OPINION
(Motion to Determine Tax Liability Pursuant to 11 U.S.C. §§ 505, 506)
P.G. Realty Company (“PG” or “Debtor”), a New York partnership, filed a voluntary petition for relief under Chapter 11 on March 25, 1994. Its sole partners are Phyllis and Golda Golub. 1 At the time of the filing, PG owned a commercial building located at 700 East 98th Street, Brooklyn, New York (the “Property”), valued on Schedule A at $400,-000.00 and unencumbered by any mortgages. See Schedules A, D; Affidavit Pursuant to Local Bankruptcy Rule 11 at ¶ 10. PG owned no other assets, and had only one creditor scheduled apart from the taxing authorities: GAG Construction Corp., an unsecured creditor owed $8,500. 2 See Schedule F. GAG has not filed a proof of claim in this case, despite the existence of and notice of a bar date. According to PG’s Local Rule 11 affidavit and its proposed disclosure statement, its bankruptcy filing was caused by the following events:
• When PG bought the Property sometime in 1986, there was approximately $42,000 owed to the City of New York, Department of Finance (the “City”) for unpaid real estate taxes, which debt PG assumed as part of the purchase.
• Thereafter, PG and the City entered into an In rem Installment Agreement (the “Agreement”) requiring PG to pay the taxes over a period of years in quarterly payments. PG made the payments for several years, but at some point,, its tenant defaulted on its lease, leaving PG without income to pay its obligations under the Agreement.
• The City commenced foreclosure proceedings based upon PG’s default, and PG therefore filed its bankruptcy petition.
Nine months after the filing, the Debtor sought permission to sell the Property free and clear of liens for the sum of $265,000, to be paid under the following terms: $15,000 cash deposit; a $35,000 lump sum cash payment at closing; and the balance ($215,000) in the form of a four-year purchase money mortgage bearing interest at 10%. The purchaser was to pay interest only in equal monthly installments during the term of the mortgage, with a balloon payment of the principal at the end of four years. The Debt- or also moved, pursuant to 11 U.S.C. § 505, to fix the tax liability owed to the City at
WHEREAS, the City of New York asserts that as of March 22, 1995 there is a tax liability in the amount of $113,573.89;
WHEREAS, the debtor asserts that the tax liability owed to the City of New York does not exceed the sum of $18,220.82 as previously determined by the Court;
WHEREAS, a prolonged delay of the closing for the sale of the subject property may provide grounds for the Buyer to cancel the contract and avoid the purchase of the subject property;
IT IS HEREBY STIPULATED and agreed as follows:
1. The City of New York consents to the sale of the subject property and to the transfer of title free and clear of its liens;
2. The liens of the City of New York shall affix and attach to all proceeds of the sale, including the proceeds in the escrow account holding the initial deposit of $15,-000.00, and to the purchase money mortgage provided to the Debtor and to the proceeds derived from the purchase money mortgage provided the debtor;
3. All post-petition real property taxes and related charges including interest thereon shall be fully paid at closing from the proceeds available from the sale of the subject property ... and, assuming the Court determines additional tax liability is owing, a plan of reorganization shall provide for payment of at least one-half of the remaining proceeds received from the sale of the property, after payment of administrative expenses as allowed by the Court, payment of at least three-quarters of the monthly mortgage payments, and payment of the balance of the tax liability, if any, from the balloon payment of the mortgage to the City of New York....
5. Both the City of New York and the debtor reserve their rights to resolve, settle or litigate the issue of what, if any, taxes are owed by the debtor to the City of New York and the appropriate amount of the lien, if any, which shall affix to the proceeds of the sale....
Several months later, the Debtor filed the present motion, pursuant to 11 U.S.C. § 505, for an order determining the Debtor’s tax liability to the City, contending that after nearly seven years of making payments under the In Rem Agreement, it “found itself owing ... more of an amount than when it first started paying off its tax obligations.” See Affidavit of Howard Golub, sworn to Dec. 6,1995, ¶ 12. The Debtor raises a variety of objections to the City’s computation of its liability under the Agreement and asserts that the Agreement is “riddled with ambiguities.” The motion is supported by the affidavit of Bernard J. Sandler, a partner in the firm of Sandler, Rosengarten, Denis & Berger, LLP, the Debtor’s duly retained certified public accounting firm. The affidavit states, in effect, that use of the City’s method of calculation of interest results in the Debt- or owing more at the end of the Agreement than it owed at the beginning of the Agreement.
The motion also seeks to reduce the interest rate on prepetition taxes allegedly owed for periods subsequent to the execution of the Agreement. The City’s claim to interest on taxes accruing after the Agreement but prior to the bankruptcy filing can be broken down into the following constituents: (1) interest which accrued prepetition pursuant to Section 11-224 of the New York City Administrative Code (“Administrative Code”)
3
, and
. The City opposed the Debtor’s motion and both sides briefed the issues, following which the Court reserved decision. Although PG initially urged the Court to decide the motion expeditiously, the parties advised the Court while the matter was sub judice that they were engaged in settlement negotiations.
Those discussions bore some fruit, and as a result of a settlement placed upon the record on October 16,1997, all arguments regarding the calculation of taxes and interest under the Agreement were consensually resolved. Therefore, the only remaining issue is whether or not the City is entitled to postpetition interest at the rate of 18%, compounded daily, on unpaid prepetition taxes. 5
The Debtor argues that the Court need not allow postpetition interest on the City’s claim at the rate set forth in the Administrative Code; rather, the Debtor contends that the federal judgment rate is more appropriate. In addition, the Debtor contends that although the charge is labeled as “interest” by the Administrative Code, some portion of it is a disguised penalty. Lastly, the Debtor alleges that the compounded rate set forth in the Administrative Code is criminally usurious under New York’s Penal Code.
The City counters that (a) in determining the appropriate rate of postpetition interest, the Court must look to state law which, in this case, dictates an 18% rate; (b) no portion of the 18% constitutes a penalty; and (e) it would be inequitable to reduce the City’s interest rate, since the City is an “involuntary” creditor and a sovereign seeking revenue to defray the costs of government.
DISCUSSION
A. The Claim for Taxes Accruing Prepetition and the Interest Rate to be Applied Postpetition
The allowance of postpetition interest is governed by 11 U.S.C. § 506(b), which provides:
(b) To the extent that an allowed secured claim is secured by property the value of which, after any recovery under subsection
(c) of this section, is greater than the amount of such claim, there shall be allowed to the holder of such claim, interest on such claim, and . any reasonable fees, eosts, or charges provided for under the agreement under which such claim arose.
Section 506(b) affects “the quantum of the allowed secured claim and provides exception to the general rule that interest stops accruing as of the filing of the petition.”
In re Harko,
Although bankruptcy courts were divided as to whether Section 506(b) entitled a creditor to postpetition interest only where such interest was provided for by agreement,
ie.,
only to consensual creditors, the United States Supreme Court resolved the issue in
United States v. Ron Pair Enterprises, Inc.,
Neither the language of § 506(b) nor
Ron Pair
dictates the
rate
of postpetition interest to be paid.
See In re Greensboro Lumber Co.,
Some courts have stated that despite the existence of a state statute fixing the interest to be paid on statutory Hens, the court has discretion to engage in a sort of case-by-ease equitable balancing analysis, wherein the competing interests of the secured and unsecured creditors are somehow harmonized.
See, e.g., In re Kalian,
The approach taken by the apparent majority of courts is somewhat more restrictive. Most courts which have visited the issue have concluded that a bankruptcy court is not necessarily bound by the state statutory rate, but should be reluctant to deviate from that rate except in very limited circumstances.
See, e.g., In re Liuzzo, supra,
It is true of course that bankruptcy, despite its equity pedigree, is a procedure for enforcing pre-bankruptcy entitlements under specified terms and conditions rather than a flight of redistributive fancy or a grant of freewheeling discretion such as the medieval chancellors enjoyed (equity itself is no longer a discretionary system in that sense). The government’s tax claim against the [debtors] is one of those pre-bankruptcy entitlements and section 506(b) specifies one of the terms for enforcing it. But the specification need not be considered exhaustive. A rigid literalism is not the only alternative to discretionary justice. A statute that says “shall” does not, by its imperative mood, extinguish all defenses. We have no reason to suppose that the statute was intended to cut off the defense of estoppel and we may assume that other defenses, such as the statute of limitations, survive as well. The point of Ron Pair was to give involuntary liens parity with voluntary ones so far as the applicability of section 506(b) was concerned, rather than to abolish defenses against claims under that section.
But this is not to say that section 506(b) is an invitation to a free-for-all equity-balancing act. That would be a swing to the opposite extreme. We deprecate flaccid invocations of “equity” in bankruptcy proceedings. Creditors have rights, among them the right of oversecured creditors to post-petition interest, and bankruptcy judges are not empowered to dissolve rights in the name of equity. Flexible interpretation designed to allow the judicial interpolation of traditional defenses in a statute silent on defenses is one thing; standardless decision-making in the name of equity is another. Ron Pair makes clear that section 506(b) provides more than merely “guidance in the exercise of [the bankruptcy court’s] equitable powers.” If the statute were read merely to authorize the bankruptcy judge to award post-petition interest as a matter of grace, secured creditors would lack a clear idea of what their rights would be if the debtor went broke.
Lapiana, supra,
There are other good reasons supporting the notion that the bankruptcy court should allow interest at the rate set forth in a state’s legislative scheme absent a compelling interest to the contrary. First, adoption of a “market rate” approach would leave “an unresolved fact issue in every bankruptcy case, which would require litigation for every new day’s market.”
Galveston Indep. School Dist. v. Heartland Fed. Sav. & Loan Assoc.,
For these reasons, Court aligns itself with the latter line of cases, and believes that it possesses the power to modify rights created by state law or private agreement. Indeed, the Bankruptcy Code itself contains many provisions which specifically modify or abrogate such rights. See, e.g., 11 U.S.C. §§ 362, 522(f), 543, 547. The Code is also replete with instances in which Congress has made such a power explicit. See, e.g., 11 U.S.C. §§ 363(l), 365(e)(1), 545, 1123(b), 1322(b). However, where that power is not explicit — where it resides only in general language directing the Court to allow interest on an oversecured claim — the Court should be loathe to exercise it in the absence of compelling evidence that recognition of a right created by state statute or private agreement would do violence to the principles which constitute the foundation of bankruptcy law. Case law offers four examples of such situations: where there has been misconduct by the creditor, where application of the statutory interest rate would cause direct harm to the unsecured creditors, where the statutory interest rate is a penalty, or where its application would prevent the Debtor’s fresh start. For the following reasons, none are applicable here.
Scenarios 1 (A Showing of Misconduct) & 2 (Direct Harm):
With respect to the first scenario, the Debtor in this ease has not presented any evidence of affirmative misconduct by the City. See In re Lapiana, supra. In the absence of such a showing, the Court declines to find any misconduct by the City.
With respect to the second scenario, the Debtor relies heavily upon
In re Wasserman,
In the present case, in addition to the City of Cambridge, there are unsecured creditors who have claims on the Debtors’ assets. The Debtors’ bankruptcy plan establishes a junior trust out of which these unsecured creditors are to obtain repayment. The unsecured creditors, however, draw on this trust only after the estate has paid off its more senior claims, including administrative costs and tax claims. According to the Debtors, the estate is already unable to satisfy all its administrative claims. Thus, there is a high likelihood, as in all bankruptcies, that the unsecured creditors will not be repaid in full. The extent of their losses, then, will depend on whether priority claims, like the tax claim, are entitled to the statutory rate of post-petition interest or the federal judgment rate in this case.... Granting the City the statutory rate, which is approximately twice the federal judgment rate, will cause the unsecured creditors a direct harm by diminishing the value of the estate from which they hope to draw. Consequently, it would be inequitable to the unsecured creditors to impose the higher, statutory rate.
Wasserman,
Scenario 3 (Whether the Statutory Rate is a Penalty):
The Debtor argues that a portion of the interest charged by the City constitutes a penalty, despite the fact that the Administrative Code does not label it as such. A penal
The Debtor argues that the City has, in effect, conceded that the interest, is really a penalty, since the City has allegedly argued that it “attempts to have an extremely high interest rate so that debtor’s [sic] will be discouraged from becoming indebted to the City, and will seek out other avenues for loans. The City is required to charge. 6% over prime. However, the City’s current charges are approximately 10% over prime. It is submitted that the City’s rate is designed to act as a penalty and a preventative measure to dissuade entities from becoming indebted to the City.” See Debtor’s Mem., at 10.
The Court disagrees. First, the Court is not convinced that the City’s position is as the Debtor so states or that the City’s “concession” is so clear. To the contrary, the City argues in its brief that the “City’s Statutory Rate is simply the cost of using the City’s money and it is statutorily created to further the collection of real property taxes by the sovereign. The fact that the cost of using the City’s money seems to be more expensive than using someone else’s money does not make it a penalty.” See Mem. of Law of the City of New York in Opposition to the Debtor’s Motion for an Order Pursuant to Section 505 of the Bankruptcy Code, Determining the Debtor’s Tax Liability to the City of New York and in Support of the City’s Objection (“City’s Mem.”), at 12-13. Rather, by its argument, the City is merely pointing out that if a taxpayer does not wish to pay the statutory rate, it has several options, including securing a loan from a commercial lender at a lower rate of interest so that it may timely pay its tax obligations. The City is not arguing, as the Debtor suggests, that the interest rate it employs is designed to punish a taxpayer who does not employ one of a variety of options.
Secondly, more probative of the City’s purpose in charging the rate it charges is the Administrative Code itself, which specifically links the interest rate to be charged on unpaid taxes to prevailing market rates on commercial loans. Section 11-224 requires the banking commission to consider, in its calculation of the rate to be charged, the “prevailing interest rates charged for commercial loans extended to prime borrowers by commercial banks operating in the city” and ties the City’s rate to those figures. This language is consistent with the notion that the City’s motivation is to compensate itself for the time value of money, and not to punish recalcitrant taxpayers.
The Debtor also urges that “when Citibank is paying 4.65% on one-year certificates of deposit ... 18% compounded daily constitutes a penalty.”
See
Debtor’s Mem., at 10. This argument is unpersuasive, as the Court does not believe that evidence
6
of the rate
paid
by a bank to a depositor is any evidence whatsoever of the rate
charged
by a bank for a loan. Simply stated, the Debtor’s argument that the City’s rate includes a punitive aspect is conclusory: the Debtor has not presented any evidence whatsoever, in the form of affidavits, legislative history or case law, to support its claim that a portion of the interest rate constitutes a penalty.
In re Liuzzo, supra,
The Court agrees with the City that simply because its rate is high does not make a portion of the rate a penalty. There are good reasons for taxing authorities to exact an interest rate when taxes go unpaid higher than that exacted by consensual mortgagees when lending money. 7
Although an 18% rate is more typical of the rates charged by
unsecured,
creditors, as opposed to secured creditors, the Court takes judicial notice of the fact that since the City is unable to bargain for lender protections such as title and hazard insurance,
In re Liuzzo, supra,
Further, the Court also relies on the exhaustive analysis contained in
In re Navis Realty, Inc.,
Lastly, the Court is not persuaded, on the present facts, by the cases cited by the Debt- or for the proposition that interest under § 606(b) in this case should be limited to the federal judgment rate. The Debtor first cites
In re Laymon,
Scenario Ip (Prevention of the Debtor’s Fresh Start):
The Debtor also cites
Wasserman
for the proposition that imposition of the statutory rate would impede its fresh start.
In re Wasserman, supra,
B. Compound Interest and Usury
No section of the Bankruptcy Code deals directly with the compounding of interest on a secured tax claim, or with the method of computation permissible for interest awarded under Section 506(b).
As
a general rule, under New York law, compound interest is disfavored,
Rourke v. Fred H. Thomas Associates,
The Debtor has not cited to any case in which a eoürt has disallowed such interest under Section 506(b). Nevertheless, the Court’s own research has revealed that prior to enactment of the Bankruptcy Code, interest upon interest was disallowed where the creditor’s security was worth less than the debt
and
the estate in general was insufficient to pay all creditors in full.
See In re Marfin Ready Mix Corp.,
There are, however, several recent cases which
have
allowed interest upon interest. In
In re Manville Forest Products Corp.,
Finally, the Court does not believe, as the Debtor contends, that the 18% rate compounded daily is usurious under Section 190.40 of New York’s Penal Code. The Debtor contends that Section 190.40 of the Penal Code makes it illegal to
take or reeeive[ ] any money or other property as interest on the loan or forbearance of any money or other property, at a rate exceeding twenty-five per centrum per an-num or the equivalent rate for a longer or shorter period.
Significantly, the Debtor omits from its quotation of the statute, critical language which defeats its argument: the statute actually states that a person is guilty of criminal
Clearly, the City is authorized by law,
i.e.,
Sections 11-223 and 11-224 of the Administrative Code, to charge the rate that it charges. In addition, a crucial element of usury is a “loan or forbearance of money.”
In re Foreclosure of Tax Liens by the City of Binghamton,
For the reasons set forth at length above, the Court concludes that the Debtor has not set forth sufficient reason or evidence by which this Court should deviate from the allowance under Section 506(b) of interest at the rate, and method of computation, set forth under New York law.
CONCLUSIONS OF LAW
1. The Court has jurisdiction over the subject matter and the parties to this core proceeding pursuant to 28 U.S.C. § 1334 and 28 U.S.C. § 157(b)(2). Venue is proper. 28 U.S.C. § 1408.
2. With respect to taxes accruing prepetition, the Court hereby allows to the City, postpetition interest from the date of the filing to the effective date of the plan, at the rate set forth in the Administrative Code, compounded as set forth in that statute.
3. The Debtor’s motion seeking to reduce the interest rate paid to the City is hereby denied.
By separate Order, the relief provided herein is entered on this day.
Notes
. Golda Golub is also a debtor before this Court. See Case No. 095-70600-511.
. On May 13, 1994, the Court entered an Order fixing June 24, 1994 as the last date by which creditors could file claims and share in a distribution of the estate. The only claim filed was on December 4, 1995 — more than a year later — by CMA Design Studio, P.C. in the sum of $6,829.48; the claim allegedly arises from an Agreement dated August 11; 1994 for architectural services to enable PG to obtain a certificate of occupancy for the Property.
. Section ll-224(g) of the Administrative Code provides in pertinent part:
No later than the twenty-fifth day of May of each year, the banking commission shall transmit a written recommendation to the council of a proposed interest rate to be charged for nonpayment of taxes on real estate.... In making such recommendations the commission shall consider the prevailing interest rates charged for commercial loans extended to prime borrowers by commercial banks operating in the city and shall propose a rate of atleast six percent per annum greater than such rates....
. In support of its motion, the Debtor states that it “has never disputed the City’s right to charge its statutory compound interest rate prepetition— except under .the Agreement.” See Memorandum of Law in Reply to the Brief of the City of New York Submitted May 2, 1996, and in Further Support of Debtor’s Motion for a Determination of it Tax Liability ("Debtor’s Mem.”), at 2.
. See Transcript of Hearing held on October 16, 1997, at 14-15.
. Notwithstanding the Debtor’s reference to a rate in its brief, there is no competent evidence in the record to establish that the rate is in fact as counsel argues it is.
.
But cf. In re Kelton,
There are no special equities raised by the fact that the interest claim asserted here happensto be held by a taxing authority. That the creditor is "involuntaiy” in the sense that no credit was intended to have been extended to this debtor does not change that creditor’s position as a competing claimant for the estate's limited assets as part of the larger distribution scheme in bankruptcy.
Kelton,
at 21. However, the
Kelton
court relied in large part on its own opinion in
In re Laymon,
. The Navis Realty court was not requested, however, to consider whether the compounding of the interest rate by the City constitutes a penalty. See discussion infra at 782.
. The Court notes that § 5-527 of New York’s General Obligations Law, entitled "Enforceability of compound interest," condones the accrual of interest upon unpaid interest for "loans and other agreements.” N.Y. Gen. Oblig. L. § 5-527 (McKinney's 1989 and Supp.1992).