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Friday, January 3, 2014

A Deep Dive into Till v. SCS Credit Corp.– Part III: Oral Argument

A review of the oral argument provides many interesting insights about the underlying reasons for the plurality opinion in Till and its applicability to chapter 11 cases.  As it was the Tills’ petition, their attorney, Rebecca Harpaer of the UAW Legal Defense Fund,  was first up.  The first question, which evidently came from Justice Scalia, noted “the interest rate that is given to different lenders is not always the same.”  Another judge chimed in with “I think the same thing that's bothering Justice Scalia, or that prompted his question in any event, is troubling me. When I read the briefs, I thought that the coerced loan approach, which you object to, did have certain deficiencies, because you had to have testimony what the interest rate is, you have to conform it to the particular transaction, it's hard to administer.” (Emphasis added).  Tills’ counsel replied with an argument that largely mirrored the dissent below, and Valenti, that the lender was fully compensated for the risk of a bankruptcy in its original interest rate, and that profit has no place in post-emergence interest rates.

Whether that was responsive or not, next, a justice debated with her how successful chapter 13s were; she asserted that 63% of confirmed plans avoided further default.[1]   

A colloquy took place in which a justice, evidently Justice Scalia again, opined that “bankruptcy judges aren’t very good risk calculators” and thus disfavored an approach that vests them with much discretion.  Another justice rejoined that “prime plus 1” vs. “prime plus 3” is not really a big range for such judges to be working within.  There was a lengthy discussion over whether it made more sense to start at a risk-free rate and build up, or to start at a presumptive contract rate and work down.
 
The Solicitor General’s office was next up, opening with a lawyerly observation that the lender’s position was slightly different than the approach proclaimed in the opinion of the Seventh Circuit, an observation that one justice echoed.  Next, the SG took up the theme of inconsistency among similarly situated creditors,[2] noting that “under the court of appeals’ approach, two creditors could make car loans to the same debtor that resulted in allowed secured claims of equal value, and yet one would receive thousands more in plan payments”.  The SG also reinforced the Rash decision as a reason “why the discount rate need not go too far in taking risks of nonpayment into account” although at least one justice snorted at the argument.  A colloquy ensued for the second time whether it made more sense to work up from the risk-free rate or down from a contract rate. The SG began emphasizing that the bankruptcy court’s finding of feasibility necessarily implied a lower rate than market, and was even arguing at the end that no risk premium might be required at all, when his time ran out.

When the lender’s attorney began, the first question he received turned back to the degree of chapter 13 failure. The second sought to reconcile the feasibility finding with the need for a risk premium. Which, of course, set the lawyer up very nicely to point out that, if as many as 37% of confirmed chapter 13’s were defaulting, then the feasibility finding wasn’t much comfort. Then the questioning turned again to the issue of whether anything more could be done than to give the bankruptcy courts discretion, and whether it made any difference if they started at the prime rate and worked up, or contract rate and worked down. 

Then the following important colloquy occurred between lender’s counsel and Justice Breyer -- who eventually, of course, joins the plurality opinion:

MR. BRUNSTAD: Your Honor, the contract rate is the best evidence,
the single best evidence of the market rate.

QUESTION: Contract rate -- if there has to be a number that's wrong,
it has to be that one. … The contract rate by definition was entered into
at some significant period of time prior to the present, and the present,
by chance in this instance, is 2 years later, and we know that interest rates
fell at least 1 or 2 percent during that time.

MR. BRUNSTAD: But not for subprime –

QUESTION: So -- what?

MR. BRUNSTAD: But not for subprime loans.

QUESTION: That's impossible. The prime rate --

MR. BRUNSTAD: No, Your Honor. This is why.

QUESTION: If that's so, then the risk went up.

MR. BRUNSTAD: No, that's not correct, Your Honor, and this is why.

QUESTION: No. It isn't?

MR. BRUNSTAD: Because State law caps the maximum rate that can be paid.

QUESTION: Oh, okay. … All right, because it's a usury problem.

MR. BRUNSTAD: Correct.

One sees in this colloquy that Justice Breyer enters it thinking that a prime-rate formula is superior to the contract rate presumption because it would have adjusted downward to the Tills’ benefit, and learns to his surprise that subprime rates wouldn’t have adjusted, because they are already capped by the usury rate -- at which the contract rate was set.  Rather critically, it seems to me, set against the backdrop of the usury law, and exactly as framed by the SG’s brief, the “prime plus” formula comes off  looking more like a “market” rate because it changes with circumstances, while the contract rate looks inflexible and not responsive to market fluctuations.  I tend to think that this realization, that an affirmance would have amounted to establishing the precedent that chapter 13 debtors could be locked into the highest rate allowed by their state’s usury law for the duration of their debt, regardless of changes in circumstances, was probably a significant factor in influencing the plurality’s preference for the “prime plus” formula.  Recognizing that the usury context lingers in the background of this opinion can also inform one’s understanding of the chapter 11 footnote, as I will discuss in a later post. 
 
The justices then pondered – for the third time -- whether there was any meaningful difference in administering a “prime rate plus” formula versus a “contract rate minus” approach. One justice asked:

Would it satisfy you if we said this? Suppose we said we see what we're after here. The objective is to equate the stream of payments plus repossession with $4,000. Now, on the one hand, we know it can't be lower than the prime. On the other hand, if the creditor wants to come in and give a -- present his evidence, the contract, of how risky this person is, then in fact it is evidence absolutely. And the bankruptcy judge will look at it, and he'll try to figure out the pluses and the minuses, what's happened to the interest rate, whether this particular person is a good or bad risk, and he'll choose a number. like that all the time?

And shortly thereafter the same or another justice suggested what s/he labeled as 

a scary thought. (Laughter.)  Is it possible that the statute does not provide an answer to this question? (Laughter.)  That since both of these schemes, your proposal and the other side's proposal, are theoretically perfect, if they are done correctly, the bankruptcy court is free to use either one so long as he comes up with the right answer.

Counsel responded, in brief, “The secured party must be fully compensated for  the risk that it must assume. The concept of indubitable equivalence must be completely compensatory. The secured party is not supposed to take uncompensated risk.”  (This as I will show in my sixth post on the case law as it stood when the Bankruptcy Code was adopted,” is a correct statement of pre-Code case law defining the contours of “fair and equitable”.)

And that justice responded, with what I think is the critical takeaway from the entire argument: “Nobody is disagreeing with you about that. That -- what we're -- I think what we're trying to get to -- it's a practical question.” (Emphasis added)

In hindsight, it seems to me, and I hope I have brought out to the reader, that the entire focus of the Court in deciding Till was not in the slightest about how to construe the statute or about haircutting secured claims by, for example, taking out their presumed profit margin: “Nobody is disagreeing with you about [fully compensating the secured creditor].”  The focus was all about what was the most “practical” approach for bankruptcy courts to employ to determine present value in chapter 13.

Interestingly, for purposes of my focus on Till in chapter 11, the lenders’ lawyer then turned to an argument based on chapter 11:

The correct standard is I think to recognize, which I think Your Honor does, that this concept of present value is an economic concept, not an equitable one[[3]], and that essentially what we're doing is we're saying there is a stream of payments to be made here and we have to figure out what it's worth. The best test for what it's worth would be what the market says. Now, the problem is, is that in chapter 11 there is a market. People do lend to chapter 11 debtors, and the standard is the same in chapter 11 as 13: value as of the effective date of the plan under 1129. So what we have to be very careful about is in chapter 11, the markets do value debtors' promises to pay and they lend money and they charge very high interest rates. Exit lenders or finance lenders charge very high interest rates, 18, 19, 20 percent. It can't be true that in bankruptcy, in chapter 13, who are the riskiest chapter -- riskiest debtors with the highest default rate, that we systematically give them a rate which approaches prime.  So I think what you need to do, recognizing it's an economic concept, is say what's the best evidence of a market rate(emphasis added)

To this argument a justice responded: “I understand. Tell me a question I don't know the answer to.”

We can see very clearly in this passage the germination of footnote 14 in the plurality opinion, the one that reflects awareness of DIP and exit lending in chapter 11: “in chapter 11 there is a market”. This is where footnote 14 comes from. We can also see in the Court’s response to it that the Court was not focusing on chapter 11 implications at all.  They were focusing, I hope the reader now sees, on devising a workable chapter 13 approach, nothing more.  In this light, I suggest, the plurality opinion should not be receiving the weight in chapter 11 practice that some judges have been affording it.

After a brief review of the various other issues raised by opposing counsel, a justice turned back to the mechanism design problem, referring to the scant evidence of the propensity for defaults in chapter 13’s:

But what about then taking this idea?  I'm trying to figure out how -- we say, okay, we really mean it. … I think, you know, prime plus or whatever, maybe the other. But then put the burden back on you to produce some real evidence and statistics about what happens to people we don't know about…. So then you have the burden of trying to bear it out with statistics and so forth that these people really are risky. And the bankruptcy judge can't just sit there and say, oh, I feel sorry for them. All right? What about something like that?

After counsel responded, the justice said: “you know, at least we'd have somewhat better information than just knowing about the default rate in bankruptcy cases in general. And we get a little finer than that. You see, that's what I'm trying to work with. I don't have an answer.”

That justice or another again emphasized the specifics of chapter 13’s:

Most of these debtors are very small debtors. You say take the contract rate as the presumptive rate and then we're going to knock down for all these other things. The high replacement cost that -- is one thing. The interest that they got before bankruptcy is another. The transaction cost that they're saved, another. And so let the debtor come in and show that. But the debtor has no money at all and certainly you don't want the debtor's money eaten up hiring an attorney and further depleting the money that could go to the creditors.  So it seems to me wildly unrealistic to expect that if you say the presumptive price is the contract price, you're going to get a debtor who will be able to -- I mean, I was surprised, looking at this record, that this debtor got an expert. Who paid the expert? Maybe because the union was involved … isn't it typical that these chapter 13 debtors don't have lawyers and don't have experts?

Again, note the focus on data and information about chapter 13’s and about the costs and other administrative aspects of chapter 13’s; the justices were looking for a practical solution for chapter 13s, not engaging in statutory construction meant to apply across the Code’s chapters.

Another justice changed the topic back to Rash, and then the argument concluded with an indisputable observation: “we're going in circles, and I mean, in some respects it's good, in some respects it's bad.”

TAKEAWAY

What jumps out from the oral argument is that none of it dealt with the typical topics judges focus on when interpreting statutory text.  There was no discussion of the words of the statute,  its legislative history, or, save the one exception of Rash, how to reconcile the case before them with prior case law.  One justice even worried the statute did not answer the question before the Court.  Everything was a practical or administrative concern. We might have been reading minutes from a rule-making conference[4]:  which is more practical – to start low and add a risk premium, or vice versa? Do they both get to the same place, so we should allow either?  What about the cost of experts?  Should we give the lower courts discretion or keep them tightly reined in?

How much of that would be a concern in a chapter 11 case?  Sure, the text of the statute is the same in both chapters.  But we just saw the justices were not focusing on the text at all. The one case they discuss, Rash, is not very meaningful in chapter 11 valuations, where typically what is being valued is a going concern.  When one counsel brought up chapter 11 as an analogy, he was brushed off immediately.  And the practical issues the justices were focused on, such as the impracticality of expert testimony, researching the market, etc., make sense only in the context of chapter 13’s; those steps are taken all the time in chapter 11, even in summary proceedings, like lift-stay hearings, where the debtor/estate relationship is completely different than in a consumer case.

Finally, we should not lose sight of the fact that the lender in Till was defending a fairly extreme position, because the contact rate happened to be the maximum rate allowed by the state’s usury law, which is a type of law not generally relevant in chapter 11’s as usury laws do not apply to business loans in most states. Would a creditor defending a market approach in a business bankruptcy that resulted in a non-usurious rate have encountered a different result?







[1]           The fact that she did not mention (and I saw nothing in the briefs that mentioned) whether the Tills themselves had fully performed under their confirmed plan piqued my curiosity, so I contacted her per the contact information in the signature block on the brief.  Graciously, Ms. Rush answered my email and informed me that the Tills had in fact performed under the plan and received a discharge.  Since the plan had a 17-month term, that must have happened while the case was pending in the 7th Circuit.  I wondered further if  it mooted the case in any way, but realized that the relief sought by the lender was to get them to pay more, so that there was still a live controversy and relief that could have been ordered, so not moot.

[2]           I must say, although the SG carefully frames the point in terms of loans to the same debtor,  I don’t think all of the participants in the case understood what the concept of “equality of treatment among similarly situated creditors” means in bankruptcy.  It means that creditors of the same rank in the same case should get equal distributions. It does not mean that creditors in different cases are supposed to get the same payout.  Creditors of different debtors are not usually “similarly situated”.  Even if the creditors’ collateral, by accident, has the same value in the different cases, the debtors’ salaries, family situation and other circumstances relevant to risk of non-payment are not likely to be identical.

[3]           I show in my sixth post that this is not correct, that in truth the Court has explicitly founded the principle of full compensation of the secured creditor on equitable grounds.

[4]           Which actually might have been a better mechanism to resolve the question.  I explore that further in my concluding post.