As you can’t help but know by now, we’ve been covering Georgia’s Ret. Judge W. Homer Drake, Jr. Click here if you missed the first four posts. We’ll wrap-up Judge Drake’s Top 10 Chapter 11 confirmation opinions by Tuesday, with today’s post covering #2. We’re excited to have financial advisor and Till expert Richard Gaudet, of GGG Partners in Atlanta, reverse engineer in this post Judge Drake’s pre-Till analysis 30 years later, because why not? And for some New York Times worthy trivia about Judge Drake’s chambers, see below in the conclusion.
Frank and Neil make the list a second time with their IPC (Noble Oaks Apartments) case. For background about IPC, be sure to read our coverage of #9 here. While #9 dealt with post-confirmation issues, #2 took place a year and a half earlier when the parties were litigating about whether Judge Drake should confirm IPC’s proposed plan over creditors’ objections, including those of Freddie Mac. We’ll skip right to the confirmation issues:
Timeliness of Withdrawal of § 1111(b) Election
If you read our coverage of #9, then, because #9 was all about whether IPC complied with § 1111(b) after confirmation, you can guess that Judge Drake rejected Freddie Mac’s pre-confirmation attempt to withdraw its § 1111(b) election.
Under Bankruptcy Rule 3014, unless the court fixes a later date, a creditor can make an 1111(b) election “at any time prior to the conclusion” of the disclosure statement hearing. Freddie Mac made a timely election. Thus, unless the IPC plan modification was “material,” IPC and other creditors could rely on Freddie Mac’s § 1111(b)election.
Judge Drake determined that the modification was not material because it did not impact Freddie Mac’s plan treatment so much that it would be “tantamount to filing a different plan.” As a result, Freddie Mac was stuck with its election.
Ironically, the first “risk shifting” objection I can recall receiving came by way of Jay Sakalo (who was nice enough recently to provide me some color for a potential series on Florida’s Judge Alexander Paskay), of Frank, and of Frank’s colleague Lisa Wolgast. In 2014, we all found ourselves in a heated, “take no prisoners” contest about some Buckhead real estate. It’s ironic only because Frank encountered that same objection when Neil raised it in IPC. I’m not sure if Collier covered it back in 1992, but it covers the objection by name these days. That is, was the debtor placing “all or substantially all of the risk of nonperformance on Freddie Mac” such that the plan was not “fair and equitable”?
After all, IPC was proposing to:
- extend the original maturity by 3 years
- reamortize the note so that the confirmation date was “day one of the loan”
- make interest-only payments during the first 2 years of repayment
- require what might be deemed insufficient partner contributions
IPC responded like you’d expect:
- future income and reserves (sourced from infusions) would cover debt service
- ongoing maintenance reserves and repairs would be sufficient
- large pre- and post-petition contributions would balance out the maturity extension
- Freddie Mac would receive a “market rate” of interest
- Freddie Mac would retain all of its remedies and could foreclose if necessary
Judge Drake agreed with the debtor, accepting each of its arguments one-by-one. If there was risk-shifting, then Freddie Mac would be compensated for it, especially if the cramdown interest rate was sufficient.
Cramdown Interest Rate
Judge Drake’s Pre-Till Approach in 1992
Essentially, Judge Drake conducted a Till analysis almost 12 years before the Supreme Court’s Till decision. You can click here for a collection of our Till coverage over the years. That said, he’d want us to point out that many bankruptcy judges were already doing Till before Till, including his Georgia colleague Judge Joyce Bihary in In re Oaks Partners, Ltd.
Adopting the method that Judge Bihary used, Judge Drake held that the correct approach—the “formula approach”—for determining the cramdown interest rate is to start with the “appropriate risk-free rate” and then add “to that base rate an additional amount of interest to take into account the risks associated with the debtor, the security, and the plan.”
Judge Drake started with a risk-free base rate of 8.5% (!) (i.e., the “yield on a treasury note which matures at approximately the same date as the note”). He then assessed debtor-specific risks as requiring an additional “risk component of 3%,” for a whopping 11.5% interest rate.
Testing Judge Drake’s Analysis 30 Years Later
How does Judge Drake’s pre-Till analysis stand up almost 30 years later?
My firm has worked with Richard Gaudet for well over a decade as a financial advisor in our bigger, more contested Chapter 11 cases and, because he’s so efficient and cost-effective, even in some of our smaller cases. He testifies all over the Southeast, including in the Buckhead case cited above. Richard and I have also published some articles about Till, including one in the ABI Journal—see here and here. We can’t recommend him enough.
I reached out to him over the weekend, then, on barely a few hours’ notice, and asked him if he could assess IPC‘s pre-Till analysis 30 years later. Not surprisingly, he dove right in and did an independent Till analysis. Here is what he had to say:
First, he noted that, in July 1992, the U.S. was “emerging from a recession and the treasury yield curve was steep, projecting a rapid increase in rates/inflation over the coming years. In fact, on the confirmation date, the 8.5% treasury rate used by Judge Drake as the base rate exceeded the prime rate of 6.5% by 200 basis points—a scenario that we have not seen in over a decade. This would have indicated that the prime rate could be expected to increase over the plan term, and in fact, it did. With the benefit of hindsight, we know that the average prime rate between the confirmation date and the plan maturity was 7.88%.”
Second, Richard pointed out that, after Till, advocates, of course, pushed “for the use of the national prime rate as the base rate.” However, in IPC, “Judge Drake opted to use the treasury rate that was coterminous with plan maturity.” He can’t be faulted, though, because, as Richard explains, back then “there was no proven methodology for estimating future inflation.”
“TIPS [Treasury Inflation-Protected Securities], which allow the determination of a market based future inflation estimate, were not issued until 1997.” By using the Treasury-based rate, Judge Drake had a “proxy for future inflation of 2% above then-current inflation rates that was not reflected in the national prime rate at the time.” In hindsight, that “estimate was fairly accurate with actual prime over the life of the plan being 1.38% higher than the then-current prime rate of 6.5%.”
Third, he took a stab at calculating the appropriate Till rate 30 years later based on info provided in the IPC opinion and interest rate data that is now so readily-available. Specifically, using the “actual changes in prime rate over the life of the plan,” Richard calculated the rate that would have compensated Freddie Mac “for the time value of money and the risk of plan default.” Assuming a “marginally feasible probability of default of 50% based on Judge Drake’s analysis,” Richard’s “hindsight” calculation resulted in a 11.24% rate. He was quick to point out that while that rate was slightly below the 11.50% rate from IPC, § 1129 requires a rate that “compensates the creditor for at least the risk imposed under the Plan.”
In his view, then, the “approved rate is surprisingly close given the facts available at the time and the fact that the economy was headed into a strong growth cycle.” He provided me a useful comparison of his and Judge Drake’s “rate stack”:
|Rate Stack Component||Judge Drake||Hindsight|
|National Prime Rate||6.50%||6.50%|
|Fixed Rate Inflation Adjust.||2.00%||1.38%|
|Debtor-Specific Risk Adjust.||3.00%||3.36%|
In summary, Judge Drake’s pre-Till analysis withstands scrutiny 30 years later. As Richard Gaudet points out, “[i]n the end, the axiom that ‘age and wisdom will beat youth and exuberance every time,’ once again holds true in Judge Drake’s decision.”
Note: Richard couldn’t find support for “Judge Drake’s use of 8.5% as the July 1, 1992 published yield on a treasury note” having the same maturity as the IPC plan note. “My research shows that the actual yield to maturity at the time should have been approximately 6.91%.” You would have had to consult the Wall Street Journal print edition or call a bond broker back in 1992, says Richard. Regardless, he was satisfied that the “2% spread over the national prime rate provides a very close proxy for expected inflation that would have been expected at the time.”
In Orchard Hills, my last case with Judge Drake, and I think his second or third to last opinion, I argued with everything I had about whether my client’s early pending plan—for a church debtor no less—was feasible for purposes of preventing stay relief. I lost the first time and lost on reconsideration, too. We settled later, but that’s still tough. Section 362(d)(2) inherits § 1129(a)(11)’s feasibility principles, but they’re considerably relaxed, especially on the front-end of the case.
Judge Drake summarized those principles in IPC, using § 1129(a)(11) to explain that a “plan may not be confirmed if confirmation is likely to be followed by liquidation or further reorganization of the debtor.” Of course, § 1129(a)(11) doesn’t require the debtor to show that confirmation is guaranteed. Rather, can (i) the debtor “realistically carry out the provisions of the plan” and (ii) does the plan offer a “reasonable prospect of success”?
Judge Drake emphasized the following feasibility factors:
- Is the capital structure adequate?
- Does the business have sufficient “earning power”?
- Are there “economic conditions” that support or undermine feasibility?
- Is the proposed management capable and likely to stick around?
- Are there other case-specific feasibility matters?
Of course, we know from #9 that Judge Drake found the plan feasible, as post-confirmation disputes arose later.
Instead of addressing other, minor objections from IPC, I’ll bury some more Judge Drake trivia down in the conclusion. Judge Drake’s “last office” is pictured above. He occupied a large portion of the second floor, with his chambers spanning a few of the windows on the left side of the building on Spring Street. Unless I was misled, I know it to be the Spring Street side only because the U.S. Marshalls mentioned that the judges were surprised one morning to have their windows filled edge to edge by a nearly building-sized Spring Street photo mural of “Tina,” which was part of a Newnan-wide photo project led by Mary Beth Meehan, a Pulitzer Prize nominated photo journalist. The mural project even made national news in the New York Times. Click through to find Tina and other murals that were placed on buildings around Newnan.
We’ll wrap-up our Judge Drake series on Tuesday when we cover his #1 most cited Chapter 11 confirmation opinion. We’ll have a little self-congratulatory bonus coverage as well, only because Westlaw left all of us hanging. As a hint, it’s Judge Drake’s most recent, and arguably his most extensive, confirmation opinion, hidden away on PACER and in my file.
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