A recent case in the Southern District of New York, U.S. Bank, NA v. T.D. Bank, NA, applied the so-called Rule of Explicitness to the allocation of recoveries among creditors outside of a bankruptcy proceeding. In the bankruptcy context, this rule requires a clear and unambiguous intention to turn over post-petition interest to senior creditors at the expense of junior creditors. The court in this case found the requisite documentary clarity to pay post-petition interest ahead of the distribution of principal. Along the way, the decision provides a useful tutorial on the rule and its application.

Facts of the Case

The case arose out of the bankruptcy of Bionol Clearfield LLC, which was the owner of a failed ethanol plant in Pennsylvania. Importantly, while Bionol filed under Chapter 7, for reasons that are not clear from the opinion, the dispute over the allocation of collateral proceeds played out in the district court under principles of state law, rather than in bankruptcy court pursuant to the Bankruptcy Code.

The plaintiff was a successor bond trustee under an indenture of trust executed by the Pennsylvania Economic Development Financing Authority, which issued approximately $65 million of bonds to finance the ethanol facility. The proceeds of the bonds were lent to Bionol under a senior Credit Agreement that also covered four additional tranches of senior debt. Defendant T.D. Bank, in addition to being a lender under three of the four other tranches, served as collateral agent and administrative agent under the Credit Agreement and related documentation.

An Intercreditor Agreement governed the distribution of the proceeds of collateral among the various tranches of debt. The driver for the case was the disparate treatment of interest and principal among four of the five tranches of debt payable under the Credit Agreement, including the tranche representing the proceeds of the indenture debt. After fees and expenses, interest was to be paid equally and ratably among the tranches, based on the outstanding principal balances. Next up was principal, but here there was an order of priority in which repayment of the proceeds of the indenture debt was last in line.

The defendant argued that the documentation did not provide for payment of post-petition interest. Alternatively, it argued that there was a measure of ambiguity as to whether post-petition interest was payable, so that under the Rule of Explicitness no priority should be afforded the payment of post-petition interest. If this were the case, the plaintiff would receive nothing from the remaining funds available for distribution to the creditors. The plaintiff countered that the Rule of Explicitness was inapplicable, but even if it were applicable, its requirements were satisfied.

The Rule of Explicitness

Generally, creditors in bankruptcy are not entitled to recover interest accruing after commencement of the bankruptcy case. The rule is expressly set forth in Section 502(b)(2) of the Bankruptcy Code. Subordination agreements, which provide for a turnover of recoveries by junior creditors until senior creditors are paid in full, often require that such turnover continue until the senior creditors have received payment equivalent to their post-petition interest. Effectively, this often results in payment to senior creditors of post-petition interest, whether or not such post-petition interest may be recovered under the Bankruptcy Code. The Rule of Explicitness requires that the right of the senior creditors to receive post-petition interest from recoveries that would otherwise be paid to the junior creditors must be evidenced by a clear documentary agreement.

As explained by the court in the U.S. Bank v. T.D. Bank case, the Rule of Explicitness was developed under the old Bankruptcy Act. There was, and continues to be, uncertainty regarding the continuing vitality of the rule under the current Bankruptcy Code because of Section 510(a) of the Code. That section provides, “A subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable non-bankruptcy law.” In light of Section 510(a), the Eleventh Circuit in In re Southeast Banking Corp., 156 F.3d 1114 (11th Cir. 1998), asked the New York Court of Appeals to weigh in on the interpretation of the payment of post-petition interest under a subordination agreement governed by New York law. The New York Court of Appeals in In re Southeast Banking Corp., 93 N.Y. 2d 178 (1999), effectively gave its imprimatur to the Rule of Explicitness as a matter of New York contract law. The First Circuit in HSBC Bank USA v. Branch, 364 F.3d 355 (1st Cir. 2004), on the other hand, took issue with the ruling of the Eleventh Circuit, finding that the New York Court of Appeals was encroaching on federal jurisdiction by effectively interpreting the Bankruptcy Code rather than opining on state law. The First Circuit therefore focused on the intent of the parties. As a factual matter, the appeals court agreed with the lower court that the junior debt did not intend to subordinate to post-petition interest. In re Bank of New England Corp., 646 F.3d 90 (1st. Cir. 2011).

The Court’s Analysis

The court began with the observation that the case before it was not a bankruptcy case. The court was therefore able to sidestep the dispute between the First Circuit and the Eleventh Circuit, and could approach the case as a pure matter of contract governed by New York law. In the court’s view, the New York Court of Appeals in Southeast Banking held that under New York law, agreements to pay post-petition interest must be clearly articulated. The court also observed that, although the Second Circuit has yet to weigh in on the split between the First and Eleventh Circuits, courts in the Second Circuit had consistently adopted the Rule of Explicitness in bankruptcy cases, both before and after passage of the current Bankruptcy Code. Score one for the defendant.

The court also rejected the plaintiff’s argument that the Rule of Explicitness was limited to the allocation of recoveries between senior and junior creditors. The court saw no reason why the same rule could not have applicability in the U.S. Bank v. T.D. Bank case, where the issue was the priority of distribution between post-petition interest and principal payments among different classes of senior creditors. Score two for the defendant.

In the end, however, the court agreed with the plaintiff that the Rule of Explicitness was satisfied in the case. The complication arose because the waterfall in the Intercreditor Agreement did not expressly reference post-petition interest. Instead, the court had to resort to an interplay between the Credit Agreement and the Intercreditor Agreement. The Intercreditor Agreement provided that the proceeds of collateral were to be available for the payment of “Obligations.” “Obligations” were defined in the Credit Agreement to include “interest and fees that accrue after the commencement by or against the Borrower of any Insolvency or Liquidation proceeding.” As both agreements included what the court termed “cross-referential principles of interpretation,” the court concluded that the two agreements were to be applied as a whole, satisfying the Rule of Explicitness. Effectively, therefore, the reference to interest in the waterfall of distributions set forth in the Intercreditor Agreement included post-petition interest, such that post-petition interest, which was payable pro rata, was recoverable ahead of principal, which was not.

The court stopped short of complete agreement with the plaintiff. As is customary, the first priority in the waterfall of the Intercreditor Agreement was fees, costs and expenses payable under the financing documents, including the fees of the plaintiff bond trustee. Conceding that the Rule of Explicitness was not addressed to fees, the court applied other New York law rulings to similar effect regarding payment of counsel fees. The court then held that the financing documents at issue were insufficiently explicit to award the plaintiff its counsel fees for litigating the priority of post-petition interest in the case.


Despite the peculiar posture of U.S. Bank, NA v. T.D. Bank — a case arising out of a bankruptcy situation, but not itself a bankruptcy proceeding, involving priority among senior lenders — the court’s decision should be read as an affirmation of the Rule of Explicitness in the Second Circuit, at least at the lower court level. Senior creditors who seek to recover post-petition interest in connection with a bankruptcy under documents governed by New York law had better assure that their documentation clearly provides for that priority. Second, while the plaintiff in U.S. Bank v. T.D. Bank succeeded in stitching together provisions in separate documentation to successfully demonstrate satisfaction of the Rule of Explicitness, this was obviously not ideal from a creditor perspective. Senior lenders should assure that the recovery of post-petition interest is expressly set forth in the distribution waterfall governing allocation of the proceeds of collateral. Finally, although not formally coming under the rubric of the Rule of Explicitness, the priority of payment for counsel fees in the case was subjected to the rule’s standard of rigorous clarity, and fell short. Senior lenders wishing to assure that fees incurred in enforcing their priorities of recovery come out first are advised to make that explicit in their documentation as well.