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In Till v. SCS Credit Corporation, 124 S.Ct. 1951 (May 17, 2004), the United States Supreme Court addressed the appropriate methodology to determine a cram down rate of interest. Till is one of several bankruptcy cases in which the United States Supreme Court has taken a complex, difficult, murky issue and made it even more complex, difficult, and murky, at least in the chapter 11 context. See, e.g., Case v. Los Angeles Lumber, 308 U.S. 106, 122-23 (1939) (shareholders' continued participation in  reorganized debtor not  permitted under absolute priority rule; igniting "new value exception" debate); Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1988) (again denying shareholder participation due to valuation difficulty but leaving door open for new value arguments); Bank of America National Trust & Savings Ass'n v. 203 North LaSalle Street Partnership, 526 U.S. 434 (1999) (declining to decide the new value exception issue, but noting in dicta conditions that must be satisfied for a successful application of the new value exception).  See also Northern Pipeline Constr. Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982) (bankruptcy court jurisdiction controversy);  Associates Commercial Corp. v. Rash, 520 U.S. 953 (1997) (secured claim valuation controversy). "May you live in interesting times" goes the saying, and "interesting times" are guaranteed for bankruptcy practitioners and judges as long as bankruptcy appeals continue to make their way to the United States Supreme Court with the ostensible purpose of settling "the embarrassing conflict of opinion" among the circuits.  Rice v. Sioux City Memorial Park Cemetery, 349 U.S. 70, 79 (1959), citing Layne & Bowler Corp. v. Western Well Works, Inc., 261 U.S. 387 (1922).

This article will discuss the secured creditor's responses to cram down under 11 U.S.C. § 1129(b)(2)(A) in light of Till.

Review of Till

Till was a chapter 13 case out of the United States Bankruptcy Court for the Southern District of Indiana, involving a retail installment contract on the debtor's truck, valued at $4,000. The debtor proposed, and the bankruptcy court approved, a 9.5% cram down interest rate, based  apparently on a 1.5% risk augmentation to the 8% national prime rate. The district court reversed, invoking the "coerced loan" theory to find that a 21% rate of interest was necessary to compensate the creditor. The Seventh Circuit Court of Appeals modified the district court's approach and remanded,  holding that the 21%  contract rate was a "presumptive rate," that could be challenged on remand.

The United States Supreme Court reversed and remanded, with a plurality opinion written by Justice Stevens— joined by Justices Souter, Ginsburg, and Bryer—and a concurrence written by Justice Thomas. There was a dissent  by Justice Scalia—joined by Justices Rehnquist, O'Connor and Kennedy—in which the dissenting Justices promoted the presumptive contract rate approach.

The plurality opinion adopted what has come to be called the "formula approach."  The formula approach starts with a known national interest rate such as the prime rate,  then allows for "appropriate risk adjustments,"  The formula approach starts from a "concededly low estimate" and then adjusts upward.  Under the plurality opinion, after identifying the prime rate, it is incumbent upon the creditor "to present evidence supporting a higher rate" to convince the court that the prime rate should not be the cram down rate. The plurality opinion did not "decide the proper scale for the risk adjustment," concluding that the adjustment issue was not presented.

Is Till Disadvantageous to Secured Creditors in a Chapter 11 Case?

Till's effect on chapter 11 cases will depend on whether a court believes it is bound to apply the Supreme Court's Chapter 13 cram down analysis in the Chapter 11 context.  As argued below, this outcome is not predetermined by anything in Till itself.  The context in which this question is presented could be important because the Chapter 11 cases reported before Till are badly fractured with respect  to interest rates.  Courts of appeals have adopted, or at least recognized, cram down interest rate standards as follows.

(1)    Coerced loan approach: There are at least two ways of articulating this approach. One articulation is that the "creditor is entitled to the rate of interest it could have obtained had it foreclosed and reinvested the proceeds in loans of equivalent duration and risk." Koopmans v. Farm Credit Servs. of Mid-America, ACA, 102 F.3d 874, 875 (7th Cir. 1996). Another articulation is that the rate is established by "looking to the rate that the debtor would pay outside bankruptcy to obtain a loan on terms comparable to the terms proposed in the plan."  DAVID G. EPSTEIN, DON'T GO AND DO SOMETHING RASH ABOUT CRAM DOWN INTEREST RATES, 49 Ala. Law Rev. 435, 442 (1998). Prior to Till, the coerced loan approach was adopted by the Fourth, Sixth, Seventh, and Eleventh Circuits. See Id. at 443. The Tenth Circuit in In re Hartzog, 901 F.2d 858 (10th Cir. 1990) adopted a test that seems to be both a formula approach and a coerced loan approach.

(2)    Cost of funds approach: Here the rate is determined based on what interest the creditor would have to pay to borrow the funds. See In re Valenti, 105 F.3d 55 (2nd Cir. 1997) (espousing view and reviewing cases but adopting a fixed-rate approach based on treasury bill rates with same maturities plus risk points, i.e., the formula approach). No circuits have adopted the cost of funds approach.

(3)    Formula approach: The formula approach starts with a base rate (pre-Till cases use different base rates) and then adds points for risk. Prior to Till, the formula approach was adopted by the Second and Tenth Circuits (see Valenti and Hartzog,supra). EPSTEIN, supra, at 443.

(4)    Presumptive contract rate approach: Under this approach the court begins with the pre-petition contract rate, which creates a rebuttable presumption that either the creditor or the debtor can counter by persuasive evidence that the current  rate is a different rate. See General Motors Acceptance Corp. v Jones, 999 F.2d 63 (3d Cir. 1993); In re Smithwick, 121 F.3d 211, 214 (5th Cir. 1997); In re Till, 301 F.3d 583, 592 (7th Cir. 2002); and In re Yett, 306 B.R. 287, 294 (9th Cir. BAP 2004) (examines but does not adopt presumptive contract rate); Till, 124 S.Ct. at 1968 (Justices Scalia, Rehnquist, O'Connor, and Kennedy, dissenting). This approach appears to be a variation on the coerced loan approach with the addition of the presumption.

A secured creditor would rarely benefit from the cost of funds approach. A secured creditor may or may not benefit from the presumptive contract rate approach and would seek to apply or avoid it depending on the contract rate. Till's adoption of the formula approach and the methodology described therein is generally in line with pre-Till case law on that approach, with the important exception of the allocation of the burden of proof, which the plurality in Till places on the secured creditor. Till, 124 S.Ct at 1961.

There are, therefore, at least two potential reasons for opposing the application of Till to a chapter 11 case: (i) the desire to have the coerced loan or presumptive contract rate approaches apply; and (ii) the avoidance of burden shifting. Any shifting of the burden of proof is discomforting, but it has to be said that it is difficult to find a reported Chapter 11 case in which the cram down interest rate determination appears to have been affected  by who had the burden of proof.

Is There a Real Difference in Result Based on Methodology?

Despite significant differences in the articulations of methodology under the three approaches (formula, coerced loan, and presumptive contract), it is not at all clear that their application results in different interest  rates, at least on any consistent basis.   See, e,g, In re Till, 301 F.3d 583, 592 (7th Cir. 2002), in which the court explains that in Koopmans Farm Credit Servs. of Mid-America, ACA, 1023 F.3d 874 (7th Cir. 1996), the court utilized the "coerced loan approach," which led to a "prime plus rate," causing some to believe that it had adopted the "formula approach." It is sometimes said that fundamentalists in different religions have more similarities with fundamentalists in other religions than they do with liberals in their own religion. Similarly, courts that apply the coerced loan approach using a general market interest rate end up closer to courts that apply the formula approach than they are to other courts that apply the coerced loan approach with a narrower definition of the defining market.

      For example, in General Motors Acceptance Corp. v. Jones, 999 F.2d 63 (3d Cir. 1993), the court explained that a loan of "similar character" used to establish a basis for a cramdown interest rate meant:

[A] loan that the creditor regularly extends to other debtors who are not in bankruptcy but who are otherwise similarly situated to the debtor who is the recipient of the loan coerced by the chapter 13 proceeding and who are seeking the same kind of credit (e.g. auto loan, home equity loan, etc.).

Id. at 7, n.42.   The Third Circuit cited a Sixth Circuit case, Memphis Bank & Trust Co. v. Whitman, 692 F.2d 427 (6th Cir. 1982) as authority for this approach.  However, in  2003, in Household Auto Fin. Corp. v. Burden (In Re Kidd), 315 F.3d 671 (6th Cir. 2003), the Sixth Circuit, also citing Whitman, supra, considered the appropriate Chapter 13 cram down interest rate for a creditor that made a  20.95% car loan to a debtor who filed bankruptcy three months later. The creditor argued for the contract rate based on risk factors in the subprime market. The creditor admitted that in some instances it made loans at 10.95%, but it was not clear that these were subprime car loans. There was other testimony that the subprime car market interest rate ranged from 13.5% to 16.25%. The Sixth Circuit approved a rate of 10.3%, apparently relying in part on evidence that the market rate for conventional car loans was 9.3%.

By broadening the "market" to conventional car loans made to the average borrower, the Sixth Circuit in Kidd reached a result that is closer to what one would expect under the formula approach rather than the coerced loan approach, at least as articulated in General Motors Acceptance Corp. v. Jones, supra.   See also In re America Homepatient, Inc., 298 B.R. 152, 183 (Bankr. M. D. Tenn. 2003) (coerced loan approach does not include interest rate at which lender would re-invest but instead more general interest rate, citing, inter alia, Household Auto Fin. Corp. v. Burden (In Re Kidd), 315 F.3d 671 (6th Cir. 2003). It is interesting  to note that in American Homepatient, supra, at 184, the court emphasized that the pre-petition contract rate was lower than what the creditor was seeking in the chapter 11 case and used that as a factor against the creditors' position.

In courts articulating a "coerced loan approach" but which look to the market generally for a rate and not to a subprime market or to the contract rate, a secured creditor will probably not be in a significantly different position than it would be under Till.  For the time being, the secured creditor will have to make alternative presentations under each potentially applicable approach, and the interest rate expert, if allowed to testify, must be prepared to do the same.

Arguing that Till  Does Not Apply in Chapter 11

Assuming that the chapter 11 case is in a court with a favorable coerced loan approach or a presumptive contract rate approach with a favorable contract rate, the secured creditor's first argument should be that Till is not applicable to chapter 11 cases.  The first consideration is that Till is merely dicta with respect to chapter 11. Till is a case interpreting 11 U.S.C. § 1325(a)(5), not § 1129(b)(2)(A). By now you have probably compared these two passages from the plurality opinion in Till:

We think it likely that Congress intended bankruptcy judges and trustees to allow essentially the same approach when choosing  an appropriate interest rate under any of these provisions [citing, among other sections, § 1129(b)(2)(A)].

Till, 124 S.Ct. at 1959.

Because every cram down loan is imposed by a court over the objection of the secured creditor, there is no free market of wiling cram down lenders [in a chapter 13]. Interestingly, the same is not true in the Chapter 11 context, as numerous lenders advertise financing for Chapter 11 debtors in possession. See, e.g., Balmoral Financial Corporation, http://www.balmoral.com/bdip.htm (all Internet materials as visited Mar. 4, 204, and available in Clerk of Court's case file)(advertising debtor in possession lending); Debtor in Possession Financing: 1st National Assistance Finance Association DIP division, http://www,loanmallusa.com/dip.htm (offering "to tailor a financing program . .  to your business needs and . .   to work closely with your bankruptcy counsel"). Thus when picking a cram down rate in a Chapter 11 case, it might make sense to ask what rate an efficient market would produce. In the chapter 13 context, by contrast, the absence of any such market obligates courts to look to first principles and ask only what rate will fairly compensate a creditor for its exposure.

Id. at 1960, n. 14.

 Pre-Till case law supports the proposition that the same cram down interest rate approach should be used in chapters 11, 12, and 13. See, e.g, In re Yett, 306 B.R. 287, 291 (9th  Cir. BAP 2004). The footnote in Till quoted above and the considerations on which the plurality opinion relied in choosing the formula approach, however, suggest that the appropriate approach in a chapter 13 for setting a cram down interest rate may be inappropriate in chapter 11 cases.

We are left once again to wrestle with the dreaded footnote, which in the twinkling of an eye renders what might have been a consistent (although arguably flawed) opinion into an ambiguous platform in the Chapter 11 context. If the footnote is our guide, must circuits that had adopted the formula approach in chapter 11 now utilize the "efficient market" approach per footnote 14—whatever that may be.  

This dicta, while interesting, is not binding, and contradictory dicta in a plurality opinion arguably is not even persuasive, much less binding, especially considering that four Justices found the presumptive contract rate approach to be the appropriate approach. For obvious reasons Supreme Court dicta generally may be a different matter insofar as "inferior courts" are concerned.  See, e.g., Peterson v. BMI Refractories, 124 F.3d 1386, 1392 (11th Cir. 1997) ("Dicta from the Supreme Court is not something to be lightly cast aside.").  However, even the Supreme Court does not hesitate to cast aside its own unsupported, conflicting or otherwise unpersuasive dicta.  The Supreme Court has repeatedly held unsupported dicta may not serve as valid precedent for its rulings  See, e.g., Colgrove v. Battin, 413 U.S. 149, 157 (1973) (declining to follow its own dicta that the Seventh Amendment requires a jury of twelve persons in civil trials); Central Green Co. v. United States, 531 U.S. 425, 431 (2001) (interpreting actual language of Flood Control Act provision rather than following "admittedly confusing dicta" of a prior Supreme Court opinion);  Humphrey's Ex'r v. United States, 295 U.S. 602, 627 (1935) (dicta "may be followed if sufficiently persuasive" but is not binding).

The second consideration is that the plurality opinion is based on policy and practical considerations inherent in chapter 13 cases  that are not inherent and are usually absent in a chapter 11 case.  For example:

(1)    The plurality opinion focuses on the need for an inexpensive, simple way to resolve the interest rate issue under § 1325(a). A balancing of interests might weigh in favor of economy and expediency over case-by-case protection of the secured creditor in a consumer chapter 13.  Setting an interest rate on a thirty-six month $4,000 car loan, however, simply does not have the same implications as setting an interest rate, for example, on a twenty-five year, $25 million loan to a multi-state nursing home company.   Confirmation of a chapter 11 plan typically involves valuation and feasibility issues requiring expert testimony regardless of the interest  rate.  Adopting a simplistic approach to interest rate issues will not significantly lessen the complexity of the case or the costs or time needed for confirmation.

(2)    The plurality opinion bases its decision in part on other  protections of creditors it presumed to be inherent  in chapter 13 cases.   The plurality states that "the postbankruptcy obligor is no longer the individual debtor but the court supervised estate, and the risk of default is thus somewhat reduced." Till, 124 S.Ct. at 1959. The following factors in chapter 13 cases would at least theoretically support this conclusion of lessened risk:

(i)    chapter 13 plan cannot exceed sixty months;

(ii)    property typically remains property of the estate during the pendency of the case;

(iii)    presence of chapter 13 trustee;

(iv)    continued access to court to seek relief during pendency of the case; and
(v)    non-volatile nature of the collateral, i.e., a car typically depreciates on progression that can be tracked, unlike the going concern value of a business in a chapter 11 that might secure a loan; and

(vi)    inability of debtor to incur additional credit during pendency of case without court approval.

In many, if not most, chapter 11 cases, few or none of these risk-lessening factors is present post-confirmation. The chapter 11 plan can call for a twenty-five or thirty year pay-out. Post-confirmation, there is no bankruptcy estate, trustee, or U.S. Trustee, and recourse to the court, although existent, is more limited and less meaningful.

(3)    The plurality opinion rejects the market approach in part because it finds there is no market for post-filing chapter 13 lending, but the plurality opinion recognizes that there is a market in the chapter 11 context. Of course prior to Till, courts have struggled to define the market rate when there is no rate at which a lender would finance a particular debtor in possession, but the Supreme Court has said that there is a market rate and therefore it must be so.

Practical Considerations When Litigating Cram Down Interest Rates in Chapter 11

As a trial strategy, the secured creditor in a chapter 11 case, at least for the time being, will have to be prepared to make its cram down interest rate objection under the pre-Till standards in that circuit and under Till. Even if the circuit had adopted the formula approach before Till, the court might now be compelled to apply an "efficient market" approach under Till's dicta, with respect to which there is little guidance (reminiscent of the "replacement value" concept in the (in)famous footnote in Associates Commercial Corp. v. Rash, 520 U.S.953, 960, n.2 (1997)).  With respect to the formula approach, the plurality opinion tells us to start with the "national prime rate," a "concededly low estimate" and to adjust upward based on the proof presented by the creditor. Till, 124 S.Ct at 1961. The risk factors identified by the Court that are to be considered in terms of an upward adjustment in interest rate are: (i) probability of plan failure; (ii) rate of collateral depreciation; (iii) the liquidity of the collateral market; and (iv) the administrative expenses of enforcement. Id. at 1964. There is very little additional guidance as to the application of these factors.  Other risk factors not mentioned in Till often important in a Chapter 11 case include: (i) the extent of any changes in the loan documents, e.g., changes in financial covenants, insurance requirements, default provisions, and remedies (see, e.g., In re Montgomery Court Apartments of Ingham County, Ltd., 141 B.R. 324, 346 (Bankr. S.D. Ohio 1992)); (ii) post-confirmation ability to borrow money, secure debt, and sell property; and (iii) presence or absence of sources for future capital in the form of debt or equity.

Below are some practical issues for consideration by the secured creditor in advance of a cram down struggle.

1.    Do you need an interest rate expert?  The plurality in Till clearly intended to minimize the need for extraneous forms of proof with respect to interest rates.  It is possible that a court would say it is now charged only with assessing risk factors and proof of market rates from an expert is not probative and inadmissible under Rule 702 of the Rules of Evidence. Of course, Till may not apply, and even if it does, there may be other probative testimony from the expert. Consider seeking a ruling from the court as to the admissibility of expert testimony well in advance.

2.    What is the interest rate expert's approach? Under Till there are at least two approaches. First, typical chapter 11 plans extend well past the 3-5 year period of a chapter 13. The extended time in and of itself is a risk factor. Consideration should be given to adjusting the prime rate by the difference between the prime rate and the commensurate risk-free treasury bill rate with the same maturity as the loan. See Valenti, supra. Second, neither Till nor any other cases explain how to convert risk factors into interest points. An expert could be asked how one or more factors increases the risk and how lenders in the marketplace would adjust rates based on those risk factors. Under the coerced loan approach, the interest rate expert should evaluate the business and creditworthiness of the debtor and assess the market for loans to a debtor in that business with those risk factors. The expert can talk with lenders and confirm a market, i.e. availability of loans, based on factors presented. A combined approach for the interest expert is to: (i) start with the prime rate; (ii) add points for extended maturity using treasury bill rates; (iii) assess risk factors and attempt to adjust upwards equating risk with increase in rate; and (iv) try to establish a market rate (using either a broad or narrow definition of market, or both) based on types of loans and borrowers, or at least a market floor. The expert may be able to opine that "based on these factors, the market rate would not be less than X."

3.    Do you need a feasibility expert? Feasibility and the interest rate are intertwined. See In re American Homepatient, Inc., 298 B.R. at 185. The less feasible a plan is, the higher the risk, and the higher the risk, the higher the interest rate, making the plan even less feasible. The secured creditor may have to argue feasibility as a component of the interest rate calculation even if it does not plan to attack feasibility as a basis not to confirm the plan.

4.    With respect to collateral (e.g., an apartment complex, nursing home, or equipment) do you need a valuation/liquidation expert for the purposes of: (i) proving the rate of depreciation, through wear and tear, obsolescence, or other factors; or (ii) proving the costs of liquidation? This type of information is not typically included in an appraisal, with the exception of some useful life information.

Cram down issues in chapter 11 will continue to provide us with "interesting times."

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Article Co-authored by:
Robert C. Goodrich, Jr., Member, Creditors' Rights & Bankruptcy Service Group
Madison L. Martin, Associate, Creditors' Rights & Bankruptcy Service Group

Reproduced with the permission of Thomsom West; no further reproductions or uses are authorized without the express consent of Thomson West.