In this post, I aim to convince
the reader that the justices signing the plurality opinion selected what they
thought was a practical, pragmatic resolution for chapter 13 cases that was not
meant to be exported to chapter 11’s at all, but rather reflected the specific
circumstances that dominate chapter 13’s.
That approach may not even have appeared to them to be the ideal
approach to implementing the statute; it may in fact have been only the
second-best approach in their minds (to looking at comps in a well-functioning
market), but the plurality, at least, convinced itself that it was the best
practical approach available to them.
In rendering a decision, the Court
split into three camps: a plurality voting to overturn the 7th
Circuit, in an opinion authored by Justice Stevens and joined by Justices
Breyer, Ginsberg and Souter; a 5th vote to do so from Justice Thomas
who authored a separate concurrence which I analyze in the next post; and the other four justices (Kennedy, O’Connor,
Rehnquist and Scalia dissenting (I will not discuss the dissent as it is not
relevant to my thesis).
In the prior recap of oral
argument, I showed that the justices devoted little time to a discussion of the
statute and one even wondered if the statute specified a particular method of
valuing the cram-down paper at all.
True to that theme, the first six words of the plurality opinion, following its
recitation of the facts and the proceedings below, are: “The Bankruptcy Code
provides little guidance ….”
The plurality goes on to make some
fairly general points that address positions taken in the Till litigation that are not particularly insightful or relevant to
chapter 11: that the Bankruptcy Code authorizes modification of pre-petition
debt over a creditor’s objection (which generally speaking begs the question of
what kind and degree of modification) and that the cramdown rate should be set
“objectively” and not “subjectively” (by which they mean the creditor’s own
cost of funds and investment practices
are not relevant). They offer four
reasons why payments under a chapter 13 plan bear reduced risk of default
compared to the prepetition debtor: the
bankruptcy judge has found the plan feasible; the debtor’s financial affairs
have been disclosed; the “public nature of the proceedings” reduce the debtor’s
ability to take on more debt and, under chapter 13, the trustee remains in
place to receive all post-confirmation income and distribute it.[1]
They offer their opinion that Congress “likely” intended
courts to use “essentially the same approach when choosing an interest rate” to
discounting payment streams to present value throughout the Bankruptcy
Code. That might afford some fodder for
the application of the “prime plus” formula to chapter 11, although it is
hedged twice by “likely” and “essentially the same”. But then, on the very next page, they reverse
field and drop footnote 14 to suggest that chapter 11 cramdowns should in fact
be handled differently, by reference to “the rate an efficient market would
produce. In the Chapter 13 context, by
contrast, the absence of any such market obligates courts to look to first
principles and ask only what rate will fairly compensate a creditor for its
exposure.” (emphasis added). These two
statements are where the impetus to apply the “prime plus” formula in chapter
11s comes from so I will analyze them in more detail in a following post. At this point, I am just summarizing the
opinion.
Ultimately, the plurality states, a bankruptcy court
“should aim to treat similarly situated creditors similarly, and to ensure that
an objective economic analysis would suggest the debtor’s interest payments
will adequately compensate all such creditors for the time value of their money
and the risk of default.” Which is
fairly broad and vague and open-ended conclusion but certainly does not imply
they thought they were breaking new ground.
In Section III of the plurality opinion, the alternatives
to the “prime plus” formula are eliminated for various reasons. Few of these reasons arise in chapter
11. The analysis begins by saying:
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 cram down loans.
The first of those criticisms is obviously chapter
13-specific with its reference to “debt-adjustment plans”: the four justices
are saying that chapter 13 proceedings don’t involve evidence about market
rates; whether that is true or not of chapter 13, it’s obviously not true of
chapter 11 cases, where bankruptcy judges hear evidence of market comps all the
time, in contexts from lift – stay appraisals to solvency determination in
avoidance actions to cram-downs at confirmation.[2] The second is vaguely worded, but in my
judgment, its reference to “court-supervised cram-down loans” is a reference to
the role of the chapter 13 trustee in collecting and disbursing payments from
debtors under confirmed chapter 13 plans, and thus likewise inapplicable to
chapter 11s; performance under chapter 11 plans, post-emergence, is generally
free of court supervision. A chapter 11 debtor is considered reorganized, and
gets a discharge, the day it comes out of 11; the chapter 13 debtor is
discharged and rehabilitated only when s/he completes the payments under the
plan. That is a vital difference in understanding Till.
The plurality
rejects the “presumptive contract rate approach” and “cost of funds” approaches
because, by focusing on something other than the debtor’s proposed payment
stream, they are less “objective”; also they might produce different interest
rates for creditors of the same debtor, based on the creditors’ own financial
condition, and finally they impose
evidentiary burdens on the chapter 13 debtor who, it goes without saying, could
not generally afford to bear them and thus would be unfairly disadvantaged at
trial. Certainly the last factor is
inapplicable to chapter 11’s, where debtors have squadrons of expensive
professionals paid for by the estate.
Conversely, the plurality asserts in Section IV, the
“prime-plus” formula “has none of these defects”. Again, note that the entire
focus here is on what is practical, what is the best mechanism to approve,
nothing about statutory interpretation.
The formula, they assert, takes “its cue from ordinary lending
practices” because it starts with the “prime rate” which is in the newspaper
every day.[3] Once a risk adjustment factor is added, “the
resulting ‘prime plus’ rate of interest depends only on the state of financial
markets, the circumstances of the bankruptcy estate, and the characteristics of
the loan, not on the creditor’s
circumstances or its prior interactions with the debtor. For these reasons, the
prime-plus or formula rate best comports with the purposes of the Bankruptcy
Code.” Although this statement is so
generalized it could be argued to apply to chapters 11 & 12, the opinion cites an amicus brief filed by an
organization of chapter 13 trustees, further indicating it was thought to be
targeted to chapter 13 cases.
This section of the opinion closes by explicitly noting
that the opinion does not approve any specific scale to be used for risk
adjustment factors. In explaining their
perspective (keep in mind this is dictum in a plurality opinion), they say
something which in my experience bears no relation to chapter 11 practice and
thus could not have been thoughtfully intended to apply to chapter 11: that the
rate on chapter 13 cramdown paper is supposed to be (a) selected by the court and (b) “high enough to compensate the creditor for
its risk but not so high as to doom the plan.” Essentially, having started at “present
value” as being required by the statute, they wind up at something I would call
“highest feasible present value“, i.e.,
“you can have as much value as we can give you and still confirm the
plan”. Whether this is right as a
chapter 13 matter, I will leave to one side, but neither in practice nor in
precedent does it resemble the chapter 11 context.
As far as the judge actually selecting the cramdown rate
in chapter 11, although on occasion a judge might more or less give fairly
clear guidance about what s/he might approve, to move things along, I cannot
recall seeing a court ever confirm a plan with language like that and specify
the rate. If a judge saw it, he or she
would likely tell the debtor that it’s the debtor’s job to propose a plan and
the judge’s job to review it, and then the parties would go out and cut their
deal.[4]
As far as turning
cramdown valuation in chapter 11 into the “highest feasible present value”
approach endorsed by the plurality, that would fly in the face of the Court’s
prior precedents on the subject as I will discuss
in the sixth post. In addition, the
process of formulating a chapter 11 plan in the real world generally operates
in a very different manner: typically, (1) financial professionals try to
figure out the debtor’s projected EBITDA;
(2) then, they look at the debt levels of comparable companies and
recent deals in the credit markets to determine (a) how much debt, as a
multiple of the projected EBITDA, the reorganized debtor should reasonably take
on; and (b) what other salient terms comparable financings are presently
carrying; and then (3) they approach potential exit lenders to test their
hypothesis and fine-tune the specific terms for the debtor in the dual track
process of negotiating with creditors and soliciting exit financing. In other words, the chapter 11 plan process
does not start with a desired debt amount and then solve for feasibility by
lowering the interest rate, as the plurality thinks chapter 13 does. It starts with the amount available to pay
debt service, then derives a feasible debt amount from that number by looking
at comps that – this is important -- are solvent. Because the comps are solvent companies by
definition, there is no need for the professionals to do a big, separate
feasibility analysis of the debtor’s risk of default, although one will be
prepared anyway to make a record that complies with confirmation
formalities. It’s just embedded in the
use of solvent comps that, if you use the same debt/EBITDA ratios and the same
interest rate solvent companies have, the debt burden will invariably meet the
feasibility test. Applying the
plurality’s approach in chapter 11 runs the risk, I think, not only of
systematically under-compensating recipients of cramdown paper contrary to the
Court’s prior precedents, but, equally important for bankruptcy policy, of
systematically over-leveraging reorganized debtors’ balance sheets and thereby
increasing the risk of “chapter 22s.”
Section V of the plurality opinion is devoted to addressing issues raised by the
other five justices’ views. First, they
respond to the four dissenters’[5] recommendation of the
“presumptive contract rate” with an argument about the subprime lending market,
which they opine, is not “perfectly competitive” in part because it is highly
regulated to protect borrowers from their own “ignorance”. This section,
whatever you think of its intrinsic merit[6], is further evidence of my two main themes: (1) reference
to the market is the first inquiry, even for these justices, although they have
been persuaded, as footnote 14 indicates, that the market does not work for
chapter 13 debtors, and (2) that the plurality opinion is driven by factors
peculiar to 13s that don’t carry over to 11s.
Next, the plurality simply reiterates its point that
chapter 13 rates are supposed to be set at a rate that enhances feasibility:
“In our view, however, Congress intended to create a program under which plans
that qualify for confirmation have a high probability of success.” Although I think this begs the very question
as to what rate is necessary to ”qualify for confirmation” in the first place,
it seems clear the plurality is reiterating its “highest feasible present
value” interpretation here and there is nothing new here to discuss vis a vis chapter 11 relevance. Further,
the plurality justices immediately make a muddle of their guidance by stating
that “Perhaps bankruptcy judges currently confirm too many risky plans, but the
solution is to confirm fewer such plans, not to set default cram down rates at
absurdly high levels, thereby increasing the risk of default.” Which is quite a “straw man” argument, as no
one was suggesting courts were or should be setting “cram down rates at
absurdly high levels” – the opponent of cramdown, is just saying, don’t
confirm! What’s “absurdly high” is the
loan to value ratio! Third, the
plurality explains that the “presumptive contract rate’ approach may lead to
stale and outdated results because circumstances may have changed since that
loan was established. This likewise has
nothing to do with my thesis and so I will not discuss it further.
Last, but most definitely not least (because the plurality
describes this as the area where they “principally differ with the dissent”, so
future interpretation should focus on this point more than any other), the
plurality again frames the issue as one of allocating the evidentiary
burden: “In our view, any information
debtors have about [risk adjustment] factors is likely to be included in their
bankruptcy filings, while the remaining information will be far more accessible
to creditors (who must collect
information about their lending markets to remain competitive) than to
individual debtors (whose only experience with those markets might be the
single loan at issue in the cases.”
That point also illustrates my thesis that the plurality was thinking of
“prime plus” as a practical chapter 13 solution and not as a trans-chapter
interpretation of the Bankruptcy Code.
In chapter 11 cases, debtors always have access to professional advisors
and experts whose fees are charged to the estate, and thus can determine
prevailing rates and other terms in the lending market as easily as creditors
can. There is an ample supply of published confirmation opinions out there that
show this to be true.
[1] However, they provide no
citations, beyond the statute, for the proposition that these reduce risk and
offer no estimate of how much of a reduction they effectuate; frankly, these
unsubstantiated assertions are nothing more than makeweights. This is one reason I think it would have made
more sense for the Court to take on the issue of chapter 13 cramdown rates via
a rule-making procedure, where factual assertions like these could have been
tested and additional real-world input could have been gathered and studied
properly.
[2] Even in the chapter 13
context, the assertion that “evidence
about the market for loans” is “far removed from [bankruptcy] courts’ usual
task” is ridiculous. Judges hear
evidence about financial conditions, including lending rates, all the time in
chapter 11 cases and they’re the same
judges who adjudicate chapter 13 cases.
As well, when these judges adjudicate preference cases and other “usual
tasks”, they have to find facts about the “ordinary course of business” of
whatever businesses the debtor and the creditor happen to be in, which is a
task at least as “far removed” from what these justices perceive their “usual
task” to be as hearing “evidence about the market for loans”.
[3] It is not the point of this post to criticize the Till plurality opinion as a chapter 13
matter, but I have to say, this part of the opinion shows such an incredible
lack of awareness of lending practices that it warrants at least a
footnote. First, the opinion itself
identifies the “prime rate” as one available to a “creditworthy commercial
borrower” but then completely fails to
explain why consumer credit should be priced like a commercial loan;
in reality, bank loans to consumers and commercial enterprises are evaluated
and priced totally differently, reported differently, etc. I fail to understand why the plurality could
not have chosen something more relevant like the “average rate for a used car
loan in the local market” as the starting point. One can go to a website like http://www.bankrate.com/auto.aspx to find out current “average auto loan rates” which
are then broken down into new and used car rates, and add a debtor-specific
adjustment from there. That was what the
Sixth Circuit had endorsed in a case virtually identical to the Tills, In re Kidd, 315 F.3d 671 (6th
Cir. 2003) and appears to have all the advantages of the “prime plus” formula
while also being more focused on the particular type of loan, a used car loan.
Second,
as a matter of economic substance, it should be kept in mind the commercial
banks which offer “prime rate” or “base rate” loans are funded primarily by
federally insured deposits, which have lower rates than other lenders’ funding
sources, enabling them to offer lower rates on their loans. So using banking
concepts like “prime rate” or “base rate” to set cramdown rates in chapter 13
probably favors debtors vs. an average or median rate drawn by looking at the
full consumer credit market.
[4] On a couple of rare
occasions, I recall seeing a debtor file a chapter 11 plans with a
“placeholder” provision for a cramdown interest rate; that is, the section
prescribing the proposed treatment for the claim would describe the interest
rate on the take-back paper to be something like “the rate determined by the
Bankruptcy Court at the Confirmation Hearing to be the rate necessary to cause
the treatment herein provided to comply with the requirements of Section
1129(b)(2) of the Bankruptcy Code”. But
those were typically filed just to comply formally with an exclusivity deadline
or otherwise to keep a case moving forward for some reason. Such terms were then amended to reflect later
negotiations.
[5] This section also discusses
Justice Thomas’s concurrence which I handle in the next post.
[6] It is intellectually
maddening that the private market rate-setting mechanism is required to be
“perfect,” while government intervention to set those rates is held to a
standard no higher than that of being “administratively easier”.
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