"RAKE"-ING IT IN: IS INTEREST
PAYABLE ON
RESIDENTIAL MORTGAGE ARREARS?
By Marc R. Kivitz
The Supreme Court in Rake v. Wade, 508 U.S. 464, 113
S.Ct. 2187, 124 L.Ed. 424 (1993) held that the Bankruptcy Code requires that interest be
paid on mortgage arrearages being cured under Chapter 13 repayment plans pursuant to
§§1322(b)(2) and 1322(b)(5). This had the effect of giving secured creditors interest on
interest payments, and interest on late charges and other fees, even where applicable
state law prohibited such interest, and even when it was not something originally
contemplated by the parties.
In response to this additional obligation imposed upon debtors,
Congress enacted The Bankruptcy Reform Act of 1994 (the "Act"), Pub. L. 103-394,
108 Stat. 4106. Section 305 of the Act, codified at 11 U.S.C. §1322(e), provides that:
Notwithstanding subsection (b)(2) of this section and sections
506(h) and 1325(a)(5) of this title, if it is proposed in a plan to cure a default, the
amount necessary to cure the default shall be determined in accordance with the underlying
agreement and applicable nonbankruptcy law.
This provision overturned Rake but only as to agreements,
including refinancings, entered into after the effective date of the Act, i.e., October
22, 1994 (see §702(b)(2)(D) of the Act).
So, when is interest payable on the cure of mortgage arrears?
The first consideration is the date of the agreement. If the debtor’s deed of trust
or mortgage was entered into on or after October 22, 1994, then interest on the arrearage
is controlled by the underlying agreement and State law. Maryland law neither imposes nor
prohibits an obligation to pay interest on arrears.
If the mortgage agreement was entered into prior to October 22,
1994, then interest on the arrearage is payable post-petition. Rake, interpreting
§506(b) of the Bankruptcy Code and citing United States v. Ron Pair Enterprises, Inc.,
489 U.S. 235 (1989), holds that the claims of oversecured creditors are entitled to both
preconfirmation and postconfirmation interest until the arrearage claim is paid. Interest
is due unless some other circumstance can be shown to eliminate or reduce this obligation.
An oversecured creditor is entitled to postpetition interest only "to the extent that
such interest, when added to the principal amount of the claim" does not "exceed
the value of the collateral." United Savings Assn. Of Texas v. Timbers of Inwood
Forest Associates, Ltd., 484 U.S. 365, 372 (1988).
One circumstance that may eliminate the interest requirement
arises when the secured creditor is undersecured – that is, when the amount of the
secured claim exceeds the value of the real property.
The leading bankruptcy treatise confirms that there is no
entitlement to interest where the creditor is undersecured:
The Court [in Rake] reached this conclusion as to
prepetition interest, assuming the creditor is oversecured,
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because it found nothing in the language of section 1322(b)(5)
that made inapplicable section 506(b), which generally requires preconfirmation interest
to be paid to oversecured creditors. Under that section, undersecured creditors are not
entitled to preconfirmation interest.
5 Collier on Bankruptcy, para. 1322.09, p. 1322-32 –
1322-32 (15th ed. 1996) (emphasis added). As for post-petition interest, the
opinion of Collier is the same: there is no entitlement to interest on the
arrearages due to the undersecured creditor.
Nonetheless, a creditor is not entitled to interest to the
extent the claim, or the arrearage being cured, is unsecured or undersecured. Section
1325(a)(5), relied on by the Supreme Court in Rake v. Wade, provides for present
value interest only on an allowed secured claim. Matter of Arvelo, 176 B.R. 349
(B.Ct., D.N.J. 1995).
5 Collier on Bankruptcy, para. 1322.09, p. 1322-32 n. 30a
(15th ed. 1996). The debtor must determine if the creditor is undersecured and,
if so, to what extent. Interest is not due on that portion of the creditor’s claim
that is undersecured.
You have determined that the mortgage claim on your
client’s mortgage agreement predating October 22, 1994 is fully secured so that
postpetition interest on the arrears must be paid under the plan. The next reasonable
inquiry is to determine the applicable rate of interest. This issue was not presented to
the Court in Rake. One appropriate interest rate to be considered is the contract
rate. A creditor might unilaterally claim a rate of interest higher than provided in the
contract, although the writer is not aware of any applicable nonbankruptcy authority which
would permit a unilateral increase. It is suggested, however, that given the admonition
which appears on every proof of claim form [the penalty for presenting a fraudulent claim
is a fine of up to $500,000], debtors should scrutinize the claims filed and creditors
should be wary of over-reaching.
Summarizing, confirm the date of the debtor’s loan
agreements. If the mortgage transaction was entered into prior to October 22, 1994,
determine if the creditor is undersecured or oversecured. If the loan agreements post-date
October 22, 1994, determine whether the loan documents provide for interest on arrears. If
appropriate, file an objection to the creditor’s claim which may dispute (i) the
right to any interest on the arrears, (ii) the amount of the arrearage claim on which
interest may accrue, and/or, (iii) the entitlement to interest at the rate claimed by the
creditor. |
Neal, of the US Trustee’s Office, who has & is investing hours of his personal time to get the new web page up & running!
