Opinion ID: 472139
Heading Depth: 2
Heading Rank: 1

Heading: The Allowed Secured Claim and Interest--Secs. 502 and 506.

Text: 16 After a debtor files a bankruptcy petition, a creditor may file a proof of claim against the estate in the amount that it asserts is owed to it by the debtor. The claim is deemed to be allowed if no party in interest objects, Sec. 502(a), or if the court after notice and a hearing allows the claim, in the amount owing as of the date that the petition was filed, Sec. 502(b). An allowed claim of a creditor secured by a lien on property of the debtor is an allowed secured claim to the extent of the value of that creditor's interest in the property, and is an unsecured claim to the extent that the amount of the allowed secured claim is less than the amount of the allowed claim. Sec. 506(a). The value of the collateral is determined in light of the purpose of the valuation and of the proposed disposition or use of the collateral. Sec. 506(a). A creditor with an allowed secured claim may receive, upon termination of the proceeding or at such earlier time as may be allowed by the court, either the collateral or the value of the collateral up to the amount of the allowed secured claim. See Secs. 506(a), 726(a), 1129. To the extent that an allowed claim is unsecured by a lien on property of the estate, the creditor's allowed claim may be paid out of unencumbered assets of the estate in accordance with the priority schedule set forth in Sec. 507(a). In summary, therefore, an undersecured creditor in effect wears two hats because it has two types of claims at the conclusion of a proceeding: an allowed secured claim in an amount equal to the value of its collateral, and an unsecured claim for any deficiency, which is treated as is any other unsecured claim. 4 17 As a general rule, creditors are not allowed a claim for interest accruing on their debts during bankruptcy proceedings. Since the middle of the 18th century, bankruptcy law has provided that interest on debts does not accrue after a bankruptcy petition is filed. Sexton v. Dreyfus, 219 U.S. 339, 344, 31 S.Ct. 256, 257, 55 L.Ed. 244 (1911) (For more than a century and a half the theory of the English bankrupt system has been that everything stops at a certain date. Interest was not computed beyond the date of the commission.). The rule developed not because of the words of the statute, but as a fundamental principle of equity. Id. The reason for the rule as it developed was as follows: 18 Exaction of interest, where the power of a debtor to pay even his contractual obligations is suspended by law, has been prohibited because it was considered in the nature of a penalty imposed because of delay in prompt payment--a delay necessitated by law if the courts are properly to preserve and protect the estate for the benefit of all interests involved.... [T]he delay in distribution is the act of the law; it is a necessary incident to the settlement of the estate. 19 Vanston Bondholders Protection Committee v. Green, 329 U.S. 156, 163, 67 S.Ct. 237, 240, 91 L.Ed. 162 (1946) (quoting Thomas v. Western Car Co., 149 U.S. 95, 116-17, 13 S.Ct. 824, 833, 37 L.Ed. 663 (1893)). In other words, allowing the accrual of postpetition interest in favor of one creditor would be inequitable to other creditors. Vanston, 329 U.S. at 164, 67 S.Ct. at 240; cf. Ticonic National Bank v. Sprague, 303 U.S. 406, 411, 58 S.Ct. 612, 614, 82 L.Ed. 926 (1938) (It is in order to assure equality among creditors as of the date of insolvency that interest accruing thereafter is not considered.). Justice Stewart reiterated this rationale in Nicholas v. United States, 384 U.S. 678, 86 S.Ct. 1674, 16 L.Ed.2d 853 (1966): 20 We believe that the decisions of this Court in Sexton and [New York v.] Saper [, 336 U.S. 328, 69 S.Ct. 554, 93 L.Ed. 710 (1949),] reflect the broad equitable principle that creditors should not be disadvantaged vis-a-vis one another by legal delays attributable solely to the time-consuming procedures inherent in the administration of the bankruptcy laws. In the context of interest-bearing debts, the equitable principle enunciated in Sexton and Saper rests at bottom on an awareness of the inequity that would result if, through the continuing accumulation of interest in the course of subsequent bankruptcy proceedings, obligations bearing relatively high rates of interest were permitted to absorb the assets of a bankruptcy estate whose funds were already inadequate to pay the principal of the debts owed by the estate. 21 384 U.S. at 683-84, 86 S.Ct. at 1679. 22 The rule barring accrual of postpetition interest on secured debt did not apply in certain situations where the reason for the rule was itself inapplicable. First, an oversecured creditor was entitled, depending on the equities of the situation, to claim postpetition interest, but only to the extent that the principal of the debt plus accrued interest did not exceed the value of the collateral securing the debt and the interest. 5 Vanston, 329 U.S. at 164-65, 67 S.Ct. at 240-41; Sexton, 219 U.S. at 346, 31 S.Ct. at 258; Coder v. Arts, 152 F. 943, 950 (8th Cir.1907), aff'd, 213 U.S. 223, 29 S.Ct. 436, 53 L.Ed. 772 (1909). Further, secured creditors (and unsecured creditors, as well) might be entitled to postpetition interest if the debtor's estate ultimately proved to be solvent. American Iron & Steel Mfg. Co. v. Seaboard Airline Railway Co., 233 U.S. 261, 266, 34 S.Ct. 502, 504, 58 L.Ed. 949 (1914) (if as a result of good fortune or good management, the estate proved sufficient to discharge the claims in full, interest as well as principal should be paid). 6 23 This rule regarding accrual of postpetition interest arose when the bankruptcy laws did not provide for reorganization and consisted only of a mechanism to liquidate an estate equitably. See American Iron and Steel Mfg. Co., 233 U.S. at 266, 34 S.Ct. at 504. Nevertheless, as the bankruptcy laws developed to provide for reorganizations, the rule was extended to Chapter XI of the Bankruptcy Act of 1898 (Act) arrangement proceedings so that the accumulation of interest must be suspended as of the date the Chapter XI petition was filed, Nicholas, 384 U.S. at 686, 86 S.Ct. at 1681, and to corporate reorganization proceedings under Chapter X of the Act, id. at 686 n. 14, 86 S.Ct. at 1681 n. 14. 7 24 The Code expressly continued these prevailing rules. 8 Under Sec. 502(b)(2), a claim against an estate will not be allowed to the extent that such claim is for unmatured interest as of the date of the filing of the petition. Section 506(b) continues the pre-Code rule applicable to the oversecured creditor: 25 (b) To the extent that an allowed secured claim is secured by property the value of which, after any recovery under subsection (c) of this section, is greater than the amount of such claim, there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement under which such claim arose. 9 26 The Code continues to treat oversecured and undersecured creditors differently as to their entitlement to a claim for postpetition interest at the end of a reorganization proceeding. 27 In summary, the interest provisions of the Code and its predecessors, as interpreted by the Supreme Court for almost a century, are premised on the equitable principle that the unencumbered assets of a debtor's estate will not be used to benefit one class of creditors at the expense of another class. Such would be the case if unencumbered assets, otherwise available for the payment of unsecured claims, were used to pay postpetition interest on undersecured debt. Allowing a claim for postpetition interest by an oversecured creditor, on the other hand, is not inconsistent with that equitable principle, because only assets encumbered by the creditor's lien will be used to fund the payment of postpetition accrued interest. 28