The rate of interest a non-consenting secured lender is entitled to when its secured loan is restructured under a Chapter 11 plan of reorganization has been a hotly debated issue since the U.S. Supreme Court handed down its decision in Till v. SCS Credit Corp.1 The decision was made in the context of a Chapter 13 case concerning an individual with regular income. As a result of the complex language of §1129(b)(2)(A) of the Bankruptcy Code and the Supreme Court’s decision in Till, case law regarding cramdown interest rates to be afforded secured lenders in the Chapter 11 context has been murky and confusing. Court decisions have produced scattered results as to the proper methodology to be applied in the Chapter 11 context and on whether secured lenders are entitled to a profit component in the interest rate.
Recent case law from the U.S. District Court for the Southern District of New York is decidedly unfavorable to secured lenders in this regard. From the secured lender perspective, the recommendations issued by the American Bankruptcy Institute in December 2014, at least with respect to the cramdown interest rate issue, present a very welcome development on the subject.
Section 1129(b)(2)(A) of the Bankruptcy Code provides that when a party in interest seeks to impose a reorganization plan on a class of dissenting secured creditors, one method for “cramming down” the plan on a class of secured creditors is to provide each holder of a secured claim in such class with “deferred cash payments totaling at least the allowed amount of such claim, with a value, as of the effective date of the plan, of at least the value of such holder’s interest in the estate’s interest in such property.”
In connection with this deferred payment approach, the question of what methodology should be used to calculate the proper cramdown rate of interest in Chapter 11 cases has been the subject of intense dispute and debate. The issue is obviously one of extreme importance to the secured lending community; a higher rate of interest is more attractive to secured lenders and also may arguably be necessary to provide the secured lender with the deferred cash payments to which the lender is entitled under the Bankruptcy Code, if the proper discount rate is taken into account. From the perspective of the debtor and junior creditors, by contrast, a higher rate of interest may be potentially cumbersome and may lead to a subsequent default.
U.S. Supreme Court Till Ruling Discrepancy
In the Till decision, the Supreme Court adopted a formulaic approach to determining the proper cramdown interest rate in Chapter 13 cases. The formula (“prime plus”) approach adopted in Till calculates the present value of deferred cash payments to a secured lender using a risk-free interest rate (i.e., the prime rate), and adjusting that rate — by 100 to 300 basis points — to account for risk. Other methods considered by the Supreme Court in Till included the “coerced loan” approach, the “presumptive contract rate” approach and the “cost of funds” approach. The coerced loan approach sets the cramdown interest rate at the level the creditor could have obtained if it had foreclosed on the loan, sold the collateral, and reinvested the proceeds in loans of equivalent duration and risk. The presumptive contract rate approach assumes that the original contract rate may serve as a presumptive cramdown rate, which could be challenged by the debtor, the secured lender and/or junior lenders with evidence that a higher or lower rate should apply.
Ultimately, a plurality of the Supreme Court ruled in Till — a Chapter 13 case in which the collateral was a truck valued at $4,000 — that the formula approach was the most appropriate method for determining what interest rate should apply in a cramdown situation. The specific formula approach applied in Till took the national prime rate and bumped it up by a risk adjustment measure (typically 100 to 300 basis points) to account for the risk of nonpayment. The amount of the risk adjustment measure depends on factors such as the debtor’s circumstances, the nature of the security, and the duration and feasibility of the reorganization plan. The plurality of the Supreme Court approved of the formula approach for Chapter 13 cases because it “entails a straightforward, familiar, and objective inquiry, and minimizes the need for potentially costly additional evidentiary hearings.”
The Supreme Court’s only reference to the question of whether the formula approach must be applied in Chapter 11 cases appeared in footnote 14 of the opinion, stating that the formula approach works particularly well in the Chapter 13 context because there is no market of willing cramdown lenders, but that in the Chapter 11 context “numerous lenders advertise financing for Chapter 11 debtors in possession.” The footnote further stated, “When picking a cramdown rate in a Chapter 11 case, it might make sense to ask what rate an efficient market would produce.” Thus, the express holding of Till appears to mandate application of the formula approach, while footnote 14 of Till leaves the door open for secured lenders to argue for application of a non-formula, market-based methodology.
District Court’s Momentive Decision
The Supreme Court’s failure to clarify whether the formula approach must be applied in Chapter 11 cases has created confusion and uncertainty. Secured lenders have consistently maintained that the prime plus formula approach does not adequately compensate them for the risks of a restructured loan in the context of a Chapter 11 case.
The Bankruptcy Court for the Southern District of New York, and the district court on appeal, recently addressed this issue head on in In re MPM Silicones, LLC (“Momentive”).2 In the case, the bankruptcy court held it is appropriate to apply the formula approach in the Chapter 11 context, because the interest rate should “put the creditor in the same economic position it would have been in had it received the value of its allowed claim immediately. The purpose is not to put the creditor in the same position that it would have been in had it arranged a ‘new’ loan.’” On appeal, the district court agreed, seeing no good reason why Chapter 11 creditors, but not Chapter 13 creditors, should be left in the same position had they arranged a new loan. The court indicated it was bound, not only by Till, but also by the decision of the U.S. Court of Appeals for the Second Circuit in In re Valenti the reasoning of which the district court in Momentive found applied in the Chapter 11 context.3 Notably, both courts explicitly stated that the cramdown interest rate should not account for the secured lender’s profit.
In December 2014, the American Bankruptcy Institute (ABI) issued its report by the Commission to Study the Reform of Chapter 11, in which commissioners debated and rejected the formula approach to calculating cramdown interest rates, and determined a market approach was necessary to reflect actual economic realities. This approach is substantially more favorable for secured lenders than the formula approach or conflicting case law.
The ABI rejects Till and makes a very clear statement about what courts should consider in determining cramdown interest rates in Chapter 11 cases:
“In selecting the appropriate discount rate, the court should consider the evidence presented by the parties at the confirmation hearing and, if practicable, use the cost of capital for similar debt issued to companies comparable to the debtor as a reorganized entity, taking into account the size and creditworthiness of the debtor and the nature and condition of the collateral, among other factors. If such a market rate is not available or the court determines that an efficient market does not exist, the court should use an appropriate risk-adjusted rate that reflects the actual risk posed in the case of the reorganized debtor, considering factors such as the debtor’s industry, projections, leverage, revised capital structure, and obligations under the plan. The court should not apply the “prime plus” formula adopted by the Supreme Court in Till…in the chapter 11 context.”
Thus, the ABI Commission Report rejects Till and the formula approach, and recommends a market-based approach that affords the secured lender a profit component.
While it is unclear whether or when the ABI Commission’s recommendations might be adopted by Congress in whole or in part, it is clear that bankruptcy judges are aware of the Commission’s recommendations. Thus, the potential exists for the bankruptcy courts on their own to choose to adopt a market-based approach — a result that is more likely to adequately compensate secured lenders for the risks of their restructured loans.
Madlyn Gleich Primoff is a partner in the Bankruptcy & Restructuring Department and a member of the Executive Committee, and Holly Martin is an associate, both at Kaye Scholer LLP in New York.
1. 541 U.S. 465 (2004).
2. 2014 WL 4436335 (Bankr. S.D.N.Y. 2014) (Drain, J.).
3. 105 F.3d 55 (2d Cir. 1997).