Chapter 11 of the United States Bankruptcy Code permits a debtor to "cram down" a chapter 11 plan on a secured creditor who votes against the plan, as long as the creditor receives the "present value" of its claim over time.1 Traditional thinking assumed the "present value" requirement mandated that the secured claim be treated as a new loan and carry an interest rate commensurate with the market for new loans at the time. However, the landscape has now changed for cramdown interest rates.
In In re MPM Silicones, LLC 2 ("Momentive"), the Bankruptcy Court held–and the District Court affirmed–that debtors could satisfy the cramdown requirements of section 1129(b)(2)(A) of the Bankruptcy Code by distributing to secured creditors replacement notes with an interest rate that does not take into account the new loan market but, instead, compensates solely for risk – typically the prime rate plus 1-3%. Several months later, the Ninth Circuit Bankruptcy Appellate Panel issued an unpublished decision ("Dunlap Oil") in which the Court took a more nuanced approach to cramdown interest rate calculation.3 Instead of establishing a cap for acceptable margins in all circumstances, as was the case in Momentive, the Dunlap Oil court concluded that creditors should shoulder the evidentiary burden to prove the risk factors used to determine the appropriate cramdown rate. It is too soon to tell whether future courts will lean more towards the Momentive approach or the Dunlap Oil approach, but with so many Chapter 11 cases filed in New York, the Momentive decision is particularly important to understand.
Till Sets the Cramdown Course
A chapter 11 plan of reorganization may be confirmed without the consent of an impaired class of secured creditors if the plan satisfies the conditions set out in section 1129(b) of the Bankruptcy Code. Such conditions include a requirement that the plan be fair and equitable with respect to the objecting class, which, in the case of secured creditors, is satisfied when creditors in the class retain the lien securing their claims and receive deferred cash payments with a present value at least equal to the value of their secured claims.4 Present value is determined as of the effective date of the plan, and deferred cash payments must include an appropriate cramdown interest rate and amortization of principal.5 The Bankruptcy Code does not determine the appropriate cramdown rate; therefore, courts have used a variety of methods of computation depending on the risk level in their cases. Such methods include the so-called formula rate, the coerced loan rate, the presumptive contract rate, and the cost of funds rate.6
Chapter 13 of the Bankruptcy Code requires a similar analysis for the cramdown of secured claims by an individual debtor. In the leading chapter 13 cramdown interest rate case, Till v. SCS Credit Corp., the Supreme Court took the national prime rate and applied a margin reflecting "the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization plan." There is always a question in bankruptcy circles as to whether judicial precedent under one chapter of the Bankruptcy Code should apply to cases under another chapters. Although Till involved a case under chapter 13, some courts have adopted Till's formulaic approach in cases under chapter 11 as either binding or persuasive precedent.7
The Momentive Decision
In Momentive, the secured noteholders objected to confirmation of the debtor's chapter 11 plan, which contemplated applying the Till approach to the appropriate rate of interest. The noteholders focused instead on the various court decisions that required the interest rate to reflect the current market rate for new loans with similar terms. Self-evidently, new loans include a profit margin and, therefore, the noteholders argued for a much higher interest rate.
Despite the relative ease of determining a market rate for new loans under the circumstances, the Momentive court rejected the market-based approach used by other courts, noting that cramdown interest is intended to put the creditor in the same economic position it would have been in had it immediately received the value of its allowed claim. Rejecting a high margin above the prime rate (or LIBOR) as an inappropriate means of achieving a market rate that included a profit component, the Momentive court noted that, absent "extreme risk," such a premium should never exceed 3 percent–and found that 1.5 to 2 percent sufficed under the circumstances. The court based its finding almost exclusively on debtor testimony that indicated healthy future financial metrics, because noteholder advisors engaged in no independent analysis.
The Dunlap Oil Decision
In the United States, only US Supreme Court decisions are binding on all courts. Therefore, while courts outside the Southern District Court might find Momentive to be persuasive, they are not bound to follow it. Thus, in the subsequent Dunlap Oil decision from an appellate court in the Ninth Circuit (New York is in the Second Circuit), the court rejected the simple Momentive approach to assigning a clear cap for the appropriate cramdown rate of interest for secured claims. Instead, the Dunlap Oil court emphasized Till's language that secured creditors must overcome the evidentiary burden of proving higher risks warrant a higher interest rate. Such "proof-of-risk" approach requires a probative inquiry without foreclosing appropriately higher rates where greater risk exists.9 Whereas Momentive's approach to the Till rate strictly limited the applicable cramdown rate to a margin of 1-3%, Dunlap Oil takes a more flexible approach of allowing the facts and circumstances in each case to dictate the warranted cramdown rate, without assumption as to what the "normal" margin should be.
As noted above, decisions from the Southern District of New York carry special weight because so many chapter 11 cases are filed there. It is also common (although not absolute) that courts in the other major chapter 11 venue–Delaware–find New York decisions to be persuasive. And, because US law affords wide latitude to debtors to choose their venue for a chapter 11 filing, the Momentive decision makes it even more likely that debtors will choose to file in New York (or Delaware). However, there are 94 US judicial districts in total, and whether Momentive or Dunlap Oil becomes the more followed decision outside their respective districts remains to be seen.
- See 11 U.S.C. § 1129(b)(2)(A).
- 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014), aff’d, 531 B.R. 321 (S.D.N.Y. 2015).
- Pineda Grantor Trust II v. Dunlap Oil Co. (In re Dunlap Oil Co.), 2014 WL 6883069 (B.A.P. 9th Cir. Dec. 5, 2014).
- See 11 U.S.C. § 1129(b)(1)(A); In re Dynamic Brokers, Inc., 293 B.R. 489, 499 (B.A.P. 9th Cir. 2003); In re Arnold & Baker Farms, 85 F.3d 1415, 1420 (9th Cir. 1996).
- See In re Briscoe Enters, Ltd., II, 994 F.2d 1160, 1169 (5th Cir. 1993).
- See Till v. SCS Credit Corp., 541 U.S. 465, 473 (2004) (discussing methods of calculating cramdown interest rates in analogous chapter 13 cases).
- See In re Texas Grand Prairie Hotel Realty, L.L.C., 710 F.3d 324, 331 (5th Cir. 2013) (discussing the persuasive, yet non-binding, nature of the "splintered" Till decision); In re Blanton, 2010 WL 4503188 at *2 (Bankr. N.D. Ohio Oct. 29, 2010) (critiquing the precedential value of Till and its formulaic approach); see also, e.g., In re Toso, 2007 WL 7540985 at *8-9 (B.A.P. 9th Cir. Jan. 10, 2007); Mercury Capital Corp. v. Milford Conn. Assocs., L.P., 354 B.R. 1, 12 (D. Conn. 2006). But see, e.g., Am. HomePatient, 420 F.3d at 566–68 (refusing to fully adopt the Till formulaic approach in a chapter 11 case).
- Dunlap Oil, 2014 WL 6883069 at *20.
- Id. (quoting Till, 541 U.S. at 479); see also In re Tapang, 2014 WL 7212959 at *2 (Bankr. N.D. Ca. Dec. 17, 2014) (likewise concluding that creditors—not the debtor—bear burden of proof on the issue of appropriate cramdown interest rate).