Following Judge Drain’s decision in Momentive, many in the bankruptcy world have written about and discussed the issue of how to determine the appropriate interest rate that should be paid to secured creditors in the context of a Chapter 11 cramdown (the so-called “cramdown interest rate”). While many questions have been asked and remain unanswered, two recent decisions have confirmed that regardless of the approach used to determine the cramdown interest rate, the burden is on the creditor to provide evidence that the debtor’s proposed cramdown interest rate is too low.
Primer on Cramdown Interest Rates
Section 1129(b)(2) of the Bankruptcy Code requires that a debtor’s reorganization plan is “fair and equitable.” This section further provides a series of ways for a debtor to meet this requirement with regard to a secured creditor that has voted to reject the plan. One of these ways is by (a) allowing the creditor to retain the lien on its collateral and (b) paying the creditor deferred cash payments having a present value totaling at least the value of the collateral. Because the deferred cash payments are paid over time, the plan must provide for payment of an appropriate interest rate (i.e. the “cramdown interest rate”).
The leading case on this issue is the Supreme Court’s decision in Till v. SCS Credit Corp. This was a case involving a provision under Chapter 13 of the Bankruptcy Code (a section of the Bankruptcy Code which offers protections to individuals) that also requires payment of an appropriate interest rate. In a plurality decision, the Supreme Court adopted what is referred to as the “prime-plus” formula approach. The prime-plus formula approach begins with the national prime rate of interest and adjusts upward for risk (typically an increase of 1 to 3%) depending on (a) the estate’s circumstances; (b) the security’s nature; and (c) the reorganization plan’s duration and feasibility. However, in a footnote to the decision, the plurality hinted that an efficient market approach may be warranted in the Chapter 11 context.
Since the Till decision, courts and commentators have debated whether the prime-plus formula approach should be applied in a Chapter 11 case. The Sixth Circuit, for example, has adopted a two-step approach which first requires a determination of whether an efficient market exists. If an efficient market exists, the market rate of interest should be applied, but if no efficient market exists, the prime-plus formula approach should be applied. The Fifth Circuit has also rejected strict adherence to the prime-plus formula approach, but has not prescribed a particular approach that courts should apply. Recently, Judge Drain in the Momentive case applied a modified prime-plus formula approach which adjusted upward from the Treasury rate (a lower interest rate that is considered to be a risk-free rate) rather than the national prime rate.
Creditors Bear the Burden When Challenging the Cramdown Interest Rate
While the debate surrounding the proper approach for determining the cramdown interest rate remains ongoing, two recent decisions from courts in the Ninth Circuit have affirmatively answered that the burden of proof is on the objecting secured creditor to provide evidence that the debtor’s proposed cramdown interest rate should be higher.
The first decision was the December 5, 2014 decision of the Ninth Circuit Bankruptcy Appellate Panel in the In re Dunlap Oil Company, Inc. case. In that case, the bankruptcy court applied the Sixth Circuit’s two-step approach. After first determining that there was no efficient market, the bankruptcy court, relying on the testimony of the debtors’ expert, approved a 5% cramdown interest rate calculated using the five-year Treasury rate as the base rate and adding a 4% risk adjustment. On appeal, the objecting creditor argued that the bankruptcy court had misapplied the Till prime-plus formula approach and that the cramdown interest rate was too low because, among other things, the debtors’ started with a lower base rate, the five-year treasury rate. The objecting creditor, however, failed to provide any evidence of its own risk adjustment. In overruling the creditor’s objection, the Ninth Circuit Bankruptcy Appellate Panel held that the evidentiary burden to demonstrate that a higher interest rate should be provided is placed on the objecting creditor. Accordingly, the bankruptcy court’s cramdown interest rate determination was affirmed because the objecting creditor failed to present evidence supporting a larger risk adjustment.
The second decision was the December 17, 2014 decision by the Northern District of California in the In re Esterlita Cortes Tapang case. The specific issue before the court was which party bears the burden of proof on the issue of the cramdown interest rate. In a five page memorandum decision, the court explained that the Till plurality placed the burden of proof on the objecting creditor to present evidence supporting an upward adjustment in a Chapter 13 case. The court noted that the burden of proof regarding plan confirmation requirements is the same in both the Chapter 11 and Chapter 13 contexts. Citing to the In re Dunlap Oil Company, Inc. decision, the court concluded that “the creditor bears the burden of proof with respect to the appropriate risk premium in the chapter 11 cramdown context.”
Although the appropriate methodology that should be used to determine the cramdown interest rate in a Chapter 11 case remains a topic of debate, the issue of which party bears the burden of proof is clear: The objecting creditor bears the burden of producing evidence that demonstrates that the cramdown interest rate should be higher. Secured creditors seeking to oppose a proposed cramdown interest rate should be prepared to present expert evidence to support their claims that a higher cramdown interest rate is warranted; otherwise, they are likely to suffer the fate of the objecting creditor in In re Dunlap Oil Company, Inc.