ENTITLEMENT TO INTEREST UNDER THE
BANKRUPTCY CODE1
by
Dean Pawlowitl'
TABLE OF CONTENTS
I.
II.
INTRODUCTION.................................
PREPETITION INTEREST ....•••••••.•.•..•.•••.••..
A.
B.
Entitlement to Prepetition Interest. . . . . . . . . . . . . . . . ..
Rate ofPrepetition Interest. . . . . . . . . . . . . . . . . . . . . ..
III. PENDENCY INTEREST ........•..••••••...•.••..••.
A.
B.
Entitlement to Pendency Interest. . . . . . . . . . . . . . . . . ..
1. General Rule - No Pendency Interest
2. Exceptions...............................
a. Debtor Solvent . . . . . . . . . . . . . . . . . . . . . . . ..
b. Oversecured Claims
c. Earnings on Collateral
Rate ofPendency Interest.
1. Debtor Solvent
2. Oversecured claims - Section 506(b)
IV. PLAN INTEREST • • • . . • . . • • • • • • • • • • . • . . . • . . . . . • • ••
A. Entitlement to Plan Interest . . . . . . . . . . . . . . . . . . . . . ..
B. Rate ofPlan Interest
1. General.................................
2. Methods for Determining Current Market Rate . . . . . ..
V. ARREARAGES AND 1994 ACT . . . . . . . . . . . . . . . . . . . . . . ..
VI. CONCLUSION ••.••••••.•••••.••••.•......•...••
150
152
152
153
155
155
155
156
156
157
162
166
166
166
168
168
173
173
175
178
182
I This article is based on a presentation delivered to the Tenth Annual Farm, Ranch and
Agri-Business Bankruptcy Institute (1994).
* Professor of Law, Texas Tech University, School of Law; B.A., Creighton University,
1970; M.A., Creighton University, 1972;j.D., summa cum laude, Creighton University, 1979.
149
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I. INTRODUCTION
In a bankruptcy case, interest is the tail of the dog, but it is a
long tail and it wags a lot. Since the enactment of the Bankruptcy
Code in 1978,2 three Supreme Court opinions,3 numerous appellate
and bankruptcy court opinions, and over twenty law review artic1es4
2 Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549 (codified at 11
U.S.C. §§ 101-1330), as amended lTj Bankruptcy Amendments and Federal judgeship Act of
1984, Pub. L. No. 98-353, 98 Stat. 333 (codified as amended in various sections of 11 U.S.C.
and 28 U.S.C.); Bankruptcy judges, United States Trustees and Family Farmer Bankruptcy Act
of 1986, Pub. L. No. 99-554, 100 Stat. 3114 (codified as amended in various sections of 11
U.S.C. and 28 U.S.C.); Retiree Benefits Bankruptcy Protection Act of 1988, Pub. L. No, 100334, 102 Stat. 610 (codified as amended in various sections of 11 U.S.C.); Omnibus Budget
Reconciliation Act of 1990, Pub. L. No. 101-508, 104 Stat. 1388 (codified as amended in various sections of 11 U.S.C.); Criminal Victims Protection Act of 1990, Pub. L. No. 101-581, 104
Stat. 2865 (codified as amended in various sections of 11 U.S.C.); Crime Control Act of 1990,
Pub. L. No. 101-647, 104 Stat. 4789 (codified as amended in various sections of 11 U.S.C. and
28 U.S.C.);judicial Improvements Act of 1990, Pub. L. No. 101-650. 104 Stat. 5089 (codified as
amended in various sections of 11 U.S.C. and 28 U.S.C.); Treasury, Postal Service and General
Government Appropriations Act of 1990, Pub. L. No. 101-509, 104 Stat. 1389 (codified as
amended in various sections of 28 U.S.C.); Department of Commerce, justice, and State, the
judiciary, and Related Agencies Appropriations Act of 1994, Pub. L. No. 103-121, 107 Stat.
1153 (codified as amended in various sections of 28 U.S.C.); Violent Crime Control and Law
Enforcement Act of 1994, Pub. L. No. 103-322, § 320934, 108 Stat. 1976, 2135; and Bankruptcy
Reform Act of 1994, Pub. L. No. 103-394, 108 Stat. 3146 (codified as amended in various sections of 11 U.S.C., 18 U.S.C., and 28 U.S.C.) [hereinafter Bankruptcy Code or Code].
, Rake v. Wade, 113 S. Ct. 2187 (1993); United States v. Ron Pair Enters., Inc., 489 U.S.
235 (1989); United Savings Ass'n of Texas v. Timbers of Inwood Forest Assocs., Ltd., 489 U.S.
365 (1988).
• Warren E. Agin, How Lenders Can Maximize the Acaual of Pastpetition, Preconjirmation
Interest in Bankruptcy Proceedings: An Analysis of the Law in Light ofthe u.s. Supreme Court s Decision
in Rake v. Wade, 13 ANN. REv. BANKING L. 325 (1994); Craig H. Averch et al., "The Right of
Oversecured Creditors to Default Rates of Interest from a Debtor in Bankruptcy, 47 Bus. LAw. 961
(1992); Walter J. Blum, Treatment of Interest on Debtor Obligations in Reorganizations Under the
Bankruptcy Code, 50 U. CHI. L. REv. 430 (1983); Paul D. Boynton, Claims of Home Mortgage Lenders Against Chapter 13 Debtors: Should FuU Payment Indude Interest on Arrearages Repaid over Time?
97 COMM. L. J. 384 (1992); C. Frank Carbiener, Present Value in Bankruptcy: The Search for an
Appropriate Cramdown Discount Rate, 32 S.D. L. REv. 42 (1987); David G. Carlson, Oversecured
Creditors Under Bankruptcy Code Section 506(b): The Limits ofPastpetition Interest, Attorneys' Fees, and
Collection Expenses, 7 BANKR. DEY. J. 381 (1990); David G. Carlson, Pastpetition Interest Under the
Bankruptcy Code, 43 U. MIAMI L. REv. 577 (1989); Thomas O. Depperschmidt, Choasing the Pr0per Interest Rate in Bankruptcy Proceedings: Resolution of Special Issues in the Sixth, Eighth, and Ninth
Circuits, 18 N. KENT. L. REv. 457 (1991); Thomas O. Depperschmidt & Nancy H. Kratzke, The
Search for the Proper Interest Rate Under Chapter 12 Family Farmer Bankruptcy Act, 67 N.D. L. REv.
455 (1991); Thomas O. Depperschmidt & Nancy H. Kratzke, The Proper Interest Ratefor Allowed
Secured Claims in Bankruptcy Proceedings: The Sixth Circuit in United States v. Arnold, 21 U. TaL. L.
REv. 459 (1990); Paula A. Franzese, Secured Financings Uneasy Place in Bankruptcy: Claims for
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Entitlement to Interest
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have addressed the treatment of interest under the Bankruptcy
Code. Even Congress was moved to join the fray, and in the Bankruptcy Reform Act of 1994 (the "1994 Act") ,5 it took aim at the Supreme Court's most recent sally.6 The purpose of this paper is to
analyze the treatment of interest under the Bankruptcy Code and to
report on the skirmishes that have shaped its borders.
Except for a qualification introduced by the 1994 Act, the right
to interest under the Bankruptcy Code is most easily viewed from
three perspectives: (1) interest accrued prior to the filing of a petition under the Bankruptcy Code (prepetition interest), (2) interest
accrued after the filing of a petition but prior to the effective date of
a reorganization plan (pendency interest), and (3) interest to accrue
under the terms of a reorganization plan (plan interest).7 As discussed in part II, prepetition interest is allowable, generally to the
extent and at the rate permitted under applicable nonbankruptcy
law. Part III explores pendency interest, which is generally not allowed, except to the extent permitted under the well-established
exceptions for a solvent debtor (at the "legal rate") and for an
oversecured creditor (in most instances at the rate provided by applicable nonbankruptcy law). Part IV discusses plan interest, which is
Interest in Chapter 11, 19 HOFSTRA L. REv. 1 (1990); Kathryn R Heidt, Interest Under Section
506(b) oj the Bankruptcy Code: The Right, the RIlte and the Relationship to Bankruptcy Policy, 1991
UTAH L. REv. 361 (1991); RobertJ. Kressel, Calculating the Present Value oj Deferred Payments
Under a Chapter 12 Plan: A New Twist to an Old Problem, 62 AM. BANKR. LJ. 313 (1988);John C.
McCoid, II, Pendency Interest in Bankruptcy, 68 AM. BANKR. LJ. 1 (1994); Aneel M. Pandey, Determining Interest and Discount RIlles Applicable to Secured Claims in the Specter oj Bankruptcy Law, 30
SAN DIEGO L. REv. 549 (1993); ToddJ. Zywicki, Cramdown and the Code: Calculating Cramdown
Interest RIlles Under the Bankruptcy OJde, 19 T. MARSHALL L. REv. 241 (1994); James F. Des
Marais, Note, The Paper Discount RIlte Under the Chapter 11 Cramdown Provision: Should Secured
Creditors Retain Their State Law Entitlements? 72 VA. L. REv. 1499 (1986); Julia A. Jansen, Comment, An Oversecured Creditor's Right to Pastpetition Interest on Mortgage Arrearages: the Interplay
Between Bankruptcy OJde Sections 506(b), 1322(b) and 1325(a)(5)(B), 71 WASH. U. L.Q. 151 (1993);
David K. McPhail, Note, Bankruptcy: Determination ojan Appropriate Cram-down Interest RIlteJor the
Family Farmer, 41 OKLA. L. REv. 489 (1988); Todd W. Ruskamp, Comment, In the Interest oJFairness: Interest Payments in Bankruptcy, 67 NEB. L. REv. 646 (1988); Waltraud S. Scott, Comment,
Deferred Cash Payments to Secured Creditors in Cram Down oj Chapter 11 Plans: A Matter ojInterest, 63
WASH. L. REv. 1041 (1988).
5 PUB. L. No. 103-394, 108 Stat. 4106 (1994) [hereinafter the 1994 Act].
6 See 140 CONGo REc. HI0,752-Ql, HI0,770 (daily ed. Oct. 4, 1994) (section-by-section
analysis of 1994 Act inserted by Sen. Jack Brooks) ('This section will have the effect of overruling the decision of the Supreme Court in RIlke v. Wade, 113 S. Ct. 2187 (1993).").
7 The terms "prepetition interest," "pendency interest," and "plan interest" are suggested
in ELIZABETH WARREN & JAY WESTBROOK, THE LAw OF DEBTORS AND CREDITORS 461-66 (2d ed.
1991).
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provided for under the reorganization chapters of the Code at the
current market rate in order to assure that deferred payments under
a reorganization plan provide for the present value of certain minimum amounts required to be paid under the plan.
As discussed in part V the 1994 Act effectively creates a fourth
category of interest - arrearage interest (for want of a better term).
If a reorganization plan proposes to cure a default under the plan,
then, notwithstanding the rules relating to pendency and plan interest, section 305 of the 1994 Act requires that the amount necessary
to cure the default be determined in accordance with the underlying
agreement and applicable nonbankruptcy law.s
II. PREPETITION INTEREST
A. Entitlement to Prepetition Interest
Very little controversy exists concerning the allowance of a timely filed claim for prepetition interest. The rules with respect to
prepetition interest are found in section 502 of the Bankruptcy
Code.9 Under section 502(a), a claim is allowed unless a party in
interest objects. 1O Section 101(5) defines a claim to mean a "right
to payment."1J Accordingly, if there is a right to payment of interest
under applicable nonbankruptcy law, then interest is included in the
definition of a claim. 12
Assuming nonbankruptcy law provides for interest, a claim for
such interest is allowed under section 502(a) unless there is an objection. If a party does object, section 502(b) directs the court to
determine the amount of the claim as of the date of the filing of the
petition and to allow the claim subject to a number of enumerated
8 Bankruptcy Refonn Act of 1994, PUB. L. No. 103-394 § 305, 108 Stat. 4106, 4134
(1994).
• II U.S.C. § 502 (1994). See II U.S.C. § 103(a) (1994) (providing that chapters I, 3,
and 5 of the Bankruptcy Code apply in a case under chapter 7, II, 12, or 13).
10 II U.S.C. § 502(a) (1994).
II II U.S.C. § 101(5) (1994).
12 See In re Larson, 862 F.2d II2, II9 (7th Cir. 1988); Princeton OverlookJoint Venture v.
Zaitz (In re Princeton Overlook Joint Venture), Adv. No. 92-2343, 1993 WL 280456, at *9
(Bankr. D.NJ. March 16, 1993). Under pre-Code law, also, prepetition interest was governed
by applicable nonbankruptcy law. See Debentureholders Protective Comm. of Continentallnv.
Corp. v. Continentallnv. Corp., 679 F.2d 264, 268 (1st Cir. 1982) (citing Vanston Bondholders
Protective Comm. v. Green, 329 U.S. 156, 161 (1946», cert. denied, 459 U.S. 894 (1982).
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exceptions. 13 Two exceptions are most likely to be invoked with respect to a claim for interest: that the claim is unenforceable under
any applicable agreement or law, or that the claim is for unmatured
interest. 14 Thus, a claim for prepetition interest, whether secured or
unsecured, is allowable under the Bankruptcy Code so long as: (1)
the claim is enforceable under the agreement, if any, and under
applicable nonbankruptcy law, and (2) the amount of the claim is
determined as of the date of the petition and does not include interest accrued or to accrue after the petition date.
B. Rate ofPrepetition Interest
Few cases discuss the rate of prepetition interest, but it is accepted that applicable nonbankruptcy law determines not only the right
to, but also the rate of prepetition interest. Based upon the definition of a claim and section 502's direction that a bankruptcy court
"shall allow" a claim except for expressly enumerated exceptions,15
this seems to be a fair implication. Following this analysis, at least
one bankruptcy court has concluded that it "does not have the power to modify accrued prepetition interest."16 This does not differ
from pre-Code practice,17 and with respect to fixed liabilities, the
Bankruptcy Act of 1898 expressly allowed interest ''which would have
been recoverable" at the date of the filing of the bankruptcy petition. IS
One issue that has arisen is the effect of a postpetition cure on
a prepetition default rate of interest. Under the general rule stated
above, a claim for prepetition interest would be allowed at a higher
default rate if that would be the result outside of bankruptcy.19 Un-
11 U.S.C. § 502(b) (1994).
See 11 U.S.C. § 502(b) (1), (2) (1994). Under § 502(b) (2), prepaid interest that represents an original discounting of the claim and that would not have been earned on the petition date is also disallowed. H.R. REp. No. 595, 95th Cong., 1st Sess. 352-53 (1977), reprinted in
1978 U.S.C.CAN. 6307, 5308-09; S. REp. No. 989, 95th Cong., 2d Sess. 62-63 (1978), reprinted
in 1978 U.S.C.CAN. 5787, 5848-49.
I" 11 U.S.C. § 502 (1994).
16 Princeton Overlook Joint Venture v. Zaitz (In re Princeton Overlook Joint Venture),
Adv. No. 92-2343, 1993 WI.. 280456, at *9 (Bankr. D.NJ. March 16, 1993).
17 See Debentureholders Protective Comm. oj Continental Inv. Corp. v. Continental Inv. Corp., 679
F.2d 264, 268 (1st Cir. 1982) (distinguishing prepetition from postpetition interest on interest), cert. denied, 459 U.S. 894 (1982).
18 Bankruptcy Act of 1898 § 63(a)(I), 11 U.S.C. § 103 (repealed 1978).
19 See In re Pinebrook, Ltd., 92 B.R. 948 (Bankr. M.D. Fla. 1988) (allowing prepetition
interest at default rate of 24% rather than predefault rate of 12%).
IS
1<
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der the reorganization chapters of the Bankruptcy Code, however, a
plan of reorganization may provide for the curing of any default. 20
If the default which triggered the increased interest rate is cured,
will the cure nullify the increased interest rate?
''Yes,'' the Ninth Circuit has answered, with respect to both
prepetition and postpetition interest rates. In Flmida Partners Corp. v.
Southeast Co. (In re Southeast Co.) ,21 the Ninth Circuit Court of Appeals ruled that section 1124(2) "authorizes a plan to nullify all
consequences of default, including avoidance of default penalties
such as higher interest."22 The court previously had reached this
conclusion with respect to postpetition default interest,23 and in
Southeast Co. it extended the analysis to prepetition default interest.24 To allow prepetition interest at the default rate after a cure,
the court reasoned, "would completely eliminate the benefits of cure
in this case, as it would fail to nullify a significant consequence of
the default. "25 The court's conclusion does not appear to be limited
to chapter 11 cases, as it quoted with approval In re Taddeo,26 a
chapter 13 case in which the Second Circuit defined the concept of
cure as used throughout the Bankruptcy Code to include a return to
predefault conditions. 27
As discussed in part V, however, the 1994 Act may have the
effect of overruling Southeast Co. and sustaining a high default rate if
permitted under the agree~ent and applicable nonbankruptcy
law. 28
11 U.S.C. §§ 1123(a)(5)(G), 1124(2), 1222(b)(3) and (5), 1322(b)(3) and (5) (1994).
868 F.2d 335 (9th Cir. 1989).
22 Id. at 336 (quoting In re Entz-White Lumber & Supply, Inc., 850 F.2d 1338, 1342 (9th
Cir. 1988».
23 See Entz-Vllhite, 850 F.2d 1338; see also In re Johnson, 184 B.R 570 (Bankr. D. Minn.
1995) (holding than an oversecured creditor is entitled to pendency interest at nondefault
rate where the debt has matured by its own terms prepetition and the plan cures all defaults
on the debt).
24 See Southeast Co., 868 F.2d at 339.
25 Id.
2fi 685 F.2d 24 (2d Cir. 1982).
27 Southeast Co., 868 F.2d at 338 (quoting Taddeo, 685 F.2d at 26-27). For further discussion of Southeast Co. and the use of cure to nullifY default interest, see Johnson, 184 B.R at 574;
Averch et al., supra note 4; Franzese, supra note 4, at 22-30.
2ll See infra part V.
20
21
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III.
155
PENDENCY INTEREST
A. Entitlement to Pendency Interest
The general rule under pre-Code law was that interest stops as
of the date of the filing of the bankruptcy petition.29 The law recognized three exceptions: (1) the debtor proved to be solvent, (2) the
creditor was secured and the value of the collateral was sufficient to
pay both principal and interest, and (3) the creditor was secured
and the collateral earned income after the filing date. so For the
most part, the Bankruptcy Code codifies the pre-Code law, and nothing in the legislative history evidences an intent to change these
rules. 3 ) It is questionable, however, whether the exception relating
to earnings on collateral survives the Bankruptcy Code in the same
manner in which it was applied under pre-Code law. 32 Also, as discussed in part V, a different rule now applies to interest on
arrearages proposed to be cured under a reorganization plan.
1. General Rule - No Pendency Interest
As already discussed, section 502 (b) directs a court to determine
the amount of a claim as of the date of the filing of the petition and
therefore does not include interest as part of a claim accrued after
the petition date. 33 Removing any doubt over this issue, section
502(b) (2) flatly prohibits the allowance of unmatured interest.34
Thus, these avo provisions of section 502 continue the basic rule
that interest stops running as of the petition date.
.. United States v. Ron Pair Enters., Inc., 489 U.S. 235, 246 (1989); Vanston Bondholders
Protective Comm. v. Green, 329 U.S. 156, 163 (1946); Sexton v. Dreyfus, 219 U.S. 339, 344
(1911). For a general history and discussion of pendency interest, see McCoid, supra note 4.
so Ron Pair Enters., 489 U.S. at 246; McCoid, supra note 4, at 1.
.. See McCoid, supra note 4, at 8-9.
!2 See id.; see also infra part III(A) (2) (c).
" See supra part II(A).
$I
11 U.S.C. § 502(b) (1994).
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2. Exceptions
a. Debtor Solvent
The first exception to this rule, that pendency interest is payable if the debtor proves to be solvent, is not commonly encountered. Congress addressed this happy event in section 726 (a) (5) of
the Bankruptcy Code.3s That section calls for the distribution of
property of the estate in payment of interest on certain claims after
the payment of priority claims, allowed unsecured claims, and claims
for penalties, but prior to any distribution to the debtor. Under this
provision, interest is payable at the "legal rate"36 from the date of
the filing of the petition.
Although by its terms, section 726(a)(5) does not provide for
interest on secured claims that are not claims for penalties, the Supreme Court has suggested that this result was unintended and
could be avoided in the case of a solvent debtor by the creditor's
waiver of collateral.37 Also, although section 726 applies directly to
only chapter 7 cases,38 it applies indirectly to cases under the reorganization chapters by virtue of the best interest test. 39
S> 11 U.S.C. § 726 (a) (5) (1994) (providing for "interest at the legal rate from the date of
the filing of the petition, on any claim paid under paragraph (I), (2), (3), or (4) of this subsection").
,. See infra part III (B) (1).
S1 United Savings Ass'n of Texas v. Timbers of Inwood Forrest Assocs., Ltd., 484 U.S. 365,
379 (1988).
3S 11 U.S.C. § 103(b) (1994).
59 See 11 U.S.C. §§ 1129(a)(7), 1225(a)(4), 1325(a)(4) (1994). See also In re Schoeneberg,
156 B.R. 963, 969-73 (Bankr. W.O. Tex. 1993) (applying § 726(a) (5) in context of §
1129(a)(7»; In re BiIlman, 93 B.R. 657 (Bankr. S.D. Iowa 1988) (discussing § 726(a)(5) in
context of § 1225(a)(4»; Boyer v. Bernstein (In re Boyer), 90 B.R. 200 (Bankr. D.S.C. 1988)
(applying § 726(a) (5) in context of § 1129(a) (7».
An interesting twist may occur under chapter 11, since under § 1129(a)(7) the best interest test appears to apply only to an impaired class of claims. See In re New Valley Corp., 168
B.R. 73, 77-80 (Bankr. D.NJ. 1994). If unsecured claims are paid in full on the effective date
of the plan, for example, the New Valley court has held that the claims are not impaired, the
best interest test does not apply, and interest therefore is not payable even though the debtor
is solvent. Id. Depending on the circumstances, however, the court noted that interest may be
required under the good faith test of § 1129(a) (3). Id. at 80-81.
In response to New Valley, the 1994 Act amended § 1124 so that a claim is no longer
unimpaired solely because the amount of the claim (which may not include pendency interest
under the general rule) is paid on the effective date of the plan. See 140 CONGo REc. HI0,768
(daily ed. Oct. 4,1994) (statement of Rep. Brooks).
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b. Oversecured Claims
The second exception permits pendency interest to the extent
that a secured creditor's claim is less than the value of the collateral
for the claim. Under section 506(b) of the Bankruptcy Code, interest "shall be allowed" on a secured claim to the extent that the value
of the collateral, after deducting any costs of preserving or disposing
of the collateral, exceeds the amount of the secured claim.40 Three
Supreme Court decisions have addressed issues relating to this exception,41 and, as discussed in part V, the 1994 Act creates a new
rule for interest on arrearages proposed to be cured under a reorganization plan.42
The first decision, United Savings Association of Texas v. Timbers of
Inwood Forest Associates, Ltd.,43 came to the Court in the guise of an
undersecured creditor's motion for relief from the automatic stay or
adequate protection under section 362 (d) (1). The undersecured
creditor argued that it was entitled to adequate protection in the
form of interest payments on the value of its collateral for the delay
in foreclosing caused by the automatic stay.44 The Supreme Court
disagreed, giving as its first reason section 506(b).45 According to
the Court, section 506(b) has two substantive effects.46 The first and
most obvious is that pendency interest shall be allowed to the extent
that the value of the collateral exceeds the amount of the secured
claim; that is, to the extent that a "security cushion" exists.47 The
second substantive effect of section 506(b) is that pendency interest
shall not be allowed if a security cushion does note exist.48 Accord-
~ 11 U.S.C. § 506(b) (1994). The Eleventh Circuit has ruled that payment of pendency
interest to an oversecured creditor should await the conclusion of a reorganization case, because until that time the value of the collateral, and thus the creditor's secured status, may
fluctuate. See Orix Credit AIliance, Inc. v. Delta Resources, Inc. (In re Delta Resources, Inc.), 54
F.3d 722, 729-30 (11th Cir. 1995). See also Ford Motor Co. v. Dobbins, 35 F.3d 860, 869-71 (4th
Cir. 1994) (holding that determination of secured status for purposes of § 506(b) should be
based on sale price of collateral, if sold, and not some earlier valuation).
41 See Rake v. Wade, 113 S. Ct. 2187 (1993); United States v. Ron Pair Enters., Inc., 489
U.S. 235 (1989); United Savings Ass'n of Texas v. Timbers of Inwood Forest Assocs., Ltd., 484
U.S. 365 (1988).
42 See infra part V.
~3 484 U.S. 365 (1988).
H Id. at 369-71.
45 Id. at 371-74.
-l<l See id.
47 See id. at 372-73.
4" Id.
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ingly, the Timbers Court relegated an undersecured creditor to the
general rule disallowing pendency interest.49
The second decision, United States v. Ron Pair Enterprises, Inc.,50
settled the narrow dispute as to whether section 506(b) allows interest on only consensual oversecured claims, such as a contract claim
secured by a voluntary security interest, or also extends to
nonconsensual oversecured claims, such as a tax claim secured by an
involuntary lien fixed by operation of law.51 In Ron Pair, the Court
ruled that all oversecured claims, whether consensual or
nonconsensual, are to be similarly treated for purposes of pendency
interest under section 506(b).52 Based on the plain language of section 506, including an analysis of its grammatical structure, the
Court stated that the right of an oversecured creditor to pendency
interest is unqualified.53
Rake v. Wade,54 the third of the decisons, was a consolidated
case which involved an oversecured55 creditor's right to pendency
interest (and plan interest) on arrearages to be paid under chapter
13 plans proposed by several debtors. Arrearages typically refer to
mortgage payments or other installment loan payments that are past
due. Ordinarily, the underlying loan agreement allocates a portion
of such payments to principal and a portion to ,interest. The principal portion of such a payment is part of the creditor's prepetition
claim under section 502, and to the extent the interest portion accrued prior to the petition date, so is the interest portion. As part of
the prepetition claim, therefore, arrearages should be subject to the
same rules with respect to prepetition, pendency, and plan interest
as any other claim. This conclusion is complicated, however, by the
.9 Id. See also Vanston Bondholders Protective Comm. v. Green, 329 U.S. 156, 164 (1947)
(noting that under pre-Code law it was thought to be inequitable to unsecured creditors to
allow pendency interest to an undersecured creditor); Sexton v. Dreyfus, 219 U.S. 339, 343-46
(1911) (holding that under pre-Code law undersecured creditors generally were not entitled
to pendency interest).
:Ill 489 U.S. 235 (1989).
" Id. at 240.
52 Id. at 248.
03 Id. at 241.
M
113 S. Ct. 2187 (1993).
55 Id. Rake addressed only oversecured claims for arrearages, and a number of courts
(with mixed results) are beginning to struggle with the issue of an undersecured creditor's
right to pendency interest and plan interest on arrearages. See, e.g., In re Arvelo, 176 B.R. 349
(Bankr. D.NJ. 1995); In reJones, 168 B.R. 146 (Bankr. E.D. Tex. 1994); In re Harned, 166 B.R.
255 (Bankr. E.D. Pa. 1994); In re Brycki, 161 B.R. 915 (Bankr. D.NJ. 1993). See also infra notes
64, 138-42, 18lHl7, and accompanying text.
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Code provisions that expressly permit reorganization plans to provide for the curing of defaults56 and by the chapter 13 provision
that prohibits modification of certain home mortgages.57 For instance, if a chapter 13 plan provides for the curing of arrearages and
the maintenance of payments on an oversecured home mortgage,
how should the requirements for pendency and plan interest under
sections 506 and 1325 interrelate with the ability to cure and the
prohibition on modification under section 1322?
This is the issue Rake addressed. In that case, the debtors proposed to cure defaults under their home mortgages by paying off
the arrearages over the terms of the plans.58 The loan documents
did not provide for the payment of interest on arrearages, and the
plans did not propose to pay either pendency or plan interest on the
arrearages.59 Previous courts had split on this issue. Some courts
had held that allowing interest on arrearages is incident to the cure
under section 1322(b) (5) (which by its terms is excepted from the
no modification rule of section 1322 (b) (2) ), and that sections
506(b) and 1325(a)(5) both indicate that interest is allowable.50
Other courts, conversely, had "construed the 'cure' and
'modification' provisions of section 1322(b) so broadly as to render
sections 506(b) and 1325(a) (5) inapplicable to the curing of defaults on home mortgages."61
In Rake, the Supreme Court concluded that the cure provisions
of section 1322 give no indication that arrearages cured under a
plan may not include interest otherwise available as part of an
oversecured claim,62 and that although curing arrearages may modify a home mortgag~ claim, such a modification is permitted under
the terms of section 1322(b) (5), notwithstanding the "no modification" rule under section 1322(b)(2).63 Eschewing a broad reading
of the cure or "no modification" provisions of section 1322, the
56
>7
See 11 U.S.C. §§ 1123(a) (5) (G), 1124(2), 1222(b) (3), (5), 1322(b) (3), (5) (1994).
See 11 U.S.C. § 1322(b)(2) (1994);· see also 11 U.S.C. § 1123(b)(5) (amended by 1994
Act).
5-'
~
Rake, 113 S. Ct. at 2189.
Id.
ro See, e.g., Cardinal Fed. Sav. & Loan Ass'n v. Colegrove (In re Colegrove), 771 F.2d 119,
122 (6th Cir. 1985).
61 Rake, 113 S. Ct. at 2191 (citing Landmark Fin. Servs. v. Hall, 918 F.2d 1150, 1153-55
(4th Cir. 1990».
62 Id. at 2191-92.
63 Id. at 2193 n.9.
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Court held that the holder of the mortgages was entitled to: (1)
pendency interest under section 506(b) because the holder's claims
were oversecured,64 and (2) plan interest under section 1325(a)(5)
because the arrearages were part of the allowed secured claims "provided for" by the plans.55 Af5 discussed in part V, the Rake Court's
conclusion that the cure provisions of section 1322 do not dictate
the terms of a cure has been altered by the 1994 Act.56
With respect to pendency interest under section 506(b), at least
three general principles can be abstracted from the Rake decision.
First, the Rake Court construed its statement in Ron Pair that the
right of an oversecured creditor to pendency interest is unqualified
to mean that such right exists "regardless of whether the agreement
giving rise to the claim provides for interest. "67 Thus, it was unimportant to the Court that the loan documents in Rake did not provide for interest on arrearages. 68 This represents an extension of
the holding in Ron Pair, because Ron Pair did not involve an agreement at all, but rather a tax lien fixed by operation of law for which
interest was provided by statute. 69 Rake, however, makes it clear that
section 506(b) allows pendency interest independent of the entitlement to such interest under applicable nonbankruptcy law,7° unlike
the rule with respect to prepetition interest under section 502. 71 Af5
already mentioned, the 1994 Act affects this ruling with respect to
the amount necessary to cure a default. 72
Second, with respect to pendency interest, the Rake Court permitted the allowance of interest on interest, because the dispute in-
&l Id. at 2191-92. Although Rake addressed only arrearages that were part of an
oversecured claim, most post-Rake courts have applied the same analysis to conclude that §
506(b) applies to the cure of arrearages that were part of an undersecured claim, See, e.g., In re
Arvelo, 176 B.R 3<19,354-355 (Bankr. D.NJ. 1995); In reJones, 168 B.R 146,149 (Bankr. E.D.
Tex. 1994). Because § 506(b) does not allow pendency interest if there is not a security cushion, these courts have not aIlowed pendency interest on such undersecured arrearages. See
Arvelo, 176 B.R 349;Jones, 168 B.R 146.
65 Rake, 113 S. Ct. at 2192-93. See infra part IV (discussing plan interest).
66 See infra part V.
(i/
Rake, 113 S. Ct. at 2190.
.., See id. at 2191-92.
6'1 See Ron Pair, 489 U.S. at 246; see also McCoid, supra note 4, at 13 (noting that federal
tax law requires accrual ofinterest on overdue taxes and questioning whether § 506(b) creates
an independent obligation to pay interest where none exists outside of bankruptcy).
70 But if. McCoid, supra note 4, at 13 (questioning whether § 506(b) creates an independent obligation to pay interest where none exists outside of bankruptcy).
71 See supra part II(A).
72 See infra part V.
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volved arrearages, and arrearages consist of, among other things,
missed payments of principal and interest.73 The Court reached this
result because section 506(b) allows pendency interest on
oversecured claims, and the arrearages (which include interest) "are
plainly part of respondent's oversecured claims."74 At least in part,
therefore, Rake overrules Vanston Bondholders Protective Committee v.
Green,75 which had concluded under pre-Code law that as a matter
of equity, pendency interest should not be allowed on interest.76
Based on this portion of Rake, the amount of an allowed secured
claim upon which section 506(b) interest is allowed should include
not only prepetition principal, but also prepetition interest. 77 With
respect to plans proposing to cure arrearages, however, the 1994 Act
must again be consulted. 78
Third, the Rake Court made it clear that section 506 (b) governs
only pendency interest, that is, interest to accrue after the filing of a
petition but prior to the confirmation or effective date of a rehabilitation plan. 79 As discussed in part II, prepetition interest is provided
under section 50280 and, as discussed in part IV, plan interest is
provided under the reorganization chapters of the Code.S!
To summarize the case law relating to the exception for pendency interest on oversecured claims under section 50b (b), Timbers
ruled that pendency interest shall be allowed to the extent that
there is a security cushion and shall not be allowed if there is none.
Ron Pair concluded that pendency interest extends to nonconsensual
oversecured claims as well as consensual claims. Rake decided that (i)
arrearages are part of a creditor's oversecured claim and are subject
to the general rules governing pendency interest, (ii) the right to
pendency interest under section 506(b) is not dependent on the
See Rake, 113 S. Ct. at 2189, 2193 12; see also Agin, supra note 4, at 353-55.
Rake, 113 S. Ct. at 2191; see also supra part I1(A) (noting that prepetition interest is part
of the definition ofa claim under § 101(5) and allowable under § 502).
75 329 U.S. 156 (1947).
76 Id. at 165.
77 See Rake, 113 S. Ct. at 2193 n.12. Cf. United States Trust Co. of N.Y. v. LTV Steel Co.
(In re Chateaugay Corp.), 150 B.R. 529, 536-40 (Bankr. S.D.N.Y. 1993) (deferring to state law
with respect to the enforceability of compound interest agreements).
7Il See infra part V.
7D Rake, 113 S. Ct. at 2190-91 (stating that interest allowed by § 506(b) accrues from the
petition date until the confirmation or effective date of the plan). See supra part I (defining
pendency interest).
"" See supra part II.
AI See infra part IV.
7S
7<
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right to interest under an agreement or applicable nonbankruptcy
law, (iii) pendency interest under section 506(b) is allowed on interest as well as principal, and (iv) pendency interest under section
506(b) applies to the period from the petition date until the confirmation or effective date of the plan. As discussed in part V, the 1994
Act affects only the first part of the Rake holding, that arrearages
proposed to be cured under a plan are subject to the general rules
governing pendency interest.
c. Earnings On Collateral
Under pre-Code law, the third exception to the general rule
that interest stops as of the filing date was that interest is allowable if
the creditor is secured and the collateral earns income after the
filing date. Under this exception, even an undersecured creditor is
allowed pendency interest to the extent of any postpetition income
earned on its collateral.
In Sexton v. Dreyjus,82 for example, the Supreme Court held
that undersecured creditors generally were not entitled to pendency
interest, but the Court expressly recognized an exception to this rule
to the extent that the collateral earned income after the filing
date. ll3 Applying the general rule to the facts of that case, the Sexton
Court refused to permit undersecured creditors to apply the sale
proceeds from their collateral first to interest, then to principal, and
then to file an unsecured claim for the balance.ll4 Rather, the proceeds were required to be applied to principal and no claim for
interest was allowed.8;; To the extent that the collateral earned income, however, the Court applied the exception to the rule "and for
this reason permitted some of the same undersecured creditors to
apply the income first to interest.86
This exception is not codified in the Bankruptcy Code,87 and
its rationale has been questioned.88 Section 552(b) of the Bankruptcy Code does provide that a prepetition security interest may extend
219 U.S. 339 (1911).
Id. at 346.
.. See id. at 343-46.
R5 Id.
R6 Id. at 346.
K7 See McCoid, supra note 4, at 9.
... Id. at 19 ("Neither the English nor American cases ever offered any satisfactory justification for this exception to the basic rule.").
II:!
II!
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to postpetition "proceeds, product, offspring, rents, or profits" of the
collateral, but this provision does not address the allowance of interest on the claim. 89 Plainly read, section 552 (b) merely "enlarges
what is the collateral. ngO Under the other exceptions to the "no
pendency interest" rule, interest would be allowed only to the extent
that the debtor is solvent or the value of the collateral exceeds the
prepetition amount of the claim.91 Thus, a difficult issue is presented concerning the viability under the Code of the Sexton exception
for earnings on collateral.
Although not often analyzed in these terms, this is the precise
problem that has arisen in a number of cases in which an
undersecured creditor has a lien on property, most typically a real
estate project, that earns income postpetition.92 If the creditor's
prepetition claim is $1 million, and the collateral is valued at
$800,000 as of the petition date, then, under sections 502 and
506(a), as of the petition date the creditor has a claim of $1 million,
consisting of a secured claim of $800,000 and an unsecured claim of
$200,000. If the creditor has a perfected assignment of rents, and
the collateral earns postpetition rentals, is the creditor entitled to
pendency interest?
The cases are not in agreement. One view suggests, at least, that
section 552 (b) does allow pendency interest, even to an
undersecured creditor, to the extent that the creditor has a lien on
postpetition earnings.93 Although the cases suggesting this view do
not cite Sexton,94 that would be the outcome if the Sexton exception
continues under the Code.95
This approach is not consistent, however, with the Timbers hold-
... 11 U.S.C. § 552(b) (1994).
McCoid, supra note 4, at 9.
91 See id.; see also supra part III (A)(2)(a), (b).
9'l See In re Veeco Inv. Co., 170 B.R. 149 (Bankr. E.D. Mo. 1994); In re KaHan, 169 B.R.
503 (Bankr. D.R.I. 1994); Mutual Life Ins. Co. of New York v. Paradise Springs Assocs. (In re
Paradise Springs Assocs.), 165 B.R. 913 (Bankr. D. Ariz. 1993); In re Bloomingdale Partners,
160 B.R. 93 (Bankr. N.D. 111. 1993); In re Birdneck Apartment Assocs., II, L.P., 156 B.R. 499
(Bankr. E.D. Va. 1993); In re Vermont Invest. L.P., 142 B.R. 571 (Bankr. D.D.C. 1992); In re
IPC Atlanta L.P., 142 B.R. 547 (Bankr. N.D. Ga. 1992); In re Oaks Partners, Ltd., 135 B.R. 440
(Bankr. N.D. Ga. 1991); In re Landing Assocs., Ltd., 122 B.R. 288 (Bankr. W.D. Tex. 1990); In
re Reddington/Sunarrow L.P., 119 B.R. 809 (Bankr. D.N.M. 1990); In re Flagler-At-First Assocs.,
Ltd., 114 B.R. 297 (Bankr. S.D. Fla. 1990).
9' See Birdneck Apartment Assot:S., 156 B.R. at 505; Vennont Invest., 142 B.R. at 573-76.
!It See supra note 93.
9:' See supra notes 82-86 and accompanying text.
00
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ing that section 506(b) not only allows pendency interest on
oversecured claims, but also bars pendency interest on undersecured
claims.96 Applying the Timbers rule to the above hypothetical, a
number of courts conclude that pendency interest should never be
allowed to a creditor that is undersecured on the date of the petition, even if the creditor has a continuing lien on postpetition earnings under section 552 (b). 97 Instead, these courts value the secured
claim as of the petition date and allocate any payments to the creditor from postpetition earnings to a reduction of the claim (measured as of the petition date, and in some cases credited against the
secured portion of the claim and in other cases credited against the
unsecured portion) or to a prepayment of plan payments.98
A logical extension of this analysis would be to permit a debtor
to create an equity cushion out of the creditor's postpetition collateral and at the same time deny the creditor any pendency interest
from the equity cushion.99 Thus, this second approach fails to take
full account of section 552(b) (since this approach values the secured claim only as of the petition date) and creates an incentive for
the debtor to delay confirmation of a plan (because it permits application of postpetition earnings to the secured claim, which is valued
as of the petition date).
More persuasive is a third line of cases, which gives full effect to
both section 506(b), as construed by Timbers, and section 552(b).100
Returning to the hypothetical (which posits a prepetition claim of $1
million, collateral valued at $800,000 on the petition date, and a perfected lien on postpetition rentals), these cases indicate
the following analysis. Assuming section 552(b) otherwise applies,
then the value of the collateral will increase to the extent of any
postpetition rentals. If $100,000 of rentals are received, then, under
section 506(a), the creditor has (as of that date) a secured claim of
$900,000 and an unsecured claim of $100,000. At this point, no
interest would be allowable under section 506(b), and the effect of
the postpetition lien on rentals would be to increase the secured
portion and reduce the unsecured portion of the creditor's claim by
See supra notes 45-49 and accompanying text.
See Killian, 169 B.R at 505-07; /PC Atlanta, 142 B.R at 558-59; Oaks Partners, 135 B.R at
449-51; Reddington/Sunarruw, 119 B.R at 813-14.
!l8 See supra note 97.
99 See Vennont Invest., 142 B.R at 574.
100 See Veeco, 170 B.R at 151-53; Paradise Springs, 165 B.R at 924-26; Bloomingdale, 160 B.R.
at 97-99; Landing Assocs., 122 B.R at 297; Flagler-At-First, 114 B.R at 297.
96
97
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a like amount. If these rentals are paid to the creditor, the creditor's
claim would be reduced to $900,000, consisting of a secured claim of
$800,000 and an unsecured claim of $100,000, and there would be
no allowance of pendency interest at this time.
At the point the rentals exceed the unsecured claim, however,
section 506(b) would allow interest to the extent of the excess. Thus,
if $300,000 of rentals are received, the total value of the collateral
would be $1.1 million, the creditor would become oversecured, and
interest would be allowable to the extent of $100,000. Assuming the
interest accruing on the claim was at least equal to the amount of
the rentals, the creditor's secured claim would in effect be increased
to $1.1 million (reflecting the prepetition claim of $1 million and
the allowance of $100,000 in pendency interest). If the $300,000 in
rentals are paid to the creditor, then the creditor's claim would be
reduced to $800,000, fully secured by the remaining $800,000 value
of the collateral.
Based upon this third reading and application of sections 506
and 552, whether interest is allowable to a creditor who is
undersecured at the petition date but who has a postpetition lien on
earnings from the collateral depends on the amount of the initial
deficiency and the amount of postpetition preconfirmation earnings.
Under this analysis, the Sexton exception is substantially modified
under the Code. Pendency interest would be allowed under section
506(b) only to the extent that an equity cushion is created by the
postpetition lien on earnings, and section 552(b) is given full effect
by enlarging the value of the collateral to the extent of any
postpetition earnings subject to the creditor's lien. It is also arguable
that this approach better accommodates the concern expressed by
the Supreme Court in Dewsnup v. Timm101 that any increase in
the value of collateral during bankruptcy "rightly accrues to the benefit of the creditor, not to the benefit of the debtor and not to the
benefit of other unsecured creditors. "102
101
10'1
112 S. Ct. 773 (1992).
Id. at 778; see also Bloomingdale, 160 B.R. at 97 (quoting Dewsnup, 112 S. Ct. at 778).
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B. Rate ofPendency Interest
1. Debtor Solvent
If the debtor proves to be solvent, section 726(a)(5) provides
for "payment of interest at the legal rate from the date of filing. "103
The Code does not define the term "legal rate," and the cases have
followed one of two paths. The first approach is that Congress intended no change in pre-Code practice by this language and that
pendency interest generally is "payable either at the contract rate, at
the statutory rate (if a specialized statute establishes a specialized
rate of interest for a particular creditor), or, if there is no applicable
statute and no rate was contracted for, at the state judgment
rate."I04
The second view is that Congress intended interest at "the" legal
rate to mean a single uniform rate, the federal judgment rate. I05
This approach finds further support by comparison with the language of section 506 (b), the other provision of the Code that permits pendency interest. With respect to an oversecured claim, section 506(b) provides that "there shall be allowed. " interest on
such claim, and any reasonable fees, costs, or charges provided for
under the agreement."106 If sections 506(b) and 726(a) (5) were intended to refer to the same rate, the question is thus raised as to
why "at the legal rate" is specified in one section and not the other.
2. Oversecured Claims - Section 506(b)
As stated above, section 506(b) provides that there shall be allowed to the holder of an oversecured claim "interest on such claim,
and any reasonable fees, costs, or charges provided for under the
agreement." Unlike section 726(a) (5), section 506(b) does not refer
to a rate of interest, and neither does the legislative history to this
section. I07 Based on Ron Pair and Rake, however, section 506(b)
11 U.S.C. § 726(a)(5) (1994).
In re Schoeneberg, 156 B.R. 963, 972 (Bankr. W.O. Tex. 1993).
105 See In re Chiapetta, 159 B.R. 152. 16lJ.61 (Bankr. E.D. Pa. 1993); In re Melenyzer, 143
B.R. 829, 832-33, (Bankr. W.D. Tex. 1992); In re Godsey, 134 B.R. 865, 867-68 (Bankr. M.D.
Tenn. 1991).
106 11 U.S.C. § 506(b) (1994).
107 Bradford v. Crozier (In re Laymon), 958 F.2d 72, 74 (5th Cir. 1992), reh'g denied, 964
F.2d 1145, cert. denied, 113 S. Ct. 328 (1992).
10'
IOf
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represents a substantive right to pendency interest independent of
the entitlement to such interest under applicable nonbankruptcy
law. l08 It has been suggested, therefore, that determination of the
rate of interest under section 506(b) is similarly independent of
applicable nonbankruptcy law.109
Most recent cases, however, reject this invitation and conclude
that because both section 506(b) and the legislative history are silent
as to the rate of interest, Congress did not intend to effect a major
change in pre-Code practice. 110 Prior to enactment of the Code,
the majority of courts applied nonbankruptcy law to determine the
rate of interest allowed to oversecured creditors, but subject to equitable principles governing bankruptcy distribution. 1l1 Following this
practice, an oversecured creditor holding a contract claim, for example, is ordinarily allowed interest under section 506(b) at the contract rate,112 and an oversecured creditor holding a state law tax
claim is allowed interest at the applicable state statutory rate. l13 In
the instance of default rates of interest under contracts, or possibly
penal rates of interest under tax statutes, however, most courts have
emphasized that the allowance of interest on claims in a bankruptcy
case is a matter of bankruptcy law and that the adoption of applicable nonbankruptcy law for the rate of interest is subject to "a balance of equities between creditor and creditor or between creditors
and the debtor. "1l4
,0.' See supra part III(A) (2) (b). As discussed infra in part V, the 1994 Act does not by its
tenns change the case law constructions of section 506(b) except as applied to the curing of
defaults.
'09 See Laymon, 958 F.2d at 74 (concluding that Ron Pair did not address this issue); Agin,
supra note 4, at 362; Carlson, supra note 4, at 397-98.
110 See, e.g., Laymon, 958 F.2d at 74-75; Foss v. Boardwalk Partners (In re Boardwalk Partners), 171 B.R. 87, 91-92, (Bankr. D. Ariz. 1994); Building Technologies Corp. v. Hannibal (In
re Building Technologies Corp.), 167 B.R. 853, 858-59 (Bankr. S.D. Ohio 1994).
III Laymon, 958 F.2d at 75.
112 See, e.g., In re Foertsch, 167 B.R. 555, 563-65, (Bankr. D.N.D. 1994); In re Dumond, 158
B.R. 309, 311 (Bankr. D. Me. 1993).
lIS See, e.g., Galveston Indep. School Dist. v. Heartland Fed. Say. and Loan Assoc., 159 B.R.
198, 203-05 (S.D. Tex. 1993).
II~ Vanston Bondholders Protective Comm. v. Green, 329 U.S. 156, 165 (1946). See In re
Terry Ltd. Partnership, 27 F.3d 241, 243 (7th Cir. 1994), cert. denied, 115 S. Ct. 360 (1994);
Laymon, 958 F.2d at 74-75; Building Technologies, 167 B.R. at 858-59. But if. Franzese, supra note
4, at n.118 (citing cases that pennit postpetition interest at enhanced default rates). For a list
of factors that courts have often considered in detennining whether to enforce a contractual
default rate, see In reJohnson, 184 B.R. 572, 573 (Bankr. D. Minn. 1995).
If a plan proposes to cure a default, that may decide this issue. See Johnson, 184 B.R. at
574. One effect of cure may be to nullify all consequences of default, including interest at a
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Thus, the developing rule is that the rate of interest under section 506(b) is a matter of federal bankruptcy law, but that applicable
nonbankruptcy law will be adopted as the federal rule. If in a particular case this rate appears excessive, the court will determine
whether another rate should apply based upon an examination of
the specific facts and equities.
IV. PLAN INTEREST
A. Entitlement to Plan Interest
Plan interest refers to interest to which a creditor may be entitled under a plan of reorganization for the period following the
effective date of the plan. Plan interest is not referenced directly
anywhere in the Code, but is implied from a number of provisions
under the reorganization chapters. 1I5 Each of these provisions require a plan to distribute to specified creditors a minimum amount
to be measured either on or as of the effective date of the plan. 116
For example, under the "best interest" test, a court shall confirm a
chapter 13 plan if "the value, as of the effective date of the plan, of
property to be distributed under the plan on account of' an unsecured claim is not less than the amount that would be paid in a
liquidation. 117 With respect to an allowed secured claim "provided
for by a plan,"118 a court shall confirm a chapter 13 plan if the
holder of such claim accepts the plan, or the debtor surrenders the
collateral, or the holder retains the lien and "the value, as of the
effective date of the plan, of property to be distributed . .. under
the plan on account of such claim is not less than the allowed
amount of such claim."119 The same or similar language is used to
establish analogous conditions for confirmation under chapters 11
and 12. 120
In each instance, courts have read the quoted language "the
default rate. See id; supra notes 19-28 and accompanying text. But if. part V (discussing effect of
1994 Act).
IJ5 See 11 U.S.C. §§ 1129(a)(7), (9), (b)(2), 1225(a)(4), (5), 1325(a)(4), (5) (1994).
IIG See supra note 115.
117 11 U.S.C. § 1325(a)(4) (1994); see also 11 U.S.C. §§ 1129(a)(7), 1225(a)(4) (1994).
11K See Rake v. Wade, 113 S. Ct. 2187, 2192-93 (1993) ("provide[d] for by a plan" includes
establishing repayment schedules for the satisfaction of arrearages and does not refer exclusively to the modification ofa claim) (quoting 11 U.S.C. § 1325(a)(5) (1994».
119 11 U.S.C. § 1325(a)(5) (1994). See also 11 U.S.C. §§ 1129(b)(2)(A), 1225(a)(5) (1994).
120 See 11 U.S.C. §§ 1129 (a)(7), (a)(9), (b)(2), 1225(a)(4), (a)(5) (1994).
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value, as of the effective date of the plan," to require a present value
analysis of the amounts the plan proposes to pay over time in connection with the particular section. 121 For purposes of present value
analysis, bankruptcy cases have not been distinguished on the basis
of the chapters under which they were filed, and the concept of
present value has been construed to have a single meaning wherever
it is used in the Code. 122 Legislative history also suggests this reading. 123 Consequently, most courts considering the issue have concluded that decisions construing present value under one section or
chapter of the Code are equally applicable to the others. l24
Although the Code itself offers no definition of value or present
value in this context, the legislative history describes the mechanical
process of determining present value in a manner consistent with
the use of the term by the economic and financial community.l25
In this sense, present value refers to the sum of an expected future
cashflow discounted to reflect the time value of money.126 In the
case of a reorganization plan, therefore, a present value calculation
would require the determination of the sum of the payments
121 See, e.g., Rake, 113 S. Ct. at 2192 (chapter 13); GMAC v. Jones, 999 F.2d 63 (3d Cir.
1993) (chapter 13); Farm Credit Bank v. Fowler (In re Fowler), 903 F.2d 694 (9th Cir. 1990)
(chapter 12); United States v. Neal Pharmacal, 789 F.2d 1283 (8th Cir. 1986) (chapter 11).
122 In re Collins, 167 B.R. 842, 845 n.2 (Bankr. E.D. Tex. 1994). See Fowler, 903 F.2d at 697
(chapter 11 and chapter 12 provisions similar); United States v. Arnold, 878 F.2d 925, 927-28
(6th Cir. 1989) (chapter 11, chapter 12 and chapter 13 provisions similar); United States v.
Doud, 869 F.2d 1144, 1145 (8th Cir. 1989) (chapter 11 and chapter 12 provisions similar); Neal
Pharmacal, 789 F.2d at 1285 (similar present value provisions within chapter 11); United States
v. Southern States Motor Inns, Inc. (In re Southern States Motor Inns, Inc.) 709 F.2d 647. 65051 (11th Cir. 1983), cert. denied, 465 U.S. 1022 (1989) (chapter 11 and chapter 13 provisions
similar). But rompare 5 COLLIER ON BANKRUPTCY 'l 1129.03(4) (f) (i) (Lawrence P. King et al.
eds., 15th ed. 1995) (in a chapter 11 case, present value should be determined by using a
discount rate based on the market interest rate that would be charged by a creditor making a
loan to a third party with terms similar to those under the plan) with id. ,
1325.06(4)(b)(iii)(B) (in a chapter 13 case, value should be determined by using a discount
rate based on the cost of funds to the creditor rather than the rate that would be charged by a
creditor making a new loan to the debtor).
123 See Southern States Motor Inns, 709 F.2d at 650; Zywicki, supra note 4, at 246-49.
12~ Carbiener, supra note 4, at 45-46.
125 Zywicki, supra note 4, at 247 (quoting In re Snider Farms, Inc., 83 B.R. 977, 988 (Bankr.
N.D. Ind. 1988».
120 See Rake v. Wade, 113 S. Ct. 2187, 2192 n.8 (1993); United Say. Assoc. of Texas v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365, 377 (1988); Irving Fisher, The Theory ofInterest 12 (1930) ("The value of any property, or rights to wealth, is its value as a source of inrome
and is found by discounting that expected income."); R. Stephen Sears & Gary L. Trennepohl,
Investment Management 546-47 (1993); Carbiener, supra note 4, at text accompanying notes 1423.
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promised under the plan, taking into account the amounts of the
payments, the timing of the payments, the length of the plan, and
the rate at which the expected cashflow is to be discounted. 127
To simplify this determination, most plans propose the payment
of a principal amount (determined by reference to the applicable
section of the Code) plus interest at a rate equal to the rate that
otherwise would be used to discount the payments to present value. 128 So long as the proposed interest rate is equal to the required
discount rate, the present value of the cashflow wiII equal the principal amount of the promised payments. l29 Thus, the discounting
process is greatly simplified, and the sole issue becomes whether the
interest rate proposed under the plan is at least equal to the required discount rate. ISO
Construed in this fashion, the "best interest" tests under sections
1129 (a) (7), 1225(a) (4) and 1325(a) (4) require that with respect to
an unsecured claim, the present value of distributions proposed
under a plan must at least equal the amount that would have been
paid in a liquidation. Stated differently, the holder of an unsecured
claim, in effect, is not entitled to plan interest on the allowed
amount of such claim, but only upon the liquidation value of such
claim. Hence, if the allowed amount of the unsecured claim is
$1,000, but the liquidation value under chapter 7 would be $100,
then the best interest test demands a present payment of at least
$100 or proposed future payments equal to at least $100 plus interest at the required discount rate.
With respect to a secured claim provided for by a plan, sections
1129 (b)(2)(A), 1225(a)(5) and 1325(a)(5) require the payment of
plan interest on the allowed amount of such claim. ulI Unless the
holder of a secured claim otherwise accepts the plan, or the debtor
surrenders the collateral, these sections provide that the present
value of distributions proposed under the plan must at least equal
127 See Sears & Trennepohl, supra note 126, at 54647; Carbiener, supra note 4, at text
accompanying notes 14-23.
128 See Rake, 113 S. Ct. at 2192 n.8; Carbiener, supra note 4, at text accompanying notes 1423.
129 Carbiener, supra note 4, at text accompanying notes 14-23.
ISO For a discussion of the required discount rate, see infra part IV(B).
... The language of § 1129(b)(2)(A) differs slightly from that of §§ 1225(a)(5) and
1325(a)(5) in order to accommodate an undersecured creditor that has elected to treat its
claim as fully secured under § 1111 (b)(2). See 124 CONGo REc. Hll,103-104 (daily ed. Sept. 28,
1978); 124 CONGo REc. S17,420-421 (daily ed. Oct 6, 1978).
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171
the allowed amount of the secured claim. 132 As discussed above,
this is accomplished most typically by the deferred payment of a
principal amount equal to the amount of the allowed secured claim
plus interest thereon at a rate equal to the required discount
rate.133
The entitlement to plan interest as summarized above has been
relatively noncontroversial, subject to only a few exceptions. Under
the best interest test, for instance, questions continue to arise concerning the date that should be used to determine the hypothetical
liquidation value of an unsecured claim.134
With respect to the payment of plan interest on secured claims,
it has been questioned whether the determination of the amount of
the allowed secured claim should include any pendency interest
allowed under section 506(b).135 For example, if a claim in the
prepetition amount of $1,000 (principal and prepetition interest) is
oversecured and pendency interest is allowed in the amount of $100,
is the allowed amount of the secured claim upon which plan interest
must be paid $1,000 or $1,100? Although pendency interest was not
addressed directly in Rake the Supreme Court in that case referred
to it under section 506(b) as "part of the allowed claim" and as "part
of the oversecured claim."136 Moreover, from a policy viewpoint, it
would make sense to treat pendency interest as part of the secured
claim for purposes of plan interest, because pendency interest is a
substantive right granted under the Code which would be subject to
dilution if payable on a deferred basis without a present value requirement. Also, the option to pay the present value of an allowed
152 Under § 1129(b)(2)(A), the specific alternatives to cash payment are sale of the collateral subject to a lien on proceeds, or the realization by the creditor of the indubitable
equivalent of the allowed secured claim. See 11 U.S.C. § 1129(b) (2) (A) (1994).
'ss See supra notes 128-29 and accompanying text.
154 See, e.g., In re Schoeneberg, 156 B.R 963, 969 (Bankr. W.D. Tex. 1993). Compare 5 COLLIER ON BANKRUPTCY, supra note 122, 1 1225.02(4) at 1225-10 (arguing for effective date of
plan) with id. 1 1325.05(2) (a) at 1325-26 (arguing for petition date).
IS> Heidt, supra note 4, at 364 n.16. As previously discussed, the amount of an allowed
secured claim upon which pendency interest is allowed under § 506(b) should include not only
principal, but also prepetition interest. See supra text accompanying notes 73-78. Thus, the issue
of whether plan interest should accrue on pendency interest involves the question of interest
on interest on interest. This question is not decided under the 1994 Act except with respect to
the curing of arrearages. See infra part V.
156 Rake, 113 S. Ct. at 2191-92. See id. at 2190 ("506(b) 'has the effect of allowing a claim
to the creditor'"); see also Prudential Ins. Co. v. Monnier (In 711 Monnier Bros.), 755 F.2d 1336,
1338 (8th Cir. 1985); 5 COLLIER ON BANKRUPTCY, supra note 122,1 1225.03(2). As discussed in
part V, the 1994 Act creates a separate rule for the curing of arrearages.
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secured claim is presented as an alternative to the surrender of the
collateral. 137 To the extent that these alternatives are intended to
be equivalents, the deferred payment of pendency interest under a
plan should be subject to a present value requirement, because if
the debtor had surrendered the collateral, such interest would have
been paid out of the collateral's proceeds.
Difficulty has also arisen with respect to the availability of plan
interest on arrearages proposed to be cured under a reorganization
plan. As previously mentioned, Rake settled this issue for arrearages
that are part of an oversecured claim, holding that plan interest is
required under the terms of section 1325(a)(5).I38 Rake did not address undersecured claims, however, and the application of section
1325(a) (5) in this context has proved to be difficult. For purposes of
the Code provisions relating to plan interest, should the arrearages
be allocated to the secured portion of an undersecured claim, and
therefore entitled to plan interest? Or should they be allocated to
the unsecured portion, thereby precluding entitlement to plan interest? In re Arvelo139 appears to offer the best compromise - calculate the percentage of the entire claim that is secured and use that
percentage to determine the portion of the arrearages that should
be deemed secured for purposes of plan interest. 14o If, for example, the entire claim is $100,000, the collateral is valued at $60,000,
and the arrearages are $10,000, then the secured portion of the
arrearages entitled to plan interest would be deemed to be $6,000,
and the unsecured portion of the arrearages not entitled to plan
interest would be deemed to be $4,000. 141 However, as discussed in
part V below, the 1994 Act expressly changes the rule for determining the amount necessary to cure a default under an agreement
entered into after the effective date of the 1994 ACt. 142
137 See 11 u.s.c. §§ 1129(b){2){A), 1225(a){5), 1325(a){5) (1994). See also supra note 132
(noting that specific alternatives to cash payment under § 1129(b){2)(A) are a sale of the
collateral subject to a lien on proceeds or realization of indubitable equivalent).
,... 113 S. Ct. at 2191-92. See also supra text accompanying note 65. But see 1994 Act § 305
(discussed infra part V).
,:59 176 B.R. 349 (Bankr. D.NJ. 1995).
'40 Id. at 357-59.
14'
142
See id.
See infra part V.
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B. Rate ofPlan Interest
1. General
Although the entitlement to plan interest invites little argument,
the rate of plan interest threatens never to be resolved. With little
exaggeration, one commentator notes that there is a case for almost
any method of determining the appropriate rate,143 and he identifies eight "major" lines of authority among the cases that address
this issue. l44 A few generalizations, however, have emerged from
the chaos.
Beginning with the statutory language,145 it is apparent that
Congress described the obligation to pay plan interest under the
reorganization chapters l46 in very different terms from the obligations to pay pendency interest under section 506(b) or 726(a) (5). As
discussed previously, plan interest is not directly referenced in the
Bankruptcy Code; rather, it derives from the obligation to pay present value. 147 Accordingly, if Congress had intended plan interest to
continue at the contract rate, as under section 506(b), or at the
"legal rate," as under section 726(a)(5), it could have done so as it
did in those sections. Moreover, because the entitlement to receive
plan interest is merely a means to provide for present value, the rate
of plan interest must equal the rate of discount that otherwise would
be used in such determination. l48 Thus, a search for the appropriate rate of plan interest is a search for the rate at which the expected cash flows would be discounted in order to determine their present value.
From an economic perspective, the discount rate represents
compensation for the time value of money.149 In effect, the discount rate is the price or exchange rate that is paid to compensate a
lender who foregoes current spending or investment opportunities
to make a loan. 150 This compensation includes three components:
Carbiener, supra note 4, at text accompanying note 9.
Id. at text accompanying notes 15lH>3.
Itl See United States v. Ron Pair Enters., Inc., 489 U.S. 235, 241 (1989) (reminding that all
such inquiries must begin with the language of the statute itself).
B6 11 U.S.C. §§ 1129(a)(7), (a)(9), (b)(2), 1325(a)(4), (a)(5) (1994).
B7 See supra part IV(A).
B" Id.
B9 Sears & Trennepohl, supra note 126, at 8-9, 546-47.
BS
1+1
lroo
[d.
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(1) a real rate (the basic rate established by the demand for borrowing and the supply of capital to compensate for the mere passage of
time, without taking into account expected inflation or risk); (2) an
expected inflation rate (to compensate for the expected loss in purchasing power); and (3) a risk premium (to compensate for the
uncertainty regarding the actual return) .151 It is broadly accepted
economic theory that the above factors determine market interest
rates. 152
Consistent with the above, each of the eight circuits that has
addressed the issue of the appropriate rate of plan interest has concluded that plan interest must reflect, in some fashion, a current
market rate of interest on a loan with duration and risk characteristics similar to those of the deferred payments proposed under the
plan. 153 Although various methods for determining what is the appropriate current market rate have been approved or prescribed by
Id.
See, e.g., id. at 571. See generally Fisher, supra note 126.
15~ Third Circuit: GMAC v. Jones, 999 F.2d 63, 65 (3d Cir. 1993) (chapter 13) [(rate that
particular creditor would change)].
Fourth Circuit. United Carolina Bank V. Hall, 993 F.2d 1126, 1130-31 {4th Cir. 1993)
(chapter 13) (rate based on creditor's lending market, not to exceed contract rate).
Fifth Circuit: Heartland Fed. Sav. & Loan Ass'n V. Briscoe Enters., Ltd., II (In re Briscoe
Enters., Ltd., II), 994 F.2d 1160, 1169 (5th Cir. 1993), cert. denied, 114 S. Ct. 550 (1993) (chapter 11) (contract rate not clearly erroneous based on comparison with Treasury bill rate plus
an appropriate adjustment for risk).
Sixth Circuit: United States v. Arnold, 878 F.2d 925, 928-30 (6th Cir. 1989) (chapter 12)
(prevailing market rate); Cardinal Fed. Sav. & Loan Ass'n. V. Colegrove (In re Colegrove), 771
F.2d 119, 122-23 (6th Cir. 1985) (chapter 13) (prevailing market rate not to exceed contract
rate); Memphis Bank & Trust CO. V. Whitman, 692 F.2d 427, 431 (6th Cir. 1982) (chapter 13)
(prevailing market rate).
Eighth Circuit: United States Dept. of Agric. V. Fisher (In re Fisher), 930 F.2d 1361, 136364 (8th Cir. 1991) (chapter 12) (prevailing market rate); United States V. Doud, 869 F.2d 1144,
1150-56 (8th Cir. 1989) (chapter 12) (prevailing rate based on Treasury bond rate plus adjustment for risk); United States V. Neal Pharmacal Co., 789 F.2d 1283, 1285-88 (8th Cir. 1986)
(chapter 11) (prevailing market rate); Prudential Ins. Co. V. Monnier (In re Monnier), 755 F.2d
1336, 1337-38 (8th Cir. 1985) (chapter 11) (contract rate not erroneous because reflected prevailing cost of funds and inherent risks when negotiated "only some twenty months" before
confirmation) .
Ninth Circuit: Farm Credit Bank of Spokane V. Fowler (In re Fowler), 903 F.2d 694, 696-97
(9th Cir. 1990) (chapter 12) (market rate derived by applying formula approach: Treasury rate,
nature of security, etc.).
Tenth Circuit: Hardzog v. Federal Land Bank of Wichita (In re Hardzog), 901 F.2d 858,
859-60 (10th Cir. 1990) (chapter 12) (rate for similar loans in region).
Eleventh CirCllit: United States V. Southern States Motor Inns, Inc. (In re Southern States
Motor Inns, Inc.), 709 F.2d 647, 650-53 (11th Cir. 1983), cert. denied, 465 U.S. 1022 (1984)
(chapter 11) (prevailing market rate).
1:;1
1S2
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175
these courts, most have compared the deferred payments proposed
under a plan to a coerced loan from the creditor, to whom a market
rate of interest must be paid in order to make the coerced loan
equivalent to payment of the same principal amount as of the effective date of the plan. 1M
As discussed in part V, notwithstanding the reorganization provisions of the Code relating to plan interest, the 1994 Act creates a
separate rule for determining the amount necessary to cure a default.
2. Methods for Determining Current Market Rate
At least three different methods for determining the appropriate current market rate have been approved or prescribed by the
appellate courts. Most recently, in a chapter 13 case, the Third Circuit Court of Appeals held that the appropriate rate of plan interest
is the rate that the particular creditor would charge, at the time of the
effective date of the plan, for a loan of similar character, amount,
and duration. 155 The court acknowledged that "the difference between the rates charged by the particular creditor in the regular
course of its business in a competitive market will not differ materially from those charged by competing creditors in that market, "156
but believed that use of the particular creditor's rates would more
closely approximate the statutory goal to place each creditor in approximately the same position it would have occupied had it received an equivalent principal amount as of the effective date of the
plan. 157 The court also thought that if the regularly maintained
documents of the particular creditor were the primary focus of the
present value inquiry, it would reduce litigation costs and encourage
stipulations as to interest rate. l58 To further minimize litigation expenses, the Third Circuit imposed a rule of practice that the contract rate, if any, would serve as a proxy for the current rate unless
there is a stipulation or evidence to the contrary. 159
154 &e GMAG, 999 F.2d at 67; United Carolina Bank, 993 F.2d at 1130; Fisher, 930 F.2d at
1364; Hardzog, 901 F.2d at 860; AT7UJld, 878 F.2d at 928.
10> Janes, 999 F.2d at 65. Cf. United Carolina Bank, 993 F.2d at 1131. But if. Travelers Ins. Co.,
878 F.2d at 358 (value must be determined objectively).
I~ Janes, 999 F.2d at 68.
1~7 leI.
Ir... leI. at 70.
1~9 leI. at 70-71.
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As suggested by the Third Circuit, a second method used by a
number of other appelate courts is to determine the prevailing market
rate in the appropriate region for "a loan of a term equal to the
payout period, with due consideration of the quality of the security
and the risk of subsequent default. "160 This method is closely related to the Third Circuit approach discussed above, except that the
inquiry extends beyond the rates charged by the particular creditor
to the rates charged by other creditors in the market for similar
loans.
A third method approved by some appelate courts for determining the appropriate current market rate is the formula method. 161
Following a formula approach, the current market rate is based not
necessarily on the rates for similar loans, but on the rates for relatively riskless securities, such as government bonds, to which a premium is added to reflect the risk factors associated with a particular
plan, such as the likelihood of repayment and the strength of the
collateral. This approach is based on the theory that government
bonds with a duration equal to the proposed plan payments are an
easily identified proxy for the first two components of the time value
of money - the real rate and the expected inflation rate - to
which an appropriate addition must be added to reflect only. the
increased risks posed by the particular debtor and collateral. In
United States v. Doud,t62 for instance, the Eighth Circuit Court of
Appeals held in a chapter 12 case that it was not erroneous to determine the prevailing market rate by utilizing the yield on a treasury
bond with a duration matched to the duration of the proposed plan
payments, plus a two percent upward adjustment to compensate for
the overall risk associated with a chapter 12 reorganization.I6.~ The
Doud court added that "[i]f the bankruptcy court has correctly considered all of the elements involved in computing a discount rate,
determination of the proper discount rate in a particular case is a
factual inquiry" subject to the clearly erroneous standard on appeal. l64
160 See 5 COWER ON BANKRUPTCY, supra note 122, i 1129.03(f) (i). See, e.g., Fisher, 930 F.2d
at 1363; Fowler, 903 F.2d at 696; Arnold, 878 F.2d at 928, Doud, 869 F.2d at 1145-46; Monnier,
755 F.2d at 1339; Southern States, 709 F.2d at 651.
161 See Fowler, 903 F.2d at 696; Doud, 869 F.2d 1145-46. But see Jones, 999 F.2d at 69 n.9;
Hardzog, 901 F.2d at 860.
162 869 F.2d 1144.
163 Id. at 1145.
16< Id. at 1146.
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All three of the above methods appear to be reasonable approaches to determining plan interest because their principal object
is to determine present value as of the effective date of the plan.
Some rates which the courts of appeals have specifically rejected because they were not consistent with the statutory goal of present
value include (1) the rate charged by the government to delinquent
taxpayers under 26 U.S.C. § 6621;165 (2) below market rates extended under special Farmers Home Administration programs;166
and (3) the "cost of funds" rate determined by the creditor's borrowing rate and excluding any element of "profit" to the creditor. 167 In
a decision going both ways, the Fourth Circuit Court of Appeals recently emphasized in a chapter 13 case the present value purpose of
plan interest and explained that once this statutory purpose is recognized, "the issue of how the applicable interest rate is to be calculated becomes essentially an economic one."168 In another portion of
the otherwise well-reasoned opinion, however, the court held that
plan interest may be capped at the contract rate as a matter of equity "so as to eliminate a windfall benefit to the secured creditor."169
One method not yet passed upon by a court of appeals is the
"blended rate" method. This approach has been used in several
chapter 11 cases in response to criticism that there is no market for
100% loan to value ratio loans, as would be the case in a reorganization plan in which the value of the collateral equals the amount of
the allowed secured claim. 170 In re Bloomingdale Partners 7J provides
an example. In that case, a creditor had a $10 million allowed secured claim collateralized by property with a value of $10 million.
The evidence showed that without any equity cushion there was no
market for such a loan. Accordingly, the court treated the proposed
repayment of the allowed secured claim as a proposal for, in effect,
See Neal Phannaca~ 789 F.2d at 1285-89; Southern States, 709 F.2d at 651-52.
See Fisher, 930 F.2d at 1363-64; Arnold, 878 F.2d at 925-29.
167 See]ones, 999 F.2d at 67; United Carolina Bank, 993 F.2d at 1130-31; Neal Phannaca~ 789
F.2d at 1286. But see In re Collins, 167 B.R. 842 (Bankr. E.D. Tex. 1994) (rejecting coerced
165
It»
loan theory "because it contained many risk elements plus a profit factor inappropriate in a
bankruptcy context").
16. United Carolina Bank, 993 F.2d at 1130.
IGO Id. at 1131.
170 See, e.g., Mutual Life Ins. Co. of New York v. Paradise Springs Assocs. (In re Paradise
Springs Assocs.), 165 B.R. 913 (Bankr. D. Ariz. 1993); In re Bloomingdale Partners, 155 B.R.
961 (Bankr. N.D. III. 1993); In re Birdneck Apartment Assocs. II, L.P., 156 B.R. 499 (Bankr.
E.D. Va. 1993).
•71 155 B.R. 961 (Bankr. N.D. III. 1993).
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two loans - a first mortgage loan for $7.5 million, and a second
mortgage loan for $2.5 million. Reducing the court's analysis to its
simplest terms, the court found that the market rate for the first
mortgage loan should be based on the market for oversecured first
mortgage loans, and that the market rate for the second mortgage
loan should be based on the market for second lien loans or equity
participations. 172 The court then combined the two rates to determine a weighted blended rate. 173 Experts supplied a number of
other checks on this methodology to test the synthesized market
rate. 174
In sum, notwithstanding the multitude of decisions addressing
the appropriate rate of plah interest, there is agreement among the
circuits concerning at least three concepts. First, the entire purpose
of plan interest is to provide the holder of a claim the present value
of the minimum amount required to be paid under the Code on account of such claim. Second, to achieve this statutory objective, the
interest rate that is selected must compensate the creditor for all of
the components of the time value of money.175 Third, the interest
rate that most nearly approximates the goal of present value is the
current market rate for a loan with duration and risk characteristics
similar to those incident to a particular plan. With respect to the
method for determining a current market rate, however, there is
disagreement, and one must consult applicable authority to identify
the methodologies permitted in a particular jurisdiction.
V. ARREARAGES & THE 1994 Acr
Section 305 of the 1994 Act, entitled "Interest on Interest," adds
to each of the reorganization chapters a subsection which provides
that notwithstanding certain other sections of the Bankruptcy Code,
if a plan proposes to cure a default, the amount necessary to cure
the default shall be determined in accordance with the underlying
agreement and applicable nonbankruptey law. 176 The sections of
the Code made subordinate to this addition include section 1123(a)
(which specifies the general contents of a chapter 11 plan), sections
172
See id. at 983-86.
I7S
[d. at 985.
174
175
.76
Id. at 986.
See supra text accompanying note 151.
See 11 U.S.C. §§ 1123(d), 1222(d), 1322(e) (1994).
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1222(b) (2) and 1322(b) (2) (which permit modification of the rights
of holders of secured claims), section 506(b) (which allows pendency interest on oversecured claims as discussed in part III), and sections 1129 (a)(7) , 1129 (b) , 1225 (a)(5), and 1325(a)(5) (which require plan interest under certain circumstances as discussed in part
IV).
According to the legislative history,!77 section 305 of the 1994
Act has the effect of overruling Rake v. Wade. 178 As suggested by the
title of this section, "Interest on Interest," and by the available legislative history, one of Congress' chief concerns was that Rake had the
effect of "giving secured creditors interest on interest... even
where applicable law prohibits such interest"179 From this, it might
be supposed that the object of section 305 is to prohibit the payment of compound interest The language of section 305, however,
circumscribes a rule that is at once both broader and narrower than
such a simple prohibition. First, section 305 is limited to amounts
necessary to cure defaults and therefore does not apply to other
types of claims, which remain subject to the pendency and plan
interest provisions of the Code. Second, section 305 is not a prohibition, but rather a reference to the underlying agreement and applicable nonbankruptcy law. Third, section 305 extends to "the
amount" necessary to cure a default and therefore is not limited to
interest on interest.
Returning to the first observation, because section 305 of the
1994 Act encompasses only amounts necessary to cure defaults, it
simply creates a separate rule for determining the amount necessary
to cure a default and divorces that rule from the ordinary rules for
determining prepetition, pendency, and plan "interest. Subject to
that exception, section 305 by its terms has no effect on the statutory
or case law summarized in parts II, III, and IV. Beginning with Rake
(the intended object of section 305), the only casualty appears to be
the Court's logical deduction that because arrearages are part of a
creditor's oversecured claim they should be subject to the same rules
as those governing oversecured claims in general. 180 Whereas prior
177
178
140 CONGo REc. HlO,770 (dailyed. Oct. 4,1994) (statement of Rep. Brooks).
113 S. Ct. 2187 (1993). For a discussion of Rake, see supra text accompanying notes 54-
81.
140 CONGo REc. HI0,770 (daily ed. Oct. 4,1994) (statement of Rep. Brooks).
113 S. Ct. at 2191-92. As previously discussed, arrearages typically refer to installment
loan payments that are past due. See supra text accompanying notes 54-57. Under the reorganization chapters, a plan may provide for the curing of such arrearages. See id.
179
1M
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to the 1994 Act the cure provisions of the Code gave no indication
that the allowed amount of arrearages cured under a plan may not
include pendency interest otherwise available as part of a secured
claim under section 506(b),181 or plan interest otherwise available
on a secured claim pursuant to the reorganization chapters,182 section 305 of the 1994 Act now so provides. Under section 305, if a
plan proposes to cure a default, the amount necessary to cure is
determined in accordance with the underlying agreement and applicable nonbankruptcy law, notwithstanding section 506(b) or the
reorganization provisions relating to plan interest on secured claims.
Accordingly, it no longer follows that because arrearages are part of
a creditor's secured claim, arrearages are subject to the rules governing pendency interest under section 506(b) or plan interest under
the reorganization provisions. To this extent, the initial conclusion
of Rake is overruled by section 305.
The other conclusions reached by the Rake Court, as well as the
holdings of Timbers and Ron Pair, are simply constructions of section
506(b) or 1325(a) (5).183 Hence, they are unaffected by section 305
except as they apply to the cure of arrearages, which is now governed by the new rule. Section 305, therefore, does not overrule: (i)
Timbers' holding that section 506(b) permits pendency interest on
oversecured claims and prohibits pendency interest on undersecured
claims; (ii) Ron Pair's holding that pendency interest under section
506(b) extends to nonconsensual oversecured claims as well as consensual claims; (iii) Rake's holding that pendency interest under section 506(b) is not dependent on the right to interest under an
agreement or applicable nonbankruptcy law, is allowed on interest as
well as principal, and applies to the period from the petition date
until the confirmation or effective date of the plan; or (iv) Rake's
indication that pendency interest is part of an oversecured claim on
which plan interest therefore may accrue pursuant to the reorganization chapters.184
Next, because section 305 of the 1994 Act is not in the form of
a prohibition, but rather a reference to the underlying agreement
and applicable nonbankruptcy law, it does not proscribe interest on
interest (or any other amount) even for purposes of determining the
See supra text accompanying note 62.
See supra part IV(A) and text accompanying note 138.
ISS See supra part III.
'84 See supra parts 1II. IV.
JRI
182
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amount necessary to cure a default. If the underlying agreement and
applicable nonbankruptcy law provide for interest on interest, then
pursuant to section 305 such amount must be considered in determining the amount necessary to cure a default. Taking the hint, at
least one state has amended its usury law so as to permit interest on
interest on certain claims in bankruptcy. ISS
Lastly, because section 305 of the 1994 Act extends to "the
amount" necessary to cure a default and therefore is not limited to
interest on interest, it presumably applies to other costs, such as simple interest, default interest, late fees, and attorney fees. With respect to the issue of simple interest, pendency and plan interest on
arrearages proposed to be cured under a plan of reorganization no
longer depend on whether the arrearages are oversecured,
undersecured, or unsecured. Rather, interest and any other amounts
relating to a cure of arrearages should be determined pursuant to
section 305 of the 1994 Act in accordance with the underlying
agreement and applicable nonbankruptcy law, notwithstanding section 506(b) or those provisions of the Code relating to plan interest.
Thus, with respect to agreements entered into after the enactment
of the 1994 Act,186 section 305 overrules the reasoning of those cases l87 which held that pendency or plan interest is not permitted to
some extent because the arrearages are part of an undersecured
claim.
Similarly, if an agreement enforceable under applicable
nonbankruptcy law provides for a default rate of interest, then section 305 may require interest to be calculated at such higher rate for
purposes of curing a default. This application of section 305 would
have the effect of overruling Florida Partners Corp. v. Southeast Co. (In
re Southeast CO.),I88 discussed in part II.B, which held that the cure
provisions of chapter 11 authorize a plan to nullify all consequences
of default, including a default rate of interest. 189 On the other
hand, the section-by-section analysis of section 305 of the 1994 Act
also states that "[i]t is the Committees's intention that a cure pursuant to a plan should operate to put the debtor in the same position
See 1995 Ga. Laws 432 (S.B. No. 408).
The amendments made by § 305 of the 1994 Act apply only to agreements entered
into after the date of enactment. 11 U.S.C. § 702(D) (1994).
187 See supra note 64 and text accompanying notes 139-41.
I.., 868 F.2d 335 (9th Cir. 1989).
189 fd. at 336.
185
106
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as if the default had never occurred. "190 This statement affirms the
basic premise of Southeast Co. This apparent conflict could be reconciled if the rule were that the rate of interest is determined by the
underlying agreement and applicable nonbankruptcy law, and as
though the default had never occurred. 191 The broad language of
section 305, however, does not make this an easy conclusion.
VI. CONCLUSION
As developed above, the general rules for the determination of
interest in bankruptcy are relatively few and quickly recited. Except
for interest on arrearages, the entitlement to interest and the rate of
interest under the Bankruptcy Code are classified into three categories corresponding to the progression of the case in bankruptcy.
Prepetition interest is allowable, generally to the extent and at the
rate permitted under applicable nonbankruptcy law. Pendency interest generally is not allowed, except to the extent permitted under
the well-established exceptions for a solvent debtor (at the "legal
rate") and for an oversecured creditor (in most instances at the rate
provided by applicable nonbankruptcy law). Plan interest is provided
for under the reorganization chapters of the Code at a current market rate in order to assure that deferred payments under a reorganization plan provide for the present value of certain minimum
amounts required to be paid under the plan. Under the 1994 Act,
interest (whether prepetition, pendency or plan) on arrearages proposed to be cured under a reorganization plan is determined in
accordance with the underlying agreement and applicable
nonbankruptcy law.
At the edges, however, these rules are both stretched and
frayed. For the rules referencing applicable nonbankruptcy law,
should an equitable exception exist with respect to default or penalty rates of interest, or interest on interest? Regarding pendency interest, should a creditor be entitled thereto if there is no right to
interest under the underlying agreement or applicable
nonbankruptcy law? If so, at what rate? What rate should apply if the
140 CONGo REc. H10,770 (daily ed. Oct. 4, 1994) (statement of Rep. Brooks).
Some support for this approach is found in § 219(a) of the 1994 Act (amending 11
U.S.C. § 365(b)(2». Under this addition to § 365(b)(2), a debtor in possession may assume
an executory contract without curing a "default that is a breach of a provision relating to ...
(D) the satisfaction of any penalty rate." 11 U.S.C. 365(b)(2)(D) (1994).
190
191
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debtor proves to be solvent? For the purposes of pendency and plan
interest, at what times should the value of a secured claim be measured, and what is the effect of a lien on collateral that earns income after the petition date? Should there be a single method for
determining the current market rate for purposes of plan interest?
As of what date should the hypothetical liquidation value of an unsecured claim be determined? With respect to interest on arrearages,
did Congress really intend to fashion a rule completely divorced
from the general rules for determining pendency and plan interest?
Although the general rules are easily stated, they are not sufficiently defined to provide clear answers to the above questions. As a
result, courts and practitioners continue to struggle to resolve many
of them, with varying degrees of success and uniformity. In light of
these problems and the establishment by the 1994 Act of the National Bankruptcy Review Commission,192 the time may be ripe for a
general review of the subject of interest under the Code, including
the role that interest should play in accommodating competing
bankruptcy policies.
102
11 U.S.C. § 602 (1994).
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