May They Have Your Interest? Unsecured Debts in Chapter 13

Credit card interest stops accruing after filing a Chapter 13 bankruptcy in most cases

In Chapter 13 bankruptcy, do you have to pay the general unsecured creditors — like credit cards and personal loans — interest on their debt?  The Bankruptcy Code specifically describes the treatment of claims with postpetition interest, so you would think unmatured interest in Chapter 13 would be settled.

“The age-old rule in bankruptcy, adopted from the English system, is that interest on claims stops accruing when the bankruptcy petition is filed. In other words, creditors cannot recover post-petition interest on their claims. This rule has been written into the Bankruptcy Code at 11 U.S.C. § 502(b)(2).” Matter of Fesco Plastics Corp., Inc., 996 F. 2d 152, 155 (7th Cir,1993)(cites omitted).

What does the Bankruptcy Code say about interest and unsecured debts

Like most things, let’s start with the relevant statutes to guide us whether you need to pay unsecured debts interest in a Chapter 13.

Section 502(b)(2) of the Bankruptcy Code, then, says, in pertinent part:

“…if such objection to a claim is made, the court, after notice and a hearing, shall determine the amount of such claim in lawful currency of the United States as of the date of the filing of the petition, and shall allow such claim in such amount, except to the extent that … such claim is for unmatured interest”

There you have it. The bankruptcy court shall allow claims, except if the claim is for unmatured interest. That sounds pretty straightforward.

(There are a couple of exceptions for when the debtor is solvent at Section 726(a)(5), and for secured creditors whose collateral is worth more than the total of principal and interest due at Section 506(b) but those are beyond the scope of this piece.)

Case law on Unsecured Debts Getting Interest: Two Views

Majority View: Section 502 means what it says

The Rule

The closest the Supreme Court has ruled on the topic of postpetition interest is in U.S. v. Ron Pair Enterprises, Inc., 489 U.S. 235 (1989). However, Ron Pair was specifically narrowed to a secured creditor, where the Court said post-petition interest was due because of the plain language of Section 506(b). Since the case involved a non-consensual oversecured creditor, Ron Pair really provides no guidance on unsecured claims in a Chapter 13.

Multiple appellate courts at the circuit level agree that unsecured claims do not get postpetition interest.

4th Cir: In the Fourth Circuit, “It is undisputed, based on § 502, that ECMC could file claims with the Debtors’ estates only for prepetition interest and principal and not for unmatured, postpetition interest.” In re Kielisch, 258 F. 3d 315, 321 (4th Cir 2001).

7th Cir: Turning to the Seventh Circuit: “The cases and § 502(b)(2), however, make it clear that interest stops accruing when the petition is filed.” In re Fesco Plastics Corp., Inc., 996 F. 2d 152, 156 (7th Cir 1993).

8th Cir: In the Eighth Circuit, “The general rule “disallowing” the payment of unmatured interest out of the assets of the bankruptcy estate is a rule of administrative convenience and fairness to all creditors. The rule makes it possible to calculate the amount of claims easily and assures that creditors at the bottom rungs of the priority ladder are not prejudiced by the delays inherent in liquidation and distribution of the estate.” In re Hanna, 872 F. 2d 829 (8th Cir 1989), finding that postpetition interest on nondischargable tax debt isn’t collectable against the estate, but is nondischargeable against the debtors.

9th Cir: Locally here in the Ninth Circuit, again, there is no justification for interest on the Code’s clear language.  “The Code, however, prohibits claims for postpetition interest on unsecured claims. 11 U.S.C. §§ 502(b)(2), 506(b).” In re Del Mission Ltd., 998 F. 2d 756, 757 (9th Cir, 1993).

But Interest on Non-Dischargable Debt is also Non-dischargeable

“The basic reasons for the rule denying post-petition interest as a claim against the bankruptcy estate are the avoidance of unfairness as between competing creditors and the avoidance of administrative inconvenience…Here, we find the reasons—and thus the rule—inapplicable, and we hold that post-petition interest on an unpaid tax debt not discharged by § 17 remains, after bankruptcy, a personal liability of the debtor.”  Bruning v. United States, 376 US 358, 362-363 (1964).

“Because we find no reason to limit the Bruning principle to nondischargeable tax debts, we conclude that postpetition interest on a nondischargeable student loan debt is nondischargeable under the Code. ” In re Pardee, 218 BR 916, 921 (9th Cir BAP 1998).

In the Ninth Circuit as well, interest continues to accrue postpetition on nondischargeable debts. In re Hamilton, 584 BR 310 (BAP 9th Cir 2019), affirmed by the Ninth Circuit (11/21/2019, 18-60026, 18-60027), citing In re Shoen, 176 F.3d 1150, 1166 (9th Cir. 1999) (per curiam).

In Hamilton, affirmed by the Ninth Circuit, the BAP cited the Supreme Court’s Bruning case, which dealt with nondischargable tax debt, and found the same rationale should apply to interest on a nondischargable judgment debt under § 523(a)(6). “In most situations, interest is considered to be the cost of the use of the amounts owing a creditor and an incentive to prompt repayment and, thus, an integral part of a continuing debt. Interest on a tax debt would seem to fit that description.” Hamilton, 584 BR at 322, citing Bruning, 376 U.S. at 360.

Also in the 9th Circuit, there’s no interest on mortgage arrearages. In re Laguna, 944 F.2d 542 (9th Cir, 1991), citing interplay between 1322(b) and 1325(a), and following the Fourth Circuit in Landmark Fin. Servs. v. Hall, 918 F.2d 1150 (4th Cir.1990).

 

Other Circuits

“Bruning, however, only addressed whether Bruning could be personally liable for postpetition interest that was not paid out of the estate; it did not address the propriety of applying estate payments to postpetition interest.”  In re Kielisch, 258 F. 3d 315, 322-323 (4th Cir 2001).

“Taken together, sections 502 and 523 simply demonstrate Congress’ intent to codify the general principle that applied under Bruning. Postpetition interest is disallowed against the bankruptcy estate under section 502. Priority tax claims remain nondischargeable for individual debtors… Thus, postpetition interest is nondischargeable, and the Hannas remain personally liable for that interest subsequent to bankruptcy proceedings.” In re Hanna, 872 F. 2d 829, 831 (8th Cir 1989)

Minority View: Give Me Your Interest

Against the many circuit courts who find interest stops accruing after the filing of a Chapter 13 petition, some courts have tried to find a way to get the credit cards paid by analogizing unsecured debt it to Till‘s risk analysis for secured debt, creating a best interest prong for it, or moving words around in the statute and pretending it has no effect.

“Best Interest of the Creditors Test” of 1325a4

6th Cir: There appears to be just one Circuit Court that has found the right to pay interest to unsecured creditors despite the Bankruptcy Code’s clear prohibition on it, and it seems, only in some situations. The Sixth Circuit Court of Appeals used the rationale of the “best interests of the creditors test” of Section 1325(a)(4).  “When liquidation will result in full payment of all allowed unsecured claims, a debtor cannot defer payment of the claims without providing interest payments to the creditors.” In re Hardy, 755 F. 2d 75 (6th Cir 1985).

In the almost-fifty years since Hardy was decided, it appears no other Circuit Court has chosen to follow it, though others in the 6th Circuit have followed it to allow interest on curing an arrearages. In re Colegrove, 771 F. 2d 119 (6th Cir 1985), where prevailing market rate is used with the contract rate being a ceiling. Id. at 123.

In the Sixth Circuit, one bankruptcy court, Harrington (EDMI 2019) sums it up by finding one court that says 1325(b)(1)(A) requires payment of interest. In re Barnes, 528 BR 501, 505-508 (SDGA, 2015). It then looked at another court that said 1325(b)(1)(A) cannot be interpreted to give interest to unsecureds. In re Eubanks, 581 BR 583, 591-593 (SDIL, 2018). It then chose Barnes. Let’s see the argument.

Effective Date of the Plan, Present Value, and 1325

A school of thought exists where courts, through twists and contortions, reach the opposite result by relying on Section 1325.  Some bankruptcy courts find that § 1325(b)(1)(A) requires interest to be paid in 100% dividend cases where debtors propose to devote less than all of their projected disposable income into the plan.  They look at Section 1325 and see:

“… as of the effective date of the plan— (A) the value of the property to be distributed under the plan on account of such claim is not less than the amount of such claim.”

Everything after subsection (A) seems to be clear and in favor of “no interest” paid by the debtor to unsecured debts. However, the preamble “as of the effective date of the plan” then is examined, and here’s where the parsing begins.

It starts with comparison and scrutiny to other parts of the Bankruptcy Code where the phrase “as of the effective date of the plan” is found. The other sections where this language is found typically deal with the present value analysis and the risk to creditor of being paid over time. 1129(a)(7) [impaired], 1129(a)(9)(C)(i) [tax debts], 1129(b)(2)(A)(i) [secured and liens], (B)(i), (C)(i); 1225(a)(4) [like 1325a4 liq value], 1225(a)(5)(B)(ii) [secured], 1325(a)(4) [liquidation value of secured], and 1325(a)(5)(B)(ii) [cramdown of secured].  Most if not all these other sections deal not with unsecured nonpriority debt, but secured, tax, or refer to liquidation value of assets.

Also, in these other sections, the phrase “the value” comes before the phrase “of the effective date of the plan.”  For example, the courts compare Section 1325(b)(1)(A)’s “as of the effective date of the plan — the value…” to 1325(a)(5)(B)(ii) language of “the value, as of the effective date of the plan…”  If Congress had intended (b)(1)(A) of Section 1325 to mean the exact same thing as (a)(5)(B)(ii) of the exact same section, it would have used it. In fact, it used the same phrasing and word order in nine (9) other places in the Bankruptcy Code (supra). It could have made it a perfect 10, but Congress intentionally changed the phrasing and word order.

One anomaly by reading these different phrases as meaning the same thing and ignoring § 502 is that it provides interest to nonpriority unsecured creditors while priority unsecured debts are not entitled to interest. In re Stewart-Harrel, 443 BR 219, 223-224 (Bkrtcy Ct, ND Georgia 2011). Clearly Congress could not have intended to place credit card debt higher than tax debt, but this is explained away as “accretions that have grown up on the Bankruptcy Code since 1978” like “barnacles on the bottom of a boat.” In re Hight-Goodspeed, 486 BR 462, 465 (Bkrtcy Ct, ND Indiana 2012).

Another argument is that by reading “present value” meaning into both (b)(1)(A) and (b)(1)(B) — subsections that are separated by the alternative “or” — is that it would make (b)(1)(A) — or the other — unnecessary.  Congress intended a Debtor to be able to satisfy (b)(1)(B) without any examination of (b)(1)(A), and by requiring it, courts change an “or” to an “and.” Accretions over time and barnacles, indeed.

Finally, interest is specifically provided for in Chapter 7 asset cases, but not in Chapter 13 cases without verbal gymnastics. “Section 726(a)(5) of the Code, which governs the distribution of property of the estate in a Chapter 7 case, provides for the payment of interest at the legal rate on any claim, including unsecured claims, before a distribution of property can be made to a debtor. 11 U.S.C. § 726(a)(5). No similar provision exists with respect to Chapter 13 cases. If Congress intended for unsecured creditors to receive interest on their claims in a Chapter 13 case, it could have so expressly legislated, but did not.” In re Ross, 375 BR 437, 444 (ND Illinois 2007)

Also,  “[t]here is no similar provision [to 726] in Chapter 13 or in Chapter 11. Instead, the requirement for the payment of interest is subsumed within the best interests of creditors test. The Court believes that is where it belongs and not as an additional element of confirmation under Section 1325(b)(1).” In re Stewart-Harrel, 443 BR 219 (ND Georgia 2011).

In short

At least one court noted that “[a]lthough § 1325(b) has been part of the Bankruptcy Code for almost 30 years, and thousands of decisions address disposable income and the required plan term, there has been surprisingly little litigation over the value of the distribution to unsecured creditors.” In re Hight-Goodspeed at 463.

This is probably because the law is so clear that of course it’s not allowed. However, some courts have twisted themselves into pretzels to create a creditor right to postpetition unmatured interest. It’s hoped that the Supreme Court will rule on the split on the Circuit Courts, pull the 6th Circuit back into line with the rest of the circuits, and make it clear that, yes, Section 502(b)(2) means exactly what it says.