UNITED SAVINGS ASSOCIATION OF TEXAS, PETITIONER V. TIMBERS OF INWOOD FOREST ASSOCIATES, LTD. No. 86-1602 In the Supreme Court of the United States October Term, 1987 On Writ of Certiorari to the United States Court of Appeals for the Fifth Circuit Brief for the United States as Amicus Curiae Supporting Petitioner TABLE OF CONTENTS Question presented Interest of the United States Statement Summary of argument Argument: "Adequate protection" of a secured creditor's "interest" in property during the pendency of the automatic stay in bankruptcy includes protection for the time value of the proceeds the creditor would otherwise have received on foreclosure A. The language of Sections 361 and 362 supports including protection for the time value of hypothetical foreclosure proceeds 1. The phrases "adequate protection" and "indubitable equivalent" 2. The phrase "interest" in property B. The purpose of the automatic stay and its relationship to the reorganization provisions of the Bankruptcy Code support recognition of the time value of the secured creditor's foreclosure right Conclusion QUESTION PRESENTED Whether the requirement in 11 U.S.C. (& Supp. III) 361 and 362(d)(1) that a secured creditor receive "adequate protection" of its "interest" in property during the pendency of the automatic stay in bankruptcy includes protection for the time value of the proceeds that the creditor would have received on foreclosure. INTEREST OF THE UNITED STATES The United States and its agencies are often creditors in bankruptcy proceedings. For example, the Internal Revenue Service is a creditor in a very high percentage of such proceedings because of federal taxes owed by the debtor. Other agencies, such as the Farmers Home Administration of the Department of Agriculture and the Small Business Administration, make loans to private parties, some of which enter bankruptcy before repaying the loans. Still other agencies, such as the Federal Deposit Insurance Corporation, become creditors in reorganization proceedings because of the failure of entities they insure. Some of the claims of federal entities against debtors in reorganization are secured or partially secured; others are unsecured but entitled to a priority under 11 U.S.C. (& Supp. III) 507; and others are unsecured, nonpriority claims. The question presented by this case affects the rights of creditors vis-a-vis debtors and vis-a-vis each other. The United States therefore has an interest in the proper resolution of that question. STATEMENT This is a one-asset bankruptcy reorganization case. Respondent's only asset, an apartment project in Houston, is the security for a loan in the original principal amount of $4,100,000 made by petitioner in June 1982 (Pet. App. 57a). Respondent defaulted on the loan, and petitioner took action to foreclose on the apartment project, but one day before the foreclosure sale respondent filed a petition under Chapter 11 of the Bankruptcy Code, 11 U.S.C. (& Supp. III) 1101 et seq. (Pet. App. 57a-58a). The filing of the petition automatically stayed petitioner's attempts to foreclose under state law (11 U.S.C. (& Supp. III) 362(a)). On a secured creditor's request, the bankruptcy court must grant relief from the automatic stay imposed by Section 362 if the debtor does not provide "adequate protection" of the creditor's "interest in property" of the debtor (11 U.S.C. (Supp. III) 362(d)(1)). Petitioner sought such relief. The bankruptcy court held a hearing and determined that, on the date of the hearing, respondent owed petitioner more than $4,300,000 in principal and accrued prepetition interest but that the value of the apartment project was only $4,250,000 (Pet. App. 58a, 155a). The court also found that the value of the property was not depreciating but was appreciating, if at all, "very slightly" (id. at 144a (emphasis in original)). The bankruptcy court held that petitioner was entitled to "adequate protection" even though the value of the apartment project was stable. The court recognized that, because of the automatic stay, petitioner had lost the opportunity to foreclose under state law and to reinvest the proceeds (Pet. App. 144a-147a). Under 11 U.S.C. (& Supp. III) 361, the court ordered respondent to pay petitioner $42,500 per month as compensation for its lost opportunity to reinvest the proceeds of a foreclosure sale, or have the automatic stay lifted. /1/ The district court affirmed (Pet. App. 136a-138a). The court of appeals reversed. A panel first held that "Congress did not intend to provide undersecured creditors with periodic postpetition interest payments on the value of their collateral as an element of adequate protection" (Pet. App. 55a-56a). The panel therefore reversed "to the extent that it ordered (respondent) to pay $42,500 monthly for 'adequate protection of foreclosure rights'" (id. at 133a). The court granted rehearing en banc on the day the panel opinion was released (id. at 134a-135a) but eventually voted ten to five to reinstate the panel opinion (id. at 1a-52a). SUMMARY OF ARGUMENT In this case the Court must interpret what Congress meant, in the adequate protection sections of the Bankruptcy Code, when it referred to the secured creditor's "interest" in property. The court of appeals interpreted the adequate protection sections to mean that the creditor is protected only against the risk that the value of the physical property will decline. But the value of the physical property does not measure the secured creditor's "interest" in its collateral. Rather, the secured creditor's "interest" is its contract and state-law right to foreclose on the collateral on default -- an interest whose value declined when the power to exercise the right is delayed. This interpretation of the statutory term "interest" in property is supported by the pre-Code usage of the terms "adequate protection" and "indubitable equivalent," which now appear in Sections 361 and 362 of the Code. "Adequate protection," a term first used by Congress in 1934, has been interpreted ever since the decision in In re Murel Holding Corp., 75 F.2d 941 (2d Cir. 1935), to recognize the value of the creditor's right to foreclose at a particular moment. "Indubitable equivalent" is a phrase that was coined in that case precisely to refer to recognition of that value (75 F.2d at 942). The context in which those terms are used in Sections 361 and 362 is not the same as the context in which they were applied in Murel Holding, but there is no reason to believe that when Congress imported them into Sections 361 and 362 it did not intend them to be given their traditional meanings. Likewise, the phrase "interest" in property is most naturally read to refer not to a fractional share of the physical property but to the bundle of rights created by the creditor's contract and by state law. The central right a secured creditor enjoys is the right to foreclose on the collateral to obtain payment of a defaulted debt. Delaying the exercise of that right decreases the value of the creditor's "interest," whether or not the property itself is depreciating in value. The "provisions of the whole (bankruptcy) law, and * * * its object and policy" (Kelly v. Robinson, No. 85-1033 (Nov. 12, 1986), slip op. 6 (original quotation marks and citations omitted)), also support reading Sections 361 and 362 to recognize the time value of hypothetical foreclosure proceeds. Corporate reorganization proceedings under Chapter 11 exist to determine whether the assets are worth more as parts of a going concern than in piecemeal liquidation, and if so to capture that extra value. The automatic stay ensures that there is time to make that determination and act on it, but the adequate protection provisions exist to ensure that the losses caused by the automatic stay do not rest with the secured creditors. That is because secured creditors generally are not the beneficiaries of successful reorganization; rather, it is unsecured creditors who enjoy the benefit of successful reorganization, and the Code therefore requires them to bear the costs of reorganization. It is plainly the purpose of Sections 361 and 362 to relieve secured creditors of costs of reorganization. The administrative expense provisions of the Code likewise place costs of reorganization on the unsecured rather than the secured creditors. And the postpetition interest provisions of the Code, which protect the time value of the rights of both oversecured creditors and (in some instances) unsecured creditors, cannot rationally be read to imply that the adequate protection provisions of the Code must in all instances ignore the time value of the rights of undersecured creditors. Rather, a reading of Sections 361 and 362 that recognizes the time value of the foreclosure rights of all secured creditors -- oversecured or undersecured -- most sensibly reconciles all of these provisions of the Code. ARGUMENT "ADEQUATE PROTECTION" OF A SECURED CREDITOR'S "INTEREST" IN PROPERTY DURING THE PENDENCY OF THE AUTOMATIC STAY IN BANKRUPTCY INCLUDES PROTECTION FOR THE TIME VALUE OF THE PROCEEDS THE CREDITOR WOULD OTHERWISE HAVE RECEIVED ON FORECLOSURE Although we believe that the language and portions of the legislative history of the adequate protection requirement support including protection for the time value of the proceeds of a foreclosure that would have occurred but for the automatic stay, neither the statute nor its legislative history addresses this question explicitly. When the statutory language is read in light of the nature of a secured creditor's interest in property and the purpose of the automatic stay, however, we believe the argument for reading it to include such time value becomes compelling. A. The Language of Sections 361 and 362 Supports Including Protection for the Time Value of Hypothetical Foreclosure Proceeds This is a statutory interpretation case. Although other provisions and the structure of the Bankruptcy Code, 11 U.S.C. (& Supp. III) 101 et seq., are relevant, the statutory phrases that the Court must interpret are found in only four subsections. The first is 11 U.S.C. (Supp. III) 362(d)(1), which provides (emphasis added): On request of a party in interest and after notice and a hearing, the court shall grant relief from the stay provided under subsection (a) of this section, such as by terminating, annulling, modifying, or conditioning such stay -- (1) for cause, including the lack of adequate protection of an interest in property of such party in interest * * * . The other three subsections to be interpreted are all found ink 11 U.S.C. (& Supp. III) 361 (emphasis added): When adequate protection is required under section 362 * * * of this title of an interest of an entity in property, such adequate protection may be provided by -- (1) requiring the trustee to make a cash payment or periodic cash payments to such entity, to the extent that the stay under section 362 of this title * * * results in a decrease in the value of such entity's interest in such property; (2) providing to such entity an additional or replacement lien to the extent that such stay * * * results in a decrease in the value of such entity's interest in such property; or (3) granting such other relief, other than entitling such entity to compensation allowable under section 503(b)(1) of this title as an administrative expense, as will result in the realization by such entity of the indubitable equivalent of such entity's interest in such property. All four of the subsections to be construed refer to the creditor's "interest" in property. Section 362(d)(1) requires "adequate protection" of that "interest." Subsections (1) and (2) of Section 361 specify means of protection against decreases in the "value" of that "interest." Subsection (3) permits other means of adequate protection but requires that they result in the realization of the "indubitable equivalent" of that "interest." It seems clear that each of the four subsections refers to the same thing when it speaks of the creditor's "interest" in property. /2/ The court of appeals interpreted the four subsections to require protection only against the risk that the value of the physical property -- here, the apartment project -- would decline to such an extent as to reduce the number of dollars the creditor would eventually receive on foreclosure. Under that interpretation, the "value" of a creditor's "interest" never decreases for purposes of Section 361(1) and (2) unless the value of the property itself decreases, and the creditor receives the "indubitable equivalent" of its "interest" for purposes of Section 361(3) as long as it is assured that the value of the property itself does not decrease. But an ordinary secured creditor's "interest" in its collateral is not a fractional share of ownership, but a right, under its contract with the debtor and state law, to foreclose on the collateral on default and apply the foreclosure proceeds to the payment of the debt. That economically valuable right is temporarily blocked by the automatic stay. That "interest" of the creditor in the property constituting its collateral is not "adequate(ly) protect(ed)" under Section 362(d)(1) unless there is not only protection of the secured creditor's ability eventually to obtain the same number of dollars in foreclosure but also protection of its ability ultimately to collect the dollars that those proceeds would have earned if it had exercised its foreclosure right at the time it bargained for. The "value" of the creditor's foreclosure right decreases over time even when the value of the collateral is stable, because the right to collect a dollar a year from now is less valuable than the right to collect a dollar today; and the creditor receives the "indubitable equivalent" of its "interest" for purposes of Section 361(3) only if the rights granted the creditor recognize the time value of foreclosure proceeds. 1. The Phrases "Adequate Protection" and "Indubitable Equivalent" This interpretation is supported by the traditional usage of the phrases "adequate protection" and "indubitable equivalent" before passage of the Code. "Adequate protection" had been held to recognize the time value of money, and "indubitable equivalent" was a term of art used precisely to mean recognition of the time value of the right to foreclose at a particular moment -- a meaning that was quite clearly intended when the same phrase was used elsehwere in the Bankruptcy Code. "Adequate protection" is a term imported by Congress from the plan confirmation context into the automatic stay context. Congress first used the term in 1934 (see Act of June 7, 1934, ch. 424, Section 1, 48 Stat. 911-922), when it added a new corporate reorganization provision (Section 77B) to the Bankruptcy Act of 1898. That provision permitted a plan of reorganization to be confirmed, over the objection of a class of creditors, only if the plan "provide(d) in respect of (that) class of creditors * * * adequate protection for the realization by them of the value of their interests, claims, or liens, if the property affected by such interests, claims, or liens is dealt with by the plan" (Section 77B(b)(5), 48 Stat. 914). Within a year after the insertion of "adequate protection" into the Bankruptcy Act, the owners of an apartment building in default on their obligations made the same argument that respondent makes today: that "adequate protection" of the "value" of an "interest(), claim(), or lien()" in property need not take account of time value. In the seminal case of In re Murel Holding Corp., 75 F.2d 941 (2d Cir. 1935), the court disagreed. Judge Learned Hand wrote for the court (75 F.2d at 942): It is plain that "adequate protection" must be completely compensatory; and that payment ten years hence is not generally the equivalent of payment now. Interest is indeed the common measure of the difference, but a creditor who fears the safety of his principal will hardly be content with that; he wishes to get his money or at least the property. We see no reason to suppose that the statute was intended to deprive him of that in the interest of junior holders, unless by a substitute of the most indubitable equivalence. Murel Holding thus interpreted the phrase "adequate protection," as it appeared in the Bankruptcy Act, to require provisions fully equivalent to the creditor's right to foreclose at a particular moment, and Murel Holding coined the phrase "indubitable equivalence" for the purpose of capturing precisely that concept. /3/ There is reason to believe that Congress intended, in the Code, to give these two phrases the meaning that Judge Hand had given them. In the context in which Murel Holding arose -- the confirmation of a reorganization plan over the objection of a class of secured creditors (or "cramdown") -- Congress no longer uses the phrase "adequate protection," but it has now used in the statute Judge Hand's phrase "indubitable equivalen(t)" (see 11 U.S.C. 1129(b)(2)(A)(iii)). That was deliberate. See S. Rep. 95-989, 95th Cong., 2d Sess. 127 (1978) ("The indubitable equivalent language is intended to follow the strict approach taken by Judge Learned Hand in In re Murel Holding Corp. * * * ."); H.R. Rep. 95-595, 95th Cong., 1st Sess. 414 (1977) ("This contemplates a present value analysis that will discount value to be received in the future * * *."). There is, to be sure, no similarly precise recognition in the legislative history of Section 361(3) of the genesis of the "indubitable equivalent" language. But the repetition in Section 361 of such a peculiar phrase, which originated to capture the concept of the value of foreclosure at a particular moment and is still used with that meaning in Section 1129, certainly suggests that the phrase should be given the same meaning when it occurs in Section 361. /4/ The phrase "adequate protection" has a comparable history. It was used in the cramdown section of the old Bankruptcy Act (see 11 U.S.C. (1976 ed.) 616(7)) and had a well-understood meaning, which included compensation for the time value of money, from the time of Murel up to passage of the Code in 1978. See, e.g., In re Schwab Adams Co., 463 F. Supp. 8, 12 (S.D.N.Y. 1978); In re Cartwright Land Associates, 3 Bankr. 277, 279 (Bankr. S.D.N.Y. 1980). Although there is again no legislative history specifically tying this phrase in Sections 361 and 362 to its antecedent interpretations, it would be surprising for Congress to use such a timeworn phrase, even in a new context, and intend that it mean something different from what it had meant under prior law. See Case v. Los Angeles Lumber Products Co., 308 U.S. 106, 115 (1939) ("where words are employed in an act which had at the time a well known meaning in the law, they are used in that sense unless the context requires the contrary"). 2. The Phrase "Interest" in Property Sections 361 and 362(d)(2) require "adequate protection" not of the value of property, but of the value of the secured creditor's "interest" in property. And a secured creditor's "interest" in property is not a fractional share of the physical property, /5/ but a contract and state-law right to act in a particular manner against the property -- to foreclose -- in order to collect a debt that has gone into default. The Bankruptcy Code does not define the secured creditor's "interest" in its collateral, but the phrase necessarily refers to the bundle of rights created by contract and state commercial law. Bankruptcy law "generally (leaves) the determination of property rights in the assets of a (debtor's) estate to state law." Butner v. United States, 440 U.S. 48, 54 (1979) (footnote omitted); see also Vanston Committee v. Green, 329 U.S. 156, 170 (1946) (Frankfurter, J., concurring) ("(C)larity of analysis justifies repetition that except where federal law, wholly apart from bankruptcy, has created obligations by the exercise of power granted to the federal government, a claim implies the existence of an obligation created by State law."). /6/ A secured creditor's "interest" in its collateral consists centrally of the right, defined by its contract and state law, to force the collateral to be sold at a foreclosure sale on default in the debt, and to have the proceeds applied to payment of the debt. Procedures of course vary, and the secured creditor may have additional rights or may have only a limited or qualified right to force foreclosure. But, insofar as the automatic stay operates to stay a creditor's enjoyment of its interest in the collateral, it does so by staying foreclosure. Significantly, a secured creditor ordinarily may not, even on default, seize the property and enjoy the rights of an owner: in order to protect debtors, state law generally requires the creditor to proceed by way of foreclosure sale, so that any value in excess of its debt is available for junior secured creditors or the debtor. See, e.g., Uniform Commercial Code Sections 9-504 to 9-506 (1985 & Supp. 1986). (The secured creditor may, of course, become the owner of the property by being the high bidder at the foreclosure sale, but that is an ownership interest acquired by purchase at the time of foreclosure.) Congress was presumably aware of these textbook principles of creditors' rights when it enacted the Bankruptcy Code. As illustrated by the present case, when the question of adequate protection arises, the debt owed to the secured creditor is generally in default, either because a default occurred before bankruptcy or because bankruptcy itself was an event of default. /7/ And, as in the present case, the secured creditor generally has a matured right to foreclose on the collateral, which the automatic stay prevents it from exercising. In such a case, the stay plainly "results in a decrease in the value of (the creditor's) interest in such property": its interest is the right to foreclose against the property on default, and delaying its foreclosure, denying it the use of the foreclosure proceeds for a period of time, decreases the value of that interest. B. The Purpose of the Automatic Stay and its Relationship to the Reorganization Provisions of the Bankruptcy Code Support Recognition of the Time Value of the Secured Creditor's Foreclosure Right When interpreting a statute, a court "must not be guided by a single sentence or member of a sentence, but look to the provisions of the whole law, and to its object and policy." Kelly v. Robinson, No. 85-1033 (Nov. 12, 1986), slip op. 6 (original quotation marks and citations omitted). To whatever extent the phrase "adequate protection * * * of an interest of an entity in property" might be thought ambiguous standing alone, when the phrase is read in light of the purpose of the automatic stay in relation to the reorganization provisions of the Code, we believe the case for reading it to include the time value of the creditor's foreclosure right becomes compelling. The oft-stated purpose of corporate reorganization proceedings under Chapter 11 is to determine whether the assets of the debtor are worth more as parts of a going concern than in piecemeal liquidation and, if so, to reorganize so as to preserve that going-concern value. See, e.g., H.R. Rep. 95-595, 95th Cong., 1st Sess. 220 (1977). If there is to be time to determine whether there is going-concern value, and if any such value is ultimately to be preserved, secured creditors must be prevented from foreclosing immediately on the separate assets in which they generally hold security interests. That is the function of the automatic stay provided in 11 U.S.C. 362(a). /8/ But for the adequate protection provisions of Section 362(d) and Section 361, the costs imposed on secured creditors by the automatic stay would rest where they fall. The undisputed purpose of adequate protection is to force junior interests to bear at least some of these costs instead. The question in this case is whether the junior interests should bear not only the cost of depreciation or other decline in the value of the physical property over the stay period but also the costs of delay in exercise of the secured creditor's rights. The underlying reason for providing adequate protection is one that applies equally to both costs: reorganization proceedings are carried on for the benefit of junior interests, and secured creditors should not have to bear their costs. /9/ Secured creditors generally have nothing to gain and something to lose from the commencement and continuation of reorganization proceedings. Their claims are finite rather than residual. At the beginning of the proceedings, they have bargained-for rights against certain property, and at the end of the proceedings, adequate protection aside, their secured claims are bounded at the top by the same bargained-for rights in the same property (see 11 U.S.C. (& Supp. III) 1129(b)(2)(A)). But if the property has declined in value in the interim, or if their rights have been delayed, they suffer a real cost. It is possible that the reorganization proceedings will increase the value of the secured creditor's collateral, but the chances are small, and the secured creditor has no assurance that it will benefit from any such increase. /10/ The secured creditor receives no benefit unless the reorganization succeeds in preserving the going concern, /11/ and the collateral itself has a value to the going concern that exceeds its liquidation value, and the plan of reorganization gives the creditor the benefit of that excess. But, first, the standard assumption is that, even when the enterprise is determined to have a going-concern value in excess of the aggregate liquidation value of its assets, the going-concern value of a given item of collateral will, in general, equal its liquidation value. See generally 3 Collier on Bankruptcy Paragraph 506.04 2 , at 506-30 to 506-33 (15th ed. 1987). Only those assets that are uniquely valuable in the hands of the debtor will be worth more to the reorganized enterprise than the highest bidder at a foreclosure auction will pay, and for obvious reasons creditors prefer security interests in property whose value is not unique to the particular debtor. Moreover, the Code does not (as the court of appeals thought, Pet. App. 24a) routinely entitle the secured creditor to recognition, in a plan of reorganization, of the unique value of its collateral to the going concern. Section 1129(b)(2)(A)(i)(II) permits a plan to be crammed down on a class of secured creditors that receives "at least the value of (their) interest in the estate's interest in such property." Although it might well seem appropriate to interpret the term "value" in Section 1129(b)(2)(A)(i)(II) to mean full going-concern value, since the collateral is being used in a going concern and not liquidated, /12/ Congress expressly indicated in the legislative history of Chapter 11 that it was not directing the bankruptcy courts to recognize going-concern value. See H.R. Rep. 95-595, 95th Cong., 1st Sess. 224 (1977) (footnote omitted) ("The question of whether creditors are entitled (on confirmation of a plan of reorganization) to the going-concern or liquidation value of the business is impossible to answer. It is unrealistic to assume that the bill could or even should attempt to answer that question. * * * The bill only sets the outer limits on the outcome: it must be somewhere between the going-concern value and the liquidation value."). Thus, although a bankruptcy court could insist that a plan of reorganization give secured creditors the benefit of going-concern rather than liquidation value in that rare case where the two diverge, the Code gives secured creditors no assurance that any bankruptcy court would do so. Secured creditors are by no means routine beneficiaries of successful reorganizations. Conversely, unsecured creditors gain greatly from a successful reorganization. Most of the going-concern value that is captured by a successful reorganization is applied to their claims. See generally Baird & Jackson, Corporate Reorganizations and the Treatment of Diverse Ownership Interests: A Comment on Adequate Protection of Secured Creditors in Bankruptcy, 51 U. Chi. L. Rev. 97, 105-109 (1984) (explaining different incentives of different types of creditors in bankruptcy proceedings). /13/ The court of appeals thought that Congress meant to deny secured creditors protection for the time value of their hypothetical foreclosure proceeds in order to make secured creditors bear some of the cost of delay associated with a reorganization proceeding, so that reorganization would be more likely to occur (see Pet. App. 108a, 112a, 120a). But the policy suggested by other provisions of the Bankruptcy Code is exactly the opposite: because in the usual case only unsecured creditors and equity owners stand to benefit from successful reorganizations, every provision that deals with the costs of delay seeks to protect secured creditors against those costs. /14/ First, as to Sections 361 and 362 themselves, the statutes, on their face, are designed to protect secured creditors, not to impose costs on secured creditors. /15/ Nothing in the legislative history of those provisions suggests that Congress intended to impose costs on secured creditors. Rather, Congress intended to give secured creditors the "benefit of their bargain" in place of "an absolute right to (their) bargain." H.R. Rep. 95-595, 95th Cong., 1st Sess. 339 (1977); see also ibid. ("the purpose of the section is to insure that the secured creditor receives in value essentially what he bargained for"); S. Rep. 95-989, 95th Cong., 2d Sess. 53 (1978) (same two statements). /16/ The legislative history gives some examples of adequate protection, and those examples fail to take account of the time value of money. /17/ But nothing in the legislative history suggests that Congress affirmatively decided, contrary to the general purpose of Section 361, to impose on secured creditors a cost equivalent to the decline, over time, of the value of their foreclosure rights. Second, other sections of the Bankruptcy Code dealing with costs of the proceeding place them squarely on junior parties. For example, administrative expenses, which are those expenses that are "necessary (to) preserving the estate" (11 U.S.C. (Supp. III) 503(b)(1)(A)) and include wages and attorneys' fees (see ibid.; 11 U.S.C. (& Supp. III) 503(b)(3)), are required to be paid after the secured creditors' claims are satisfied but before any other creditor receives anything from the debtor. See 11 U.S.C. (& Supp. III) 507(a)(1), 507(b), 725, 726. The assets subject to claims of secured creditors cannot be used to pay such costs. /18/ This treatment of administrative costs is wholly inconsistent with the notion of the court of appeals that all parties should share in the costs of reorganization; it is consistent, however, with congressional recognition that it is junior classes who benefit from successful reorganizations and should bear their costs. Third, the treatment of postpetition interest in the Code -- on which the court of appeals heavily relied -- supports rather than refutes the proposition that Congress intended junior parties to participate in a reorganization only if secured creditors have received protection for the time value of the proceeds they would have received by exercising their rights. It is true, as the court of appeals noted, that no creditor -- oversecured, undersecured, or unsecured -- is allowed to include "unmatured interest" at the time of the petition in its claim. 11 U.S.C. (Supp. III) 502(b)(2). The court of appeals apparently inferred from this that all creditors, except an oversecured creditor receiving the benefit of 11 U.S.C. (Supp. III) 506(b), /19/ lose forever the right to compensation for the delay that bankruptcy brings in the payment of their claims. That is not true. Under 11 U.S.C. 726(a)(5), an unsecured creditor is entitled, on liquidation, to "interest at the legal rate from the date of the filing of the petition" before the debtor may receive anything. On confirmation of a plan of reorganization, the unsecured creditor is entitled (unless it consents to different treatment) to "receive or retain under the plan on account of (its unsecured) claim or interest property of a value * * * not less than the amount that such holder would receive or retain if the debtor were liquidated under chapter 7" (11 U.S.C. 1129(a)(7)(A)(ii)). Thus, if the assets of the estate are sufficient to allow equity holders to receive something from the estate even if the debtor were liquidated, then the unsecured creditor is entitled, in reorganization as in liquidation, to postpetition interest under Section 726(a)(5). The construction of Section 361 adopted by the court of appeals brings about a bizarre state of affairs when the assets of the estate are sufficient to allow participation by equity holders even on liquidation. /20/ In that situation, oversecured creditors are entitled, on liquidation or on confirmation of a plan, to receive postpetition interest under Section 506(b) in recognition of the delay in enforcement of their rights, and unsecured creditors are entitled to postpetition interest under Section 726(a)(5). But undersecured creditors must -- to the extent of their security -- suffer the delay in enforcement of their rights without any compensation, since no section of the Code provides them with postpetition interest on the secured portion of their claims, and the construction of Section 361 adopted by the court below would not protect the time value of their security interest. /21/ The only parties who have been forced to subsidize the bankruptcy proceeding are the undersecured creditors. The solution to this odd state of affairs is to accept the proposition -- consistent with the words Congress has used in Sections 361 and 362 -- that the time value of the secured creditor's hypothetical foreclosure proceeds is part of the "interest" that must be "adequate(ly) protect(ed)." Thus, oversecured creditors are entitled to their Section 506(b) rights in all cases and are entitled to additional rights in cases in which the Section 506(b) rights are not sufficient to provide adequate protection. /22/ See Pet. App. 39a-41a (Jones, J., dissenting); Note, Compensation for Time Value as Part of Adequate Protection During the Automatic Stay in Bankruptcy, 50 U. Chi. L. Rev. 305, 321-322 (1983). And unsecured creditors, if the estate has sufficient assets to allow them to participate in full if the debtor were liquidated, will (either on liquidation or on reorganization) receive postpetition interest under Section 726(a)(5). By providing "adequate protection" in the form of additiona liens that will entitle the undersecured creditor to have more of its claim allowed as a secured claim at the end of the proceeding -- or by providing the equivalent in cash payments -- Section 361 relieves the undersecured creditor of having to subsidize the proceeding. Nothing in the Code supports the perception of the court of appeals that Section 361 should, as a matter of policy, be read to limit rather than fully protect the economic rights of undersecured creditors. There is no general rule in bankruptcy -- at least not under the Code -- against the payment of postpetition interest, and there is most certainly no general rule that secured creditors must share with unsecured creditors the costs of reorganization. /23/ In sum, delay imposed by the automatic stay is a cost of the reorganization proceeding. By preventing the secured creditor from exercising its state-law rights, bankruptcy imposes a cost on the secured creditor. The value of its security interest is decreased both by the depreciation in its collateral during the bankruptcy proceeding and by the fact that the time when it can transform its security interest into cash has been extended into the future. Conversely, the debtor's estate appropriates any economic benefits of the automatic stay for itself. It is able to use this property to continue its operations. /24/ The property left in the estate, like services purchased by the estate, is used in the hope that the reorganized entity will ultimately achieve more benefit from it than its cost -- not, as the court of appeals thought, because the estate should be entitled to use property cost free in the hope that reorganization will ensue. /25/ The uncompensated retention of a secured creditor's collateral by the estate would transfer wealth from the secured creditor to the estate for the benefit of unsecured creditors and/or the debtor. It would also create a strong and inappropriate incentive for debtors to enter and prolong reorganization solely in order to delay their secured creditors, when there is no real hope of preserving "going-concern" values. The congressional policy reflected in the Bankruptcy Code suggests that it is the junior parties, not the secured creditor, who should bear the cost of the estate's retention of the collateral. CONCLUSION The judgment of the court of appeals should be reversed. Respectfully submitted. CHARLES FRIED Solicitor General RICHARD K. WILLARD Assistant Attorney General LOUIS R. COHEN Deputy Solicitor General ROY T. ENGLERT, JR. Assistant to the Solicitor General ROBERT S. GREENSPAN ROBERT K. RASMUSSEN Attorneys AUGUST 1987 /1/ Petitioner and respondent had previously agreed that respondent would pay petitioner the net income produced by the apartment complex. The bankruptcy court held that such payments should be applied against the required monthly payment of $42,500 (Pet. App. 153a-154a). /2/ For this reason, if any one of the four subsections assigns a clearly discernible meaning to the creditor's "interest" in property, it is logical to conclude that all four subsections assign that same meaning. The court of appeals thought that the meaning of "interest" in property could most clearly be determined from the language of subsections (1) and (2) of Section 361 (see Pet. App. 70a) and then reached the logical conclusion that Section 361(3) did not mean anything different. We submit, however, that it is very far from clear that subsections (1) and (2) have the meaning that the court of appeals assigned to them and that it is in subsection (3) that Congress has -- through use of the phrase "indubitable equivalent" -- most clearly indicated what "interest" in property was to be protected. See pages 8-10, infra. Because subsection (3) assigns an unambiguous meaning to the "interest" that is to be protected, it is that unambiguous meaning that should guide interpretation of "interest" in subsections (1) and (2), and not vice versa. /3/ The court of appeals observed (Pet. App. 101a): "In 1978, Congress did codify the holding of Murel, as distinguished from its rhetoric, in the cram-down provisions of the Code." That is true. But Congress also codified the phrases "adequate protection" and "indubitable equivalen(t)" -- what the court of appeals called Murel's "rhetoric" -- in Sections 361 and 362. Although the legislative history does not explain the source of the phrases as used in those sections, neither does it suggest that Congress meant them to be construed without reference to prior statutes and cases that employed them. /4/ Section 361(3) in its present form was contained in neither the bill as first passed by the House nor the bill as first passed by the Senate; the "conferees" added the "indubitable equivalent" language without explanation (see Pet. App. 97a-99a). But the best evidence of what Congress intended is the words used in the statute that Congress passed. /5/ This was apparently the view taken by the court of appeals. In its lengthy opinion, its only discussion of the meaning of the phrase "interest in such property" is a quotation of the statute followed by the statement "(c)learly neither subsection (1) nor (2) authorizes periodic payments to a creditor whose collateral is not decreasing in value" (Pet. App. 70a). /6/ Indeed, it is a fundamental principle of bankruptcy law that it operates on substantive rights created outside of bankruptcy. See, e.g., CFTC v. Weintraub, 471 U.S. 343, 351-352 (1985) (corporation's attorney-client privilege controlled by actor whose role approximates that of management outside of bankruptcy); Ohio v. Kovacs, 469 U.S. 274, 286 (1985) (O'Connor, J., concurring) ("the classification of Ohio's interest as either a lien on the property itself, a perfected security interest, or merely an unsecured claim depends on Ohio law"); Hill, The Erie Doctrine in Bankruptcy, 66 Harv. L. Rev. 1013, 1035 (1953) ("apparent purpose" of federal bankruptcy laws is to provide a system for the effectuation of state-created rights). /7/ Often, the terms of the debt specify that bankruptcy will be treated as an event of default. Furthermore, regardless of the terms of the debt, the Code -- in particular 11 U.S.C. (& Supp. III) 502 -- generally treats bankruptcy as an event of default and acceleration. See H.R. Rep. 95-595, 95th Cong., 1st Sess. 352-353 (1977) ("bankruptcy operates as the acceleration of the principal amount of all claims against the debtor"). /8/ The present case is a poor illustration: the single asset, an apartment building, obviously has the same "liquidation" value as "going-concern" value. What this case does appear to illustrate is the misuse of Chapter 11. The relevant question about the one asset is, "Does it have any present value in excess of the debt it secures?" If not, then its value properly belongs wholly to the secured creditor. The appropriate way to answer the question would appear to be a foreclosure sale. Requiring the debtor to pay (or provide additional collateral to cover) the time value of the secured creditor's estimated foreclosure proceeds would at least prevent the debtor from gambling (on an upturn rather than a downturn in value) at the direct expense of the secured creditor. It would also curtail reorganization proceedings founded solely on the hope of such an upturn, rather than on the premise that reorganization would produce more value than liquidation. /9/ The court of appeals took a directly contrary view, opining that reorganization in general is carried on for the benefit of secured creditors as well as junior parties (see Pet. App. 24a). The court of appeals never endeavored to explain why, in that case, Congress shifted any costs away from secured creditors to the junior parties -- which is indisputably what the adequate protection provisions do. /10/ It is also possible that market conditions will change so as to increase the value of collateral during the proceedings, but that sort of increase is of course not a product of the proceedings. There is no good reason why a secured creditor should have to incur any cost on the chance that market conditions will increase the value of its collateral after the moment at which, under its contract, it would have been entitled to foreclose. /11/ Most reorganization attempts -- roughly 90% -- are not successful (see Pet. App. 25a n.17, 47a). /12/ Section 506(a) directs the bankruptcy court to determine the value of a creditor's interest in the estate's interest in property "in light of the purpose of the valuation and of the proposed disposition or use of such property." /13/ The automatic stay and the adequate protection requirement also apply in a liquidating bankruptcy. Although the issue is much less important in that context, there too the automatic stay benefits unsecured creditors (whose interest lies in orderly distribution of the estate), not secured creditors (who bargained for the right to foreclose on specific assets and are temporarily barred from exercising that right). See generally Jackson, Bankruptcy, Non-Bankruptcy Entitlements, and the Creditors' Bargain, 91 Yale L.J. 857, 860-868 (1982) (decribing the benefits that unsecured creditors obtain from a collective bankruptcy proceeding). /14/ Of course, the Code treats undersecured creditors as both secured ("to the extent of the value of (the) creditor's interest in the estate's interest in" the collateral) and unsecured (to the remaining extent of the allowed claim). 11 U.S.C. 506(a). In their capacity as holders of unsecured claims, undersecured creditors do and should bear the costs of reorganization to the same extent as other holders of unsecured claims. But the fact that they must -- as holders of unsecured claims -- bear some of the costs of reorganization does not mean that they should bear additional costs in their capacity as secured creditors. /15/ An amicus brief filed in the court of appeals at the rehearing en banc stage put the point well (C.A. Br. for Amicus Curiae Thomas H. Jackson 18 n.18): The panel opinion * * * argues that "(t)here would be little economic incentive for the undersecured creditor . . . to cooperate in developing a negotiated plan. Pet. App. 112a. This elides the fact that such cooperation is not necessary, see 11 U.S.C. Section 1129(b). Such an argument, moreover, turns 11 U.S.C. Section 361 upside down: it turns a section designed to protect secured creditors into a vehicle for coercing their cooperation (by imposing economic harm on them). The fact that, if time value were protected, delay "would have little adverse effect on the (secured) creditor,"