The issue before the U.S. Supreme Court in Till v. SCS Credit Corp., 124 S.Ct. at 1959 (2004), was the appropriate interest rate to utilize under 11 U.S.C. §1325(a)(5)(B)(ii). The court had a virtual smorgasbord of options from which to choose. The bankruptcy court approved the debtors' use of the formula approach, the prime rate (8.0 percent) plus 1.5 percent for the risk of default. The district court reversed, holding that the appropriate rate was a "coerced-loan" rate, in this case the contract rate (21 percent), because cramdown rates must be set at the level the creditor could have obtained had it foreclosed on the loan, sold the collateral and reinvested the proceeds in equivalent loans. The majority of the Seventh Circuit held that the original contract rate was a "presumptive rate" that could be challenged with evidence that a higher or lower rate should apply, and remanded the case to the bankruptcy court to afford the parties an opportunity to rebut the presumptive 21 percent rate.

The Supreme Court granted certiorari to resolve a conflict among the circuits. A majority of the Court rejected the coerced-loan, contract-presumptive-rate and cost-of-funds approaches. A plurality adopted the formula approach utilized by the bankruptcy judge: the national prime rate, adjusted to compensate for the greater nonpayment risk that bankruptcy debtors typically pose.

On its face, Till appears to instruct lower courts to apply the formula approach endorsed by the bankruptcy judge in confirming the plan. But is that really so? It is true that the Supreme Court rejected the three approaches endorsed by the district and circuit judges, but only a plurality accepted the formula approach utilized by the bankruptcy judge. Plurality pronouncements have long been the bane of lower federal courts in attempting to apply them. "When a fragmented [Supreme] Court decides a case and no single rationale explaining the result enjoys the assent of five justices, the holding of the Court may be viewed as that position taken by those members who concurred in the judgments on the narrowest grounds." Grutter v. Bollinger, 539 U.S. 306 (2003), quoting Marks v. United States, 430 U.S. 188, 193 (1977). As Justice O'Connor observed in Grutter, and as this case illustrates, that principle is much easier to state than to apply.

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The applicable discount rate to be applied when confirming a plan is determined by a formula: the risk-free prime rate plus an upward adjustment for additional risk of default inherent in a bankruptcy situation.

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Justice Thomas, the fifth vote in Till, concurred in the judgment, but in his opinion §1325(a)(5) (B)(ii) does not provide for a risk of default adjustment. Justice Thomas opined that the "appropriate risk-free rate" was sufficient, and since the bankruptcy court used 9.5 percent, which exceeded the risk-free rate, he concurred in the judgment. To discern what the appropriate "risk-free rate" is, in the opinion of Justice Thomas, requires a bit of tea-leaf reading. Reading footnote 2 and the accompanying text to Justice Thomas's opinion, the apparent logical inference to be drawn is that Justice Thomas concurred in the use of the prime interest rate. Thus, under Grutter-Marks, the appropriate cramdown rate under §1325(a)(5)(B)(ii) is the prime interest rate without adjustment. But wait—let us cloud this a little further and count the votes. The plurality (4 votes—Stevens, Souter, Ginsburg and Breyer, JJ) and the dissent (4 votes—Rehnquist (Chief Justice), O'Connor, Scalia and Kennedy, JJ) agreed on one point: that the risk of default had to be considered in setting the rate. Only Justice Thomas was of the opinion that risk of default was not to be considered. What we have is:

Base rate = prime rate: 5 votes (Stevens, Souter, Ginsburg, Breyer and Thomas, JJ).
Base rate = contract rate: 4 votes (Rehnquist, O'Connor, Scalia and Kennedy, JJ).
Base rate to be adjusted for increased risk of default: 8 votes (all but Justice Thomas). But, do only four count because four did not concur in the judgment? Tilt!

Predictions

While it is an interesting intellectual exercise (perhaps an excursion into a cul-de-sac), as a practical matter, bankruptcy judges will likely apply the formula approach of the plurality opinion (essentially treating Justice Scalia's dissenting opinion as concurring in part and dissenting in part). Adjustments for risk will continue to fall within the 1-3 percent range, depending on the court's view of the degree of feasibility. Rarely, if ever, will there be an appeal (only if someone is foolish enough to tempt the gods), and the Supreme Court will nevermore revisit the issue.

Another question is the extent to which Till applies in the context of similar provisions in other chapters of the Code. There are several provisions in the Bankruptcy Code in which the term "the value, as of the effective date" appears, e.g.: §§901 (incorporates §1129(b)(2)(A) and (B)), 1129(a)(7)(A)(ii), 1129(a)(7)(B), 1129(a)(9)(B)(i), 1129(b)(2)(A)(i)(II), 1129(b)(2)(B)(i), 1129(b)(2)(C)(i), 1173 (a)(2), 1225(a)(4), 1225(a)(5)(B)(ii) and 1325(a)(4). In general, where the same term is used in various sections throughout the Bankruptcy Code, those terms are presumed to have the same meaning. Patterson v. Shumate, 504 U.S. 753, 758, n. 2 (1992). Thus, it seems logical to assume that the appropriate rate to be applied with respect to those sections is the same adjusted prime interest rate Till made applicable to §1325(a)(5)(B)(ii). Those lower-court decisions utilizing some other base rate, e.g., Treasury rate or federal judgment rate, have been abrogated. Footnote 14 of the plurality opinion may cast a cloud on that assumption.

In footnote 14, Justice Stevens indicated that "in picking a cramdown rate in a chapter 11 case, it might make sense to ask what an efficient market would produce." Justice Stevens preceded this observation with the following statement: "Because every cramdown loan is imposed by a court over the objection of the secured creditor, there is no free market of willing cramdown lenders. Interestingly, the same is not true in the chapter 11 context, as numerous lenders advertise financing for chapter 11 debtors-in-possession (DIPs)." (emphasis his.) With all due respect to Justice Stevens, his underlying premise is erroneous. DIP financing is governed by §364 and is negotiated between the DIP and lender, subject to approval by the bankruptcy court. However, the bankruptcy court has no power to force a lender to loan money to a DIP on any terms (i.e., it cannot cram down the loan). Certainly, the court can refuse to approve DIP financing unless it is modified, but that modification must be acceptable to the lender: It cannot be crammed down. The closest one that comes to cramdown in DIP financing is the use of cash collateral proceeds under §363. In that case, since it is not utilized to reduce the balance of the pre-petition loan, unless the creditor agrees otherwise, the interest rate is the contact rate. Contrast that situation to the cramdown provisions of §1129, whose raison d'étre is to force-feed castor oil to the recalcitrant creditor to confirming the plan, which terminates the existence of the DIP.

The two web sites to which Justice Stevens refers do offer DIP financing, although the manner in which they define DIP financing is misleading; both erroneously imply a reorganization plan is DIP financing. The financing offered is principally receivables financing, a line of credit or factoring—intended to fund day-to-day operations, not takeout financing. Historically, true DIP financing, i.e., a post-petition operating line, is more often than not negotiated with an existing receivables lender(s) either as part of a cash collateral utilization agreement or some omnibus short-term global package in place prior to filing or very shortly thereafter. Rarely does a business, especially a small or mid-sized operation, enter chapter 11 with sufficient cash reserves to fund operations for more than a few days. In the absence of unusual circumstances, if that lender is not willing to work with the debtor, DIP financing is either going to be too late or with a subprime lender at an exorbitant interest rate; either scenario more likely than not dooms reorganization. A business is in chapter 11 because it cannot manage its existing debt load and needs to restructure it. If unable to reduce the debt, which is the usual case (stripdown does not reduce debt; it simply changes its characterization from secured to unsecured), this restructuring usually involves reducing the interest rate and/or lengthening the repayment period on pre-petition debt, secured and unsecured alike. Total refinancing with a new lender taking out pre-petition creditors is exceedingly rare.

There is no more of a "free market of willing cramdown lenders" in a chapter 11 (or a chapter 12, for that matter) than in a chapter 13. Indeed, if there is, there is no need to resort to a cramdown provision.

Here is prediction no. 2: Until someone finds a free market of willing cramdown lenders, bankruptcy judges will likely apply the Till formula approach to §1129. Rarely, if ever, will there be an appeal, and the Supreme Court will nevermore revisit the issue.

Although one might say that the message of Till is somewhat garbled, Till nevertheless provides the framework for the parties and the bankruptcy court. The applicable discount rate to be applied when confirming a plan is determined by a formula: the risk-free prime rate plus an upward adjustment for additional risk of default inherent in a bankruptcy situation.

The sole potentially triable issue is the amount of the adjustment, and on this point, Till provides no assistance whatsoever. Indeed, Till does not even tell us who has the burden! The plurality (four votes) puts the burden on the creditor; the dissent (also four votes) puts the burden on the debtor. The ninth justice (Thomas), being of the opinion that no adjustment is appropriate in any event, obviously abstained from this issue.

Advantage: Debtors

And now for prediction no. 3: As long as the rate proposed by the debtor is within the range deemed appropriate, unless and until otherwise directed by controlling authority, bankruptcy judges will, by and large, at least place the burden of producing evidence that the adjustment is inadequate on the objecting creditor. Appellate courts have historically given bankruptcy judges wide discretion in deciding these types of issues and are not likely to overrule the adjustment unless the appellate court feels it is an abuse of discretion, or at least clearly erroneous.

Footnotes

¹ Board Certified in Business Bankruptcy Law and Consumer Bankruptcy Law by the American Board of Certification. Return to article