Virtually all of the claims being treated in a Chapter 11 plan are based on underlying agreements that call for debtor to pay some form of interest to the creditor. For example, take ordinary Joe Debtor. He may have the following claims:

Unsecured:   A).  Credit card agreements charging 22 to 30% interest   B).  Default judgment against him bearing simple interest at 10% per annum   C).  $ 7500 owed to his beloved Aunt Iphigenia bearing interest at 5% per annum   Secured:   A).  $ 180,000 home mortgage loan at 6%;   B).  $ 16k car loan at 8.75% on the 2009 Debtor family minivan   C).  $ 10k at 11% interest on the debtor's 4-year- old Bayliner boat and trailer, with the collateral being worth only $ 6k and thus "underwater".   Taxes:   A).  Delinquent real property taxes on the Debtor homestead, at 18% interest/yr.   B).  Income taxes with interest at the applicable IRS federal rate

Solvent Debtors

      If Joe Debtor is solvent and his assets exceed his liabilities, then all of his creditors would receive interest. This would be a very unusual case.

Insolvent Debtors

If, however, Joe Debtor is like the normal Chapter 11 debtor, his assets are well exceeded by his liabilities, meaning that he is insolvent. In this case, very few of his creditors are going to be entitled to interest under a Chapter 11 plan. The likely result would be:

Unsecured Nonpriority Claims   A).  The credit cards will receive no interest and a fraction of the principal.   B).  The judgment creditor will receive no interest and a fraction of the principal.   C).  Beloved Aunt Iphigenia will receive no interest and a fraction of the principal.   Secured Claims   A).  The home mortgage will receive interest at the note rate, unless it agrees to less favorable treatment.   B).  The car loan will need to be paid in full and receive the note rate of interest, 8.75%, since it is less than 910 days old.   C).  The boat claim is subject to "cramdown", since the debt exceeds the value. The boat claim is a secured claim up to $6k, the value of the boat, and unsecured as to the $4k balance. The $4k portion would receive the same treatment as the credit cards and Aunt Iphigenia. Only the $6k secured portion would be entitled to interest. It would not necessarily be the 11% note rate. The court is authorized to set a new interest rate which is based on the national prime rate that a bank would charge a creditworthy commercial borrower, and then adjust that rate for the circumstances of the individual case, such as credit risk, the type of collateral, and the duration and feasibility of the proposed plan. In many cases, this comes out to prime + 1 or 2%.   Taxes   A).  The income taxes will receive interest if they are "priority" in nature (generally, less than 3 years old), but no interest otherwise.   B).  The property taxes will bear interest at the statutory rate, according to most courts. In practice, this often prompts the mortgage lender to advance money to cure the tax arrears, and then add the advance to the principal of the loan.

Summary of Interest on Claims

      By way of general summary, then: interest must be paid on pre-bankruptcy secured claims if the claim is "fully-secured", i.e., the collateral is worth more than the amount of the claim. If not fully-secured, then interest is payable only on the secured portion, and the court can modify the interest rate via a "cram-down". Generally, no interest is payable on pre-bankruptcy unsecured nonpriority claims. Priority tax claims will generally be paid interest at the statutory rate, as will real property tax claims. No interest is payable on unsecured nonpriority tax claims (generally, taxes which are more than 3 years old).

Written by Henry Rendler