Restructuring

Contributed by Ijeoma Anusionwu
This is the first in a series of blog entries on cramdown cases and the determination of the “indubitable equivalent” of secured claims in a cramdown scenario under a bankruptcy reorganization plan.  Cramdowns of secured lenders are frequently spoken about, but less often implemented.  As such, the purpose of this ongoing series of posts is to explore precedent in this area to better understand how courts compute the indubitable equivalent of claims where a debtor proposes a plan that seeks to cram down a secured creditor.
One of the primary issues raised in a cramdown is how to determine the appropriate rate of interest when, pursuant to a plan, a secured creditor will receive new loan terms in satisfaction of its claim.  The Bankruptcy Code does not provide any guidance on how to determine the appropriate rate of interest in a cramdown, but virtually all circuits look to Till v. SCS Credit Corp., 541 U.S. 465 (2004), a case we wrote about last week, which is the Supreme Court case that set the standard from which most courts begin their analysis of cramdown interest rates.  In Till, a chapter 13 case, the Supreme Court adopted the “prime-plus” formula approach for computing the appropriate interest rate for a secured cramdown loan.  In employing this approach, a court determines the publicly accessible national prime rate, and then adjusts it upward to reflect the greater risk of default associated with the particular debtor.  However, for a chapter 11 case, the Till court proposed a two-step approach: First, courts should try to ascertain whether a preponderance of evidence exists to show that an efficient market interest rate exists for the loan in question, and whether the plan reflects such a rate.  If an efficient market rate cannot be determined, courts should, secondly, proceed with the Till prime-plus formula described earlier to compute the appropriate cramdown interest rate for the repayment of a secured lender’s debt.
The court in In re Mace, No. 08-06124, 2011 WL 284435 (Bankr. M.D. Tenn. Jan. 26, 2011) recently considered some of the cramdown issues explored by Till.  Mace involved a debtor homebuilder and developer who was one of the largest property owners in the Clarksville, Tennessee area.  Regions Bank held three secured claims against Mace, amounting to a debt of over $1,100,000.  Each claim was secured by rental real properties.  Mace’s plan provided that Regions Bank’s secured claims would accrue interest at an annual rate of 6% for 5 years following the effective date, which rate would then adjust to the prime rate plus 2.0%, with a floor of 6% and a ceiling of 11%.  The plan also sought to amortize Regions Bank’s secured claims over a period of 20 years, with equal monthly payments of principal and interest.  This treatment is unlike cramdown loans secured by similar collateral in other cases, where the typical cramdown loan term is between five and seven years.
Regions Bank objected to the plan because the proposed 20-year repayment period exceeded the customary terms that might be available to the debtor in the marketplace.  Regions Bank further argued that, even if an efficient market did not exist, pursuant to Till’s prime-plus formula, an interest rate of 6% would not compensate it sufficiently in light of the added risk associated with a longer repayment period.  The Court disagreed, concluding that, not only did a market rate exist, but also that the regional market was broad enough to include a 20-year amortization as evidenced by the acceptance of similar terms by other similarly-situated secured lenders in the Mace case.  Accordingly, the court held that an efficient market existed, the plan reflected that market’s interest rate, and that Regions Bank had been provided with the indubitable equivalent of its secured claim.
Notwithstanding the finding that an efficient market interest rate existed, the court justified confirmation of the plan under Till’s prime-plus formula approach as interpreted by the Sixth Circuit in In re American HomePatient, Inc., 420 F.3d 559 (6th Cir. 2005).  In American HomePatient, the Sixth Circuit stated that in addition to looking at the national prime rate, a bankruptcy court is required to “adjust the prime rate accordingly for the greater risk sometimes posed by bankruptcy debtors.”  By its choice of emphasis, the Mace court appeared to highlight the fact that not all debtors are alike, and some debtors might not pose greater risk of default; therefore, the interest rate for those debtors should reflect this minimal risk.  This reasoning is also supported by Till, where the Supreme Court noted that “if [a] court could somehow be certain a debtor would complete his plan, the prime rate would be adequate [without risk adjustment] to compensate any secured creditors forced to accept cramdown loans.”  In the Mace court’s opinion, the debtor presented minimal risk because there were no challenges to the feasibility of the plan and, prior to its chapter 11 petition, the debtor had never missed or made late payments to Regions Bank.  Hence, even under a prime-plus analysis, the court confirmed the 6% interest rate without additional adjustment for a longer 20-year period because, in the court’s opinion, a 6% interest rate fairly compensated Regions Bank for the minimal risk involved in a 20-year repayment arrangement with this particular debtor.
Another recent and similar decision issued by the Bankruptcy Court for the District of Arizona reinforces the possibility that a new norm of long repayment periods paired with relatively low interest rates is gradually taking root.  In re Red Mountain Machinery Co., 2011 WL 1428266 (Bankr. D. Ariz., April 14, 2011) considered the issue of whether a 15-year repayment period of a secured lender’s cramdown loan was too long.  In Red Mountain, a chapter 11 debtor sought to cram down lender Comerica Bank to which it owed a fully secured debt with a present value of $10 million.  Much like the Mace case, the debtor proposed a 6% interest rate and a 20-year amortization with the full balance of the loan due in 15 years.  Pursuant to Till, finding there was no efficient market for the cramdown loan, the debtor employed the prime-plus formula; applying a minimal risk premium to the national prime rate for a cramdown rate of 6%.  The lender, who felt that a 8.5-10.5% range would be more appropriate, objected to both the low interest rate and the length of the repayment period.  Reasoning that the debtor posed minimal risk of default, the Red Mountain court decided a 15-year payout at 6.5% was appropriate.
At a time when credit markets are easing up and interest rates are rather low, Mace and Red Mountain serve as a caution to secured lenders that the plan repayment periods may exceed the “customary” cramdown plan repayment period of five to seven years.  Furthermore, if a court deems a debtor to be low-risk and believes its proposed plan is feasible, there is also a possibility that secured lenders may not be compensated with higher cramdown rates for the longer repayment period.