Fifth Circuit Clarifies Interest Rates for Cram-Down Plans
In a recent decision affirming the confirmation of a chapter 11 plan of reorganization, the United States Court of Appeals for the Fifth Circuit adds to the growing body of judicial precedent that explains the requirements for selecting an interest rate applicable to secured creditors' claims in cramdown plans. In the context of a challenge to expert testimony, the court was required to endorse or reject the mechanics of an expert opinion as to the proper interest rate to be paid in a cramdown plan. Endorsing the expert's opinion, the court's decision provides a roadmap for the proper methodology to select cramdown interest rates.
Section 1129(b) of the Bankruptcy Code permits a court to confirm a debtor's plan of reorganization over the objection of a class of creditors (or where those creditors' claims are impaired) if the plan does not discriminate unfairly and is "fair and equitable" as to the impaired or objecting class. To be considered "fair and equitable," the plan must (among other things) provide the creditor with deferred cash payments of a value at least equal to the allowed amount of the claim as of the effective date of the plan. In other words, the total amount of the deferred payments, discounted to net present value by applying an appropriate interest rate, must equal the allowed amount of the creditor's claim.
In Till v. SCS Credit, a plurality of the United States Supreme Court endorsed a "prime plus" methodology to select interest rates for cramdown plans proposed by chapter 13 debtors. The "prime plus" methodology begins by reference to the national prime rate, and adjusts that rate upward to reflect the greater risk of nonpayment associated with insolvency. Generally, such adjustments increase the rate of interest by amounts ranging from 1% to 3% over prime. Till also suggested that "Congress likely intended bankruptcy judges and trustees to follow essentially the same (prime plus) approach when choosing an appropriate interest rate under (Chapter 11)," reasoning that the applicable statutory the language in both chapters was functionally identical. However, because Till is a plurality decision, made in the context of chapter 13, many courts have declined to accept the "prime plus" methodology as a "hard, fast" rule for chapter 11 plans.
Texas Grand Prairie Hotel involved an effort to reorganize four hotel properties located in Texas. The debtors' secured lender objected to confirmation of the reorganization plan, claiming that the plan failed to provide an adequate rate of interest to ensure that the deferred payments would provide a value equal to the allowed amount of its claim. More particularly, the creditor attempted to strike the testimony of the expert who testified in support of the proposed interest rate, claiming he had not correctly applied Till and its progeny, and therefore had not rendered a reliable expert opinion.
The Fifth Circuit first considered whether Till's "prime plus" methodology is mandatory in a chapter 11 case. The Till decision features a widely-acknowledged footnote 14, which endorses a market-driven approach to determining the proper interest rate, if an "efficient market" exists for a loan substantially identical to the cramdown loan. Citing a disinclination to "tie the hands of the lower courts as they make the factual determination involved in establishing an appropriate interest rate," the Fifth Circuit declined to establish "a particular formula for the cramdown interest rate in Chapter 11 cases."
Curiously, the debtors and the lenders in Texas Grand Prairie Hotel stipulated that Till's "prime plus" methodology was the proper starting point to determine an acceptable interest rate. Moreover, in the two day evidentiary hearing conducted by the bankruptcy court in Texas Grand Prairie Hotel, the secured creditor had not adduced any evidence that an efficient market existed for a loan substantially identical to the cram down loan. Indeed, the secured creditor's expert had testified that there was no such market: he concluded that exit financing could be cobbled together through a combination of senior debt, mezzanine debt and equity financing, but that no one lender would make the required loan to the debtors.
The debtors' expert had testified in support of the proposed plan's interest rate of five percent (5%). The rate was determined - as guided by Till - by first referencing the prime rate: at the time of the confirmation hearing, that rate was 3.25%. The debtors' expert continued the "prime plus" analysis by adjusting the rate by evaluating risk factors: the circumstances of the debtors' estate; the nature of the security; and the duration and feasibility of the proposed plan. The expert concluded that the debtors' hotel properties were well maintained and excellently managed; that the debtors' were committed to the business; that the debtor's revenues exceeded their projections in the months prior to the hearing; that the value of the collateral for the loan was stable or appreciating; and that the proposed cram down plan was "tight, but feasible." Accordingly, the debtors' expert utilized a risk adjustment of 1.75%, a value slightly higher than the middle of Till's risk scale. Thus, the adjusted "prime plus" rate proposed for the plan was 5%.
The secured lender's expert reached all of the same factual findings as the debtors' expert with respect to the applicable prime rate, the debtors' properties, their management, ownership and projected earnings. However, because the lender's expert concluded that the market would charge a blended rate (of senior debt, mezzanine debt, and equity) amounting to 9.3%, his risk adjustment from the 3.25% prime rate started as an 8.05% adjustment, and was then further adjusted downward 1.5% to reflect the "sterling circumstances of the bankruptcy estate" and upward 1% to account for the "tight" feasibility of the proposed plan. Ultimately, the secured lender's expert concluded that a proper rate of interest for the plan was not less than 8.8%, and that the plan could not be confirmed because the lower rate it proposed did not result in a payment that was equal to the allowed amount of the creditor's claim.
The bankruptcy court accepted the testimony of the debtors' expert, determining that it was "defensible" because the expert had "properly interpreted Till, and properly applied it," and that his "assessment of the circumstances of the estate, the nature of the security and the feasibility of the plan ... [were] credible and persuasive." By contrast, the bankruptcy court rejected the analysis of the secured lenders' expert, observing that it established a (market influenced) benchmark, before adjustment, that the bankruptcy court viewed to be "completely inconsistent with Till."
The Fifth Circuit agreed with the bankruptcy court that the rate determination proffered by the debtors' expert rested on an "uncontroversial" application of Till's prime-plus formula. The Circuit court concluded that the proposed rate had been determined based on an adjustment arising from a "holistic evaluation of the debtors," and that it fell squarely within the range of adjustments other bankruptcy courts had assessed in similar circumstances. It agreed with the bankruptcy court that the secured lender's expert had used an analysis that had been rejected in Till.
In the end, the Fifth Circuit concluded that the bankruptcy court's confirmation of the plan should be affirmed, because the plan calculated a cramdown rate on the basis of a straightforward application of the "prime plus" approach; an approach "endorsed by a plurality of the Supreme Court, adopted by the vast majority of bankruptcy courts, and, perhaps most importantly, accepted as governing by both parties to this appeal." On the record before it, the Circuit found the cramdown rate was not clearly erroneous.
The Fifth Circuit's decision in Texas Grand Prairie Hotel provides additional guidance into the determination of an appropriate interest rate for those who are tasked with the formulation of a cramdown plan. The decision emphasizes two points: first, that the "prime plus" methodology is not the exclusive methodology by which an interest rate can be selected; but, second, if the "prime plus" methodology is selected, it should be applied strictly, and without significant variation from its standard formulation.
It remains to be seen how broadly the holding in Texas Grand Prairie will be applied. In many respects, it would appear that the result in the case was driven by the secured lenders concessions, for the purposes of the evidentiary hearing, that there was no market for exit financing, and that Till's "prime plus" methodology was the appropriate manner to determine the interest rate for the cramdown plan. There might well be a different outcome where an objecting creditor chooses a to litigate those matters.
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