Rupp v. United States (In Re Rocky Mountain Refractories)

208 B.R. 709, 14 Colo. Bankr. Ct. Rep. 172, 38 Collier Bankr. Cas. 2d 150, 1997 Bankr. LEXIS 766, 79 A.F.T.R.2d (RIA) 3055, 1997 WL 287038

• Court: Bankruptcy Appellate Panel of the Tenth Circuit
• Decided: May 30, 1997
• Docket: BAP No. UT-96-040, Bankruptcy No. 94-21665
• Status: Published

Opinions

OPINION

ROBINSON, Bankruptcy Judge.

Stephen W. Rupp, trustee of the Chapter 7 bankruptcy estate of Rocky Mountain Refractories, appeals the judgment of the United States Bankruptcy Court for the District of Utah finding that the interest incurred during the Chapter 11 case on the administrative expense claims must be paid at the same priority as the underlying administrative expense claims after the Chapter 11 case is converted to a case under Chapter 7. See In re Rocky Mountain Refractories, 205 B.R. 307 (Bankr.D.Utah 1996). We affirm the Bankruptcy Court’s judgment.

Neither party disputes the Bankruptcy Court’s findings of fact. Therefore, this Court must review the Bankruptcy Court’s statutory interpretation of the priority provisions of the Bankruptcy Code. The Bankruptcy Court’s legal determinations are subject to de novo review. Pierce v. Underwood, 487 U.S. 552, 558, 108 S.Ct. 2541, 2546, 101 L.Ed.2d 490 (1988).

PACTS

Rocky Mountain Refractories (“Debtor”) filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code on April 4,1994. After the Debtor incurred in excess of $350,000 in unpaid administrative claims, the Bankruptcy Court converted the Chapter 11 case to a Chapter 7 case on September 29, 1995. Stephen W. Rupp was appointed as the Chapter 7 trustee (“Trustee”). Pursuant to the Trustee’s request, the Bankruptcy Court fixed May 1, 1996 as the bar date to file requests for payment of administrative expense claims.

The following governmental entities filed proofs of claim against the Debtor’s estate, which the Bankruptcy Court deemed to be requests for payment of administrative expense claims pursuant to 11 U.S.C. § 503(a):¹

Claimant Claim No. Date Filed Tax & Penalties Interest

Salt Lake County Assessor 65 9/14/95 $ 2,596.10 $ 305.00

Internal Revenue Service 68 1/10/96 $71,692.86 $8,362.50

Utah State Tax Commission 106 4/29/96 $29,030.84 $1,430.43

Utah Dept. Empl. Security 111 5/30/96 $ 8,032.03 $ 929.29

On February 6, 1996, Jerry W. Brailsford, a trade creditor of the Debtor, filed a proof of claim which was designated as claim number 88. On its face, the trade claim seeks payment of $17,504.38 as an unsecured nonpriority claim for goods sold during 1994 and 1995. The documents attached to the trade claim demonstrate that it is for goods sold to the Debtor prior to and during the Debtor’s Chapter 11 case, plus interest on unpaid amounts for goods sold to the Debtor during the Debtor’s Chapter 11 ease. At a hearing held on July 29, 1996, the Bankruptcy Court reclassified the trade claim into pre- and postpetition claims. The stipulated amount of interest on the postpetition portion of the claim is $1,062.88.

The Bankruptcy Court held that the interest incurred during the Chapter 11 case on these administrative expense claims is allowable, but that such interest stopped accruing when the ease was converted to a case under Chapter 7, and that the interest incurred during the Chapter 11 case must be paid at the same priority as the underlying administrative expense claims.

DISCUSSION

The Trustee does not dispute the Bankruptcy Court’s finding that interest incurred during the Chapter 11 case on the administrative expense claims in issue is allowable. Although the appellees discuss at great length whether § 503(b) is ambiguous regarding the allowance of interest, the Trustee is not challenging the allowance of interest on Chapter 11 administrative expenses, but frames the issue as “whether the bankruptcy court erred in concluding that, in a Chapter 7 case, interest on administrative expense claims is payable as a first priority claim notwithstanding the unambiguous language of § 726(a)(5).” The Trustee notes that in his objection to the claims filed by the taxing entities he stated that “the tax and related penalty asserted by each of the taxing entities should be allowed as a Chapter 11 priority administrative expense and that interest on such claims should be subordinated pursuant to Bankruptcy Code section 726(a)(5).” Thus, we will not address whether § 503(b) provides for the allowance of interest as an administrative expense.² Rather, the issue on appeal is whether interest that accrues on administrative expenses must be subordinated in priority pursuant to § 726(a)(5).

The Bankruptcy Court held that Nicholas v. United States, 384 U.S. 678, 86 S.Ct. 1674, 16 L.Ed.2d 853 (1966), dictates that interest on the Chapter 11 administrative expense claims should be paid at the same priority as the underlying administrative expense claims; and that this finding is in accord with all of the decisions of the United States Courts of Appeals which have addressed this issue. See Varsity Carpet Servs., Inc. v. Richardson (In re Colortex Indus., Inc.), 19 F.3d 1371 (11th Cir.1994); United States v. Flo-Lizer, Inc. (In re Flo-Lizer, Inc.), 916 F.2d 363 (6th Cir.1990); United States v. Ledlin (In re Mark Anthony Constr., Inc.), 886 F.2d 1101 (9th Cir.1989); United States v. Cranshaw (In re Allied Mechanical Servs., Inc.), 885 F.2d 837 (11th Cir.1989); United States v. Friendship College, Inc. (In re Friendship College, Inc.), 737 F.2d 430 (4th Cir.1984); see also Towers v. United States (In re Pacific-Atlantic Trading Co.), 64 F.3d 1292, 1298 (9th Cir.1995); United States v. Boatmen’s First Nat’l Bank, 5 F.3d 1157, 1160 (8th Cir.1993). The decisions by the Court of Appeals have been cited with approval by the Tenth Circuit in Small Business Admin. v. Preferred Door Co. (In re Preferred Door Co.), 990 F.2d 547, 550 (10th Cir.1993), where the Court assumed that interest on administrative expense claims is allowable and paid at the same priority as the underlying claim. The Bankruptcy Court held that although Nicholas was decided under the former Bankruptcy Act, it remains binding law. In enacting the Bankruptcy Code, Congress did not express a clear intent to abolish the rule in Nicholas.

The Trustee argues that § 726 is unambiguous and therefore should be applied according to its natural reading. We agree that the statute is unambiguous, but disagree with the Trustee as to what constitutes its natural reading.³ The proper starting point for statutory interpretation is with the language of the statute itself. United States v. Ron Pair Enters., Inc., 489 U.S. 235, 241, 109 S.Ct. 1026, 1030, 103 L.Ed.2d 290 (1989). The relevant provisions of the Bankruptcy Code include § 726(a) and (b), § 507(a)(1), and § 503(b). Section 726(a) and (b) provides that:

(a) Except as provided in section 510 of this title, property of the estate shall be distributed—

(1) first, in payment of claims of the kind specified in, and in the order specified in, section 507 of this title ...;

(5) fifth, in payment of interest at the legal rate from the date of the filing of the petition, on any claim paid under paragraph (1), (2), (3), or (4) of this subsection; ...

(b) Payment on claims of a kind specified in paragraph (1), (2), (3), (4), (5), (6), (7), or (8) of section 507(a) of this title, or in paragraph (2), (3), (4), or (5) of subsection (a) of this section, shall be made pro rata among claims of the kind specified in each such particular paragraph, except that in a case that has been converted to this chapter ... a claim allowed under section 503(b) of this title incurred under this chapter after such conversion has priority over a claim allowed under section 503(b) of this title incurred under any other chapter of this title or under this chapter before such conversion and over any expenses of a custodian superseded under section 543 of this title.

Section 507(a)(1) provides that:

(a) The following expenses and claims have priority in the following order:

(1) First, administrative expenses allowed under section 503(b) of this title, and any fees and charges assessed against the estate under chapter 123 of title 28 [28 U.S.C. § 1911 et seq.].

Section 503(b)(1) provides that:

(b) After notice and a hearing, there shall be allowed administrative expenses, other than claims allowed under section 502(f) of this title, including—

(1)(A) the actual, necessary costs and expenses of preserving the estate, including wages, salaries, or commissions for services rendered after the commencement of the case;

(B) any tax—

(i) incurred by the estate, ...

... and

(C) any fine, penalty, or reduction in credit relating to a tax of a kind specified in subparagraph (B) of this paragraph____

Section 726(a)(5) applies to post-Chapter 7 interest. The Chapter 7 priority scheme should not affect the Chapter 11 claims, which were fixed at the time of conversion, except as expressly provided for in Chapter 7 of the Bankruptcy Code. See 11 U.S.C. § 103(b) (providing that Subehapters I and II of Chapter 7 apply only in a Chapter 7 case); 11 U.S.C. § 726(b) (providing that upon conversion, § 503(b) claims incurred in the Chapter 7 ease have priority over § 503(b) claims incurred in the Chapter 11 case); 11 U.S.C. § 726(a)(4) (setting the priority for certain claims arising before the earlier of the order for relief or the appointment of a trustee).

The Trustee argues that nothing in § 726 limits its reach to postconversion interest. The Trustee cites § 726(b) and § 726(a)(4), and argues that Congress has carved out exceptions that are subordinated upon conversion. However, § 726 only comes into play postconversion. See 11 U.S.C. § 103(b). Therefore, if § 726 affects preconversion claims, it should expressly so provide. That is why Congress has carved out exceptions that subordinate certain claims upon conversion, such as § 726(b) (which subordinates Chapter 11 administrative expense claims to Chapter 7 administrative expense claims), rather than paying all administrative expense claims pro rata in the first tier of distribution under § 726(a)(1).

The real focus should be on the absence of any language in § 726(b) bifurcating the Chapter 11 administrative expense claim. A Chapter 11 administrative expense claim is fixed upon conversion. Pursuant to § 101(5)(A), a “claim” means a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.” Accrued interest constitutes a “right to payment.”⁴ Since administrative expenses incurred by the estate in a Chapter 11 case are allowable, upon conversion the claim includes both the underlying claim and accrued interest. Although § 726(a)(5) bifurcates a claim into underlying claim and interest, that rule applies to claims incurred in a Chapter 7 and has no application to claims incurred in the Chapter 11 case.⁵ If Congress intended to bifurcate a Chapter 11 administrative expense claim, surely it would have expressly said so in § 726(b). There is no language in § 726 or elsewhere that directs bifurcation of a claim that was essentially fixed in amount on the date of conversion.

Viewing the interest as an integral part of the fixed claim is consistent with ease law and statutory law, which view interest on tax claims as part of the underlying claim. See Bruning v. United States, 376 U.S. 358, 360, 84 S.Ct. 906, 907-08, 11 L.Ed.2d 772 (1964); 26 U.S.C. § 6601(e)(1); Utah Code Ann. § 59-1-705 (1996).

The Trustee argues that the interest on administrative expense claims must be paid pursuant to § 726(a)(5), and any other reading would render that section meaningless. However, our reading of § 726(a)(5) as applying to post-Chapter 7 interest would not render the section a nullity. The Bankruptcy Court noted that § 726(a)(5) can be read in conjunction with Nicholas without being rendered meaningless. The administrative expense claim, including interest incurred during the Chapter 11 case, is paid as the “claim” under § 726(a)(1). Under § 726(a)(5), after the entire administrative expense claim including interest is paid pursuant to §§ 507(a)(1) and 726(a)(1) and (b), and all other claims listed in subsections (a)(1) through (4) of § 726 are paid in full, any remaining funds may be used to pay interest accrued postpetition on all of the claims, including claims that contain interest.

This interpretation is consistent with the history of § 726(a)(5), which was enacted to codify the “solvent debtor rule.” This rule provides that if “the debtor ultimately proves solvent, a balance of the equities dictates that creditors may receive any surplus, including claims for interest arising postpetition, ahead of payment to the debtor.” Colortex Indus., 19 F.3d at 1376 (citing City of New York v. Saper, 336 U.S. 328, 330 n. 7, 69 S.Ct. 554, 555-56 n. 7, 93 L.Ed. 710 (1949)).

This interpretation is also consistent with the treatment of prepetition unsecured creditors, whose prepetition claims include interest incurred prepetition. If there are sufficient funds to make a distribution under § 726(a)(5), these prepetition creditors also receive interest accrued postpetition on the entire claim.

This interpretation also prevents the stripping of a Chapter 11 claimant’s priority claim by the mere happenstance of conversion to Chapter 7. Chapter 11 does not have a provision similar to § 726(a)(5), which could be read to prevent the payment of interest on administrative expense claims. Under Nicholas and § 1129(a)(9), Chapter 11 administrative expense claimants could expect to be paid cash on the effective date of a plan for the entire amount of their claims, including interest. Disallowing such claims would deter creditors from dealing with Chapter 11 debtors. Chapter 11 administrative expenses are given priority “‘to encourage creditors to supply necessary resources to debtors post-petition.’” General American Transp. Corp. v. Martin (In re Mid Region Petroleum, Inc.), 1 F.3d 1130, 1134 (10th Cir.1993) (quoting In re Grant Broadcasting, 71 B.R. 891, 897 (Bankr.E.D.Pa.1987)). Granting first priority to postpetition interest on administrative expense claims incurred in a Chapter 11 case facilitates § 503(b)’s general purpose of encouraging creditors to continue dealing with Chapter 11 debtors. Bifurcating the administrative expense claim would destroy the Bankruptcy Code’s protection of Chapter 11 creditors.

For the reasons set forth herein, the Court concludes that interest incurred during the Debtor’s Chapter 11 case must be paid at the same priority as the underlying administrative expense claim. Accordingly, the judgment of the Bankruptcy Court is hereby affirmed.

1 . Unless otherwise noted, all references to a section are to the respective section of Title 11, United States Code.

2 . Several of the arguments made by the dissent, such as when interest begins to run and whether § 503(b)(1)(B) and (C) provide for interest, go to the issue of allowance, which is not before the panel in this case.

3 . We base our decision on statutory interpretation. Although we noted that the Bankruptcy Court relied on Nicholas, we are not, as suggested by the dissent, relying on Nicholas to determine the priority issue.

4 . The arguments regarding when the interest accrued address the allowance issue, which the Trustee admits he has waived in this case.

5 . The dissent misconstrues this statement as alleging that the priority of a claim incurred under Chapter 11 is not governed by § 726 upon conversion. We recognize that “ § 726 only comes into play postconversion." We are not saying that priorities are not determined under § 726. The point is that § 726(a)(5) should not be read to bifurcate a fixed claim. Surely § 726(a)(5) would not bifurcate a prepetition claim that was comprised of interest. That is not the same as saying § 726(a)(5) does not apply to prepetition claims. We are saying that bifurcation under § 726(a)(5) only applies to post-Chapter 7 interest, not that priorities are not determined under § 726.