Wednesday, September 24, 2014

False Premises of Bankruptcy Reform Agenda

The ABI Commission on bankruptcy reform has posted a short video that "identifies some key findings of the Commission to date." The purpose of the video, I suppose, is to try to begin to justify in advance the reforms the commission has been crafting since it was self-appointed in 2012, which are likely to be designed to transfer value from secured creditors, and lengthen the time and increase the cost of chapter 11 proceedings, and shift those to the secured creditors. The video should appear below, although my embedding skills are rudimentary at best: If for any reason there is no video above, it is currently on the commission home page, .

The "findings" mentioned in the video are not factually supported, but are just false premises created to rationalize the anti-secured-claim agenda that the professionals who dominate the commission (there are virtually no clients, debtor or creditor, on the commission) have been sponsoring since the commission's earliest days.

For example, once the first few frames of vapid generalizations pass, one comes to the assertion that there is an "emerging consensus" that the Bankruptcy Code needs to be modernized. I have followed the commission's "field hearings" and see nothing of the sort. I have seen various constituencies expressing their points of view, which are often varying and opposed. There is no consensus among them at all. Any claim of consensus - which just happens to match the pre-existing viewpoints that dominate the commission - is just self-justifying and not objective fact.

Some of the quotes that the video displays to demonstrate the purported consensus are downright dieceptive.  For example, the video quotes one Danielle Spinelli to the effect that " there does appear to be widespread concern that the expansion of secured credit has had a deleterious effect on the bankruptcy process...." That quote is excerpted from a statement Spinelli read at a field hearing in November 2012, as a representative of the Loan Syndication and Trading Association (LSTA), not an organization likely to have argued for negatively impacting secured debt. When you read the statement as a whole, it is clearly taken out of context: Spinelli was describing what she observed to be transpiring on the Commission, not concerns that she shared or perceived to be emanating from anywhere else. She then proceeded to defend secured creditors' rights to credit bid. It's alarming that the Commission would stoop to such intellectual dishonesty to advance its agenda as to twist the words of a witness in that fashion.

Another sorry misrepresentation is the claim made in the video that "Debt and capital structures have grown more complex due to multiple layers of debt and complex intercreditor agreements not imagined in 1978." This is just nonsense with no factual support. The capital structures of today are not meaningfully more complex from those of the 70's and 80's when the Code was first crafted and implemented. A typical capital structure of a typical chapter 11 debtor may have a first and second lien secured by all domestic assets and a pledge of 65% of the foreign subsidiaries; there may be a layer of structurally or contractually subordinated unsecured debt and the equity. That capital structure differs little from the ones that appeared in pre-Code case law. For example, if you look at the capital structure of the Depression-era debtor described in my last post, you'll see a virtually identical capital structure, save only the stock pledge. That is not a meaningful increase in complexity. If anything, the older case presented more complexity because the first liens did not overlap the collateral held by the junior lien, and thus separate valuations were required of the different collateral packages; whereas, today, one merely has to value the entire enterprise one time and then follow the order of priorities.

And the reference to intercreditor agreements being more complex is another red herring. I had the unpleasant duty off and on in my associate days in the 1980s of reading collateral trust agreements and other intercreditor agreements and the subordination provisions of old-time indentures in various utility, transportation and manufacturing companies. Today's provisions may have different focal points, but they are not at all more difficult to work with than those of the earlier era. In many ways, because they are written with current law in mind, they are actually easier.

If cases had indeed grown more complex, one would see that reflected in cases taking dramatically longer. But they don't. The distressed debt market would show wide bid-ask spreads and low liquidity as investors were scared away. But it doesn't. The bit about increased complexity just has no objective support.

A lawyer is quoted complaining that "new lending" and "aggressive investing" have made it "significantly more difficult to restructure successfully in chapter 11". Again, there is no documented evidence to back that up. The chapter 22 phenomenon has not meaningfully changed over the life of the Code. Airline recidivism, for instance, has dropped precipitously since the early days of the Code.  And when a chapter 22 does occur, it is implausible that its occurrence can be confidently attributed to chapter 11 having failed to afford a "fix" for the business the first time around; equally or more plausible alternative explanations would be: (1) the business suffers from problems beyond the capacity of a legal fix (e.g., a lack of sales, or a misguided and expensive construction project, or a failed merger); (2) the first 11 should have been converted to a 7 to begin with; or (2) the balance sheet of the reorganized debtor should have been more conservative with the consequence that more junior constituencies should have seen their recoveries reduced or eliminated.

This lawyer's lament may reflect to some extent the economic reality that, when a debtor enters chapter 11 over-encumbered, a 363 sale tends to end cases sooner than some constituencies, including bill-by-the-hour professionals, might find in their interest. The argument appears to be that, in some hypothetical scenario that the secured creditors are cutting off, the company would somehow stay longer in chapter 11 and by doing so fix itself thereby enabling more creditors, or even equity, to recover. It is of course impossible to prove a negative, that is, to prove the imaginary alternate universe would not happen. But the burden of proof should be on those seeking to change the status quo that has worked well. I suspect that a sample of non-professional persons with chapter 11 experience - the executives and creditors, I mean - will find very few proponents of the idea that longer stays in chapter 11 are systematically better for businesses. The truth, as opposed to the myth that the self-interest of bankruptcy professionals aligns with, is that solvent companies "fix their businesses" all the time outside of bankruptcy court with far less professional expense. My post last fall about the SiriusXM restructuring makes this point in greater detail.

Except for the power to reject bad leases and contracts, there is really very little in the mythical "bankruptcy toolkit" that companies need to make operational fixes. Indeed, the principal operational fix that companies do - headcount reduction - is not something that anybody should be encouraging more of in chapter 11. I suspect the proponents of the "missed opportunities to fix businesses" would have a very hard time coming up with concrete examples of things companies can only do in chapter 11 and would actually do if they spent longer in chapter 11, other than taking longer to reject leases.

Ironically, a slide that complains too many cases end in a "quick sale or recapitalization" is promptly followed by two other slides that complain that chapter 11 cases have grown "too complex and expensive" and "too slow and costly". These positions are difficult to reconcile (unless the commission is going to propose radical changes in professional compensation, which seems unlikely given its makeup).

In fact, there is no evidence that cases have grown more expensive. In aggregate dollars, perhaps, but that is partly due to inflation and partly due to the vast increase in the size of the companies going through chapter 11. By a more useful metric, e.g., professional costs as a percentage of the liabilities resolved in chapter 11 cases (which is the fundamental point of reorganizing businesses), the reorganization process has gotten significantly cheaper, which makes sense. as more issues have been clarified over time by the courts and there is less to litigate, other than valuation. And I struggle to understand how a "quick" resolution of a problem is something the average citizen not in the bankruptcy industry should be upset about.

What has really happened is chapter 11 has grown more efficient, in large measure due to the resolution of various issues by the courts, both in the form of reported opinions, and also in the maturation of custom and practice in the major venues. The other source of efficiency is the greater role of market-driven creditors, who have produced a dramatic increase in reorganization efficiency with no adverse effects on operations or workforces. Like many industries in the 21st century, the bankruptcy professional industry has to adapt to an environment of increased efficiency. Seen in this light, the so-called reform agenda starts to look like a special interest group trying to use the legislative process to protect its economic position against the forces that affect the workforce generally.

Thursday, September 18, 2014

The Role of Profit in Valuing Chapter 11 Cramdown Paper

Judge Drain's recent bench ruling in the Momentive Performance confirmation hearing rests primarily  on the proposition that profit has "no place" in calculating the interest rate payable to secured creditors under a plan satisfies the standards of section 1129(b)(2)(A)(i).   His ruling invokes two chapter 13 cases, In re Valenti in the 2d Circuit and the plurality opinion in Till v SCS Credit Corp., and treats them as binding in chapter 11 as well.  I have written at length about the reason why the second part of that reasoning is wrong, that Till was entirely chapter 13-specific.  Now I want to write about the first part, the substantive claim that profit has "no place" in valuing cramdown paper.  As I did in my deep dive into Till, I have gone back to the opinions the Supreme Court issued in the 1940s affirming the absolute priority rule in chapter X and railroad reorganization cases, on the twin premises that (1) they embody the law as it existed when chapter 11 was drafted to replace them, and (2) the absence of any legislative evidence that Congress meant to overrule those cases when it enacted chapter 11 means those cases are still good law for chapter 11 purposes.  Neither Till nor Valenti cite any legislative history in support of their reasoning that profit has "no place" in cramdown paper valuation, just lower court cases.

As younger readers may not be aware, let me first note that the Bankruptcy Reform Act made some changes to the role of the fair and equitable standard and the absolute priority rule in confirming plans of reorganization, but those were largely procedural.  The principal change was to empower classes protected by the standard/rule to override it by acceptance of the plan, meaning that the standard/rule only came into play for a non-accepting class; the effect of this was to eliminate the ability of dissenters within the accepting class to invoke the standard/rule -- they were remitted only to the protection of the best interests standard.  Secondarily, the role of the SEC (or, in the case of railroad reorganizations, the ICC) to pass muster on the substantive economics of the plan, among other things, was eliminated in favor of allowing the parties in interest to bargain toward a consensus against the backdrop of the applicability of the standard/rule. 

But those were procedural changes.  I think it is quite evident that the substantive standard/rule was not weakened in the slightest from the "full compensation" mandate in cases like Consolidated Rock Products and the cases I will review in this post. Indeed, in his contemporaneous explanation of the then-new cramdown matrix, Ken Klee, the "author of the Bankruptcy Code" (because he was the staff member of the House Judiciary Committee that took the lead in writing the Bankruptcy Reform Act of 1978) stated that the new Code would afford additional "protection for secured claims that is not provided under present law. "  See "All You Ever Wanted to Know About Cramdown Under the New Bankruptcy Code"53 American Bankruptcy Law Journal 133, 143 (1979).  Elsewhere in the article (page 158), Klee wrote, "The discount rate [used in computing the present value of a stream of deferred cash payments on a secured claim] is equivalent to the rate of interest that would be paid on an obligation of the debtor considering a  market rate of interest that reflects the risk of the debtor's business." (Emphasis added).  In a companion article, Ron Trost, a member of the National Bankruptcy Conference that was deeply involved in the 1970s reform project, wrote: "In the usual chapter 11 case either secured creditors will consent to the plan or the business will not be able to be reorganized."  Trost, Business Reorganizations Under Chapter 11 of the New Bankruptcy Code" 34 Business Lawyer 1309, 1335 n. 182 (1979)  (Parenthetical observation: keep that in mind when you hear someone argue that the Code as enacted in 1978 struck a purported balance between debtor and creditor that has somehow shifted over time in favor of the secured creditor; that's just not true).

The Bankruptcy Reform Act of 1978's changes to prior law reflected a broader trend in the legislation of that decade toward deregulation, which was seen in the airline deregulation legislation and changes President Carter made in the makeup of regulatory agencies; motor carrier (trucking) deregulation; and railroad deregulation, and initial aspects of banking deregulation.  All of those laws reduced heavy-handed regulation by New Deal government agencies (the CAB, ICC, etc.) in favor of increased respect for market forces.  One of the intellectual drivers of the trend was now-Justice Stephen Breyer, who was then a protege of Senator Ted Kennedy, who sponsored several of the deregulating bills  Breyer said at the time:
"Efforts, both here and abroad, to have people guess what the market
would produce if it were free to create a price are so very different in
their result from what the market does produce when it is free that it
becomes a kind of parody of a free market situation." 
Quoted in Andrew Crain, "Ford, Carter and Deregulation in the 1970s", 5 Journal on Communication and High-Tech Law 413, 425 (2007). In the case of the era's bankruptcy reform, there were many alternative approaches debated throughout the decade, but it was clearly the consensus outcome that the SEC's role was virtually eliminated, and a more laissez-faire environment arose in which the parties were encouraged to reach privately negotiated resolutions within parameters set by the substantive provisions of section 1129.
It's implausible in my estimation that a law passed in that era dealing with commercial financial situations was intended to eliminate market and profit considerations from judicial analysis, especially given that the reform act was the subject of years of legislative revision, debate and study through three Congresses before it was passed and such a contrarian perspectie does not manifest itself in the legislative history.
In addition to those contemporary insights into the intent behind the Bankruptcy Reform Act of 1978, it is very instructive to turn back to the 1940s, to see not just what the law was, but what section 1129(b)(2)(A) really means today.    Perhaps the reader has already read my re-visiting of Consolidated Rock Products from1940.  In this post, I will explain how RFC v. Denver & Rio Grande WesternRailroad Co., 328 U.S. 495 (1946) and its companion case Insurance Group Committee v. Denver &Rio Grande Western Railroad Co., 329 U.S. 607 (1947) establish the following proposition:  because a secured creditor class is entitled to "full compensation" for any alteration of its rights by a reorganization plan, if it is necessary to achieve full compensation that the creditor class make a profit, then profit must be afforded the creditor to satisfy the fair and equitable standard.   This proposition of course, negates the converse, that profit has "no place" in cramdown treatments.   Of course, a debtor can always pay off the creditor in cash at confirmation, or reach a consensual bargain with the creditor, and obviate analysis of the topic.  But the creditor class cannot be forced to take back paper priced below par just because a higher rate would enable a profit to occur.  (Note, this is slightly different than saying the paper must actually trade at a market value of 100 per cent.   Courts are not infallible and the other creditors were not legally obligated to insulate the creditor against market fluctuations.  It is clear from the pre-Code cases that no court was applying the rule that strictly.  What they were requiring, though, was a good-faith, well-reasoned valuation, backed by specific evidence, and not an off-the-rack formula, that led to the conclusion that, more likely than not, the secured creditor would hold something worth 100 cents of its claim upon confirmation). 

The Facts of the Case

As the two Denver & Rio Grande Railroad cases are over 70 years old, they use a number of unfamiliar terms and references that make reading the opinions more laborious than modern opinions. Yet the effort pays off as the underlying plan issues turn out to bear a close resemblance to those presented by many modern chapter 11 cases. 

The railroad filed its petition for reorganization in 1935.  Its capital structure was complex, as was typical of the railroad reorganizations of the era, principally because various branches and subsystems and asset classes had been separately financed from one another and from the system as a whole.  So while various creditors thus had first liens on parts of the system, there was another layer of secured debt, the General Mortgage Bonds, that had blanket, but junior, liens on the system as a whole.  There were other layers of creditors and equity holders, but on the valuation that the ICC and the district court adopted, there was no value for anyone below the two classes of secured debt, and the other stakeholders were eliminated under the plan.  So this was quite analogous to many cases we see today: first lien holders and second lien holders battling over the enterprise value, with everybody else out of the money.  

Based on the aforementioned ICC and court approved valuation, the plan provided that the first liens would get a package of secured debt instruments and new stock amounting to 90% of the reorganized debtor's equity, while the second liens would receive only the remaining 10% of the equity.

The Proceedings Below

The plan was proposed on the basis of an effective date of January 1, 1943.  It cleared the ICC in June of that year, and was confirmed by the district court in June 1944 after creditor voting.  The first liens voted in favor and the second liens (General Mortgage Bonds) voted against the plan.  Several appeals were taken from confirmation, principally arguing that the valuation and consequently the treatment of creditors had failed to account for the "excess war profits" the railroad would reap after the effective date, 90% of which would, per the plan, flow to the first lien holders through the common stock stake awarded them under the plan.  For present purposes, the fact that the case turned on the awarding of "profits" to first lien holders makes the case highly relevant to Till-in-chapter-11 analysis, as exemplified in Momentive Performance.   

The circuit court of appeals agreed with the appellants, whereupon the secured creditors brought the case to the Supreme Court.  The appellate court had ruled that the secured creditors were over-compensated by the debtor's plan as approved by the ICC and the district court:  "The senior bondholders were paid in full.  They received all the new securities and most of the common stock.  Ninety percent of the General Mortgage Bonds were wiped out, . They received only a small amount of the common stock, ten per cent of their total claim.  ... We think any plan which fails to take this [buildup of huge retained earnings during WW2] into account and gives the Senior Bondholders their claims in full by substantially delivering the road to them, and gives them the surplus cash actually on hand and further enables them to receive in addition the excess war profits which are reasonably sure to come, is inherently inequitable and unfair, so long as there are class of creditors whose claims are not fully satisfied."  (Emphasis added)

The first liens argued to the Court that " The circuit court defeats the private right of creditors to full satisfaction of their claims.  The senior creditors are entitled to realizable value in the full amount of their bonds before the general mortgage bonds are entitled to anything. (Citing the then recent Supreme Court opinions  Case v. Los Angeles Lumber; Consolidated Rock Products; Ecker v. Western Pacific; and Group of Inst'l Investors. v. Chicago, Milwaukee & St. Paul Ry Co.)"

The Supreme Court's Opinion

In a 7-1 ruling, the Supreme Court reversed the circuit, reinstated the confirmation of the plan, and justified the award of "profits" to the first lien holders as necessary to achieve "full compensation" under the fair and equitable standard.

The Court said: "junior claims can receive nothing until the senior claims receive securities of a worth or value equal to their indebtedness.  The [General Mortgage Bonds] are definitely junior [to the holders of liens on discrete systems within the overall railroad].  The Commission did not make a finding that the cash value of the securities awarded the senior claims as of the effective date of the plan equalled [sic] the face of the claims. It did, however, carefully state its reasons for concluding that compensation 'flowing under the plan to the various classes of bondholders for the rights surrendered by them' was adequate in the light of the full priority rule.  For those classes, other than the Junior Generals, that received common stock, the Commission said that the possibility of 'unlimited dividends on common stock' was a factor in offsetting loss of position. Thus it is clear that when the Commission made its allocations it had definitely in mind that one thing that gave the senior creditors compensation for the admission of junior claimants to participation in securities before the seniors obtained full cash payment was their chance to share in the unlimited dividends that might be earned and paid on the common stock to have a part in the 'lush years'."   328 U.S. at 517-18.

In a section of the opinion titled "Cash and War Earnings", the Court noted that the ICC had justified the plan's departure from full cash equivalency by the fact that the senior secured bondholders would receive 90% of the common stock and thereby participate in the "excess war profits".  "The error of the Circuit Court lies in its assumption that the senior bondholders were paid in full by the securities allotted to them without also accepting the determination of the Commission ... as of January 1, 1943, [that] all subsequent earnings were a part also of the common stock  that was awarded the senior bondholders."  328 U.S. at 523-24.

In other words, it was the profit component, conveyed through the common stock distributed  to the first liens, that saved the plan from failing the fair and equitable test!  "[T]hrough these common stock advantages the [secured creditors] may be compensated for their loss of payment in full in cash." Id. at 525.

A Second Bite at the First Liens' Apple

After the Court issued its opinion, the railroad debtor went back to its reorganization court for permission to abandon its confirmed plan in favor of one that gave better treatment to the junior constituencies.  It argued changed circumstances, in particular that, due to the "radical lowering of money rates for the indefinite future", the interest payable to the secured creditors under the plan as confirmed was just too damn high.    Once again, the district court rejected the attempt, but the circuit court stayed the lower court's order to consummate the plan.   The first liens took the matter before the Supreme Court again.  

In Insurance Group Committee v. Denver & R.G.W.R. Co., 329 US 607 (1947), the Court, again with only one dissenter, vacated the appellate court's ruling and reinstated the district court's order.  The Court confirmed its holding from the prior year: "To justify the change of position of creditors from fully secured to partially secured, creditors were given opportunities to participate in profits through common stock ownership with a change at larger earnings than the Commission's forecast anticipated. We held the priority rule was satisfied by this type of allocation." 329 U.S. at 617 (emphasis added). 

Regarding the allegedly excessive interest rate on the debt instruments issued to the first liens, the Court said: " As none of the authorized securities is alleged by the debtor to have shown values much above par, the chosen rates of return have not proven to be excessive."  Id. at 615.   Supporting that statement, the Court footnoted a table taken from Moody's that showed the first lien bonds included in the package of debt and equity issued to the first liens had traded in the 102.89-103.82 range during 1945 and 46, although they had traded below 90 during 1947, and the package as a whole was not precisely valued by the Court:  "The debtor has made no allegation ... that the existing cash value of the securities allotted any creditor has ever aggregated the amount of the creditor's claim against  the debtor. ... Until it can be contended with some show of reasonableness that the creditor[senior creditors[ have received more in value than the face of their claims, the debtor's insistence on a re-examination of the plan is without substantial support [citing Northern Pacific Railway v Boyd and Group of Institutional Investors].  ... the debtor [fails] to allege any actual sales or value of the securities which would show that the creditor have received through the allotted securities payments on their claims in excess of their face...." 

Clearly the Court found market values relevant, not as the sole determinant of the "fair and equitable" analysis, but as a very relevant component  thereof.   And the Court clearly reaffirmed the crucial role of profits in satisfying the fair and equitable standard.  As these cases has never been questioned in subsequent Supreme Court opinions, or in the legislative revisions of the bankruptcy law since then, these principles remain good law in the chapter 11 context.

Tuesday, September 9, 2014

MPM Ruling Unwisely Endorses Till in Chapter 11

On August 26, Judge Drain, who sits in the White Plains courthouse in the Southern District of New York, delivered a surprising bench ruling confirming a plan of reorganization for the Momentive Performance Materials group of debtors ("MPM").   His rulings covered a number of issues, including interpretation of an inter-creditor agreement and denial of a make-whole premium to senior secured creditors, each of which was resolved against the senior secured creditors.  But probably the most explosive ruling, because it is not confined to the language of a particular contract, but, rather, presented as an interpretation of section 1129(B)(2)(A) of the Bankruptcy Code, was his expansive, almost literal, application of the Till plurality opinion to "cram up" the senior secured creditors with a below-market piece of 7-year paper.  

Judge Drain's analysis is noteworthy for four reasons.  First, the vast majority of Till-in-chapter-11 cases involve single-asset-real-estate or closely analogous fact patterns, in which the case is nothing more than a simple two-party dispute between the owner of the asset, who controls and dictates strategy to the debtor, and the mortgage holder, and there are no other significant creditor groups.  Rarely has any chapter 11 case involving a corporate group of debtors with multiple large creditor constituencies presented a Till litigation. 

Second, and a related point obviously, this is the first time a judge sitting in one of the main forums for complex chapter 11 cases has endorsed Till-in-chapter-11.  So it portends potential significance for future cases.  Judge Drain is a well-respected bankruptcy judge who practiced in an elite New York firm and his background will certainly give the analysis in his ruling more weight as a practical matter than a similar decision from a financially less-sophisticated judge or district (that said, Judge Drain has been known for a tendency to push the envelope in favor of junior constituencies -- see, e.g., the victory of the second lien bidder in the Westpoint Stevens 363 case (reversed on appeal at the District Court level, which reversal was then vacated by the Second Circuit on the ground the appeal had been moot under section 363(m)), or his decision in MacMenamin's Grill, that the safe harbor of 546(e) did not apply to private stock transactions (a distinctly minority view later rejected by the Second Circuit in Enron Creditors Recovery Corp v. Alfa).  

Third, his endorsement of Till conflicts with the decision of his fellow SDNY Judge Gerber in the DBSD case, who rejected, albeit with little explanation, a Till approach in the chapter 11 cramdown context.  As one of the creditor briefs (I forget which, sorry) summarizes the law in the Circuit: "There are four published Second Circuit decisions citing Till. Of those four decisions, only DBSD involved a corporate debtor and facts similar to this case and in that case Judge Gerber determined that Till was of limited value and that the market rate had to be considered. See DBSD, 419 B.R. at 209. The other three decisions in the Second Circuit all involved a single-asset real estate debtor and are thus inapposite to a complex chapter 11 case for the reasons set forth herein. Even so, two of those three decisions considered whether there was an efficient market before applying Till’s formula. See Mercury Capital Corp. v. Milford Conn. Assocs., L.P., 354 B.R. 1, 12 (D. Conn. 2006) (remanding confirmation order for determination of whether there was an efficient market for the debtor’s cramdown loan); In re 20 Bayard Views, LLC, 445 B.R. 83, 107-08 (Bankr. E.D.N.Y. 2011) (considering whether there was an efficient market before applying Till); but see In re Lilo Props., LLC, Case No. 10-11303, 2011 Bankr. LEXIS 4407 at *6 (Bankr. D. Vt. Nov. 4, 2011) (applying the Till formula without a discussion of whether there was an efficient market)."  Oddly (given that on the other issues his ruling cites decisions authored by Judge Gerber), Judge Drain ignored the DBSD conflict in his ruling, invoking instead bankruptcy court opinions from Vermont and EDNY.  

Last, the MPM reasoning departs from the main line of post-Till cases, which follow the American Homepatient line of reasoning that a court should look first to whether the relevant loan market is "efficient" and then, only if the answer is no, apply the Till formulaic approach.  Instead, Judge Drain applies the Till plurality approach in virtually undiluted fashion, as if it were settled law, rejecting the reference to the "rate an efficient market might produce" in footnote 14, and modifying the formula approach only to change the base on which the interest rate payable by the debtor was calculated to substitute a  "comparable Treasury" base for the "prime rate" base in the Till formula, in part because the pre-petition senior secured debt carried a fixed rate to begin with.

The Judge offers a remarkable twist on footnote 14, which I analyzed in this post.  Noting that Collier's and others have criticized the footnote for naively confounding DIP loans with exit financing, Judge Drain adopts their criticism, but uses it oddly, not as a means to discount Till as a chapter 11 precedent, but solely to discredit the footnote's reference to markets, leaving chapter 11 a non-market environment!  "In addition, there clearly was some form of market in the Till case. The market, in fact, had a lot of data behind it with regard to subprime auto loans. Nevertheless, the court referred to it as not a perfect market, when discussing those types of loans, for which Justice Scalia somewhat berated the plurality. But that fact, that the court again referred to a perfect market, underscores the notion that it wasn't really markets that was driving the court's analysis"

I have not seen this analysis in other post-Till cases.  As a description of Till, it is actually wrong; as I noted in my earlier posts, the interest rate in Till was the usury rate in Indiana, not a rate that moved up or down as the prime rate or LIBOR-based rates do.  That was why the creditor in TIll advocated for the "presumptive contract" approach, not the "coerced loan" approach, a change in tactics that the Supreme Court noted at the outset of argument, and it led to a key colloquy with Justice Breyer that, in my opinion, ensured he voted for the debtor, because he recognized that, under the creditor's approach, the rate would not change post-confirmation, even though the debtor had supposedly been rehabilitated, and that, in his mind, denied the debtor the benefit the statute was meant to provide. And most obviously, from a real world perspective, the leveraged loan market in 2014 is a lot more competitively priced than the subprime auto loan market has ever been.

As I put up 12 posts on Till-in-chapter 11 back in January, going through Till's facts, the briefs, the oral argument, the plurality opinion and the concurrence of Justice Thomas, as well as the post-Till application of the plurality opinion in some chapter 11 cases and offered evidence of the efficiency of the commercial loan markets, I think this is a subject where I might add some value.  So, although I always enjoyed practicing alongside the Judge when he was in private practice and in front of him since he took the bench,  I am going to briefly explain why this aspect of his decision in MPM is not well founded.

Like all opinions extending Till to chapter 11, Judge Drain observes that the language of 1129(b)(2)(A)(i) is identical to the language in 1325(a)(5)(B)(ii), the section at issue in Till, and further that the plurality opinion said that courts should take "essentially the same approach"  to the two sections.  As I explained earlier this year, that is a correct observation, but it does not necessarily mean quite what the advocates of Till-in-chapter-11 take it to mean.
First of all, the remark "essentially the same" obviously leaves room for differences between the two, depending on how strictly you read "essentially" and how you characterize the Till opinion (I show in my January posts, summarized below, that it is chapter-13-specific, which implies that the correlative section in chapter 11 should be interpreted in the context of chapter 11).  One vital fact overlooked by pretty much every analysis of the two sections is that the chapter 11 appearance of the wording appears in a clause subordinate to the well-developed phrase "fair and equitable", while the chapter 13 section contains no mention of "fair and equitable".  Fairly plainly, I think, this signals that Congress intended the chapter 11 version to be interpreted in the same vein as then-existing "fair and equitable" precedents, while its omission of the phrase from the chapter 13 context perhaps affords more leeway to plans and judges.  So the most informed way to understand the "essentially the same approach" remark is that the endorsed approach is chapter-focused; one interprets the language in 11 in the context of the entire chapter and interprets the language in 13 in the context of that chapter.

Second, the remark appears right at the beginning of the legal analysis  and appears to be utterly prefatory, as it is not followed by any development of what the "approach" had been in chapter 11.
Third, neither in the Till opinion nor in its oral argument and briefs was there any discussion of what either section meant, only how the chapter 13 version of it was to be practically applied.   For example, the Solicitor General's brief in Till, which clearly served as a source for much of the plurality opinion's reasoning, states quite emphatically: "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).
So, for me, it is difficult to give much weight to the plurality's  remark that the two sections require essentially the same approach when the remark was neither preceded nor followed by any significant exposition of what either section meant.  Rather, the remark is better seen as an effort -- naive or disingenuous, the reader may pick -- on the part of the justices in the plurality to portray their approach as consistent with prior law, not as a departure therefrom.  I tend to go with the "naive" version -- I don't think they were trying to rewrite the historic standard that secured creditors have to get full value; I think they believed they were adopting a pragmatic approximation of that standard that was appropriate for the unique characteristics of chapter 13 cases.

As I explained,  and as anyone who goes back and reads the opinion critically and examines the oral argument and briefs can confirm, the Till decision is not in the slightest based on a textual analysis of the words of the statute, but is entirely driven by chapter-13-specific concerns about ease of administration and pragmatic allocation of the burden of trial when one party, the debtor, is unable to pay for adequate representation.  (Plus, the usury context noted above, that appears to have influenced Justice Breyer)   So I don't think it's reasonable to infer that the Court was establishing chapter 11 policy, and indeed, it would have been a ridiculous step to do so in a case where the subject was not presented in the grant of cert or the briefing.

I think this point really needs to be emphasized.  At the time the Bankruptcy Code was enacted in 1978, the leading cases on cramdown strongly protected the secured creditor's right to be compensated for any alteration the chapter 11 plan might work in its right to payment in full,  so long as the collateral value was there.  Even an extension of maturity was a basis to receive value.  Go back and read the exposition I laid out in January of the leading case on a creditor's rights in the face of cramdown at the time the Code was adopted, Consolidated Rock Products, to confirm that.  There is no sign in the Code, nor in the legislative history leading up to it, that Congress intended to depart from the concept of full recovery, in economic substance, on the secured claim when it enacted the Code in 1978.  And in Till, there was absolutely no contention in the briefs or oral argument that 1129(b) authorized delivery of secured debt having a present value less than a 100% recovery on the secured claim.   So it is extremely implausible -- one has to be almost to believe in a secret conspiracy of some kind -- to contend in the face of such widespread silence that 1129(b) changed the law to authorize delivery of secured debt with a present value less than 100 cents of the secured claim.  How did this come to pass with no discussion of any kind by anyone in any branch of government?  There is no answer, of course.  Yet here we are with numerous lower courts adopting such a view based on some dictum in a plurality opinion.  That sort of shallow thinking is the reason I wrote the posts on Till earlier this year, and why I write this one.

Judge Drain's ruling goes on to note, correctly of course, that the plurality opinion rejected a "coerced loan" or "forced loan" approach, and infers that he is required to do the same.   Unfortunately, that is a superficial line of reasoning.  One ought to look at the reasons why the plurality rejected that approach.  When one does so, one will see that the reasons are mainly unique to chapter 13 and not applicable to large, complex chapter 11s.  Judge Drain fails to look at those reasons (he says at one point in his ruling that he will come back to them later but unfortunately does not), and this, I think, is why he goes astray in his analysis.

Here are all two of the reasons the plurality opinion gives for not adopting the "coerced loan" approach:

"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 were 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.   I cannot think of a determination of value in chapter 11 that does not involve some evidence about market value.  For example, to cite the most pertinent example, when parties present to the judge their estimates of a debtor's reorganization value, the most common method is the DCF, or discounted cash flow method, in which the debtor's projected net cash flow for several post-reorganized years is discounted to present value, and the typical discounting rate is the WACC, or weighted average cost of capital, in which all the inputs are determined by arrived at by referring to market rates, whether they be rates specific to the debtor, or to similar companies, or to broad swaths of the market.  And that's how you get to the asset side of the post-reorganization balance sheet.  That quantifying the liability side would be done by excluding market evidence is utterly incoherent.   Like all chapter 11 judges, Judge Drain sits through testimony market value testimony repeatedly, so it's not very convincing to then adopt  a line of reasoning that "considering evidence about the market" is "far-removed" from his "usual task".  That is the usual task of bankruptcy judges in commercial bankruptcies!  Honestly, the Till plurality was comprised of four men and women with no experience in private commercial practice, finance, or chapter 11; they were just ignorant of how chapter 11 worked, and those who are expert in it should be correcting that ignorance, not perpetuating it.  

The second factor identified by the plurality is vaguely worded, but in my judgment, based on the topics that were addressed in briefing and oral argument, 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, a mechanism that is 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. Also, under section 1322(d), a chapter 13 plan cannot extend payments beyond five years from the date of confirmation, a creditor protection not found in chapter 11.  These are all vital differences that need to be recognized when contemplating Till-in chapter-11 disputes.  The two chapters do not work the same way.  Even though the text of one section in one chapter resembles the text of another section in another chapter, the two chapters are not the same.   And of course it is the statute as a whole, not the phrase in isolation, that a court is charged with interpreting.  

Chapter 11 courts need to recognize this, instead of just superficially thinking that the plurality ruling reaches chapter 11 cases.   The only justification the plurality offers for its bald contention that the "coerced loan" approach should be rejected -- because "transaction costs" and "profits" are allegedly "no longer relevant" to cramdown paper -- rests on what they call the chapter-13-specific  "context of court-administered and court-supervised cramdown loans".  Thus, the whole point appears, as a matter of logic, not to carry over to chapter 11.  There is zero logic in Till that makes the "coerced loan" approach inappropriate in chapter 11.  The right way to interpret 1129(b)(2)(A)(i) is in the context of the rest of chapter 11, not by latching onto a plurality opinion from a case that interprets partially similar wording in the context of chapter 13.  Unfortunately, Judge Drain fails to read the plurality opinion this closely and simply concludes that cramdown rates must be evaluated on a not-for-profit basis.   

This troubles me for three additional reasons, which might be called policy reasons, as opposed to the statutory interpretation and case law interpretation fallacies I have just laid out.  First, at the highest conceptual level, profit, like price or cost, is information, and information is what makes a judgment valid.  Excluding information because it is unreliable is one thing; excluding it as a matter of substantive law strikes me as deeply contrary to basic modern Western notions of how decisions are arrived at and justice is delivered fairly.   Second, it results in a bizarre and inconceivable subsidy of companies emerging from chapter 11 versus their solvent competitors, in that the latter, obviously, have to borrow at market rates which include a profit component, while the newly emerged debtor is apparently, according to the Till-in-chapter-11 dogma, entitled as a matter of law to cheaper borrowing costs.  As I wrote in criticizing Justice Thomas's concurrence in Till  (which, the reader may be forgiven for not recalling, opined that, once a bankruptcy judge made an affirmative feasibility finding, the secured creditor was entitled to receive nothing more than the risk-free rate on the repayment paper (because every bankruptcy judge is apparently always right when s/he makes a financial evaluation and we citizens are just so lucky they have chosen to deploy their talents on the bench, not running banks and hedge funds where they of course would make billions of dollars with such omniscience)): 

"Justice Thomas’s interpretation also leads to nonsensical outcomes in the real world that Congress cannot have intended.  If no debtor under a confirmed plan can be compelled to pay more than a risk-free rate, then all debtors wind up paying less than the most creditworthy citizens, the most creditworthy businesses and pretty much all state and local governments, even less than members of Congress and justices on the Supreme Court probably pay on their mortgages! 

"Were his interpretation extended to the chapter 11 context,  companies in chapter 11 would be entitled to turn all their debt into 30-year interest-only bonds with interest at the rate the U.S. Treasury pays on its 30–year bonds.  What a huge financing advantage it would give them over their competitors – for decades!  And, as a consequence, they would be much more likely to reduce their debt as little as possible in the reorganization, since it would be the cheapest kind of capital possible.  It is hard to believe Congress thought the public interest would be served by a reorganization process that reduced corporate debt as lightly as possible.  One also wonders why Congress bothered to provide for disclosure and voting by secured creditors in chapter 11, if a non-consensual approach was only capable of producing a risk-free rate.  Finally, since the Bankruptcy Code does not require insolvency as a prerequisite for filing an 11 or proposing a plan, this kind of interpretation would invite companies to resort frequently and  liberally to chapter 11 just to re-price their debt downward in a falling rate environment.  It is absurd to think that these outcomes were intended by Congress." 

Albeit to a lesser degree, Judge Drain's approach is susceptible to the same criticisms.  MPM gets to carry debt far cheaper than the market believes it deserves.  The debtor had procured stand-by exit financing to take out the secured creditors, and its rates -- fairly obvious and persuasive evidence of the debtors' credit risk  -- were set at LIBOR plus 400 bps, in the case of the first lien, and LIBOR plus 600 bps in the case of the layered one-and-a-half lien.   Those rates were over 100 bps higher than the rates the Judge approved, meaning the debtors saved millions of dollars each year by going with the cramdown paper.  That is a huge subsidy for them vis-a-vis their competitors once they emerge. I find it inconceivable that Congress intended such a systematic subsidy for reorganized debtors.  The Judge simply swept that evidence aside with his reasoning that market rates were not relevant because they contained elements of profit.   

Last, forcing senior secured creditors to systematically provide such a subsidy upends the policy of the Code that chapter 11 is supposed to induce negotiated, consensual outcomes.  If a debtor knows as a matter of legal certainty that it can impose a below-market rate on a senior secured creditor, why would it ever choose not to?  It would be financially irrational to do otherwise, and only some sort of corruption or incompetence would explain not doing so.  Specifically, why would it ever refinance the creditor, which would necessarily require going into the market and incurring higher debt service post-emergence?  Debtors would never provide for unimpairment, unless the secured creditor's collateral were sold during the case.  By the same token, why would a debtor negotiate new payout terms with the creditor, except over how much of a haircut the creditor would take:  "I can give you 96 cents on the dollar now, or I can give you paper worth 95 cents under Till, which would you rather have?"  That's all the negotiation you'll see one year. Maybe the next year, the figures are 93 and 92, depending on where interest rates go.  You can't imagine senior secured paper ever getting 100 cents on the dollar again, except, as I said before, in the sale of collateral context.  

That is just an incoherent reading of the statute as a whole.  It turns on its head a carefully crafted complex of substantive provisions such as unimpairment, and procedural provisions such as disclosure and voting, as to all of which cramdown has historically served as a backdrop or last resort, that guides constituencies to negotiated resolutions in the main and thereby reduce the amount of judicial resources needed to reorganize businesses.  Instead it makes cramdown the default rule, and negotiated outcomes aberrations, and thereby renders all the other sections of chapter 11 dealing with claim treatment mere exceptions to that rule.