Statutory Interest On Overdue Property Tax Claims In Bankruptcy – Code Section 511

Real Estate

Posted in on March 14, 2014

Despite its passage as part of BAPCPA almost a decade ago, Section 511 of the Bankruptcy Code continues to be overlooked by debtors’ counsel and courts in deciding matters related to the treatment of post-petition interest on municipal tax claims. In particular, where debtors’ real estate is subject to large pre-petition tax claims, Section 511 provides that post-petition interest on such claims must be calculated at, “the rate determined under applicable nonbankruptcy law.” Prior to BAPCPA bankruptcy courts could employ equitable considerations to alter the rate of post-petition interest on such claims; however, with the passage of Section 511, municipal creditors are entitled to statutory interest – 18% in the case of unpaid real estate tax claims. As a result, substantial post-petition interest may accrue during the course of a bankruptcy depending on the amount of pre-petition arrearage. Such interest will accrue ahead of the secured claim of any first mortgagee and actively erode any equity cushion that may exist. Therefore, in order to maintain the status quo, mortgagees are well advised to push for the debtor to pay post-petition statutory interest accruing on pre-petition real estate tax claims, in addition to post-petition taxes that may become due. This analysis may have an impact on disputes over the use of cash collateral and motions for relief from stay where the extent and reliability of any equity cushion protecting the mortgagee is in dispute. Although a mortgagee may not be entitled to adequate protection payments, and a court may not be inclined to grant a motion for relief from stay, the debtor may be compelled to pay post-petition statutory interest to a municipality holding a secured priority tax claim. Such payments will inure to the benefit of mortgagees in the event a motion for relief from stay is granted and the property does proceed to foreclosure where the value of the collateral is reduced by the amount of any priority real estate tax claim. Absent coaxing from mortgagees’ counsel, debtors and courts may overlook the impact of post-petition statutory interest on a debtor’s plan.