In October 2017, the 2nd U.S. Circuit Court of Appeals, in In re MPM Silicones (Momentive) LLC, held that a non-consenting class of creditors is entitled to receive post-confirmation interest at a market rate if an efficient market exists to determine such a rate. In reaching its decision, the 2nd Circuit overruled prior decisions by the Bankruptcy Court and the District Court, which had held that the applicable rate of interest should be determined using the formula method adopted by the Supreme Court in Till v. SCS Credit Corp., 541 U.S. 465 (2004) in Chapter 13 bankruptcy cases, which set the rate as the prime rate plus an additional risk premium.
The Bankruptcy Code provides, in part, that a plan can be confirmed over the objection of a class of creditors, in both Chapter 11 and Chapter 13 cases, if the plan is “fair and equitable.” With respect to a class of secured creditors, a plan is fair and equitable if the creditors receive deferred cash payments having a present value, as of the effective date of the plan, equal to the allowed amount of the secured creditors’ claims.
Prior to the Supreme Court’s decision in Till, the circuits were split as to whether the applicable interest rate used to determine present value was equal to (i) then-current market rate or (ii) a formula-based rate. In Till, a plurality of the Supreme Court held, in the context of a Chapter 13 plan, that the formula approach dictated the applicable rate for providing a secured creditor with the present value of its secured claim. Specifically, the plurality held that under the formula approach, the applicable interest rate should equal the national prime rate plus a risk adjustment based on “the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization plan.” However, the Supreme Court went on to note that a different approach may apply in the Chapter 11 context:
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.... Thus, when picking a cramdown 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.
Following the Supreme Court’s decision in Till, lower courts split on whether, in the Chapter 11 context, the cram-down rate of interest should be determined using the formula approach utilized in Till or a market rate. Momentive brought this issue squarely before the 2nd Circuit.
In 2006, Momentive issued $500 million of subordinated unsecured notes. In 2009 and 2010, it issued over $1 billion of second-lien notes, which were in part used to redeem a portion of the subordinated notes. In 2012, Momentive issued over $1.3 billion of senior secured notes (first-lien notes), which included a make-whole premium payable in connection with certain prepayments.
In 2014, Momentive sought protection under Chapter 11 of the Bankruptcy Code. The plan of reorganization it later proposed contained a “death trap,” which provided that the holders of the first-lien notes could, as a class, either (i) accept the plan and receive an immediate cash payment equal to the entire principal amount of the notes plus all accrued interest, and waive any right to payment of the make-whole premium; or (ii) reject the plan, receive replacement notes equal to the allowed amount of their claims, which would bear interest at a rate determined under the formula approach, and litigate whether the post-confirmation interest rate should be a higher market rate and whether they were entitled to payment of a $200 million make-whole premium. The proposed plan provided that the second-lien notes would be converted into equity of the debtor and the subordinated notes (and prior equity interests) would be canceled.
The plan also provided that, if the class accepted, the immediate cash payment would be funded by an exit facility that had a market rate of interest equal to 6 percent per annum or, if the class rejected, the replacement notes would bear interest using a formula-based interest rate equal to 4 percent to 5 percent per annum.
Holders of the first-lien notes voted to reject the proposed plan. The Bankruptcy Court then confirmed the plan over the objection of the noteholders, including approval of the post-confirmation rate of interest for the replacement notes, applying the formula approach set forth in Till, and held that the noteholders were not entitled to payment of the make-whole premium. Immediately upon confirmation of the plan, the replacement notes began trading at less than 93 percent of their par value. The noteholders appealed to the U.S. District Court, which affirmed the decisions of the Bankruptcy Court. The noteholders then appealed to the 2nd Circuit.
2nd Circuit Rejects Application of Till
The 2nd Circuit rejected application of the Till formula in the Chapter 11 context, instead adopting the Sixth Circuit’s two-step approach for determining the proper interest rate: “First, the market rate should be applied in Chapter 11 cases where there exists an efficient market. But where no efficient market exists for a Chapter 11 debtor, then the bankruptcy court should employ the formula approach endorsed by the Till plurality.” In re MPM Silicones, L.L.C., Case No. 15-1771 (2nd Cir. Oct. 20, 2017), at 19.
The 2nd Circuit also held that (i) noteholders were not entitled to the make-whole premium because the premium was not triggered based on the language of the indentures; (ii) the second-lien notes constituted senior indebtedness under the subordination agreement with the subordinated notes based on extrinsic evidence used to interpret an ambiguity in the agreement; and (iii) the appeal was not equitably moot, even though the plan had been substantially consummated, because the noteholders diligently pursued their appeals and the potential change in interest rate would not create an unmanageable, uncontrollable situation.
The 2nd Circuit reasoned that the Till plurality had not conclusively determined whether the formula approach would apply in the context of Chapter 11 cram-down plans and rejected a reading of the Till plurality decision as stating that market rates are irrelevant with respect to Chapter 11 plans. The 2nd Circuit then remanded the matter to the Bankruptcy Court to determine whether an efficient market rate for the replacement notes can be ascertained, and, if so, to apply that rate to the replacement notes.
The 2nd Circuit’s decision in Momentive is a positive development for secured creditors who have faced increased risks, following Till and the prior decisions in Momentive, that a debtor may obtain confirmation of a plan that forces the lenders to accept a below-market interest rate, while transferring a portion of the debtor’s going concern value to creditors with a lower priority. However, the nature of the 2nd Circuit’s two-step approach may result in uncertain litigation as to whether an efficient market exists and, if so, the applicable market rate. Indeed, while there is an active market for debtor-in-possession financing, it is unclear whether that market would be applicable to the financing of a debtor as it exits bankruptcy.