If you are looking for summer vacation destinations, the Bankruptcy Court for the Western District of Texas has a recommendation for you:  Austin, Texas.  Music festivals, independent film festivals, the Circuit of Americas racetrack, college football (“Hook’em Horns!”), and Texas Relays are just some of the diversions that Austin offers leisure travelers throughout the year.  Increased tourism to Austin has created a “rising” hotel market, and one hotel debtor in particular has reaped the benefits, making a remarkable turnaround from the brink of foreclosure to confirming a plan of reorganization over its secured creditor’s objection.  In this post, we cover In re LMR, LLC, our latest case on chapter 11 cramdown, and one of the first published decisions to apply the Fifth Circuit’s recent guidance in In re Texas Grand Prairie Hotel Realty, L.L.C. on setting chapter 11 cramdown interest rates.  
The Facts
The debtor, LMR, LLC, owns and operates the Baymont Inn & Suites, a limited-service hotel in Austin, Texas.  (Austin-bound readers: you can book a room here.) When LMR first purchased the hotel in 2007, it was operating as a Best Western franchise.  In 2010, Best Western terminated the franchise, and subsequently LMR experienced a loss of revenues.  It also incurred additional costs to convert to a Baymont (affiliated with Wyndham) property.  Unable to refinance the secured loan on the hotel, LMR almost ended up in foreclosure in 2012, but filed its chapter 11 petition to preserve the property and prevent the foreclosure.
Post-bankruptcy, the debtor’s hotel business experienced a “remarkable turnaround.”  The debtor operated profitably, even with the monthly adequate protection payments the bankruptcy court ordered the debtor to make to its secured lender and the cost of repairs. 
The debtor’s chapter 11 plan proposed to continue the hotel’s operations and pay off creditors with interest over five years through revenues generated by the hotel and restaurant leases on the hotel property.  The debtor’s members would pay $200,000 cash as equity for improvements to the hotel and an operating reserve and, in exchange, retain their interests.  Equity would not receive any distribution unless and until all creditors are paid. 
With respect to its secured lender, Asset Ventures Fund I Ltd. (“AVF”), the debtor proposed to pay the secured claim in 59 monthly payments amortized over 25 years at 6% interest, with a balloon payment for the remaining amount of the secured claim in the 60th month.  The debtor would use its best efforts to refinance the balloon payment in the fifth year.  Any unsecured portion of AVF’s claim would be paid in 60 equal monthly payments at 6% interest, with the entire unsecured amount repaid (with interest) in full in 5 years.  If the debtor were to default on any payments owed on the secured or unsecured claims, and could not cure such default, AVF had recourse to its state law remedies, including foreclosing on the hotel.  If the debtor sold the hotel, the proceeds would first pay the lender’s secured and unsecured claims and then other creditors before the members received any distributions.
At confirmation, AVF was the only creditor which voted to reject the plan.  It contended the plan was not feasible, was not proposed in good faith, and did not satisfy the cramdown provisions of section 1129(b)(2) of the Bankruptcy Code.  The core dispute was AVF’s assertion that the 6% interest rate the debtor proposed was too low because it was a below market interest rate.  Plan confirmation centered on the appropriate cramdown interest rate.
The Legal Framework:  A Review of Chapter 11 Cramdown Interest
As covered extensively on our blog, one of the most powerful tools in a debtor’s arsenal is the threat of “cramming down” a chapter 11 plan on a dissenting creditor.  To do so, the debtor’s proposed plan must not discriminate unfairly and must be “fair and equitable” with respect to the impaired rejecting class of creditors.  For secured claims, this often means that the holder of the claim retains the lien securing the claim to the extent of the allowed amount of the claim and receives deferred cash payments (including interest) equaling or exceeding the amount of the secured claim, and with a present value, when discounted at the proposed interest rate, equaling or exceeding the amount of the secured claim. 
Impaired rejecting secured creditors usually take issue with the cramdown interest rate, essentially arguing that the rate is too low and therefore not fair and equitable.  Despite its importance, the Bankruptcy Code is silent on how cramdown interest rates should be computed.
The US Supreme Court’s plurality decision in Till v. SCS Credit Corporation, which we have written about here and here, established the method for determining an appropriate cramdown interest rate for a chapter 13 plan, but muddied the waters as to how to pick a cramdown interest rate in a chapter 11 case.  For chapter 13 debtors, the Supreme Court adopted the “formula” approach or “prime-plus” rate, which starts with the national prime rate and adjusts the rate upward to reflect the particular debtor’s default risk based on such factors as “the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization plan.” 
The Till plurality, however, sent mixed signals about chapter 11 cramdowns.  It noted that Congress likely intended for courts to apply the same approach to choosing an interest rate under “any [cramdown] provision.”  Yet, in the now-famous footnote 14, the Court drew a distinction between chapter 13 and chapter 11 cramdown loans and asserted that “it might make sense to ask what rate an efficient market would produce” in selecting a chapter 11 cramdown interest rate.  The majority of courts to apply Till’s rationale to chapter 11 cramdown interest rates have extrapolated a two-part process:  first, if an efficient market exists, apply the market rate; otherwise, apply Till’s formula approach.   
One issue not resolved by Till is whether the national prime rate is the correct base rate for the formula approach.  Given footnote 14, should the Supreme Court’s selection of the prime rate as the base rate in chapter 13 cases be binding in chapter 11 cases?  Other common base rates may be appropriate under the circumstances, such as LIBOR or T-bill (treasury bill).
Outcome in LMR
The LMR court first determined the value of the hotel to be $3.2 million.  AVF’s uncontested proof of claim set forth that the debtor owed AVF $3,815,355 as of the filing date.  Thus, AVF had an allowed secured claim equal to the value of its collateral ($3.2 million) and an unsecured claim for about $520,000 (i.e., its claim as of the filing date, less $95,000 of adequate protection payments made during the case, less its secured claim).
Next, the court turned to whether the 6% interest rate to be paid to AVF on its $3.2 million secured claim was an appropriate cramdown interest rate that would yield AVF at least the present value of its secured claim. 
The bankruptcy court looked to Texas Grand, which is one of only two Circuit Court of Appeals decisions after Till to provide guidance on the appropriate interest rate for a chapter 11 cramdown plan. There, the Fifth Circuit held that the prime-plus methodology is not the exclusive—or even the optimal—way to select an interest rate, but found no clear error in the bankruptcy court’s application of Till’s formula approach (and acknowledged that the Till formula approach has become the “default rule” followed by a “vast majority” of courts in chapter 11 cases).  The LMR court extrapolated from Texas Grand that the formula approach was the preferred method to evaluate the debtor’s proposed cramdown interest rate for AVF’s claims.
Assuming that an efficient market is a predicate to applying the Till formula approach, the bankruptcy court also concluded that no efficient market existed for the cramdown loan the debtor proposed.  To obtain a loan contemplated by the debtor’s plan in the market would require “tiered financing” (e.g., mezzanine debt and some equity participation), which the court held demonstrated that no efficient market exists. 
In the absence of an efficient market, the bankruptcy court applied Till’s formula approach.  It started with the national prime rate of 3.25% and added a 2.75% risk adjustment.  The court found that the risk adjustment could have been even lower under the circumstances – the debtor’s increasing revenue stream, improvements and upgrades to the property, the appreciating value of the hotel, equity’s substantial cash infusion, AVF’s recourse to expedient state law remedies upon the debtor’s default, and the overall “bright” prospects for the hotel provided AVF with enough protection and no undue risk that would require cramdown interest in excess of 6%.  Thus, the debtor’s proposed 6% cramdown interest rate on AVF’s secured claim provided AVF with at least the present value of its secured claim, and was more than sufficient to support cramdown of AVF’s secured claim.
Because the debtor’s plan proposed to pay AVF’s unsecured deficiency claim in full, with interest, over five years, the court undertook a similar analysis and determined that the proposed 6% interest rate was sufficient to provide AVF with the present value of its unsecured claim, and satisfied the requirement for cramdown of the unsecured creditor class that included AVF.
Interest Rate Analysis 
The court noted that the national prime rate already has some risk built into it, and some courts have started the upward adjustment not from the prime rate but, rather, from the (true) risk-free T-bill rate.  The court was not willing to go so far as to use the T-bill rate as a base rate, but pointed out that, since the T-bill rate was less than 1% at the time of confirmation, AVF was receiving over a 5% upward risk adjustment above a truly riskless rate.
Yet, was the prime rate the best starting point for a secured loan for a commercial real estate property repayable over 25 years at a fixed interest rate?  Prime is commonly used as a foundation rate for pricing short- or medium-term consumer loans, such as home equity lines of credit and credit card rates.  Here, the bankruptcy court might have looked to other relevant rates like LIBOR or T-bill that financial markets consider to be risk-free or nearly risk-free and then adjusted that rate (just like a commercial lender would) to account for the particular attributes of the debtor’s proposed loan.
Another consideration is that not all debtors will be inclined to pursue a contested plan confirmation.  It is far more likely that the debtor will seek a consensual resolution with secured creditors to facilitate a quicker and less costly exit from chapter 11.  Therefore, a debtor may have less incentive to fight for a cramdown rate that is based on a lower reference rate, especially if not many courts have signed on to that approach.
In another recent single asset real estate case, In re SCC Kyle Partners, Ltd. (which will be the subject of a more detailed upcoming blog post), the same court that decided LMR had another opportunity to consider whether the T-bill rate was a more appropriate starting point for its risk adjustment analysis.  The court again declined to use the T-bill rate, citing the following reasons: the Fifth Circuit affirmed the prime-plus approach in Texas Grand, the majority of courts applying Till’s formula approach start with the prime rate, and Till started with the prime rate.  More on SCC, and an updated cramdown matrix, coming soon – just in time to read on your plane ride to Austin!