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Friday, January 3, 2014

A Deep Dive into Till v. SCS Credit Corp.– Part II: Briefs

The Supreme Court briefs of the parties are remarkably different.  The Tills’ brief, prepared by the UAW Legal Defense Fund, made the following points: (1) the Seventh Circuit opinion “defeats a fundamental purpose of Chapter 13 to enable all individuals who qualify for Chapter 13 relief under 11 U.S.C. § 109(e) to retain basic necessities” and is “inexplicably hostile to Chapter 13 and its rehabilitative intent” (citing Lundin, 2 Chapter 13 Bankruptcy, § 112.1 at 112-16)(3d ed. 2000); (2) “Congress frequently rewards certain individuals and groups with favorable interest rates. Debtors under Chapter 13 are among those singled out for special treatment under 11 U.S.C. § 1325(a)(5)(B)(ii). Consumer bankruptcy reform was considered a fundamental objective of the Bankruptcy Reform Act of 1978….”; (3) “The ‘coerced loan’ or ‘presumptive contract’ cases are based on fictional premises. There are no loans in the Chapter 13 cramdown statute — only ‘claims.’ … There is no ‘market rate’ for a bankruptcy ‘loan,’ because pre-petition loans become ‘claims’ upon filing of bankruptcy”[1]; and (4) “The decisions of numerous Circuits, including the Seventh Circuit below, have transformed this mechanical process of calculating the “present value” of the ‘allowed secured claim’ into a fact-specific inquiry into a particular creditor’s use of interest as a vehicle for profit in the nonbankruptcy marketplace.  Once the myriad of inappropriate fact-specific characteristics are removed from the ‘present value’ equation, discounting of payments to present value under § 1325(a)(5)(B)(ii) becomes a straightforward process that lends itself to predictable results.”[2].  Therefore, “the most direct method to arrive at an appropriate discount factor is use of a formula method with a readily accessible national rate base. If the chosen national rate is truly risk-free, a risk premium may be added at the discretion of the bankruptcy court upon the creditor’s demonstration of uncompensated risk. On the other hand, an additional risk premium may be unnecessary — for instance, because the chosen national rate already includes a risk allowance, or because the higher Rash replacement value has eliminated the necessity for inclusion of an additional risk premium.”

I will take a minute to explain the reference to Assoc. Comm. Corp. v. Rash, 520 U.S. 953 (1997), which may be unfamiliar to some readers who do not have any reason to follow consumer bankruptcy law.  As the Tills’ brief explains, the Court in Rash held that “[a]djustments in the interest rate do not fully offset the risks of debtor default and property deteriorat(ion), incurred by the creditor when the debtor retains the collateral, whereas the replacement-value standard accurately gauges the creditor’s exposure to these ‘double risks’ occasioned by the debtor’s continued use of the property.” Thus, certain lower courts and the dissent below had concluded that, by requiring the debtor to pay the creditor the (higher) replacement value of the vehicle, the Court had “shifted compensation for the risk of default and property deterioration from the ‘interest’ component to the ‘valuation’ component of the present value equation.” [3]

A couple of additional points in the brief deserve to be drawn out, in hindsight. First, the Tills opened with two wholly non-legal points, an uncontroversial definition of “present value” and, of more consequence, a description of subprime auto lending, to the effect of  “the higher interest rates charged by subprime lenders cannot be fully explained solely as a function of the ‘additional risks’ presented by these loans.”

Second, the brief also made a telling point (in hindsight) when it pointed out that “under the majority panel’s ruling, every unsecured claimant would be entitled to a different interest rate based on its contract or lending market….”.  They also observed that “another goal of Chapter 13 is efficiency of administration. The emergence of fact-specific inquiries (and the need for evidentiary hearings to resolve otherwise routine present value calculations) can overwhelm the bankruptcy courts’ limited judicial resources and substantially increase the costs of administration of the typical Chapter 13 case.”  The topic, covered in just a single paragraph in the brief, proved to be the predominant focus of both the oral argument and the plurality opinion, as we shall see in subsequent posts

Lender’s Brief

The lender’s brief was fairly straightforward.  It opens with several pages explaining what it means to calculate present value by using a risk-adjusted discount rate.  There is not a lot of legal discussion in that section, but what there is includes as many references to non-bankruptcy precedents as to bankruptcy decisions.  As its sole bankruptcy precedents in the opening section, lender cited BFP v. Resol. Trust Corp., 511 U.S. 531 (1994) to show that the Court had instructed bankruptcy courts, in valuing assets, to recognize “price-affecting characteristics” in determining fair market value and reject “artificially constructed” formulations.  Next, lender argued section 1325(a)(5)(B) was not intended for the protection of debtors, but rather that of creditors; the  lender is entitled to present value of its claim, citing Johnson v. Home State Bank, 501 U.S. 78 (1991).  The only rational way to discount a claim to present value is with a risk-adjusted interest rate.   That means a market rate, but the contract rate is “in most chapter 13 cases” a good approximation of the market rate. Because the contact rate is just an approximation of market, it should serve as a presumption, allowing for evidence to move it up or down, to the extent permitted by law.
The brief next devotes 5 pages to an exposition of data supporting the propositions that Chapter 13s have a high risk of default, that a lender’s enforcement of rights imposes on it additional costs, that used car loans are several times more risky than new car loans, and subprime auto finance is not “predatory” – if anything, it is less profitable than other lending channels because of the higher default rate.

The third section of the lender’s argument devotes 10 pages to expounding a “holistic” vision of the Bankruptcy Code in which section 1325(a)(5)(B) joins with sections 361, 362 and 506 in a harmonious fashion to collectively preserve the value of a secured claim.
In the only section of the brief to reference chapter 11 law, the lender next argued that Section 1325(a)(5)(B) traces its history to early reorganization practice, specifically the principle of “indubitable equivalence”, which requires that the secured creditor is entitled to keep  its lien on the collateral and receive full value of its claim.  Under old Chapter XIII, a secured lender’s claim could not be modified without its consent, period.  In enacting section 1325(a)(5)(B), the lender argued, Congress explicitly incorporated the law that had developed under chapter X and section 77B, that a secured claim could be modified non-consensually as long as the creditor receives the indubitable equivalence of that claim, citing In re Murel Holding Co., 75 F. 2d 941 (2d Cir. 1935).  (Unfortunately, the lender did not serve up a citation showing that Congress intended that principle to apply in chapter 13; the brief only cites legislative history referring to section 1129(b)(2)(A)).  The lender asserted that only a market rate of interest results in the indubitable equivalence principle being satisfied. 

The following section of the brief argues that the market rate approach / contract rate presumption is consistent with other policies of the Bankruptcy Code, in particular, that of equality of distribution.  The argument that “similarly situated creditors” must receive similar treatment is portrayed as a red herring because it’s unlikely creditors with different liens are really “similarly situated”; their collateral cushion is unlikely to be similar. Judge Friendly’s epigram that “equality among creditors who have lawfully bargained for different treatment is not equity but its opposite…” is invoked.  See Chemical Bank N.Y. Trust Co. v. Kheel, 369 F.2d 845, 848 (2d Cir. 1966) (Friendly, J., concurring).

The final two sections argue that a “market-based” approach is “economically efficient” and “the most practical”.  As in the debtors-petitioners’ brief, non-legal, practical arguments dominate the lender’s brief.  Only four pages in the lender’s brief have any connection to chapter 11 matters and arguably the lender was simply wrong in contending they were even relevant to the Court’s task since it failed to prove a link between corporate reorganization case law and chapter 13.

Solicitor General's Brief

The Solicitor General weighed in, endorsing the “prime plus” formula over the presumptive contract rate.  The OSG argued:

One appropriate method to calculate such a discount rate is to adjust low-risk interest rates, such as the prime rate, to account for plan-specific risks of nonpayment. That “prime-plus” formula approach determines the present value of a debtor’s future payments based on the price of such payments in general financial markets, where the prime rate measures the value of low-risk capital. By including an adjustment for plan-specific default risks, a “prime-plus” formula provides a direct, fair market appraisal of the risk-adjusted present value of future payments. Such a formula approach is readily administrable; treats all creditors equally—thereby avoiding unfair disparities in cases where, as here, multiple secured creditors are parties to a single bankruptcy proceeding; and avoids the need for expert testimony regarding individual creditors’ lending practices or credit status. 

In contrast, the OSG continued:

the “contract-rate” approach used by the court of appeals would require courts presumptively to value identical plan payments differently if those payments are made to creditors with different pre-bankruptcy contract rates. Such presumptions could be rebutted only by evidence of a specific creditor’s current investment opportunities, but such opportunities are often difficult for courts to evaluate and are not directly relevant to the debtor’s financial status. Furthermore, burdening debtors with often “eyepopping” contract rates, would undermine debtors’ ability to pursue bankruptcy under Chapter 13, and would force many cases into liquidation under Chapter 7, to the general detriment of debtors and creditors alike.

We can see several of the points ultimately made in the plurality opinion in the SG’s brief: ease of administration; equal treatment of creditors; avoiding the need for expert testimony; and at the end a disdain for “eye-popping” interest rates.  We also see the SG characterizing the “prime plus” approach as a self-adjusting “market” approach while the “contract rate presumption” is characterized as more rigid and unchanging, which also appears to me to be how the plurality thought of the formula.[4]   In the succeeding posts, I will focus on how these themes dominate the plurality’s opinion. The SG’s brief definitely seems to have had a significant persuasive effect on the plurality. 

All the more relevant, then, to note that little of the SG’s argument involves an argument that might apply in chapter 11.  Expert testimony is common in chapter 11; eye-popping interest rates are not an issue, and so on.  In fact, in a footnote 9, the SG’s brief expressly disclaims any connection between the law governing chapter 11 cramdowns and the question before the Court:

The statutory term “indubitable equivalent,” however, appears only in two provisions of the Bankruptcy Code, neither of which applies here. See 11 U.S.C. 361(3) (dealing with automatic stay and trustees’ authority to sell estate property or obtain credit); 11 U.S.C. 1129(b)(2)(A)(iii) (prescribing an “indubitable equivalent” standard as an alternative to cram down in Chapter 11 proceedings). Moreover, even if secured creditors did deserve an “indubitable equivalence” under Chapter 13, it would be only an equivalence between the plan’s proposed payments and the creditor’s allowed secured claim. Disputes over present value and discount rates concern how courts should calculate that equivalence. Language quoted from Sections 361(3) and 1129(b)(2)(A)(i) does not in any way answer that question.

(Emphasis added)

[1]           This argument gained no traction with any justice and, in general, “argument-by-labels” (“it’s not an ____, it’s an ____”) has been disfavored as a basis for decision ever since the advent of legal realism, which has focused on the functional and policy justifications for legal results rather than forms and labels.  The point is that the statute calls for the "value" of a debt to be calculated and the debt market is the best reference to do that.  Calling it a loan or a claim or a debt does not change that fact.

[2]           This was a rather odd argument which says, more or less, “once we ignore facts, it’s much easier to get predictable results”.  I think Stalin found that doctrine worked quite well for his purposes, if I'm not mistaken.  Ultimately, the plurality embraced a hybrid approach that contains elements of predictability, in the baseline of the prime rate, and some amount of fact-specific adjustment in the “plus X”, or so they claimed.

[3]           I think that argument is myopic when applied to an undersecured claim, as was the case here.  Whatever overstatement of value allegedly takes place per Rash is likely to be systematically offset by the elimination of the lender’s deficiency claim. In any event, Rash does not come up that often in chapter 11 cases where what is being valued is usually producing income and the valuation is usually one form or another of discounting the cash flow being thrown off.

[4]           This is not to say that the SG or plurality were correct in an objective, absolute sense, just that, as between the contract rate and the prime plus alternative, one adjusts and one doesn’t, and the one that adjusts looks more like how a market rate would move. The “prime plus” formula is not at all a “direct, fair market appraisal of the risk-adjusted value of future payments” as the SG contended.  It is not “direct” and it is not “fair market” at all. It is an administratively simpler, but otherwise crude and imperfect proxy for that value.