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On May 17, the U.S. Supreme Court issued its decision in Till v. SCS Credit Corp., 124 S. Ct. 1951. In that case, consumer debtors had purchased a used truck pursuant to a financing agreement by which they agreed to pay an annual interest rate of 21%. As part of their Chapter 13 plan, the debtors proposed to pay interest to the finance company on account of its lien against the truck, which was worth $4,000, at the rate of 9.5%. Over the finance company’s objection that the interest rate did not accurately reflect the present value of its security interest in the truck, the bankruptcy court confirmed the debtors’ plan of reorganization, and the finance company appealed. The question presented in this case was by which method a court should calculate the rate of interest that must be paid to a secured creditor when allowing a debtor to “cram down” a plan of reorganization. A cram down occurs when the bankruptcy court confirms a plan of reorganization over the objection of a secured creditor that it is being deprived of its contractual right to possession of the collateral and is, instead, being provided with the promise of installment payments over time. Such payments are supposed to equal or exceed the “value, as of the effective date of the plan,” of the allowed amount of such claim. The decision in Till is important for two reasons. First, even though Till is a consumer case under Chapter 13 of the Bankruptcy Code, there is a comparable version of the cram down provision in Chapter 11, which applies principally to corporate reorganizations. Thus, the decision will have a significant impact on business cases throughout the country. Second, interest rates in the current economic cycle have apparently bottomed out. With interest rates on the rise, it is important for debtors and creditors to know to what extent a court’s interest rate calculation will affect their claims in a bankruptcy case. The Supreme Court’s description of the decisions by the lower courts demonstrates the divergence of opinions on the subject. As the case made its way through the lower courts, each employed a different approach for calculating what it believed was the appropriate interest rate. Like the courts below, the Supreme Court also failed to form a consensus. As a result, we are left to ponder the different approaches set forth in the plurality opinions. A review of the approaches by the various courts The bankruptcy court applied the formula rate approach in setting the interest rate in the debtors’ plan of reorganization. The starting point in determining this rate is the national prime rate, which was 8% at the time. The court then augmented this rate to account for the additional risk of nonpayment posed by borrowers in a similar financial condition to the debtors. After considering evidence (including expert testimony) of what those risks were and the role of the bankruptcy process in assessing that risk, the court set the interest rate at 9.5%. On appeal, the district court reversed. It held that the 7th U.S. Circuit Court of Appeals required application of the forced loan approach. Under that test, the court must consider what interest rate the creditor could obtain if it had foreclosed on its loan, sold the collateral and reinvested the proceeds in loans of comparable duration and risk. Based upon the secured creditor’s unrebutted testimony in the case, the district court determined that the rate should be 21%. On further appeal, the 7th Circuit adopted the contract rate approach, which was characterized as a modified forced loan analysis. Beginning with the forced loan rate, the court looked to the rate set in the prebankruptcy contract between the parties. Either party could then object and seek to have a higher or lower rate applied based upon the particular circumstances of the case and how they affect the risk of nonpayment under the proposed reorganization plan. The 7th Circuit’s decision was not unanimous. The dissenting opinion advocated utilizing either the formula approach or a “cost of funds” approach. Under the latter, the court would have to determine what the cost would be to the creditor to obtain the cash equivalent of the collateral from an alternative source. The dissenter also thought it appropriate to consider the extent to which the creditor had already been compensated for its risk of nonpayment in making the loan. On further appeal, a plurality of the Supreme Court reversed and remanded. Justice John Paul Stevens delivered an opinion in which justices David H. Souter, Ruth Bader Ginsburg and Stephen G. Breyer joined (and Justice Clarence Thomas concurred). In determining which approach to use, these justices were guided by three considerations. First, the Bankruptcy Code contains many provisions that require a present-value analysis and there should be a uniform method for doing so. Second, the method should reflect the risks and protections offered by the bankruptcy process. Third, it should be familiar to the financial community, minimize the need for expensive evidentiary proceedings and adequately compensate secured creditors on an objective basis for the time value of their money and risk of default. With these considerations in mind, the plurality adopted the formula approach. It rejected the other approaches as being too complicated, imposing significant evidentiary costs and improperly focusing on the circumstances of individual creditors as opposed to an objective present-value analysis. Indeed, the plurality favored the formula approach because it begins by looking to the national prime rate, which is reported daily in the press and reflects the financial market’s estimate of the amount a commercial bank should charge a creditworthy borrower to compensate for the opportunity costs of the loan, the risk of inflation and the relatively slight risk of default. The bankruptcy court will then have to adjust the rate to reflect such factors as the circumstances of the estate, the nature of the security and the duration and feasibility of the reorganization plan. The result is that the analysis will begin with a low estimate of the proper rate of interest and place the burden squarely on the creditor to have that rate adjusted upward. Thomas concurred in the plurality’s decision on separate grounds. As a matter of strict statutory construction, he stated that there was no requirement in � 1325 of the Bankruptcy Code that a secured creditor be compensated for the risk of nonpayment because such risk is included within the consideration of the value of its secured claim. Contrary to the plurality and dissent, Thomas believed that the statute only requires a straight present-value analysis and that the prime rate, without adjustment, was sufficient to compensate a secured creditor for the time value of money. Because the debtor’s plan provided for payments in excess of this amount, he would have upheld confirmation of the debtor’s plan. The dissenting justices preferred the contract rate Justice Antonin Scalia, with whom Chief Justice William H. Rehnquist and justices Sandra Day O’Connor and Anthony M. Kennedy joined, filed a dissenting opinion advocating the contract rate. Their preference for the contract rate was premised upon two assumptions. The first was that financial markets, including the subprime market involved in this case, were competitive and largely efficient. The second was that risks associated with a Chapter 13 plan are at least as great as at the time of the initial loan. The inference to be drawn from these assumptions is that the contract rate reasonably reflects the actual risk at the time of borrowing and that the same risk persists in the bankruptcy case. The dissent therefore opined that the contract rate is a decent estimate, or at least the lower bound, of the appropriate interest rate in a cram down and should therefore be the presumptive rate. Either party would have the opportunity to prove that a higher or lower rate should apply. The dissent’s approach has some appeal to it. Foremost of its advantages is that the contract rate presumption would eliminate the need for a fact-intensive inquiry except in cases in which one party disputed the actual contract rate. At the same time, the approach is flexible enough to allow parties to alter contract rates based upon significant changes in the financial markets. Of course, the contract rate approach appears to be somewhat draconian when applied to the debtors in Till. But that is due in part to the fact that we are in an era of interest rates that have gone as low as they could virtually go. Thus, the disparity between the prime rate and the contract rate is so great that it is difficult to find a middle ground. Certainly, 9.5% seems too low under the circumstances. With interest rates on the rise, however, the contract rate approach may provide a favorable presumption to debtors in the future. If they continue to rise, many contract rates will soon be lower than current market rates. In that situation, secured creditors will then bear the burden of demonstrating that the contract rate is too low and should be adjusted upward. As it is, the plurality’s more traditional formula approach will probably continue to be the method applied by bankruptcy courts. However, it should not be forgotten that the method is only a means of reaching the ultimate end of accurately compensating a creditor in a cram down situation. Keeping that objective in mind, application of a particular method should not lead to results as disparate as the 9.5% to 21% spread in Till. Craig Rankin is a partner at Los Angeles-based bankruptcy boutique Levene, Neale, Bender, Rankin & Brill. Christopher Alliotts is counsel to the Menlo Park, Calif., office of Los Angeles-based SulmeyerKupetz.

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