The United States Court of Appeals for the First Circuit upheld a bankruptcy court’s ruling that, where subordination agreements lacked explicit provisions addressing the payment of post-petition interest on senior unsecured debt, the agreements were ambiguous, and an inquiry into the parties’ intent was required. After probing the facts and analyzing New York law, the bankruptcy court determined that the contracting parties did not intend to subordinate the junior unsecured debt to post-petition interest on the senior debt.


Under the Bankruptcy Code, as in prior law, unsecured creditors are generally denied interest arising after the date the petition was filed. Section 502 of the Bankruptcy Code states:

  1. A claim or interest, proof of which is filed under section 501 of this title, is deemed allowed, unless a party in interest . . . objects.
  2. If such objection to a claim is made, the court . . . shall allow such claim . . . except to the extent that . . . such claim is for unmatured interest.

11 U.S.C. § 502. However, it is possible for a pre-bankruptcy subordination agreement to address the payment of interest so as to modify the above general rule. Section 510(a) of the Bankruptcy Code provides that a subordination agreement is enforceable “to the same extent that such agreement is enforceable under applicable nonbankruptcy law.” 11 U.S.C. § 510(a). Thus, state law, which generally governs the interpretation of private contracts, determines the enforceability of subordination agreements, including their provisions regarding the payment of post-petition interest.

Typically, subordination agreements provide that senior debt must be paid in full, including principal, interest and related fees, before any payment on junior debt is made. The issue on appeal in HSBC Bank USA v. Bank of New York Mellon Trust Co. (In re Bank of New England Corp.), 2011 WL 2476470, No. 10-1456 (1st Cir. June 23, 2011) (“BNEC VII”) was whether senior unsecured creditors could receive post-petition interest where their subordination agreements did not specifically state that post-petition interest must be paid to senior creditors before junior creditors may receive any distributions.  

BNEC VII involved six series of unsecured debt instruments issued by the Bank of New England. Three of these offerings, the senior debt, were entitled to the benefit of contractual subordination provisions. The remaining three offerings, the junior debt, were subordinated to the senior debt. Each trust indenture for the junior debt contained a subordination provision substantially similar to the following:

all principal . . . and interest due or to become due upon all Senior Indebtedness of the Company shall first be paid in full . . . before any payment is made on account of the principal of or interest on the indebtedness evidenced by the [Subordinated Notes] due and owing at the time . . .(emphasis added). BNEC VII, 2011 WL 2476470 at *1.

On January 7, 1991, the Bank of New England filed a voluntary petition for relief pursuant to Chapter 7 of the Bankruptcy Code. The Chapter 7 Trustee later made distributions that satisfied in full all principal and interest due under the senior notes as of the petition date, along with approved fees and expenses incurred. The Chapter 7 Trustee, in 2001, sought bankruptcy court authority to make distributions to holders of the junior debt. The senior creditors objected, arguing that they should first be paid accrued post-petition interest.

Initial Proceedings

The bankruptcy court granted the Chapter 7 Trustee’s motion over the senior trustee’s objection and authorized the distributions. In re Bank of New England Corp., 269 B.R. 82 (Bankr. D. Mass. 2001) (“BNEC I”). BNEC I held that the “Rule of Explicitness,” an aspect of bankruptcy law that predates the 1978 enactment of the Bankruptcy Code, governs (and imposes strict requirements for) the payment of post-petition interest. Further, the bankruptcy court found that New York adopted the Rule of Explicitness in matters of contract interpretation. On that basis, the bankruptcy court determined that the senior creditors could recover postpetition interest prior to a distribution to junior creditors only if the subordination agreement explicitly reflected the junior creditors’ undertaking of the risk of such a payment – which the indenture language failed to do.

On appeal in 2004, the First Circuit reversed, finding that the enactment of the Bankruptcy Code, including section 510(a), “extinguished the Rule of Explicitness in its classic form.” HSBC Bank USA v. Branch (In re Bank of New England Corp.), 364 F.3d 355, 359 (1st Cir. 2004) (“BNEC III”). Because section 510(a) calls for subordination agreements to be enforced in keeping with applicable nonbankruptcy law, the First Circuit examined New York law to determine the extent to which the Rule of Explicitness could be applied. Reversing the bankruptcy court’s findings in BNEC I, the First Circuit found that “New York courts had not developed any rules of interpretation that apply specifically to subordination agreements,” and that “the Rule of Explicitness [was] not part of New York’s general contract law.” BNEC III, 364 F.3d at 364–65. Thus, the First Circuit reasoned that the focus of the inquiry should be on general contract interpretation under New York law.

The First Circuit recognized that a straightforward and unambiguous contract is to be interpreted as a matter of law, but when the meaning of the contract is ambiguous, New York law requires that the meaning be “resolved through a contextual examination of the parties’ intent, taking full account of the surrounding facts and circumstances.” Id. at 367. Finding that the phrase “interest due or to become due” (with regard to amounts payable to the senior noteholders) was ambiguous, as it was not clear this phrase was meant to include post-petition interest, the First Circuit remanded the case to the bankruptcy court to conduct the required “contextual examination of the parties’ intent.” Id. at 366–68.

Recent Proceedings

On remand in 2009, the bankruptcy court concluded that the senior creditors were not entitled to post-petition interest prior to the repayment of the junior debt. The court began its analysis by noting that although the senior noteholders were not entitled to postpetition interest under section 502(b)(2) of the Bankruptcy Code, they might nonetheless have an enforceable contractual right to receive post-petition interest pursuant to section 510(a) and applicable nonbankruptcy law. In re Bank of New England Corp., 404 B.R. 17 (Bankr. D. Mass. 2009) (“BNEC V”). The bankruptcy court examined New York contract law and investigated the context of the transaction to determine whether the junior creditors had intended to allow senior creditors to be paid post-petition interest before any distributions were made on junior claims.

Neither party to the dispute could locate any witness who had been directly involved in the drafting of the junior indentures over twenty years earlier. To determine the parties’ intent regarding the subordination provisions, the bankruptcy court heard expert testimony, reviewed similar documents drafted by prominent law firms, and reviewed authoritative treatises. The junior trustee submitted as evidence, among other things, the American Bar Association’s Model Simplified Indenture (1983) (including explicit language to prioritize post-petition interest), and a 1977 drafting manual from the law firm involved in preparing the indentures at issue (advising its lawyers to address the treatment of post-petition interest explicitly in subordination agreements). Both the junior trustee and senior trustee elicited expert testimony from investment bankers familiar with the economic significance of subordination provisions in common use during the 1980s.

The weight of the evidence established that, at the time the indentures were prepared, it was generally understood that unsecured senior creditors were not entitled to post-petition interest. The senior trustee was therefore unable to overcome the presumption that the absence of language explicitly addressing this point indicated that the parties had not intended to subordinate the junior debt to the payment of post-petition interest on the senior debt. Although an expert witness called by the senior trustee opined that senior debt is entitled to payment in full without regard to the wording of the subordinating instruments, the bankruptcy court found that view “inconsistent with the law, common law, the Bankruptcy Act and the Bankruptcy Code, as well as common sense.” BNEC V, 404 B.R. at 36.

The bankruptcy court found that investment bankers in the 1980s understood that an unsecured creditor’s right to interest on its claim ceased upon the filing of a bankruptcy case, as mandated by section 502 of the Bankruptcy Code, and that the drafters of the indentures must be presumed to have understood this as well. Taking into account the expectations of the issuers and informed traders, as well as the expertise of drafting counsel, the bankruptcy court in BNEC V concluded that if the drafters had intended to include post-petition interest within the priority rights of the senior creditors, the indentures’ language would have been explicit on that point. The district court affirmed, HSBC Bank USA v. Branch (In re Bank of New England Corp.), 426 B.R. 1 (D. Mass. 2010), and the senior trustee appealed the rulings.

The First Circuit, in BNEC VII, affirmed, noting that the bankruptcy court had conducted a comprehensive, fact-intensive inquiry into the parties’ intent at the time of the agreements. The First Circuit held that a determination of the parties’ intent as to an ambiguous term is not limited to a review of custom and practice at the time of the agreement, and rejected the senior trustee’s claim that the evidence presented was insufficient under the custom and practice doctrine as applied in New York. The First Circuit also held that the bankruptcy court had not reverted to a per se Rule of Explicitness in finding that unequivocal contractual language was required to establish the parties’ intent to prioritize post-petition interest. The appellate court therefore upheld the lower court’s finding that, under New York custom and practice at the time the agreements were drafted, the clause “interest due or to become due” did not manifest an intent to provide the senior class with post-petition interest at the expense of the junior class.


The rulings in the Bank of New England cases do not directly address subordination agreements among secured creditors, but like several other recent bankruptcy decisions, they underscore the need for precise drafting of subordination provisions in a broad range of transactions. In particular, it is essential that subordination provisions explicitly address the parties’ intent regarding the payment of post-petition interest, taking into account the effect of applicable state law on the interpretation of such provisions.

In BNEC III, the First Circuit held that after enactment of the Bankruptcy Code, the Rule of Explicitness was no longer a per se rule of construction under federal law. Rather, the enforcement of a subordination agreement in bankruptcy will depend on governing state law (usually identified in a choice of law provision). BNEC VII teaches that in New York, notwithstanding the status of the Rule of Explicitness, a subordination agreement should clearly manifest the parties’ intent as to the payment of post-petition interest on senior debt. In the latter decision, the First Circuit repeatedly adverted to the bankruptcy court’s consideration of a contemporary drafting model, which suggested explicit language to prioritize post-petition interest. In preparing transactional documents today, it is wise for parties and their counsel to remain abreast of current standards and practices for intercreditor provisions.