§ 83.1 — In General: Rake and Contracts before October 22, 1994
Revised: July 8, 2004
When the debtor cures default under § 1322(b)(3) or (b)(5), typically the default includes missed installment payments of principal and interest, and sometimes costs, charges or fees. Debtors can rarely cure these monetary defaults immediately at confirmation but instead propose to pay the arrearages over time with monthly distributions.
Prior to the Supreme Court’s decision in Rake v. Wade,1 there was much controversy whether debtors must pay interest on arrearages cured through the plan. The Code does not define “curing default,” and the courts were unable to agree whether the concept included paying the mortgage holder the present value of the amount in default.
At one extreme, it was held that interest was never payable as an element of curing default because state usury law prohibited the payment of interest upon interest.2 There was no stampede in support of this view. State usury statutes are mathematically complex. Interest on a past-due installment of a home mortgage would include interest on unpaid interest with a multiplier effect that could generate a true interest rate prohibited by nonbankruptcy law. Another court reached the conclusion that interest was never allowable on arrearages as an element of curing default based on the absence of present value language in § 1322(b)(5).3
A majority of courts prior to 1993, including the U.S. Courts of Appeals for the Third, Fourth, Ninth and Eleventh Circuits, allowed interest on arrearages as an element of curing default only if the mortgage contract allowed interest on unpaid installments outside bankruptcy.4 These courts reasoned that 11 U.S.C. § 1322(b)(5) is a specific exception to the general treatment of secured claim holders in 11 U.S.C. § 1325(a)(5)(B). As a general rule, secured claim holders retain their liens and receive the present value of their allowed secured claims during the life of the plan—including interest to compensate for payment over time.5 Applying this logic to the curing of a mortgage arrearage entitles the mortgage holder to the present value of the installments that are unpaid at the petition and thus to the payment of interest while the creditor waits for defaults to be cured.
But there is no present value language in § 1322(b)(3) or in § 1322(b)(5) as there is in § 1325(a)(5)(B). As explained by the U.S. Court of Appeals for the Eleventh Circuit in Foster Mortgage Corp. v. Terry,6 the absence of present value language in § 1322(b)(5) precluded entitlement to interest unless the contract being cured required the payment of interest. Stated another way by the Third Circuit in In re Capps,7 if the debtor elected to cure defaults and maintain the original contract under § 1322(b)(5) and if the contract contained no provision for interest on unpaid installments, then the antimodification provision of § 1322(b)(2) prohibited the bankruptcy court from imposing an interest requirement.
Other courts, led by the U.S. Court of Appeals for the Sixth Circuit, required Chapter 13 plans to pay interest as an element of curing default without regard to the underlying contract.8 These courts reasoned that the arrearage claim was entitled to the same present value treatment as any other secured claim and thus must be paid interest if defaults were cured over time.
In 1993, the Supreme Court resolved much of the confusion about interest on arrearages in Rake. The mortgages in Rake were oversecured and in default at the petition. The mortgage contracts had provisions for late charges but no provision for interest on a late or unpaid installment. The Chapter 13 plans proposed to maintain the future monthly installments of principal and interest through the plan and to cure the prepetition defaults without interest over the terms of the plans.
Relying in part on the Sixth Circuit’s opinion in Cardinal Federal Savings & Loan Ass’n v. Colegrove,9 the Tenth Circuit denied confirmation because § 506(b), as interpreted by the Supreme Court in United States v. Ron Pair Enterprises, Inc.,10 entitled an oversecured mortgage holder to postpetition interest on its entire secured claim, including the arrearage portion, without regard to whether the mortgage contract or state law required interest.
A unanimous Supreme Court agreed with the Tenth Circuit, but Justice Thomas explained the outcome somewhat differently. Justice Thomas first observed that 11 U.S.C. § 506(b) applies in Chapter 13 cases with this effect: “Under § 506(b) the holder of an oversecured claim is allowed interest on his claim to the extent of the value of the collateral. . . . [S]uch interest accrues as part of the allowed claim from the petition date until the confirmation or effective date of the plan.”11 Reviewing the Supreme Court’s earlier decision in Ron Pair, Thomas explained, “In Ron Pair, we held that the right to postpetition interest under § 506(b) is ‘unqualified’ and exists regardless of whether the agreement giving rise to the claim provides for interest.”12 Noting that the prepetition arrearages were part of the mortgage holder’s allowed secured claim, Justice Thomas concluded that when a debtor uses § 1322(b)(5) to cure default on an oversecured home mortgage, “§ 506(b) entitles the mortgagee to preconfirmation interest on such arrearages.”13
Justice Thomas then focused on § 1325(a)(5). As discussed elsewhere,14 § 1325(a)(5) requires either that each secured claim holder consent to the plan; that the plan surrender all the claim holder’s collateral; or that the claim holder retain its lien and receive through the plan the present value of the allowed secured claim. Justice Thomas applied § 1325(a)(5) to the arrearage claim:
Section 1325(a)(5) applies by its terms to “each allowed secured claim provided for by the plan.” . . . Petitioners’ plans clearly “provide for” respondent’s home mortgage claims by establishing repayment schedules for the satisfaction of the arrearages portion of those claims. As authorized by § 1322(b)(5), the plans essentially split each of respondent’s secured claims into two separate claims—the underlying debt and the arrearages. . . . [E]ach plan treated the arrearages as a distinct claim to be paid off within the life of the plan pursuant to repayment schedules established by the plans. Thus, the arrearages, which are a part of respondent’s home mortgage claims, were “provided for” by the plans, and respondent is entitled to interest on them under § 1325(a)(5)(B)(ii). . . . [R]espondent is entitled to the present value of the arrearages that were paid off under the terms of the plans as an element of an “allowed secured claim provided for by the plan.”15
The holding of Rake is that an oversecured mortgage holder is entitled to preconfirmation interest on its arrearages under § 506(b) and postconfirmation interest under § 1325(a)(5)(B)(ii) when a Chapter 13 plan cures default and maintains payments under § 1322(b)(5). In two important footnotes, the Supreme Court observed, “The arrearages portion of respondent’s oversecured claim in this case included the amounts past due on the notes and the ‘other charges’ to which the Tenth Circuit referred,”16 and “[w]e express no view on the appropriate rate of interest that debtors must pay on arrearages cured pursuant to § 1322(b)(5).”17
Rake did not address the entitlement of an undersecured creditor to postpetition interest on arrearages. Section 506(b) would not apply to an undersecured claim—eliminating the statutory basis for preconfirmation interest in Rake. At confirmation, § 1325(a)(5) requires present value even for undersecured creditors, to the extent of the allowable secured claim, but only postconfirmation. If the undersecured mortgage contract requires interest on arrears and if that contract right is protected from modification by § 1322(b)(2) and Nobelman v. American Savings Bank,18 it is arguable that the mortgage holder can demand preconfirmation and postconfirmation interest without regard to Rake or § 506(b).19
Congress reacted quickly to Rake. For agreements prior to October 22, 1994, Rake controls the entitlement of oversecured creditors to interest on defaults cured through the Chapter 13 plan. For agreements after October 22, 1994, (new) § 1322(e) fixes a different set of rules.20
1 508 U.S. 464, 113 S. Ct. 2187, 124 L. Ed. 2d 424 (1993).
2 Guccione v. First Fed. Sav. & Loan Ass’n of Suffern, 41 B.R. 289 (Bankr. S.D.N.Y. 1984) (New York law prohibits the payment of interest upon past-due interest in a home mortgage; therefore, creditor cannot claim interest on arrearage.).
3 In re Siegfried, 114 B.R. 358, 360 (Bankr. N.D.N.Y. 1990) (“[T]he language of Code §§ 1322(b)(3) or (5) does not require that present value be provided to creditors holding secured claims on which prepetition defaults are cured through a plan. Congress is presumed to have intentionally excluded the present value language included in other sections under Chapter 13 from the cure provisions of Code § 1322. . . . The absence of such language indicates Congress’ intent that interest is not payable where the debtor is curing a default under §§ (3) or (5) of Code § 1322(b).”).
4 See Shearson Lehman Mortgage Corp. v. Laguna (In re Laguna), 944 F.2d 542 (9th Cir. 1991); Landmark Fin. Servs. v. Hall (In re Hall), 918 F.2d 1150 (4th Cir. 1990); In re Capps, 836 F.2d 773 (3d Cir. 1987); Foster Mortgage Corp. v. Terry, 780 F.2d 894 (11th Cir. 1985); In re Latimer, 110 B.R. 968 (W.D. Okla. 1989); In re Robinson, 85 B.R. 721 (E.D. Pa. 1987); In re Sanchez, 137 B.R. 214 (Bankr. E.D. Tex. 1992); In re Hannon, 129 B.R. 238 (Bankr. N.D. Okla. 1991); In re Thompson, 127 B.R. 717 (Bankr. D. Conn. 1991); In re Smith, 118 B.R. 424 (Bankr. D.S.C. 1990); In re Murray, 116 B.R. 307 (Bankr. M.D. Ga. 1990); In re Penick, 108 B.R. 776 (Bankr. W.D. Okla. 1989); In re Kooker, 106 B.R. 233 (Bankr. D. Nev. 1989); In re Brown, 91 B.R. 19 (Bankr. E.D. Va. 1988); In re Brady, 86 B.R. 166 (Bankr. D. Minn. 1988); In re Stamper, 84 B.R. 519 (Bankr. N.D. Ill. 1988); In re Ward, 73 B.R. 119 (Bankr. N.D. Ga. 1987); In re Harmon, 72 B.R. 458 (Bankr. E.D. Pa. 1987); In re Fries, 68 B.R. 676 (Bankr. E.D. Pa. 1986); In re Small, 65 B.R. 686 (Bankr. E.D. Pa. 1986); In re Christian, 35 B.R. 229 (Bankr. N.D. Ga. 1983).
6 780 F.2d 894 (11th Cir. 1985).
7 836 F.2d 773 (3d Cir. 1987).
8 Wade v. Hannon, 968 F.2d 1036 (10th Cir. 1992), aff’d sub nom. Rake v. Wade, 508 U.S. 464, 113 S. Ct. 2187, 124 L. Ed. 2d 424 (1993); Cardinal Fed. Sav. & Loan Ass’n v. Colegrove, 771 F.2d 119 (6th Cir. 1985); Resolution Trust Corp. v. Adams, 142 B.R. 331 (E.D. Mo. 1991); Blinde v. Spader (In re Spader), 66 B.R. 618 (W.D. Mo. 1986); In re Chavez, 138 B.R. 979 (Bankr. D.N.M. 1992); In re Day, 139 B.R. 674 (Bankr. N.D. Ohio 1991); In re Parker, 125 B.R. 479 (Bankr. W.D. Tex. 1991); In re Hall, 117 B.R. 425 (Bankr. S.D. Ind. 1990); In re Thomas, 115 B.R. 305 (Bankr. E.D. Okla. 1990); In re Catlin, 81 B.R. 522 (Bankr. D. Minn. 1987); In re Mascari, 70 B.R. 325 (Bankr. N.D.N.Y. 1987); In re Van Gordon, 69 B.R. 545 (Bankr. D. Mont. 1987); Cervantes v. General Elec. Mortgage Co. (In re Cervantes), 67 B.R. 816 (Bankr. E.D. Pa. 1986); In re Trigwell, 67 B.R. 808 (Bankr. C.D. Cal. 1986); In re LaLonde, 65 B.R. 237 (Bankr. S.D. Ohio 1986); In re Paul, 62 B.R. 269 (Bankr. D. Neb. 1986); In re McCall, 57 B.R. 642 (Bankr. E.D. Pa. 1986); In re Nesmith, 57 B.R. 348 (Bankr. E.D. Pa. 1986); Gincastro v. Fairlawn Credit Union, 48 B.R. 662 (Bankr. D.R.I. 1985); In re Wilkinson, 33 B.R. 933 (Bankr. S.D.N.Y. 1983); In re Webb, 29 B.R. 280 (Bankr. E.D.N.Y. 1983).
9 771 F.2d 119 (6th Cir. 1985).
10 489 U.S. 235, 109 S. Ct. 1026, 103 L. Ed. 2d 290 (1989).
11 508 U.S. at 471.
12 508 U.S. at 468 (citing United States v. Ron Pair Enterprises, Inc., 489 U.S. 235, 241, 109 S. Ct. 1026, 103 L. Ed. 2d 290 (1989)).
13 508 U.S. at 472.
14 See discussion beginning at § 74.1 General Rules before BAPCPA.
15 508 U.S. at 473–75.
16 508 U.S. at 475 n.12. See § 83.2 Section 1322(e): Contracts after October 22, 1994 and § 83.6 Late Charges, Attorneys' Fees, Costs and Other Charges for discussion of attorneys’ fees, costs and late charges as elements of the arrearage claim under § 1322(b)(3) and (b)(5).
17 508 U.S. at 472 n.8. See § 136.1 [ Rate of Interest to Cure Default: Contracts before October 22, 1994 ] § 83.3 Rate of Interest to Cure Default: Contracts before October 22, 1994.
18 508 U.S. 324, 113 S. Ct. 2106, 124 L. Ed. 2d 228 (1993).
19 See § 137.1 [ Undersecured Mortgage and Interest to Cure Default ] § 83.5 Undersecured Mortgage and Interest to Cure Default.
20 See § 135.1 [ Section 1322(e): Contracts after October 22, 1994 ] § 83.2 Section 1322(e): Contracts after October 22, 1994.