Chemical Bank v. First Trust

• Court: Court of Appeals for the Eleventh Circuit
• Decided: September 28, 1998
• Docket: 97-4436
• Status: Published

Opinion

PUBLISH

IN THE UNITED STATES COURT OF APPEALS FILED FOR THE ELEVENTH CIRCUIT U.S. COURT OF APPEALS _______________ ELEVENTH CIRCUIT 07/01/99 No. 97-4436 THOMAS K. KAHN CLERK _______________

D. C. Docket No. 95-2045-CIV-FAM

In re: SOUTHEAST BANKING CORPORATION,

Debtor.

CHEMICAL BANK, as Indenture Trustee under the Indenture, stated as of March 1, 1983, of Southeast Banking Corporation, and GABRIEL CAPITAL, L.P.,

Plaintiffs-Appellants,

versus

FIRST TRUST OF NEW YORK, NATIONAL ASSOCIATION, as Indenture Trustee, THE BANK OF NEW YORK, as Indenture Trustee, and SOUTHEAST BANKING CORPORATION, Debtor,

Defendants-Appellees.

______________________________

Appeal from the United States District Court for the Southern District of Florida ______________________________

(July 1, 1999)

Before EDMONDSON and BIRCH, Circuit Judges and FAY, Senior Circuit Judge.

BIRCH, Circuit Judge: We summarize briefly the facts surrounding this bankruptcy proceeding.1

Southeast Banking Corporation (“Southeast”) filed a voluntary bankruptcy petition

pursuant to Chapter 7 of the Bankruptcy Code on September 20, 1991. Appellant,

The Chase Manhattan Bank (“Chase”), formerly Chemical Bank, is the indenture

trustee (the “Senior Trustee”) under an indenture agreement, pursuant to which

Southeast issued $60 million in principal amount of unsecured notes (the “Senior

Notes”). Appellant, Gabriel Capital, L.P. (“Gabriel”) holds a substantial portion of

the Senior Notes. Appellees, First Trust of New York, N.A. and The Bank of New

York (collectively the “Junior Trustees”) are indenture trustees under five

indentures (the “Subordinated Indentures”) pursuant to which Southeast issued in

excess of $300 million in principal amount of subordinated notes (“the

Subordinated Notes”). Each of the Subordinated Indentures contains language that

subordinates collection of the Subordinated Notes to the prior payment in full on

the Senior Notes. The Subordinated Indentures make no specific mention of the

issue of post-petition interest or of the Senior Trustee's fees and costs for collecting

post-petition interest.

1 A more extensive discussion of the procedural and factual history of this case can be found in our prior panel opinion, In re Southeast Banking Corp., 156 F.3d 1114 (11th Cir. 1998) (“Southeast I”).

2 The bankruptcy court, see In re Southeast, 188 B.R. 452 (Bankr. S.D. Fla.

1995), denied the Senior Creditors' (Chase and Gabriel) motion for summary

judgment for (1) post-petition interest, (2) reasonable costs and fees, including

attorneys' fees, incurred after the petition date, and (3) for compound interest

(interest upon the post-petition interest). Payment of all claims would have come

out of distributions otherwise payable to holders of the Subordinated Debt (the

“Junior Creditors”). The district court affirmed. See In re Southeast, 212 B.R. 682

(S.D. Fla. 1997). Both the bankruptcy court and the district court based their

holdings on the doctrine of the “Rule of Explicitness,” which, effectively, prevents

a senior creditor from recovering post-petition interest from junior creditors unless

the subordination agreement articulates the obligation in unusually express

language.

In reviewing the opinion of the district court, we determined that section

510(a) of the Bankruptcy Code, directing that subordination agreements should be

enforced according to applicable nonbankruptcy law, “required us to enforce and

interpret the subordination clause in the Subordinated Indentures under New York

law.” Southeast I, 156 F.3d at 1125. After ascertaining that New York courts had

not had the opportunity to determine what kind of language would be necessary to

put a junior creditor on notice regarding the risk of subordinating a debt to senior

3 creditors' claims for post-petition interest and post-petition fees and costs, we

certified the following question to the State of New York Court of Appeals.

What, if any, language does New York law require in a subordination agreement to alert a junior creditor to its assumption of the risk and burden of the senior creditor's post-petition interest?

Id.

After reviewing the facts of the case and our prior panel opinion, the State of

New York Court of Appeals has answered the question as follows:

For the purposes of answering the particular question posed to us, we are confined by key features of the Eleventh Circuit's ruling. Nevertheless, we face up to whether New York should adopt its version of the Rule of Explicitness as a guiding interpretive principle of State contract dispute resolution in cases such as this. In doing so, we are acutely cognizant of the practical effect that our answer to the certified question will have on a vast sea of subordination agreements not before us now in live cases or controversies, nor even within the framework of this Eleventh Circuit litigation, involving enormous sums of outstanding public debt. Indeed, while it is not our forum's role to rule ultimately on the subordination agreements at issue in this case, we recognize that they and many others were drafted and entered into before the Rule of Explicitness was called into question by the ruling of the Eleventh Circuit in the instant case. This practical policy consequence is a matter of legitimate concern in the common law developmental process, especially with respect to commercial matters where reliance, definiteness and predictability are such important goals of the law itself, designed so that parties may intelligently negotiate and order their rights and duties. Parties to subordination agreements undoubtedly relied on the Rule – their lawyers would have been quite remiss had they not – since recent case law, as well as a leading authority and many commentators have consistently recognized the continued vitality of the Rule [citations omitted].

4 In addition to practical realities, however, we are persuaded that the commercial and legal policies underlying the Rule of Explicitness remain sound and relevant. The general rule in bankruptcy is that interest stops accruing against a debtor upon the date of filing of a petition (see, Vanston Bondholders Protective Comm. v Green, 329 US 156, 163; 11 USC § 502[b][2]). This rule recognizes that post- petition delay in distribution by a debtor “results by operation of law and prevents creditors from profiting or suffering a loss in relation to each other because of the delay” (Chemical Bank v First Trust, N.A. [In re Southeast Banking Corp.], 156 F3d 1114, 1119, citing Vanston Bondholders Protective Comm. v Green, 329 US 156, supra). The Rule of Explicitness evolved as an equitable principle of contract construction in Federal common law to rectify the perceived inequity that results when, pursuant to a subordination agreement, a junior creditor's potential distributions go first to satisfy post-petition interest of a senior creditor (Chemical Bank v First Trust, N.A. [In re Southeast Banking Corp.], 212 Bankr 682 [S.D.Fla. 1995]). If a senior creditor is allowed to recover post-petition interest from a subordinated creditor, a senior creditor could end up receiving more recovery than it would have been entitled to against the debtor, while the subordinated creditor's recovery is proportionately diminished (4 Collier on Bankruptcy § 510.03[3], supra). Because this consequence violates the general rule against entitlement to post-petition interest, courts until now have consistently required that the language of the instrument make absolutely clear that a subordinated creditor intended also to subordinate post-petition interest entitlements (see, In re King Resources Co., 528 F2d 789, supra; In re Kingsboro Mtge. Corp., 514 F2d 400, supra; In re Times Sales Fin. Corp., 491 F2d 841, supra; In re Ionosphere Clubs, 134 Bankr 528, supra). The 1978 revisions to the Bankruptcy Code did not change the general rule that creditors are not entitled to post-petition interest. Thus, considerations underlying the Rule of Explicitness survive. Indeed, they echo the policies underlying Matter of Pavone Textile Corp. v Bloom (302 NY 206, affd 342 US 912). Pavone provides an analytical counterpart and precedential building block for our recognition of the applicability of the Rule of Explicitness to the instant controversy. In Pavone, the assignor made a general assignment for the benefit of creditors pursuant to article 2

5 of the Debtor and Creditor Law. This Court noted the general rule that creditors are not entitled to post-assignment interest because the “

6 a junior creditor to its assumption of the risk and burden of allowing the payment of a senior creditor's post-petition interest demand.

In the Matter of Southeast Banking Corp., (emphasis added).

Based on the New York Court of Appeals' opinion in this case, New York

law applies the Rule of Explicitness to subordination agreements. We return,

therefore, to our prior panel's determination that

we find it beyond question that the subordination language in the indenture agreements in this case, which requires “payment in full” without any specific reference to post-petition interest, is insufficiently “precise, explicit and unambiguous” on the topic of post-petition interest to satisfy the Rule of Explicitness.

Southeast I, 156 F.3d at 1120

As a result, we conclude that the district court was correct in the portion of

its opinion affirming the bankruptcy court's holding that Chase and Gabriel may

not claim post-petition interest or reasonable costs or fees for prosecuting this

action because the right to post-petition interest, fees, or costs is not “clearly,

explicitly, precisely, and unambiguously provided for in the indentures.” 212 B.R.

at 689.2 Because appellants have not succeeded in their claim for post-petition

2 To further clarify our decision, we note that the district court opinion was incorrect in concluding that under bankruptcy law, the Rule of Explicitness survives the enactment of section 510(a) of the Bankruptcy Code. Rather, we must look to the “applicable nonbankruptcy” law to determine the extent to which a subordination agreement is enforceable. In this case, we determined that the applicable nonbankruptcy law is the law of New York. See Southeast I, 156 F.3d at 1121. We apply the Rule of Explicitness here because New York law, not the Bankruptcy Code, requires us to do so. We affirm, therefore, the final result reached by the

7 interest, we need not address whether the recent changes in New York law would

require enforcement of contracts for compound interest.

AFFIRMED.

district court, but we maintain our previous rejection of the reasoning of the district court to reach that result.

8 FAY, Senior Circuit Judge, concurring specially:

I concur in the result finally reached in this matter, which is an affirmance of the rulings

made by the bankruptcy court and the district court. I continue to dissent from the abolishment of

the "Rule of Explicitness" announced by the majority in Southeast I, 156 F.3d 1114 (11th Cir.

1998) for the reasons stated. My dissent is reinforced by the opinion of the State of New York

Court of Appeals, which states:

The 1978 revisions to the Bankruptcy Code did not change the general rule that

creditors are not entitled to post-petition interest. Thus, considerations underlying

the Rule of Explicitness survive. Indeed, they echo the policies underlying Matter

of Pavone Textile Corp. v. Bloom (302 N.Y. 206, affd 342 U.S. 912).

In re Matter of Southeast Banking Corp., (N.Y. 1999).

The Rule of Explicitness is a sound, long-established rule and Congress has not explicitly

eliminated it. The Rule has been relied upon by those in the financial world. It's abolishment can

have enormous consequences. I, therefore, most respectfully, urge the en banc court to consider

this issue when appropriate.1

1 Since the Appellees-Trustees have prevailed in this matter, I recognize the difficulty of a prevailing party petitioning for en banc consideration.