Restructuring

Contributed by Ijeoma Anusionwu
In our first ever installment of “Throwback Thursdays” we explore the famous Supreme Court decision Till v. SCS Credit Corp., 541 U.S. 465 (2004) that strongly divided the Supreme Court justices and, ultimately, was decided based on the support of a plurality.  Despite losing our Sweet Sixteen contest, it’s still a winner in our minds for being the least likely individual chapter 13 case to affect corporate reorganizations.
In Till, the Supreme Court examined the issue of what interest rate is the proper rate to compensate secured lenders forced to accept loans proposed in a chapter 13 reorganization plan, pursuant to the cramdown provision of the Bankruptcy Code.  The chapter 13 cramdown provision (much like the chapter 11 cramdown provision) allows a debtor to restructure secured loans through recurring deferred payments totaling at least the allowed amount of the secured claim, of a present value equal to that of the collateral as of the plan’s effective date.  The Bankruptcy Code, however, provides little guidance as to the appropriate method for computing the applicable interest rate to the resulting cramdown loan.
The facts of Till are fairly straightforward.  Till involved a couple, Lee and Amy Till, who filed jointly for chapter 13 bankruptcy protection.  They owned a used truck for which they still owed $4,894.89 to SCS Credit Corporation, the lender to whom the loan was assigned.  As of the petition date, the value of the truck securing SCS Credit’s loan was $4,000.  The Tills’ chapter 13 plan contemplated making monthly payments to SCS Credit to repay the loan using a 9.5% yearly interest rate – slightly higher than the average loan rate at the time, to compensate for the increased risk that the Tills would default, because they had already declared bankruptcy once before.  SCS Credit objected to the plan, arguing that the proposed interest rate would not provide it with the present value of the truck, as required by the cramdown provisions.  SCS Credit insisted that it was, instead, entitled to a 21% interest rate, because that was how much it would have made if it had foreclosed on the loan, taken the truck, sold it, and reinvested the proceeds.  SCS Credit further supported its position stating that other local lenders would similarly charge an interest rate of 21% for loans to debtors like the Tills facing financial distress.
In determining the appropriate method for calculating the cramdown interest rate, the Court considered four different approaches, namely: (1) the coerced loan method, (2) the presumptive contract rate method, (3) the cost of funds method, and (4) the “prime-plus” formula.  The coerced loan method requires creditors to extend a new loan to the debtor using the interest rate the creditor would have obtained had it foreclosed and reinvested the proceeds into comparable loans to similar, though nonbankrupt, debtors.  In Till, the coerced loan method would have resulted in a rate of 21%, in the lender’s opinion.  The presumptive contract rate method is based on the original prepetition contract rate, which is adjusted upwards or downward to reflect the credit risks posed by the particular debtor.  The cost of funds method sets the interest at the rate the lender would have to pay to borrow the cash equivalent of the truck’s value from another source; basing the decision on the lender’s, not the debtor’s, creditworthiness.  A “prime-plus” formula, on the other hand, is based on the risk-free market rate, which is then adjusted upwards to reflect the particular debtor’s default risk.  Any risk adjustment depends on such factors as the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization plan.
In the plurality decision, the Court adopted the prime-plus formula approach, reasoning that the first three options were complicated, imposed significant evidentiary costs, and aimed to make individual creditors whole, rather than to ensure that the debtor’s payments have the required present value.  Conversely, in the Court’s opinion, the prime-plus formula was more straight-forward because the risk-free market rate is publicly and easily accessible and the adjustment was based on the debtor’s default risk.  In the case of the Tills, the Court concluded that a cramdown rate of 9.5%, augmenting the national prime rate of 8% with a risk premium of 1.5%, was appropriate.
Importantly, in dicta, the Court noted that in a chapter 11 case, the market rate of interest would be an additional alternative for a cramdown interest rate since there often exists an efficient market for the debt of similarly situated corporate distressed entities.  And with that, the use of Till in chapter 11 cases began. . .
Since Till, courts have tackled the interest rate issue in cramdowns of secured lenders in chapter 11 cases by following a two-step approach.  First, courts 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 have used the Till prime-plus formula or a T-bill (treasury bill) rate to compute the appropriate cramdown interest rate for the repayment of a secured lender’s debt.
Till, however, has not answered all of the outstanding questions when it comes to a debtor’s ability to cramdown a secured lender.  Subsequent posts will explore more recent decisions that address questions left unanswered by Till – for example, the appropriate length of the repayment period.  Stay tuned.