Opinion
Case No. 00-17635-BKC-RAM, Adv. No. 02-1526-BKC-RAM-A.
October 24, 2007
ORDER AWARDING PREJUDGMENT INTEREST
This adversary proceeding was tried on January 10, 2007. At issue were certain transfers from the Debtor, Sophisticated Communications, Inc., into a Debtor bank account at the Defendant's bank which cured overdrafts in the Debtor's account. The Court issued a Memorandum Opinion on May 25, 2007 (CP# 114) ruling that these transfers, totaling $690,934.65, were avoidable as preferences under 11 U.S.C. § 547 (the "Preferential Transfers"), and that Plaintiff was entitled to a judgment in that amount under 11 U.S.C. § 550. The Court deferred entry of judgment pending further briefing and argument on whether the judgment should include prejudgment interest. The Court has considered the Trustee's Memorandum of Law in Support of an Award of Prejudgment Interest (CP# 122), City National Bank of Florida's Response (CP# 124), the Trustee's Reply (CP# 125), and the arguments of counsel at a hearing on August 1, 2007. For the reasons set forth below, the Court finds it appropriate to award prejudgment interest on the full amount of the Preferential Transfers from the filing date of the Amended Complaint and to determine the interest rate in accordance with 28 U.S.C. § 1961.
Background
A full recitation of the procedural and factual background of this adversary proceeding can be found in the Memorandum Opinion. A portion of that background relevant to the Court's decision to award prejudgment interest is repeated below.
The Trustee's pursuit of the estate's avoidance actions against City National Bank of Florida ("City National") began with a letter dated March 7, 2002 demanding return of certain alleged preferential transfers (the "Demand Letter"). The Demand Letter sought recovery of transfers which were alleged to have occurred in August 2000, within 90 days of the August 28, 2000 involuntary Chapter 7 bankruptcy petition. By letter dated March 14, 2000, City National responded that it was not subject to preference liability for any transfers during the preference period, including the August transfers described in the Demand Letter, because it had held "a security interest in the deposits that are utilized to cover the overdrafts" and in any event "payments to cover the overdrafts are not considered antecedent debts." (Ex. B Trustee's Mem. of Law.) City National maintained and argued this position throughout this proceeding. Although the Trustee ultimately established that the Preferential Transfers were avoidable and recoverable, the specific transfers ultimately avoided were not the subject of the Demand Letter.
The Preferential Transfers, which occurred on July 20, 2000, first appeared in the record in the Trustee's Complaint filed on November 12, 2002. The Complaint was dismissed with leave to amend because it named the wrong City National entity as the defendant. Subsequently, the Trustee filed the Amended Complaint on December 24, 2002. The Amended Complaint sought in three counts to recover in excess of $15 million from City National. Count I sought recovery of preferential transfers into the Debtor's account at City National. Count II sought to recover preferential transfers into a City National account in the name of a related entity, Locin, based on an alter-ego theory. Count III sought recovery of alleged fraudulent transfers from the Debtor to Locin and then into Locin's account at City National.
In January 2004, City National moved for summary judgment on all counts. The summary judgment motion presented several significant and complex issues and was the subject of substantial briefing and several hearings. It remained under advisement for an unusually long period of time, nearly two and a half years. The delay, in part, arose from the pendency of an appeal in a related proceeding which included similar legal issues. In large part, it was simply delay by the Court in issuing its Order. Neither party was at fault.
Ultimately, on June 26, 2006, the Court issued its 25 page Order (the "Summary Judgment Order") (CP# 78). The Summary Judgment Order discussed the difference between collected funds overdrafts and ledger balance overdrafts and ruled that the Trustee could not avoid transfers which simply cured collected funds overdrafts arising from provisional credits on deposits (S.J. Order 16). Moreover, in limiting the Trustee to pursuing avoidance of only those transfers curing ledger balance overdrafts, the Court preliminarily rejected the Trustee's theory that every transfer curing a ledger balance overdraft during the preference period could be avoided and the amounts aggregated (S.J. Order 3, n. 1). Rather, the Summary Judgment Order preliminarily ruled that only those transfers made on the "darkest day" were subject to avoidance and recovery. This significantly limited the estate's possible recovery since, as to the Debtor's account alone, the Amended Complaint sought to avoid 22 transfers totaling in excess of $6,000,000.
In September, 2006, the Trustee abandoned Count II. At trial, he abandoned Count III. Count I of this adversary proceeding was tried on January 10, 2007.
Discussion
A. The Court has Discretion to Award Prejudgment Interest in Preference Actions if the Award Compensates the Estate and is Equitable
Entitlement to and the amount of prejudgment interest are to be determined in the court's discretion. In re International Administrative Services, Inc., 408 F.3d 689, 709 (11th Cir. 2005); Industrial Risk Insurers v. M.A.N. Gutehoffnungshütte GmbH, 141 F.3d 1434, 1446-47 (11th Cir. 1998). The award of prejudgment interest, however, must serve to compensate the estate, not penalize the preference defendant. See International Administrative Services, 408 F.3d at 710; Industrial Risk Insurers, 141 F.3d at 1446-47. Because prejudgment interest is an exercise of the court's discretion, the award of prejudgment interest must also be equitable. Osterneck v. E.T. Barwick Industries, Inc., 825 F.2d 1521, 1536 (11th Cir. 1987). No provision of the Bankruptcy Code provides that the estate may recover prejudgment interest in an action to avoid a preferential transfer. 5 Collier on Bankruptcy ¶ 550.02[3][b] (15th ed. rev. 2007). Relying on federal common law and the authorization in § 550(a) to award the estate "value", however, courts have awarded prejudgment interest in preference actions. In re Milwaukee Cheese Wisconsin, 112 F.3d 845, 849 (7th Cir. 1997); In re Cybermech, 13 F.3d 818, 822 (4th Cir. 1994); In re Investment Bankers, Inc., 4 F.3d 1556, 1566 (10th Cir. 1993).
B. Prejudgment Interest Compensates the Estate for the Time Value of Money and Compensates the Estate's Creditors by Ensuring they Receive an Equal Distribution
The compensatory purpose served by an award of prejudgment interest in preference actions is to compensate the estate for the time value of money of the contested funds withheld by the preference defendant. Milwaukee Cheese, 112 F.3d at 849 (holding that prejudgment interest is necessary to fully compensate a prevailing plaintiff because "[c]ompensation deferred is compensation reduced by the time value of money"); Cybermech, 13 F.3d at 822 (prejudgment interest compensates the estate for the loss of the opportunity to accrue interest on the contested funds); Investment Bankers, 4 F.3d at 1566 ("[a]n award of prejudgment interest would serve to compensate the debtor's estate for [the preference defendant's] use of those funds that were wrongfully withheld from the debtor's estate during the pendency of the current suit").
An additional compensatory purpose in preference actions is to ensure equality among the estate's creditors. Not awarding prejudgment interest frustrates creditor equality because the preference defendant effectively receives a greater distribution than the other creditors. If prejudgment interest is not awarded, the estate's other creditors are under compensated because the preference defendant keeps the interest accrued on the preference to the detriment of the other creditors. Awarding the prejudgment interest allows all the estate's creditors to share equally in both the preference amount and the accrued interest.See Milwaukee Cheese, 112 F.3d at 849 ("the longer the case lasts, the more of the stakes the [preferential creditor] keeps even if it loses (and the less the victorious [estate] receives), unless interest is added"); Cybermech, 13 F.3d at 823 (prejudgment interest "ensur[es] that all similarly-situated creditors will receive the same pro rata share of the interest").
C. A Judgment Avoiding a Preferential Transfer Determines that the Contested Funds were Withheld Wrongfully
Language in the Eleventh Circuit's Administrative Services decision suggests that the contested funds must be wrongfully withheld. 408 F.3d at 710 ("[w]e think that policy [of compensation to the plaintiff] is appropriate here, to compensate `the debtor's entire estate for the use of the funds for the period of time in which they were wrongfully withheld'") (emphasis added). A judgment avoiding a preferential transfer determines the prior existence of liability under §§ 547 and 550, and the preference defendant's retention of the contested funds after the Trustee has elected to avoid the transfer is wrongful.In re Neponset River Paper Company, 219 B.R. 918, 921 (Bankr. D.Mass. 1998) ("a judgment on the [preference] claim does not create liability; it merely recognizes and determines the prior existence of the liability"); In re Investment Bankers, Inc., 135 B.R. 659, 668 (Bankr. D.Colo. 1991); In re Independent Clearing House Co., 41 B.R. 985, 1015 (Bankr. D. Utah 1984), aff'd in part and rev'd in part, 62 B.R. 316 (D. Utah 1986).
D. Timing and Calculation Issues
The majority of courts awarding prejudgment interest in preference actions start calculating the interest from the date of demand. Cybermech, 13 F.3d at 822. Absent special circumstances, it would be inequitable to impose prejudgment interest from the date of transfer because the estate's funds are not wrongfully held as of the transfer date. At that time the transfer is simply payment of a debt.Independent Clearing House, 41 B.R. at 1015. Nor is the petition date generally an appropriate date from which to begin calculating prejudgment interest. A trustee may in exercise of his or her business judgment decide not to pursue preference actions. Only once the bankruptcy petition is filed, the preference cause of action accrues, and the trustee demands return of the preference is the preference defendant wrongfully holding funds of the estate. At that point the preference defendant is on notice that it is holding the preference funds in contravention of the Bankruptcy Code and is obligated to return those funds to the bankruptcy estate. Id. Judgment for the plaintiff determines that the defendant wrongfully withheld the preference funds from the date of demand. Neponset River Paper, 219 B.R. at 921 (preference defendant's liability arises upon demand); Investment Bankers, 135 B.R. at 668 (judgment deems preference defendant wrongfully withheld contested funds from the date of demand).
The Court finds it appropriate to begin calculating the prejudgment interest not from the date of the Demand Letter but rather from the date the Amended Complaint was filed. The Demand Letter identified transfers that were not ultimately avoided and did not identify the transfers that were ultimately avoided. Because the Preferential Transfers were not identified in the Demand Letter, City National was not on notice with respect to these transfers. It would be inequitable to find that City National was wrongfully withholding the avoided transfers as of the Demand Date. The Preferential Transfers were identified upon the filing of the Complaint. Although the Complaint named the wrong City National entity, there is no question that at the time of the Complaint City National had actual notice that it held funds of the estate. However, the need to amend the Complaint to name the correct City National entity caused a delay of approximately one month until the Amended Complaint was filed. Because this delay is chargeable to the Trustee, it would be inequitable to start calculating prejudgment interest until the date of the Amended Complaint.
The majority of courts have determined the prejudgment interest rate in preference actions in accordance with 28 U.S.C. § 1961, which provides for postjudgment interest in federal actions at the Treasury bill rate. See, e.g., Investment Bankers, Inc., 135 B.R. at 669-670. The compensatory purpose of prejudgment interest may suggest a higher interest rate in certain circumstances. In re NETtel Corp., Inc., 327 B.R. 8, 13 (Bankr. D.D.C. 2005) (applying prime rate in a reorganizing Chapter 11 to compensate the estate for the cost of borrowed funds). However, where the estate's opportunity to utilize the contested funds is limited to accruing interest, the § 1961 rate appropriately reflects that opportunity.
The Court concludes that calculating the prejudgment interest by applying the rates applicable under 28 U.S.C. § 1961 is equitable and appropriate. At the hearing, City National acquiesced to this calculation method. The Trustee in his briefing and at the hearing sought a higher interest rate based on the prime rate and semi-annual compounding. The Trustee, however, did not point to any facts in this case which establish that the damage to the estate for the loss of the opportunity to utilize the contested funds was greater than a conservative, savings-based utilization of the preference funds.
In doing the calculation, the Court finds it appropriate to compute the interest in yearly increments utilizing the federal rate under 28 U.S.C. § 1961, applicable for each yearly increment. See Odom v. Frank, 782 F. Supp 50 (N.D.Tex. 1991). This calculation method approximates the Trustee's lost opportunity to utilize the funds. Thus, the federal rate of 1.43% applicable on December 24, 2002, is used to calculate interest of $9,880.37 for the period of December 24, 2002, through December 23, 2003. This interest component for year one is added to the Judgment, and interest for year two (December 24, 2003, to December 23, 2004) is then calculated against the new total, applying the 1.27% federal rate applicable on December 24, 2003, the start of the second year. The same methodology is used for the remaining period through the date of this Order and the yearly calculations are provided at the end of this Order.
E. Awarding Prejudgment Interest is Equitable
Because prejudgment interest is awarded in the court's discretion, the court must examine the facts and circumstances of each particular case to ensure that an award of prejudgment interest is equitable. See Osterneck, 825 F.2d at 1536. The Court's discretion, however, is not a license to decide which party deserves the money more. Milwaukee Cheese, 112 F.3d at 849. "[P]rejudgment interest should be awarded unless there is a sound reason not to do so." Id.
City National makes three arguments that it would be inequitable to impose prejudgment interest. First, relying on two Eighth Circuit cases, In re Armstrong, 291 F.3d 517, 528 (8th Cir. 2002) and In re Bellanca Aircraft Corp., 850 F.2d 1275, 1281 (8th Cir. 1988), City National argues that prejudgment interest is inappropriate because the Trustee's claims could not be resolved without judicial determination. In both cases, the Eighth Circuit affirmed each bankruptcy court's exercise of its discretion to deny prejudgment interest. In Armstrong, a good-faith dispute as to liability existed. 291 F.3d at 528. InBellanca, the amount of the preference payment was not ascertainable without a judicial determination. 850 F.2d at 1281. Neither case announced a rule that prejudgment is inappropriate where a judicial determination is necessary as to either liability or amount. They simply affirmed the bankruptcy court's exercise of discretion to deny prejudgment. The decisions are not particularly instructive since they do not describe or analyze what circumstances or reasons in those cases led those bankruptcy courts to deny prejudgment interest.
To the extent Armstrong suggests that prejudgment interest should not be awarded where liability is contested, this Court disagrees. Instead, it finds persuasive the holding and analysis in Neponset River Paper Co. v. Travelers Insurance Co., 219 B.R. 918, 921 (Bankr. D. Mass. 1998), aff'd, 231 B.R. 829 (B.A.P. 1st Cir. 1998). That court awarded prejudgment interest even though preference liability was disputed. The court reasoned that regardless of the potential merits of the defenses, once a judgment is entered the estate is entitled to a complete recovery, which includes prejudgment interest to compensate the estate for the time value of money. Neponset River Paper, 219 B.R. at 921. The judgment determining liability on the preference claim "does not create liability; it merely recognizes and determines the prior existence of the liability." Id. Preference defendants can mitigate any perceived unfairness or hardship by reasonably investing the contested funds during the course of the litigation. Milwaukee Cheese, 112 F.3d at 849. More importantly, vis-a-vis the estate and its creditors, the preference defendant — because it actually has the contested funds and the opportunity to invest them — is the most appropriate party to bear the risk and it is therefore fair to impose that risk. Thus, it is not inequitable to impose prejudgment interest in this case even though liability was disputed.
Second, City National argues that the Court should exercise its discretion to deny prejudgment interest because of the difference between the scope of the initial claims plead in the Amended Complaint and the scope of the Trustee's ultimate victory. For the proposition that inflated claims alone are sufficient reason to deny prejudgment interest City National cites two cases. The first, Osterneck v. E.T. Barwick Industries, Inc., 825 F.2d 1521 (11th Cir. 1987), is inapposite. In Osterneck, the Eleventh Circuit affirmed a district court order reducing the initial award of prejudgment interest by two-thirds. However, the district court's reason for reducing the award was that the award of prejudgment interest exceeded the plaintiff's actual damages and was therefore punitive. Id. at 1536. The decision had nothing to do with the issue raised here, namely, whether prejudgment interest should be disallowed where the initial claim greatly exceeds the damages ultimately awarded.
City National's second case does relate to inflated damage claims. In re Windsor Communications Group, Inc., 80 B.R. 712 (Bankr. E.D.Pa. 1987). In Windsor the bankruptcy court declined to award prejudgment interest where the plaintiff's claims were "overblown," approximately $1.5 million sought contrasted with less than $38,000 recovered. Id. at 724. However, the magnitude of the difference between the Trustee's initial claims and ultimate victory was not the issue. The reason the court found it appropriate to deny prejudgment interest was that the overblown claims caused delay that prejudiced the defendant.
Turning to the issue of delay, City National's third argument is that it is inequitable to charge it for prejudgment interest for the full length of this litigation. It argues that it should not be charged for the delay caused by the necessity to resolve the complex legal issues in this proceeding, by the various motions and Orders which winnowed down the number of transfers at issue in the Trustee's Amended Complaint, by waiting for the Summary Judgment Order, and by the Trustee failing to identify the Preferential Transfers in the Demand Letter and failing to name the proper defendant in the Complaint.
The Court acknowledges that this proceeding was pending an unusually long time before trial and entry of the Memorandum Opinion determining liability. The Court also acknowledges that a significant portion of the delay in ruling on the Summary Judgment Motion was solely the Court's responsibility. Nevertheless, in reviewing the case law and the purposes served in awarding prejudgment interest, the Court does not find that the delay renders the award inequitable, where, as here, it was not the Plaintiff's conduct which caused the delay.
Delay is essentially the loss for which the estate is being compensated. Milwaukee Cheese, 112 F.3d at 849 ("[d]elay is a reason to award interest, not to avoid interest"). It is not enough to point to some circumstance that increased the length of the litigation; rather, the delaying circumstance must have prolonged the length of the litigation in a way that is unfair to the preference defendant. To apply unfairness in a principled manner it must be measured against the compensatory purpose of prejudgment interest. For example, where the litigation is delayed because of the plaintiff's error or strategy it may be appropriate to reduce, or in drastic circumstances to deny, the award of prejudgment interest. Id. ("Gratuitous delay by the party seeking the award — delay that injures the other side by forcing it to act as an uncompensated trustee or investment manager — might be a reason to limit an award of interest.")
In this case, the greatest part of the delay resulted from the length of time in which the Court had the Summary Judgment Motion under advisement. Delay attributable to the judicial branch is neutral as between the parties. Milwaukee Cheese, 112 F.3d at 849. Delay attributable to the judicial branch increases the harm — the loss of the opportunity to invest the contested funds — through no fault of either party. It is nevertheless equitable, or at least not inequitable, to impose prejudgment interest on the preference defendant because the preference defendant has possession of the contested funds, and therefore, as between the parties, it is in the best position to minimize or eliminate the loss.
In this case, the fact that the Trustee's initial claims were subject to some winnowing did not create an equitable reason to reduce or deny prejudgment interest. To the extent that this winnowing was attributable to the difficult legal issues presented, that is a circumstance inherent in the judicial process. The winnowing of the factual allegations from numerous transfers to City National throughout the preference period to only the Preferential Transfers either was necessary to the "darkest day" defense and City National's other defenses or followed naturally once the legal issue was resolved. Moreover, the inclusion of Count II and III did not unduly delay this proceeding. From the record, there was a good-faith basis to allege that Locin was an alter-ego of the Debtor (Count II) and to allege that certain transfers from the Debtor through Locin to City National were fraudulent (Count III). Nor can a negative inference be drawn from the fact that Counts II and III are inconsistent because it is permissible to plead for alternative, inconsistent relief.
Conclusion
Resolution of this adversary proceeding took an unusually long time and required analysis of several complex legal issues relating to bank deposits, overdrafts and the application of preference law. Moreover, the ultimate judgment in Plaintiff's favor avoids only a fraction of the transfers subject of the Amended Complaint. Nevertheless, the Court concludes that awarding prejudgment interest is equitable and appropriate to compensate the Plaintiff for the time value of the funds constituting the Preferential Transfers. Therefore, it is —
ORDERED as follows:
1. The Trustee is awarded prejudgment interest for the period from December 24, 2002, to October 24, 2007, the date of this Order, and the Final Judgment being entered separately this day.
2. Applying the calculation methodology described in Section D. above, the Court is awarding prejudgment interest in the amount of $101,401.77, calculated as follows: YEAR RATE ANNUAL INTEREST TOTAL
Source: http://www.federalreserve.gov/releases/H15/data/weekly_friday_/H15_TCMNOM_Y1.TXT