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.
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