“Cramdown” is a term of art used to describe a situation in a Chapter 13 or Chapter 11 bankruptcy in which a secured creditor is being paid to the fair market value of the collateral secured by its claim, rather than the full loan balance. In a Chapter 11 plan, if the plan proposes to pay the secured claim in deferred cash payments, those payments would include post-confirmation interest at the “market rate.”
The market rate is a rate that the bankruptcy court considers fair in light of current market factors. In Re Hardzog, 901 F.2d 858, 860 (10th Cir. 1990); Till vs. SCS Credit Corp., 541 U.S. 465, 476 n. 14 (2004).
In the case of In Re American Homepatient, Inc., 420 F.3d 559 (6th Cir. 2005), the court determined that the Chapter 11 cram down interest rate should be market rate where there exists an efficient market; if a market does not exist, then a court should employ the “formula approach” described by the Till case for Chapter 13 cases.
Under this “formula approach”, the interest rate is set as the national prime rate adjusted to reflect risk posed by the debtor. Of course, secured creditors in a Chapter 11 or Chapter 13 case are never really going to be satisfied with this “market rate.” Several methods have been advanced by courts in determining how this “market rate” should be determined. We will describe each of these approaches.
Formula Approach. Under the so-called formula approach, as stated above, the court begins with a base rate (such as prime rate) and then adds points for “risks” posed by the debtor. The formula approach was adopted by the Second Circuit in In re Valenti, 105 F.3d 55, 64 (2nd Cir. 1997) and by the Tenth Circuit in In re Hardzog, 901 F.2d 858, 860 (10th Cir. 1990).
Cost of Funds Approach. Under this method, the rate is determined based on what interest the creditor would have to pay to borrow the funds. This approach is apparently not favored and has not been formally adopted by any circuits.
Coerced Loan Approach. There are two variations of the “coerced loan approach.” One variation is that the cram down interest rate is set as the same as the creditor would receive if it could foreclose and reinvest the proceeds in loans of equivalent duration and risk. Koopmans v. Farm Credit Servs., 102 F.3d 874, 875 (7th Cir. 1996). Another permutation on this approach is to examine the rate that the debtor would pay outside of bankruptcy to obtain a loan on terms comparable to those proposed in the Chapter 11 plan.
Presumptive Contract Rate Approach. Under this approach, the court begins with the pre-bankruptcy contract rate. This rate then creates a rebuttable presumption that either the creditor or the debtor can counter by persuasive evidence that the current rate should be different. In re Smithwick, 121 F.3d 211, 214 (5th Cir. 1997).
What is the guiding principle behind all of these approaches? Bankruptcy courts generally take the position that in reviewing reorganization and cramdown issues, it is important to balance the interest of the creditor in obtaining protection and compensation, while at the same time, setting an interest rate that is consistent with the fresh start offered by bankruptcy. There should be some consistency in approaches. Bankruptcy courts have the power to modify interest rates. There should be objective economic analysis applied, that weighs the risks of default with the fresh-start objective of bankruptcy.
Starting with the national prime rate of interest makes good sense. The “prime” rate (in the view of the Till case, cited above) is the “national prime rate, reported daily in the press, which reflects the financial market’s estimate of the amount a commercial bank should charge a creditworthy commercial borrower to compensate for the opportunity costs of the loan, the risk of inflation, and the relatively slight risk of default.” Till, 124 S. Ct. at 1960. “A bankruptcy court is then required to adjust the prime rate to account for the greater nonpayment risk that bankrupt debtors typically pose.” Id.
But how should this “risk adjustment” be determined? There are several factors that need to be weighed. The interest rate should be high enough to allow the creditor some relief, but not so high as to torpedo the plan. As discussed in Till, the following factors are normally relevant:
- Circumstances of the estate. This term is rather vague, but presumably means any factor or issue that will impact on the debtor’s ability to perform on the loan, or otherwise increase risk.
- Nature of the security. This means specific things directly related to the security. Value, depreciation characteristics, and the debtor’s use of the collateral are some of these things.
- Duration of the plan. Inflation and expected market volatility are typically factors here.
- Feasibility of the plan. This would be the projected likelihood of success, that is, the debtor’s ability to perform the terms of the plan.
Regardless of the methods used, the setting of a cramdown interest rate is important in both Chapter 13 and Chapter 11 cases. In Chapter 13 cases, the issue may not come up with as much frequency as in Chapter 11 cases.
This is because many jurisdictions already have procedures whereby “trustee’s discount rates” of interest may be used. However, even model Chapter 13 plan formats allow debtors to set their own rates. Chapter 11 cases typically allow more creativity (or freedom) in crafting interest rates that can assist in the success of a Chapter 11 plan.