Remembering Ho We Got to Till
18 January 2014 ABI Journal, Turnaround Topics By Franklind Lea
Before the U.S. Supreme Court’s Till v. SCSCredit Corp.1 decision in 2004, there wasconsiderable debate about the methodologyused to determine the appropriate rate of interest tobe paid to secured creditors in bankruptcy cramdowncases. The underlying cause for this debate was therequirement by § 1129 of the Bankruptcy Code thata plan be “fair and equitable.” Although the case isconsidered an “interest rate case,” at its forefrontwas the condition in § 1129 (b) (2) (A) (II) that thesecured creditor receive the present value of thesecured creditor’s security interest in its collateral.2In Till, the Supreme Court was presented withfour methods commonly used to determine interestrates by the bankruptcy courts and was askedto choose from among these methodologies.Ultimately, the Court reviewed the matter andstrongly encouraged, if not directed, the use of theformula approach to determine the interest rate forbankruptcy plans. Unfortunately, due in part to theopinion’s murky wording and the fact that Till was achapter 13 case, the debate continues over the propermethodology for determining interest rates in chapter11 cases. In retrospect, perhaps a better questionto ask the Supreme Court might have been how oneshould test a debtor’s plan for conformity for returningthe present value of the secured creditor’s claim,rather than how to formulate the interest rate.The value of a creditor’s collateral to be repaidby debtors to creditors in cramdown cases will likelyalways be a contentious issue. When the parties arenot able to agree to a value of a creditor’s collateralincluded in a reorganization plan, parties routinelyseek that determination through the bankruptcy courts.The court-determined value then becomes the valuethat a debtor must repay through the remaining planterms. As such, in the confirmation of a bankruptcycase, the subtitle of this article, “You Name the Price,I’ll Name the Terms” can take on real meaning.The argument over whether a plan is fair andequitable often focuses on the interest rate ratherthan the Bankruptcy Code’s present value requirementsand other claim-repayment terms. Presentvalue is a well-founded financial concept based ona mathematical computation, not a legal or equitabledetermination. It is calculated by combining the timingand amount of future payment(s) and discountingthese at a “rate” that compensates the creditorfor the use of its money over time and the risks ofdebtor default.3 The same discounting process canbe used to determine other values, but only one thatuses a rate that reflects the time value of money andthe pricing risk meet the definition of present value.Franklind LeaTactical FinancialConsulting; AtlantaRemembering How We Got to TillYou Name the Price, I’ll Name the Terms1 Till v. SCS Credit Corp., 541 U.S. 465 (2004).2 Section 1129(b)(2)(A)(II) mandates “deferred cash payments totaling at least the allowedamount of such claim, of a value, as of the effective date of the plan, of at least the valueof such holder’s interest in the estate’s interest in the property.”Franklind Lea,CIRA, is presidentof Tactical FinancialConsulting, anationally orientedAtlanta firm thatprovides financialconsulting andrelated services,as well as expertwitness testimony.Chart 1: Schools of ThoughtSchool of Thought: Prime Plus 1 to 3 Percent (Say Prime Plus 2 Percent)Year 1 2 3 4 5Annual Payment $363,703 $363,703 $363,703 $363,703 $363,703Balloon Payment $0 $0 $0 $0 $4,437,988Total Payment $363,703 $363,703 $363,703 $363,703 $4,801,691School of Thought: Make the Plan Work (Say 7.25 Percent)Year 1 2 3 4 5Annual Payment $438,760 $438,760 $438,760 $438,760 $438,760Balloon Payment $0 $0 $0 $0 $4,559,258Total Payment $438,760 $438,760 $438,760 $438,760 $4,998,018School of Thought: Risk-Oriented RateYear 1 2 3 4 5Annual Payment $519,378 $519,378 $519,378 $519,378 $519,378Balloon Payment $0 $0 $0 $0 $4,657,899Total Payment $519,378 $519,378 $519,378 $519,378 $5,177,2773 The rate can go by a number of different names, including discount rate, mortgage discountrate, internal rate of return and, most commonly, interest rate.ABI Journal January 2014 19Neither the Code nor the Till opinion suggests that the present-value formula be altered from its normal usage in the financialcommunity for use in bankruptcy cases. In fact, in Till, thejustices go to great lengths to express their intention of protectingthe Code’s requirement that the creditor receive the present valueof its collateral interest, as they mention the present-value conceptnumerous times throughout the opinion.4 The most direct ofall of these is in footnote 4, in which Justice John Paul Stevensstated that “we use the term ‘present value’ to refer to the valueas of the effective date of the bankruptcy plan.”5 Equally tellingis the substantial discussion at the Till hearing before the justiceswhen the term “present value” is used nine times and the conceptis discussed at length, with neither party arguing that the conceptor calculation process of present value should be adjusted.6Due in large part to the imprecise wording in the SupremeCourt’s opinion, the outcome of Till appears to be the developmentof three different interpretations or “schools ofthought” for determining the interest rate. These include the“prime plus 1 to 3 percent interest rate,” the “find an interestrate that makes the plan (feasibly) work,” and the “determinean interest rate that reflects the risk to the secured creditor.”Until this area of the law is further refined, restructuring professionalsand their clients will continue to debate this issue.In some bankruptcy cases, some or all of these schools ofthought may overlap and coincide to agree on a single interest rate.In many cases, however, they do not, and each one creates its ownunique interest rate. As an example, the three interpretations ofTill may allow for each of these three conclusions: (1) a rate in therange of prime plus 1 to 3 percent, say prime plus 2 percent (currently5.25 percent); (2) a rate of 7.25 percent that makes the planwork; and (3) an interest rate of 9.25 percent that compensates thecreditor for the time value of money and the risk that it will incurin the plan. To provide the present value, however, as required byits common-use definition as described by both § 1129 and the Tillopinion, the interest rate must compensate the debtor for the risksthat it is anticipated to experience from the plan repayment terms.In addition to our interest rates, assume that the value of thesecured creditor’s interest in its collateral is $5 million, and that theplan has a five-year term and a 25-year amortization. Also assumethat the debtor has $525,000 of cash flow available to service thedebt in the first year of the plan, and that in order to prove feasibility,the bankruptcy court has required the debtor to show that itsfirst year of cash flow will provide a 1.20 debt service coverage(DSCR). Using the parameters of these three schools of thought,Chart 1 shows some payment scenarios that can be generated.The examples in Chart 2 provide that at the interest ratesof 5.25 percent and 7.25 percent, the plan has sufficient cashflow to meet a DSCR of at least 1.20. Therefore, the firsttwo schools of thought provide a feasible outcome. Chart 2also shows, however, that at the higher risk-oriented rate, theDSCR is only 1.01 and plan feasibility fails to occur.Therefore, if the court were to approve a rate of 7.25 percent(or lower), feasibility will be assured. This approval will set annualplan payments of $438,760, with a balloon payment of $4,559,258due in the fifth year. However, in addition to proving feasibility fora plan’s confirmation, the Code also specifically requires — andTill confirms — the need for the plan to provide to the securedcreditor its $5 million of present value. As a result, the plan mustbe further scrutinized to assure its compliance with providing thepresent value back to the secured creditor. This can be done bytaking the proposed payment stream that is feasible (generated atthe 7.25 percent interest rate) and discounting this payment streamby the risk-oriented interest rate of 9.25 percent (see Chart 3).The discounted plan payments generate a present value of$4,625,065. In this instance, the amount paid to the securedcreditor is $374,935 less than the required present value of its$5 million security interest in the debtor’s collateral. Sincethe plan does not provide at least $5 million of value to thesecured creditor, the plan does not meet the Bankruptcy Coderequirement of § 1129 (b) (2) (A) (II) as required for plan confirmation.Further, if the payment stream shown in Chart 1 forthe “Prime Plus 2 Percent” (i.e., 5.25 percent) had been usedinstead of the 7.25 percent interest rate payment stream, theresulting amount would have been even lower, creating aneven greater deficit in the present value paid to the creditor.In instances in which the risk-oriented interest rate risesabove the rates generated from the other schools of thought,plan confirmation cannot be achieved without additionalvalue being paid to the secured creditor. In order to ascertainwhen these situations might occur, bankruptcy judges need torely on evidence proffered by attorneys who are well versedin present-value analysis, coupled with knowledgeable expertwitnesses who are equally well versed in pricing risk. abi4 See Till, 541 U.S. at 469, 472, 476 and 483 (discussing concept of present value).5 See id. at 439, n.4.6 See Transcript of Oral Argument, Till v. SCS Credit Corp., 541 U.S. 465 (2003) (No. 02-1016), available atwww.supremecourt.gov/oral_arguments/argument_transcripts.aspx.Chart 2: Plan Feasibility5.25 Percent 7.25 Percent 9.25 PercentCash Flow - Year 1 $525,000 $525,000 $525,000Annual Payment $363,703 $438,760 $519,378Debt Service Coverage Ratio 1.44 1.20 1.01Required DSCR for Feasibility 1.20 1.20 1.20Feasibility Test Pass Pass FailChart 3: School of Thought: Make the Plan Work (Say 7.25 Percent)Year 1 2 3 4 5Annual Payment $438,760 $438,760 $438,760 $438,760 $438,760Balloon Payment $0 $0 $0 $0 $4,559,258Total Payment $438,760 $438,760 $438,760 $438,760 $4,998,018Discount Factor of 9.25 Percent 0.91533 0.83783 0.76689 0.70196 0.64253$401,611 $367,607 $336,482 $307,993 $3,211,372Present Value $4,625,065Copyright 2014 American Bankruptcy Institute.Please contact ABI at (703) 739-0800 for reprint permission.
This article was originally published by the American Bankruptcy Institute Journal, in Volume XXXIV / November 2015 and can be accessed by ABI members at http://journal.abi.org. Please contact the ABI at (703) 739-0800 for reprint permission.
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