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By Bernard J. Pazanowski
Courts calculating the cramdown rate in Chapter 11 bankruptcy cases can simply add the prime rate and a risk adjustment amount between 1 and 3 percent, the U.S. Court of Appeals for the Fifth Circuit held March 1 (Wells Fargo Bank N.A. v. Texas Grand Prairie Hotel Realty LLC, 5th Cir., No. 11-11109, 3/1/13).
In an opinion by Judge Patrick E. Higginbotham, the court said that a bankruptcy court did not err when it used the formula, which was first proposed by a plurality of the U.S. Supreme Court in the Chapter 13 case, Till v. SCS Credit Corp., 541 U.S. 465 (2004)(16 BBLR 439, 5/20/04).
In 2007, the debtors, including Texas Grand Prairie Hotel Realty LLC, obtained a $49 million loan to renovate and operate four hotels in Texas. Wells Fargo Bank NA eventually ended up with the loan, which was secured by the hotel properties and most of the debtors' other assets.
In 2009, the debtors filed for Chapter 11 protection. When Wells Fargo objected to their reorganization, the debtors sought to cram down their plan under Bankruptcy Code Section 1129(b), that is, they asked the court to allow modification of the loan terms. Under Section 1129(b), a cramdown reorganization plan will be allowed if it provides the secured creditors with deferred payments of “value” at least equal to the “allowed amount” of the claim as of the effective date of the plan. Or in other words, “the deferred payments, discounted to present value by applying an appropriate interest rate (the 'cramdown rate'), must equal the allowed amount of the secured creditor's claim,” the Fifth Circuit explained.
The debtors' reorganization plan valued Wells Fargo's secured claim at roughly $39 million, and proposed to pay that amount over 10 years, with interest accruing at 5 percent. The interest rate reflected the applicable prime rate of 3.25 percent, plus a risk adjustment of 1.75 percent.
In Till, a plurality of the Supreme Court decided that the prime plus rate is acceptable in Chapter 13 cases. To make the computation, courts should add the prime rate--the rate that banks charge creditworthy commercial borrowers--and the supplemental risk adjustment, which accounts for “such factors as the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization plan.” The Supreme Court did not decide the proper scale for the risk adjustment, but noted that “other courts have generally approved adjustments of 1% to 3%.”
The plurality reasoned that its method cuts down on the need for costly evidentiary hearings, and the risk adjustment factors “fall squarely within the bankruptcy court's area of expertise.” It also said that the approach varies only in “the state of financial markets, the circumstances of the bankruptcy estate, and the characteristics of the loan,” and does not require looking into a particular creditor's cost of funds or prior contractual relations with the debtor, the Fifth Circuit said.
The Till plurality also “reject[ed] the coerced loan, presumptive contract rate, and cost of funds approaches,” saying that they were too complicated.
Justice Antonin Scalia dissented in Till, calling the risk adjustment amount “a smallish number picked out of a hat,” and complaining that the plurality's formula will “systematically undercompensate” creditors.
In Drive Financial Services LP v. Jordan, 521 F.3d 343 (5th Cir. 2008)(20 BBLR 363, 3/27/08), the Fifth Circuit recognized that as a plurality opinion Till “is limited even in Chapter 13 cases.” Nevertheless, it noted here that many courts have been “persuaded” by the plurality's reasoning to apply Till in Chapter 11 cases. Among other things, the other courts note that the Till court suggested that its analysis governs Chapter 11 cases.
The parties in this case agreed that using the Till analysis was proper.
The debtors' expert, Louis Robichaux, testified that the applicable prime rate was 3.25 percent. He also noted that the hotels were well maintained and well managed, that the debtors were committed to the business, that revenues from the properties recently exceeded projections, the value of the collateral was stable or appreciating, and that the proposed cramdown, although tight, was feasible. Because of these factors, he concluded that the risk of default was “just to the left of the middle of the risk scale.” Because Till suggested a risk adjustment of between 1 percent and 3 percent, Robichaux concluded that 1.75 percent was appropriate and the cramdown rate should be 5 percent.
Wells Fargo's expert, Richard Ferrell, corroborated virtually all of Robichaux's findings. But he concluded that there is no market for single, secured loans comparable to the one proposed by the debtors, and calculated the market rate by looking at the weighted average of the interest rates the market would charge for a multi-tiered exit financing package. He came up with a blended market rate of 9.3 percent, which was the 3.25 percent prime rate plus an upward adjustment based on the “nature of the security interest.” He then subtracted 1.5 percent to reflect the sterling condition of the bankruptcy estate, but added back in 1 percent because of the plan's tight feasibility. Wells Fargo, he said, was entitled to a cramdown rate of 8.8 percent.
The district court accepted Robichaux's calculation, and the Fifth Circuit affirmed.
The appeals court refused to “tie bankruptcy courts to a specific methodology as they assess the appropriate Chapter 11 cramdown rate of interest.” Instead, it said that a proper review of a bankruptcy court's entire cramdown rate analysis is “for clear error.”
While it said that it has no problem with using the Till formula in Chapter 11 cases, even though it was developed in a Chapter 13 case, the court noted that in Footnote 14, the Till court “appears to endorse a 'market rate' approach under Chapter 11 if an 'efficient market' for a loan substantially identical to the cramdown loan exists.” Most bankruptcy courts, however, “invariably conclude that such markets are absent,” it said. Applying Till's 1 percent to 3 percent risk adjustment range, those courts “typically select a rate on the basis of a holistic assessment of the risk of the debtor's default on its restructured obligations,” it said.
In this case, Robichaux's cramdown rate was based “on an uncontroversial application of the Till plurality's formula method,” the appeals court said. Robichaux engaged in a holistic assessment of the debtors and assessed a risk adjustment of 1.75 percent over prime, it said. This risk adjustment is “squarely within the range of adjustments” used by other bankruptcy courts, it said.
Moreover, the court said that Ferrell's computation was based “on the sort of comparable loans analysis rejected by the Till plurality.” The plurality “expressly rejected methodologies” that consider the market for comparable loans, it said.
Even if the result reached by Robichaux is “smallish,” or “absurd,” it conforms with the plurality opinion in Till, “which has become the default rule in Chapter 11 bankruptcies,” the court said. It also said that while the Sixth Circuit has found Footnote 14 persuasive and applies a market rate approach to calculate cramdown rates, that “does not suggest that the bankruptcy court here committed any error.”
While the appeals court concluded that the bankruptcy court in this case did not err by applying the Till formula, it stressed that it was not suggesting “that the prime-plus formula is the only--or even the optimal--method for calculating the Chapter 11 cramdown rate.”
Judges Jennifer Walker Elrod and Catharina Haynes joined the opinion.
Brian C. Walsh, Bryan Cave, St. Louis, argued for Wells Fargo. Davor Rukavina, Munsch Hardt Kopf & Harr, Dallas, argued for the debtors.
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