Opinion ID: 472139
Heading Depth: 2
Heading Rank: 2

Heading: The Missing Provisions--Necessity and Invention.

Text: 96 Those courts that have adopted the American Mariner approach and required postpetition interest payments to an undersecured creditor on the value of its collateral have been faced with numerous questions for which the Code provides no guidance. 97 Because the only support in the statute for the payment of interest, the phrase indubitable equivalent, does not even use the word interest, and because some courts are understandably reluctant to speak in terms of interest in light of Secs. 502, 506, which clearly preclude an undersecured creditor from receiving postpetition interest as part of its claim, many courts have latched onto the concept of compensating for lost opportunity through the adequate protection provisions. See supra note 1. Lost opportunity costs are said to be those amounts that an undersecured creditor would have earned if it had been permitted to foreclose on its collateral upon default, sell the collateral, and re-invest the proceeds, which the stay prevents. A formula for adequate protection is thus created, using at its base a hypothetical foreclosure and sale of actual collateral, and a hypothetical re-investment of the proceeds. The problem that courts have struggled with is that the Code provides no instructions on how to fill in the blanks in the formula, namely (1) whether to compensate for lost opportunity costs from the date of the petition, the date of the motion for relief from the stay, or the date of a ruling on the motion; (2) whether to take into account the practicalities of delay in the state foreclosure process and delay in selling the property in order to realize something more favorable than a forced-sale price, during which a creditor would not be able to invest proceeds from its collateral; (3) whether to apply to the hypothetically re-invested proceeds of sale the contract rate of interest, or the current market rate, and, in that case, the long-term or short-term market rate; and (4) whether to apply lost opportunity cost payments that are actually made to the principal amount of the debt. Necessity being the mother of invention, courts have invented answers. Not surprisingly, the answers have varied markedly. 98 The bankruptcy court in the instant case ordered that postpetition interest payments begin six months after the petition was filed, because the court found that there would be a six-month delay in realizing proceeds from a foreclosure and orderly sale of the property. 49 B.R. at 458. See also American Mariner, 734 F.2d at 435 n. 12 (the timing of adequate protection should take account of the usual time and expense involved in repossession and sale of collateral). But in Grundy National Bank, 754 F.2d at 1441, the Fourth Circuit held that interest should not begin until the filing of a motion for relief from the stay, rather than the date that the petition was filed, and [e]ven then the timing of interest should be postponed to take account of the time that would be subsumed in repossession and sale of the collateral. 42 The Code is silent on the issue. 99 The bankruptcy court in this case did not advert to the fact that the bankruptcy petition was filed on the eve of foreclosure, so that a portion of the six-month period had already elapsed. The court did acknowledge, and indeed recognized as a flaw, the fact that if the stay lifts at the end of the six-month period, the creditor will have to endure for a second time the six-month delay incident to foreclosure and sale, and is thus not actually compensated for lost opportunity. 49 B.R. at 458 n. 9. In effect, under this rule, the length of time that a debtor would have before adequate protection interest payments would commence would depend in part on foreclosure procedures in the forum state and in part on how long it would take the creditor to market the property in an orderly (non-forced sale) way, if the evidence establishes that the creditor would in fact market the collateral in that way. Nevertheless, the court determined that the rule, although flawed, is reasonable, because, in part, delay would further the Congressional objective to promote reorganization. Id. In so doing, the court made explicit what has perhaps been implicit in the decisions of numerous other courts engaged in determining when adequate protection interest payments should commence: the reorganization process will be aborted in a fashion inconsistent with the congressional objective of Chapter 11 to promote reorganization, if adequate protection interest payments commence immediately after the imposition of the stay, which is when opportunity costs begin to be incurred. These courts, in effect, compromise what are perceived to be conflicting requirements of the Code. By qualifying the creditor's right to postpetition interest in various fashions, they are able to further the congressional goal of promoting reorganization. But there is something anomalous about applying in a free-floating manner, with markedly varying results, a rule that depends for its very existence on the rule in Murel Holding, which itself is absolutely rigid in its application, regardless of the consequences. 100 Courts have also struggled to set an appropriate rate of interest for the hypothetically re-invested proceeds. American Mariner fixed the rate at the lower of the market rate and the contract rate. 734 F.2d at 435 n. 12. Although perhaps fairer, this qualification makes little logical sense if Sec. 361 was intended to fully protect a creditor's opportunity costs; the rate should always be the market rate, which will rarely be the same as the contract rate, because the hypothetically foreclosing creditor could rarely re-invest the proceeds at the contract rate. The court in In re Victory Construction Co., 9 B.R. 570, 574 (Bankr.C.D.Cal.1981), found a rate of 18% to be appropriate without discussion, in a case where the contract rate was 8%. The bankruptcy court in the instant case determined 12% was the applicable rate ... at the time that the creditor could expect to receive the foreclosure proceeds for reinvestment, six months after the petition was filed, and assume[d] stable interest rates absent contrary evidence. 49 B.R. at 458. There seems to be little discussion of whether the rates awarded are for long- or short-term investments. Presumably the bankruptcy court would be obligated to take evidence on the normal investment practices of the creditor seeking relief, as well as the likelihood that interest rates might change if that creditor normally placed its funds in short-term investments, despite the summary nature of automatic stay litigation and the need for speed. Again, the Code offers no advice on the issue. 101 Another difficult question is how to treat opportunity cost payments in the event of a successful reorganization. Courts addressing the issue seem to be uncertain about what to do with American Mariner interest. See generally Fortgang & Mayer, Valuation in Bankruptcy, 32 U.C.L.A.L.Rev. 1061, 1088-90 (1985). The court in In re Alexander, 48 B.R. 110 (Bankr.W.D.Mo.1985), stated that American Mariner interest is wholly separate from contract interest and speculated that it may or may not go to reduce the other forms of interest which are meantime building. Id. at 119 n. 18. 43 102 Finally, courts awarding opportunity cost payments will ultimately be forced to invent a refund procedure if a debtor is able to cure past defaults under Sec. 1124(2). See Fortgang & Mayer, supra, 32 U.C.L.A.L.Rev. at 1089-90. That section allows a debtor upon proposal of a plan to cure defaults and reinstate the original terms of the loan, including the interest rate. In that event, the creditor is unimpaired and may not vote on the plan. If postpetition interest payments were ordered at a market rate higher than the contract rate, then a debtor who subsequently is able to unimpair the creditor under Sec. 1124(2) presumably would be entitled to a refund of excess interest paid when the terms of the original loan are reinstated. No refund provision appears in the Code. Aside from the administrative inconvenience of such a course, the need to invent a procedure is proof that Congress never contemplated opportunity cost as adequate protection in light of Sec. 1124(2). In re South Village, Inc., 25 B.R. at 998; see In re Manville Forest Products Corp., 43 B.R. 293, 301-02 & n. 7 (Bankr.S.D.N.Y.1984) (Sec. 1124(2) cannot be reconciled with postpetition interest payments in the guise of adequate protection payments). 44 103 In In re Victory Construction Co., 42 B.R. 145, 155-56 (Bankr.C.D.Cal.1984), the court directly faced the issue of how to treat American Mariner payments when a debtor cured past defaults under Sec. 1124(2) and a plan was confirmed. The debtor had been making interim adequate protection payments at the market rate of 18% of the value of the collateral in return for the stay. The contract rate was 8%. The court recognized that one's first thought would be to give to the debtor, and thereby other creditors, the benefit of any excess over the contract rate if a debtor is able to reinstate the original note. The court, however, had a second thought: 104 But I do not think that any principle compels this result. From the start, the payment was something other than compensation under the contract. Judge Ordin in Victory II expressly recognized that he was ordering a (supposed) market, rather than the contract, rate. The debtor has paid it on that basis--and with the recognition that he might never recover any of it at all. [The] debtor may have credit against his adequate protection payments for interest at the contract rate on his ongoing contract obligation, but ... the creditor may retain the balance. 105 Id. at 156 (emphasis added). In other words, the creditor received a temporary revision of its loan agreement to provide the higher market interest rate, simply because the debtor was in a reorganization proceeding. When the debtor cured past defaults and reinstated the original note, the creditor received precisely what it had bargained for. The balance that the court referred to clearly came from unencumbered assets that could have paid other creditors part of their principal. Although it is said that the purpose of the bankruptcy laws is not to rewrite deals for creditors to improve their investments, the Victory Construction ruling certainly had that effect. 106