As part of our ongoing project to monitor and report on cramdown interest rate cases, today’s post covers the recent opinion in In re Robert S. Turner, in which the United States Bankruptcy Court for the District of New Hampshire found that an interest rate of 5% was “sufficient to satisfy the cramdown requirements of [section] 1129(b), using the formula approach articulated in Till v. SCS Credit Corp.”
Robert S. Turner filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code.  As of the petition date, Mr. Turner owned, among other properties, a non-income producing second home located in Moultonborough, New Hampshire with a fair market value of $230,000.  The Moultonborough property was subject to a fully secured first mortgage held by Residential Credit Solutions, Inc.  Residential Credit asserted a secured claim against Turner’s estate in the amount of $157,249.23.
Competing Cramdown Interest Rate Proposals
Roughly six months after commencing the chapter 11 case, Turner filed an amended plan of reorganization.  Pursuant to the plan, Residential Credit’s secured claim would be allowed in the full asserted amount; however, the Residential Credit loan would be extended by nine years (to thirty years from the effective date of the plan), and the applicable interest rate would be lowered to 4% per annum.  Mr. Turner subsequently amended the plan further to provide an interest rate of 5% per annum.
Residential Credit objected to the proposed interest rates.  The parties agreed that there was no efficient market for the loan and, therefore, that the correct method to calculate the cramdown interest rate was the formula approach from Till v. SCS Credit Corp.  The parties also agreed that the national prime interest rate at the time of the confirmation hearing was 3.25%.  They disagreed, however, over the appropriate upward adjustment over the prime rate.  Residential Credit argued that the interest rate should be set at 6.25% to account for the following risk factors:  (i) Turner filed for chapter 11; (ii) Turner was seeking to extend the loan term by an additional nine years; and (iii) the Moultonborough property is not Turner’s primary residence.  Residential Credit argued that one percentage point should be added to the prime rate for each of the foregoing risk factors.  Additionally, Turner had defaulted on his monthly payments to Residential Credit after filing for chapter 11 protection.  Before the confirmation hearing, however, Turner had caught up on payments and was current on the loan. Turner argued that an interest rate of 5% reflected the appropriate upward adjustment over the prime rate not only because he was current on payments, but also because Residential Credit had an equity cushion of approximately $72,750.
Bankruptcy Court Opinion
The bankruptcy court found that the 5% interest rate proposed by Turner contained an adequate upward adjustment and was the appropriate rate to apply under the circumstances.  In reaching that conclusion, the bankruptcy court noted that the appropriate interest rate in a cramdown scenario is a question of fact and that the burden lies with the secured creditor to prove that an upward adjustment from the prime rate is justified.  The bankruptcy court then considered the risk factors Residential Credit had cited in support of the higher interest rate it had proposed.
First, the bankruptcy court acknowledged that a borrower’s status as a chapter 11 debtor justifies an upward adjustment, finding that “some risk of nonpayment is present here, as in all bankruptcies, given the financial difficulties that result in an individual filing for bankruptcy protection.”  Specifically, the bankruptcy court noted that the plan did not allow for any surplus income that could be used to preserve or maintain the Moultonborough property.
Next, the bankruptcy court noted that other courts, including the Till Court, cited extension of the loan term as a reason for upward adjustment where the term extension “increased risk of nonpayment over a longer and/or more uncertain period.”  In the present instance, however, the bankruptcy court found that “there is no significant increase in the amount of risk by extending the term of the loan by nine years.”
Then the bankruptcy court noted that, although the Moultonborough property was a non-income producing second home, there were no other claims secured by that property, and Residential Credit held an equity cushion of approximately $72,750.  Thus, the bankruptcy court found that even though it was “unlikely, though not impossible, that the [p]roperty will decrease in value by $73,000 over the next thirty years . . . some risk adjustment seems appropriate for the risks inherent in holding a long term mortgage on the reorganized Debtor’s second home.”
Finally, the bankruptcy court noted that “[n]o evidence was presented at the [confirmation] hearing that demonstrated the Debtor’s situation constitutes a higher than average risk of nonpayment nor did any expert testify as to the appropriateness of a 3% increase over the prime rate.”  Thus, the bankruptcy court found that Residential Credit had failed to meet its burden to support the higher interest rate it had proposed.  Nevertheless, the bankruptcy court found that, because some upward adjustment was justified under the circumstances, the adjustment contained in Turner’s proposed interest rate was “both unrebutted and appropriate.”
Lessons Learned
The bankruptcy court’s decision provides two significant lessons.  First, the bankruptcy court found that the risk of nonpayment present “in all bankruptcies” justifies upward adjustment from the prime rate.  Although the bankruptcy court stated that cramdown interest rates should be calculated on a case-by-case basis and declined allocation of specific amounts to any risk factor in particular, this finding suggests that, at least in the District of New Hampshire, courts may find that some upward adjustment is appropriate in all secured cramdown situations.  Second, the bankruptcy court rejected the position that extending the maturity of a loan exposes the lender to more risk as a matter of law.  Such a finding makes clear that the risk associated with the extension of loan maturities is a question of fact and, therefore, the party seeking an upward adjustment in rates must be prepared to provide evidence on this point.