In re Melenyzer
| Decision Date | 12 August 1992 |
| Docket Number | Bankruptcy No. 5-85-00338-C. |
| Citation | 143 BR 829 |
| Parties | In re Charles L. MELENYZER, Debtor. |
| Court | U.S. Bankruptcy Court — Western District of Texas |
Lawrence A. Beck, Beck & Beck, P.C., San Antonio, Tex., for George A. Benz.
James S. Wilkins, San Antonio, Tex., for trustee Martin W. Seidler.
Bill Frazell, San Antonio, Tex., Asst. U.S. Trustee.
CAME ON, for hearing and further consideration, the objection of George Benz to the Trustee's Supplement to the Trustee's Final Report and Account filed pursuant to this court's previous directive. At issue is the construction of the phrase "interest at the legal rate" used in 11 U.S.C. § 726(a)(5). Upon consideration of the arguments of counsel and the relevant case law, the court concludes that "interest at the legal rate" means the federal judgment rate, determined as of the date the bankruptcy petition was filed, for the reasons set forth herein.
Although the facts of this case are quite complicated,1 the relevant facts of the specific issue at hand are quite simple. The Trustee's Supplement proposes to pay the unsecured creditors interest, pro rata, from the approximately $12,000 in cash remaining in the estate. Under the Trustee's proposal, however, some property would be returned to the debtor. Accordingly, the court has requested that the Trustee liquidate further assets, so as to pay — if possible — the unsecured creditors the full amount of interest due on their claims from the date of filing, until the date the claims are paid. Creditor Benz has argued that the term "interest at the legal rate" means that he is entitled to the contract rate of interest (18%). This court, in dicta in In re Laymon, however, has construed the phrase to mean the federal judgment rate. See In re Laymon, 117 B.R. 856 (Bankr. W.D.Tex.1990), rev'd on other grounds, 958 F.2d 72 (5th Cir.1992). Regardless of which rate applies, more assets have to be liquidated to pay the interest claims, but the interest rate used will dictate the extent to which further liquidation must proceed.
Case law construing "interest at the legal rate,"2 as that term is used in 11 U.S.C. § 726(a)(5), is rather sparse and essentially is divided into two basic categories: (1) those courts which have held that state law defines the phrase, and (2) those which have held that the phrase means the federal judgment rate.
The first category includes those courts which have held that state law defines "interest at the legal rate." See, e.g., In re Adcom, Inc., 89 B.R. 2, 2 (D.Mass.1988) (); In re Anderson, 28 B.R. 628, 631-32 (S.D.Ohio 1982) (); In re Rivera, 116 B.R. 17, 18-19 (Bankr. D.P.R.1990) (); In re Boyer, 90 B.R. 200 (Bankr. D.S.C.1988) (). Although this first category represents the majority approach, few of the cases explain why state law should define "interest at the legal rate." To the extent that any rationale is offered at all, the courts have focused upon the purpose of Section 726(a)(5) in providing for postpetition interest, i.e. "to prevent debtors from abusing the bankruptcy process by using it to delay payments and avoid interest obligations when at the time of filing the petition the debtor was actually solvent." In re Kentucky Lumber Co., 860 F.2d 674, 676 (6th Cir.1988). Viewed in this light, Section 726(a)(5) appears to require a balancing of the equities between the creditor and the debtor (as opposed to among the creditors) because the next distribution, after Section 726(a)(5), goes to the debtor. See In re Continental Airlines Corp., 110 B.R. 276, 280 (Bankr.S.D.Tex.1989).
In In re Beck, for example, the court found that the "scale balancing the equities . . . overwhelmingly tilted toward restoring the creditor to as near a position as the creditor would have occupied absent bankruptcy before benefitting the debtor with surplus funds." In re Beck, 128 B.R. 571, 573 (Bankr.E.D.Okla.1991). As a result, the Beck court held that "interest at the legal rate" means "that rate of interest to which creditors would have been entitled through any appropriate legal proceeding had the bankruptcy petition never been filed." In re Beck, 128 B.R. at 573. Thus, if a contract between the parties establishes the rate of interest on any unpaid but payable amount, the rate established in the contract would control. Id. On the other hand, if a specialized rate of interest for a particular creditor is established by a specific statute, that rate would likewise be applied on any claim for post-petition interest. Id. Finally, any general unsecured claims without the benefit of a specified rate of interest — either by contract or by specific statute — would be paid pursuant to the federal judgment rate established by 28 U.S.C. § 1961. Id. The Beck court went on to point out that a debtor already "receives the ultimate benefit of a discharge through bankruptcy and should not be permitted to overextend the `fresh start' concept to unrecognizable bounds." Id.
Id. In the absence of any authority to the contrary, the court found the reasoning of Fortgang & King compelling and held that "where the debtor's estate proves solvent, a contract creditor is entitled to post-petition interest at the rate set forth in the contract." Id. In the alternative, the court held that "where a claim in bankruptcy is based upon a contract which provides for a rate of interest, and where the bankrupt estate is solvent, the `legal rate' under Section 726(a)(5) is the applicable prejudgment rate for breach of contract actions under state law." Id. ().
The problem with the state law approach is that different creditors will have different rates of interest, depending upon their contracts or the applicable statutory rate. One contract might provide for interest at 18%, another at 9%. One state statute might set the rate at 10%, another applicable statute a rate of 6%. So long as there are enough remaining assets to pay all these varying interest claims, the intention of Beck and A & L Properties is easily vindicated — the debtor is not permitted to retain assets while creditors still have entitlements outstanding. Quite often, though, there are only enough assets to pay some interest to creditors, not enough to pay all creditors all the interest they claim at their contract or statutory rates. Using those rate, some creditors would receive a disproportionately large percentage of the remaining assets compared to their underlying unsecured claims, to the prejudice not of the debtor, but of other, otherwise equally situated, unsecured creditors. The rationale of Beck and A & L Properties will not support such disproportionate treatment as among similarly situated creditors.3
These pitfalls of the state law approach and other problems as well are avoided by the second category of cases, wherein the courts have held that "interest at the legal rate" means the federal judgment rate, a position which this court adopted in In re Laymon, 117 B.R. 856 (Bankr.W.D.Tex.1990). Although Laymon involved the appropriate rate of interest payable to an oversecured creditor under 11 U.S.C. § 506(b), the court explored the meaning of "interest at the legal rate" in 11 U.S.C. § 726(a)(5) because both Code sections are exceptions to the general rule that post-petition interest is not payable. Id. at 859-60; see also 11 U.S.C. § 502(b)(2). Initially, we pointed out that the award of post-petition interest is a matter...
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