However, bankruptcy courts in the Circuit are already interpreting the opinion as a license to apply Till in chapter 11 cramdowns over the objection of the secured creditor. See, e.g., the May 24, 2013 decision of the bankruptcy court in Austin, In re LMR, LLC, reproduced on Weil's website). (Although LMR is another hotel owner in Texas, nothing about the reasoning of either Grand Prairie or LMR supplies any basis to think the approach is limited to that kind of debtor. But the coincidence is remarkable that the other modern Fifth Circuit case on chapter 11 plan interest rates, In Re T-H Limited Partnership, is also a case involving an owner of multiple hotels.). I write this post frankly to argue against that trend. I don't think the Till approach is correct at all, but setting that aside, a deep dive into the record and briefs in Texas Grand Prairie has unearthed some facts about Texas Grand Prairie that did not make it into the Fifth Circuit opinion that I think make it a particularly bad vehicle to reach any grand conclusions about cramdown interest rates.
In particular, from the briefs and record, I learned that the 5% interest rate crammed down on the lender compared to a 1.9% rate that would have resulted had the contract rate been reinstated (although the contract rate was a floating rate and the 5% was fixed). Since the dissent in Till advocated a presumption in favor of the contract rate, which would then be adjusted up or down based on a variety of factors, one can see that the plurality approach probably resulted in the Texas Grand Prairie getting a higher (albeit fixed) rate than under the Till dissent's approach.
Secondly, the lender's expert had conceded the plan was feasible, if barely so (I am puzzled as to why the objector's expert gave such an opinion; there is no requirement to have an opinion on more than one issue and, although experts cannot be controlled at the end of the day, trial counsel normally manage to keep their side's experts from volunteering opinions that are not helpful to their client's case). That seems to me to have harmed the lender's case, because it undercut its claims about the level of risk in the plan. Even the plurality in Till says in a couple of places that plans with high risks of default ought not be confirmed and on appeal you would like to be able to argue as forcefully as possible that the plan you're challenging was one such plan.
Last, the appellant framed its challenge, not as an issue of law related to the interest rate methodology, which would be reviewed de novo, but as a challenge to the admissibility and weight to be given the debtor's expert's testimony, which of course is reviewed for abuse of discretion (it attempted to repair that mistake in its reply brief but, as one of my professional friends who later became a federal circuit judge once told me, "we don't have time to read reply briefs"). Challenging the expert's methodology is not the same as challenging the Till plurality's methodology. I would hope that future courts considering Texas Grand Prairie as a precedent would recognize this and accordingly recognize that it did not really involve a properly framed challenge to the Till plurality's methodology and not misconstrue it as an endorsement of Till.
At the same time, there are some aspects of the case that might have been litigated differently to produce a different result. As alluded to above, the Fifth Circuit opinion says that "Both parties stipulated that the applicable rate should be determined by applying the “prime-plus” formula endorsed by a plurality of the Supreme Court in Till...." But the odd thing is that I don't see any reference in any of the briefs to such a stipulation. What I do see is a very strained interpretation of Till by the creditor-appellant that may have confused the panel and contributed to the decision in the debtor's favor.
The appellant's brief makes a chest-thumping proclamation that Till requires "objective analysis" of "market evidence" and "ordinary lending practices" in formulating an interest rate. So, in that sense, the creditor-appellant is definitely saying that Till governs and maybe that is what the opinion means by a stipulation. But the appellant has Till all wrong. Its brief makes virtually no mention of the "prime plus" formula. While I wish Till had said what the appellant claimed it said, because that is what the law should be, Till's plurality opinion explicitly rejects incorporating market evidence, stating in the first paragraph of Section III of that opinion:
"For example, the coerced loan approach requires bankruptcy courts to consider
evidence about the market for
comparable loans to similar (though nonbankrupt) debtors an inquiry far removed from such courts usual task
of evaluating debtors financial circumstances and the feasibility of their debt
adjustment plans. In addition, the approach overcompensates creditors because
the market lending rate must be high enough to cover factors, like lenders’ transaction costs and
overall profits, that are no longer relevant in the context of
court-administered and court-supervised cramdown loans." (Emphasis added)
Now, if the plurality had adopted the "coerced loan" approach, the appellant in Texas Grand Prairie would have been correct that the Court wanted bankruptcy courts to look at the loan market. But they rejected it, obviously; that was the approach endorsed by the Seventh Circuit opinion overturned by Till. So the appellant was just off the mark in how it presented the key legal argument to the panel. (Appellant's reply brief tried to correct for that, but see quote above for the value of reply briefs in fixing your mistakes.) The Fifth Circuit opinion quite clearly spells all this out.
The wrong-headed appellate approach is too bad because the case contained some decent facts for the appellant, had it framed them differently. Among the key facts that would have supported a different strategy, I found these in the briefs:
1. Although the circuit court opinion only refers to the appellant's secured claim of $39 million, which was equal to the value of the collateral, its allowed claim was $51 million, so it had a general unsecured claim of roughly $12 million that was lumped in with the general unsecureds in a class that was also crammed down with periodic payments eover 5 years equal to 25-30% of the claim. So, one might wonder, how did the plan get confirmed if both the mortgage and unsecured claims were crammed down. Apparently, there were two small secured claims (property tax and a vendor with a deposit) that were classified separately and called "impaired" because the plan provided them to be paid in full ten business days after the effective date of the plan, on account of which treatment they voted to accept, giving the debtor accepting impaired classes. There is no indication in the briefs that appellant either raised an objection to the artificial impairment, or preserved it for appeal. Notwithstanding the Circuit's recent Camp Bowie decision, I don't understand how that could have gone uncontested in 2010. Also, while I have not done the math, I cannot quite understand why the lender chose not to make an 1111B election on these facts because the economics seem to favor keeping that extra $12 million as a secured balloon payment getting some interest, even if it reduces the interest rate on the $39 million portion of the claim somewhat. Perhaps it was to keep the general unsecured class from voting to accept, but what does that matter if you're not going to object to the artificial impairment of the other secureds?
2. The plan was, of course, a "new value" plan and the debtor conducted an "auction" of sorts for the equity that was being infused by old equity. The person conducting the auction was the same one who testified at trial as an expert on the proper interest rate. He did not find anyone interested in paying more for the equity than the insiders. One reason he gave for the lack of response seems highly relevant to the cramdown issue on appeal: "the assignment was challenging
because the reorganized debtors would be fully leveraged, with the lender’s
secured claim encumbering the hotels at a loan-to-value ratio of 100%." He further testified:
"And so what you’re really selling is an option, sort of an upside option. Okay? And so on a fully valued estate, is someone willing to pay more than 1.5 million dollars for
the option that there’s value accretion in excess of that….
"So as a valuation guy, I looked at it and said, you know,
this seems to be fully priced…. But the universe for this type
of buyer in this atypical transaction that, to me, seemed to
be fully priced, I was -- I knew we had an uphill battle, and frankly, I didn’t know if we’d get any takers on the front
end.”
Bizarrely, the bankruptcy judge agreed with him: "the owner of the new equity “may receive a return on its investment, but … they have put their money into a high risk investment and may receive no return". (Emphasis added). Of course, I look at that and say, if the equity in a 100% LTV asset has high risk of no return, then the loan must have a similarly high risk of a loss of some kind because the odds are pretty small that the losses are going to magically stop right at the debt/equity line. And you would expect that recognition to show up in the interest rate analysis, but sadly it does not.
3. The debtor's expert testified that average terms for loans to limited-service hotels in 2010 included a loan-to-value ratio of 58%, an interest rate of 7.9%, and a debt-coverage ratio (net operating income divided by debt service) of 1.5, none of which come close to the terms of the plan. But he disregarded the market "because he believed that the market for hotel and hospitality loans generally was not an efficient market". Which of course are magic words, if you want to invoke Till, as I shall discuss further below.
Thus, he positioned himself to develop an interest rate based on the prime-plus formula. He formulated one by determining that the obligation at issue was “just to the left of the middle of the risk scale,” which he understood to be a range of one to three percentage points above the prime rate, absent “extreme circumstances”. Obviously the "1-3 percentage points" of risk spectrum come from dictum in Till, not finance or controlling precedent. He testified: “I used a one-to-three, which seems to be suggested in Till, and the middle of the one-to-three range [above prime] would’ve been two. The rate just to the left of that, 1.75. That’s what I chose”. Personally, were I a judge, I would have a hard time seeing that as expert testimony, even under an abuse of discretion standard.
So somehow the "high risk" of the equity infusion became "just to the left of the middle of the risk scale" when the focus turned to the 100% LTV mortgage. And even though the loans that are being made to better-capitalized companies were yielding 7.9% interest, the 100% LTV loan was only going to earn 5%.
It sure seems to me there was an appellate case to be made out of those facts, although the "clear error" and "abuse of discretion" standards of review are definitely hurdles. I can't think of any support for deeming the "risk scale" to be limited to 1-3 percentage points; that other courts have frequently (but not always - for example, the recent Camp Bowie decision in the same circuit involves a a risk adjustment over 3%) adopted risk premia within those parameters does not make such a range law, and certainly there was no factual basis in 2010 to limit the upper end to 3%. Appellant did make those arguments, but, as I read the opinion, combining them with the position that they were inconsistent with Till may have confused the appellate panel, as they are quite slavishly consistent with Till.
Given these details, I don't feel that Texas Grand Prairie is an opinion that should be interpreted aggressively in favor of debtors. There were several questionable strategic decisions by appellant, any one of which might have led to a different result. I would say, rather, that the door remains open in the Fifth Circuit to a well-thought-out challenge to the Till plurality's method in chapter 11 cases. Such a challenge would entail, among other things, not misunderstanding Till; not conceding its prime-plus formula governs in 11's; and not having an expert muddy the record with unhelpful opinions. It would also, I think, benefit from challenging the claims made by the Till plurality about the defects of the "coerced loan" approach, challenging the 1-3 percentage points range; challenging what "prime" rate means; and last, challenging the application of the "efficient market" reference in footnote 14 of the plurality opinion. I will discuss these last points in a subsequent post.
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