This is the next post in Plan Proponent’s series on the confirmation-related recommendations in the ABI Commission Report (and, in particular, its Exiting the Case piece). In this post, we’ll cover the Commission’s recommendations regarding Section 1129(b)(2)(A) and “cramdown” interest rates.
Background on Cramdown Rates and Till
At least for plans proposing deferred cash payments to secured creditors, the issue of the appropriate rate of interest is arguably the most important and most litigated plan confirmation issue. Under Section 1129(b)(2)(A), “cramdown” requires 1 of 3 things: (i) preserving the secured creditor’s lien and making deferred cash payments having a present value equal to a secured creditor’s allowed secured claim; (ii) a sale of the secured creditor’s collateral with its lien following the proceeds; or (iii) providing the secured creditor the “indubitable equivalent” of its claim.
In particular, anyone who has been involved in a real estate Chapter 11 during the “Great Recession” is likely no stranger to the first option: paying the value of the real estate (see here) over time with interest. Everyone can agree that a promise of future payments is worth less than an immediate lump-sum payment for various reasons, including the lack of immediate use of the funds, the risk of inflation, and the risk of nonpayment. Conceptually, that is straightforward. However, as the the Commission points out, the application can be challenging. Which risks must a secured creditor be compensated for under the Code? What interest rate (“discount rate”) will compensate a creditor for those risks?
In 2004, the Supreme Court weighed-in, at least in the context of a Chapter 13 plan, with Till v. SCS Credit Corp, 541 U.S. 465 (2004). Till involved the valuation of a payment stream secured by a $4,000 truck on a $4,895 claim. As a starting point, the Supreme Court identified the four approaches that courts were then employing to determine rates. A short (“nuance-less”) description of those approaches is useful, even if outside of the scope of the Commission’s report:
- Formula Approach: A rate equal to the “national prime rate” plus some debtor-specific risk adjustment.
- Coerced Loan Approach: The rate that the creditor could have obtained if it had foreclosed on its collateral and reinvested the proceeds in loans of equivalent duration and risk.
- Presumptive Contract Rate Approach: The rate in the original contract, subject to evidence that the rate should be lower or higher.
- Cost of Funds Approach: The rate that accounts for the costs that a creditor would incur in issuing a new loan.
The Supreme Court adopted the formula approach and rejected the other approaches. Stated more specifically, the formula approach (at least as described by the Court) first involves identifying the “risk-free” rate (i.e., the rate that a lender would charge a credit worthy commercial borrower to compensate the lender for the opportunity costs of the loan, the risk of inflation, and the relatively slight risk of default). The Court identified the “national prime rate” as that risk-free starting point. [Today, experts argue about whether the prime rate is an appropriate risk-free rate or whether some other starting point (e.g., treasury-based rates) is more appropriate.]
From there, a “risk adjustment” should be made, as necessary, to account for “the circumstances of the estate, the nature of the security and the feasibility of the reorganization plan.” Unfortunately, the Supreme Court provided very little guidance on the adjustment. Rather, it provided a range. On the one hand, if there is certainty that the debtor will perform without a default, then the prime rate should be sufficient. On the other hand, if the risk of default is so high as to require a seemingly usurious rate, then the plan is likely not confirmable to begin with. In between those bookends, the Court referred generally to 1% to 3% adjustments, resulting in a “prime plus 1% to 3%” or “prime plus” shorthand for Till.
That’s all fine and well for Chapter 13, but Till‘s applicability to Chapter 11 cases is still not entirely clear, even if Till is almost always the starting point for Chapter 11 rate determinations. That is because the Supreme Court noted that Till is limited to Chapter 13 cases and then added some mystery with its now infamous “Footnote 14” wherein the Court suggested that the formula approach is not appropriate in Chapter 11, at least not when there is an “efficient market.” Specifically, the Court noted: “Thus, when picking a cram down rate in a Chapter 11 case, it might make sense to ask what rate an efficient market would produce. In the Chapter 13 context, by contrast, the absence of any such market obligates courts to look to first principles and ask only what rate will fairly compensate a creditor for its exposure.” Till, 541 U.S. at 476 n.14.
Although some courts have refused to apply Till to Chapter 11 cases, most courts (with very little post-Till appellate-level guidance) look to Till as a persuasive starting point. From there, cramdown rates have become the exclusive purview of experts, bringing with it a sort of Daubert hell where one $1,000/hr expert argues that the other $1,000/hr expert is not an expert at all (and vice-versa). In any event, most experts account for Footnote 14 by first asking whether an efficient market exists for a loan similar to the deferred payments proposed under the plan, and then go from there–employing a “market” rate if there is an efficient market and a “formula” rate if there is not an efficient market.
Commission’s Recommendations
It appears that the Commissioners (and the brute force teams employed by the Commissioners to tackle these issues) engaged in a swirling debate about the appropriate method of determining cramdown rates. In short, the Commission acknowledges that there are many ways of accomplishing the objective of Section 1129(b)(2)(A)(i), that is, providing a secured creditor the “same return, regardless of whether the debtor elects to pay the allowed secured claim in cash on the effective date or through deferred cash payments over several years.” The Commission agrees that the rate should reflect the “economic realities of the case.”
Consistent with its approach in other controversial areas, the Commission rejected a “one-size-fits-all” approach.
Rather, the Commission recommends “(i) clarifying section 1129(b)(2)(A)(i)(II) to emphasize the present value calculation required to implement the purpose of that section; (ii) adopting a general market approach to determining an appropriate discount rate; and (iii) rejecting the Till ‘prime plus’ formula.”
Basically, the Commission advocates a “market rate” approach that focuses on the “cost of capital for similar debt issued to companies comparable to the debtor as a reorganized entity.” If a market rate cannot be ascertained, then an “appropriate risk-adjusted rate that reflects the actual risk posed in the case” should be employed, with an emphasis on the “debtor’s industry, projections, leverage, revised capital structure, and obligations under the plan.”
Humbly, I’m not sure whether the recommendations do anything other than ensure that Courts will remain entrenched in expert witness beauty contests–the rules of which contests the Courts will be required to glean from the experts themselves (experts who, as a threshold matter, tend to disagree about which rules should be employed).
Plan Proponent hopes to sift through those disagreements in future posts. For now, we’ll leave readers with perhaps the greatest ever contribution from a bankruptcy blog: Version 14 of Weil Gotshal’s Cramdown Interest Rate Table.
In our next post, we’ll cover the Commission’s recommendations on “Class-Skipping and Intra-Class Discriminating Distributions.” (Sounds like something better-suited for a trusts and estates blog.)