In 1983 Southeast Banking Corporation issued $60 million in unsecured senior notes. Southeast also issued more than $300 million of subordinated junior notes. The subordinated indenture instruments contained language subordinating collection to the prior payment in full of the senior notes.
In September 1991, Southeast filed a Chapter 7 bankruptcy petition. The bankruptcy court ordered Southeast to distribute to the senior noteholders amounts sufficient to pay principal and interest accrued prior to filing the bankruptcy petition. The bankruptcy code does not provide for the recovery of post-petition interest. Accordingly, the senior noteholders commenced an action in the bankruptcy court to collect post-petition interest not from Southeast but from amounts that would otherwise be distributed to the subordinated noteholders. The subordinated indentures were silent on whether the terms of subordination covered post-petition interest.
The bankruptcy court held that the senior noteholders were not entitled to post-petition interest. The case was appealed to the US Court of Appeals for the Eleventh Circuit which certified the question to the New York Court of Appeals because the indentures were governed by New York law.
The New York Court of Appeals has ruled that under the Rule of Explicitness the senior noteholders were not entitled to post-petition interest from the proceeds of the bankrupt's estate. Under the Rule of Explicitness a senior creditor's claim for post-petition interest will not be allowed unless the subordination agreement explicitly alerts the subordinated creditors to the risk that their recoveries may be diminished by the payment of such amounts.Here, the subordinated indentures were silent as to the possible payment of post-petition interest, and therefore the senior creditors were not entitled to recover such interest.
The New York Court of Appeals found the Rule of Explicitness to be based on sound commercial and legal policies. Since the bankruptcy code does not permit creditors to recover post-petition interest from the bankrupt debtor, they should not be allowed to recover such interest from amounts otherwise payable to junior creditors unless such creditors have been notified in advance of such risk. The indenture or other subordination agreements must explicitly provide for the payment of post-petition interest to the senior creditors before the subordinated creditors are entitled to any recovery. Indentures and subordination agreements must be drafted with this decision in mind.Robert S Rendell