11 plan.[note]Energy Future Holdings Corp., 540 B.R. 109.[/note]
Defining the “Legal Rate” of Interest for Plan Confirmation
So now that we’ve established that unsecured creditors can be entitled to be paid interest on their claims through a Plan, the next step is to figure out what bankruptcy court have been interpreting the “legal rate” of interest to mean.
There is a split of authority right now over what the legal rate of interest should be when unsecured creditors are entitled to be paid interest on their claims. One line of cases holds that unsecured creditors should be compensated for the inherent risk forced upon them under a Plan and have adopted the Till interest rate.[note]Till v. SCS Credit Corp, 541 U.S. 465 (2004).[/note]
The Till Rate
In Till, the Supreme Court considered the present value of money (a dollar today is worth more than a dollar tomorrow) are held that secured creditors should receive payments equal to the prime rate plus a nominal risk factor of 1 to 3 percent.[note]Id.[/note] While Till was decided in the context of a Chapter 13 case and the “cram-down” confirmation language under sec. 1325(a)(5)(B), this language is similar to the language under Chapter 11’s sec. 1129(b) regarding cram-down interest rates that deal with paying secured creditors deferred payments discounted to their present value. Although the Till decision involves secured creditors, there is a line of bankruptcy courts that apply the same prime-plus formula approach to unsecured creditors.[note]In re Hoskins, 405 B.R. 576 (Bankr. N.D. W. Va. 2009); In re Evans, 2010 WL 2976165 (Bankr. M.D.N.C. July 28, 2010); see also In re Jozil, slip copy, 2010 WL 5559697 (Bankr. M.D. Fla. October 1, 2010); In re LMR LLC, 496 B.R. 410 (Bankr. W.D. Tex. 2013).[/note]
The Federal Judgment Rate
There is another line of cases holding that the appropriate “legal rate” of interest under 726(a)(5)[note]Remember that unsecured creditors only receive post-petition interest on claims if they would receive a distribution in a hypothetical Chapter 7.[/note] is the federal judgment rate of interest.[note]In re Energy Future Holdings Corp., 540 B.R. 109; In re Smith, Case No. 09-06440-8-RDD (Bankr. E.D. N.C. 2010); In re Washington Mutual, Inc., 461 B.R. 200 (Bankr. D. Del. 2011).[/note] The distinction between the federal judgment rate of interest and determining interest under Till is significant. Right now, the federal judgment rate of interest sits at less than 1%. Under Till, the minimum interest rate, given a prime rate of 3.5%, is 4.5% (prime plus 1%). If a debtor is dealing with hundreds of thousands of dollars, this distinction can mean the difference between a confirmed plan and a dismissed case.
In Energy Future, a Delaware bankruptcy case, Judge Sontchi gives a very well-reasoned and thorough opinion on why the legal rate of interest should be the federal judgment rate. Citing Washington Mutual[note]461 B.R. 200 (Bankr. D. Del. 2011).[/note], Judge Sontchi concisely summarizes his opinion:
- First, section 726(a)(5) states that interest on unsecured claims shall be paid at “the legal rate” as opposed to “a” legal rate or the contract rate. As the LTW Holders note, where Congress intended that the contract rate of interest apply, it so stated.
- Second, the payment of post-judgment interest is procedural by nature and dictated by federal law rather than state law, further supporting use of the federal judgment rate.
- Third, the use of the federal judgment rate promotes two important bankruptcy goals: “fairness among creditors and administrative efficiency.”
What Happens in Georgia Bankruptcy Courts?
Unfortunately, Georgia bankruptcy courts haven’t decided this issue yet. In fact, I couldn’t find a single case in the 11th Circuit on this issue. From my own personal experience, I have resold objections with unsecured creditors and the United States Trustee in the Northern District of Georgia by paying unsecured claims at the federal judgment rate. The prevailing view seems to be the use of the federal judgment rate, which is obviously far more favorable for debtors than the Till rate. As an attorney who primarily represents debtors in Chapter 11 proceedings, I’m going to be partial to the federal judgment rate for my clients, but even taking the “debtor’s bias” out of it, I think the rationale for using the federal judgment rate is the right choice.
For a different view, David Bury of Stone and Baxter wrote an excellent opinion piece for the ABI Journal. In summary, he thinks Till should apply to the claims of unsecured creditors, even if they would receive no distribution under a hypothetical Chapter 7. The caveat is that if the unsecured creditor would receive no distribution under the “best interest of creditors test”, then it should only be compensated for the time-value of money and not for any risk of default when applying Till.