In Momentive Performance Materials Inc. v. BOKF, NA (In re MPM Silicones, L.L.C.), 2017 BL 376794 (2d Cir. Oct. 27, 2017) ("Momentive"), the U.S. Court of Appeals for the Second Circuit, in a long-anticipated decision, affirmed a number of lower court rulings on hot-button bankruptcy issues, including allowance (or, in this case, denial) of a claim for a "make-whole" premium and contractual subordination of junior notes. However, the Second Circuit disagreed with the lower courts on the appropriate interest rate for replacement notes ("cramdown notes") issued to secured creditor classes that voted to reject a chapter 11 plan. In doing so, it joined the Sixth Circuit in requiring that cramdown notes bear a market rate of interest if an efficient market exists; if no such market exists, the notes may bear interest at the typically below-market formula rate.
Cramdown Under Section 1129(b)(2) of the Bankruptcy Code
To be confirmed by the bankruptcy court, a chapter 11 plan must satisfy the requirements of section 1129(a) of the Bankruptcy Code, including the mandate that the plan be accepted by each impaired class of claims or interests. Nevertheless, if an impaired class does not vote to accept the plan, the plan may still be confirmed if it satisfies the nonconsensual confirmation, or "cramdown," requirements set forth in section 1129(b).
Under section 1129(b), a plan may be confirmed over the objection of a rejecting class of claims or interests if the plan does not "discriminate unfairly" and is "fair and equitable." With respect to a dissenting class of secured claims, a plan is "fair and equitable" if, among other alternatives, the plan provides that:
[T]he holders of such claims retain the liens securing such claims, whether the property subject to such liens is retained by the debtor or transferred to another entity, to the extent of the allowed amount of such claims; and . . . that each holder of a claim of such class receive on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder’s interest in the estate’s interest in such property.
11 U.S.C. §§ 1129(b)(2)(A)(i)(I) and (II) (emphasis added).
Whether the plan satisfies the language of section 1129(b)(2)(A)(i)(II) of the Bankruptcy Code italicized above depends in part on the interest rate borne by the replacement notes issued under the plan to the dissenting secured creditor class. In Till v. SCS Credit Corp., 541 U.S. 465 (2004), a plurality of the U.S. Supreme Court held that the interest rate on a cramdown loan under a similar provision of the Bankruptcy Code applicable to individual debtors in a chapter 13 case (section 1325(a)(5)(B)(ii)) should follow a simple "formula approach"—a risk-free rate (in that case, the prime rate) plus a premium for the risk of the debtor’s nonpayment of the replacement loan (but excluding any profits, costs, or fees). The Court stated that the risk premium would typically range from 1 to 3 percent and factor in the circumstances of the debtor’s estate, the nature of the collateral security and the terms of the cramdown note(s), and the duration and feasibility of the plan.
In selecting the formula approach, the Till plurality opinion rejected alternative theories of calculating the applicable cramdown interest rate, including:
(i) The rate the creditor could have obtained if it foreclosed on the loan, sold the collateral, and reinvested the proceeds in equivalent loans (the "coerced loan approach");
(ii) The contractual rate under the existing loan, which could be challenged with evidence that a higher or lower rate should apply (the "presumptive contract rate approach"); and
(iii) The cost to the creditor to obtain the cash equivalent of the collateral from another source (the "cost of funds approach" ).
The plurality opinion reasoned that each of these approaches is complicated, imposes significant evidentiary burdens, and overcompensates the creditor by including items like transaction costs and profits which are not relevant in the context of court-administered and court-supervised cramdown loans. Instead, the Supreme Court concluded that the formula approach more closely resembles a bankruptcy court’s usual analysis in evaluating a chapter 13 debtor’s financial condition and the feasibility of his or her plan.
It is important to note that in footnote 14, the Supreme Court expressly left open the possibility that the formula approach might not apply in a chapter 11 case. In its view, unlike in chapter 13, where there is no free market of willing cramdown lenders, many lenders are willing to provide debtor-in-possession financing in chapter 11 cases. Thus, the Court stated that "in chapter 11 it might make sense to ask what rate an efficient market would produce."
Taking this cue, a number of courts after Till have adopted the two-step analysis articulated by the Sixth Circuit in In re American HomePatient, Inc., 420 F.3d 559 (6th Cir. 2005). Under that approach, "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." Id. at 568; see also Mercury Capital Corp. v. Milford Conn. Assocs., L.P., 354 B.R. 1 (D. Conn. 2006) (remanding to the bankruptcy court to determine whether an efficient market exists); In re Prussia Assocs., 322 B.R. 572, 588–89 (Bankr. E.D. Pa. 2005) ("The Supreme Court’s dicta implies that the Bankruptcy Court in such circumstances (i.e., efficient markets) should exercise discretion in evaluating an appropriate cramdown interest rate by considering the availability of market financing.").
However, a number of lower courts have employed in chapter 11 cases the formula approach adopted by the Supreme Court plurality in Till, including both lower courts in Momentive.
Momentive Performance Materials Inc. and its subsidiaries (collectively, "MPM"), a leading producer of silicone and silicone derivatives, filed for bankruptcy in April 2014 in the Southern District of New York. At the time of its filing, MPM had approximately $1.35 billion of outstanding first- and 1.5-lien notes (bearing interest rates of 8.875 percent and 10 percent, respectively). MPM also had outstanding junior indebtedness, including more than $1.1 billion of second-lien notes.
MPM proposed a chapter 11 plan containing a "death trap" voting choice for the classes of the first-lien and 1.5-lien notes: either (a) accept the plan as a class and receive payment at par plus accrued interest, but excluding any make-whole or early prepayment premiums (as to which there was a pending dispute); or (b) reject the plan as a class and receive replacement notes bearing an interest rate to be determined by the bankruptcy court, with a face amount that might include any make-whole or similar prepayment premium ultimately allowed by the bankruptcy court. The second-lien noteholders were to receive nearly 100 percent of the equity of reorganized MPM.
The first-lien and 1.5-lien note classes rejected the plan. During the confirmation proceedings, MPM argued that Till’s formula approach should determine the annual rate of interest to be borne by the replacement notes. For the first-lien notes, this rate consisted of the seven-year Treasury note rate (because the replacement notes would have a seven-year maturity) plus 1.50 percent, for a total of approximately 3.60 percent. For the 1.5-lien notes, this rate consisted of a 7.5-year Treasury note rate (based on the weighted average of seven- and 10-year Treasury notes) plus 2 percent, for a total of approximately 4.09 percent. MGM chose the Treasury note rate, rather than the prime rate (the risk-free rate in Till), because the prime rate generally applies to consumer borrowers, while Treasury rates more often apply to corporate borrowers.
The indenture trustees for the noteholders countered that the appropriate rate was a market rate based on what lenders would expect for new notes issued by comparable borrowers. MPM had already obtained commitments for backup financing facilities to cash out the first- and 1.5-lien notes, in the event that those classes had voted to accept the plan. Thus, the indenture trustees argued that the commitments received from potential third-party lenders—generally ranging from 5 to 6 percent and tied to LIBOR—should determine the interest rates for the replacement notes. Experts for the indenture trustees also testified that, at the rates suggested by MPM, the replacement notes would immediately trade below par after issuance because of their below-market characteristics.
The Lower Courts Apply the Till Formula Approach
Bankruptcy judge Robert Drain applied the formula approach and confirmed MGM’s plan, albeit with slightly increased interest rates for the replacement notes. Judge Drain’s increases amounted to 0.50 percent and 0.75 percent for the replacement first-lien and 1.5-lien notes, respectively, because the formula used by MPM was tied to Treasury rates (a truly riskless rate), whereas the base rate used in Till began with prime (an interbank lending rate that accordingly carries some risk).
In so ruling, the bankruptcy court found "no sufficiently contrary basis to distinguish the chapter 13 and chapter 11 plan contexts in light of the similarity of the language of the two provisions [sections 1129(b)(2)(A)(i)(II) and 1325(a)(5)(B)(ii)] and the underlying present value concept that Till should be applied uniformly throughout the Code." The bankruptcy court also relied on prior precedent from the Second Circuit in In re Valenti, 105 F.3d 55 (2d Cir. 1997), a chapter 13 case cited favorably by Till that also applied the formula approach.
The bankruptcy court reasoned that, read together, Till and Valenti establish certain "first principles" which support application of the formula approach in chapter 11 despite Till’s dicta suggestion that the approach might not be appropriate in that context. The bankruptcy court echoed Till’s concerns regarding the drawbacks of market-based approaches, among other things. Referring to Valenti, the bankruptcy court reiterated that the purpose of the cramdown rate is "to put the creditor in the same economic position it would have been in had it received the value of its allowed claim immediately" and "not to put the creditor in the same position that it would have been in had it arranged a ‘new’ loan." In re MPM Silicones, LLC, 2014 BL 250360, at *32 (Bankr S.D.N.Y. Sept. 9, 2014) (quoting Valenti, 105 F.3d at 63–66).
The bankruptcy court also characterized footnote 14 of the Till opinion as a "very slim reed" to support a market rate approach in chapter 11. According to the court, "[T]here is no meaningful difference between the chapter 11, corporate context and the chapter 13, consumer context to counter Till’s guidance that courts should apply the same approach wherever a present value stream of payments is required to be discounted under the Code." It also wrote that "the rights of secured lenders to consumers and secured lenders to corporations are not distinguished in Till, nor should they be." The court noted that other language in Till indicates a disagreement with market rates. For example, in footnote 15, the Till plurality rejected the coerced loan approach, which would put the creditor in the same position had it obtained a new loan of comparable duration and risk.
Finally, the bankruptcy court rejected the American HomePatient approach as the kind of unworkable, expensive, and burdensome standard that Till sought to avoid. The court cited to a number of cases in which the courts undertook an extensive inquiry into whether an efficient market existed, only to conclude that one did not exist, and applied the formula rate. See In re 20 Bayard Views LLC, 445 B.R. 83 (Bankr. E.D.N.Y. 2011); In re Cantwell, 336 B.R. 688 (Bankr. D.N.J. 2006). In addition, the court explained, unlike the Sixth Circuit, which followed a market or coerced loan approach even prior to Till (and American HomePatient), the pre-Till case law in the Second Circuit was Valenti, which supported a formula rate approach.
After the district court affirmed the ruling, the indenture trustees appealed to the Second Circuit.
The Second Circuit’s Ruling
A three-judge panel of the Second Circuit reversed that portion of the lower court rulings regarding the appropriate interest rate for the replacement notes. Relying on footnote 14 of the Till plurality opinion, the court adopted the two-step American HomePatient approach. The Second Circuit invoked other U.S. Supreme Court precedent in other contexts, explaining that exposure to the market is the best determination of value. See Bank of Am. Nat’l Trust & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434, 457 (1999); U.S. v. 50 Acres of Land, 469 U.S. 24 (1984).
The Second Circuit accordingly remanded the case below for additional findings on whether "an efficient market can be ascertained, and, if so, [to] apply it to the replacement notes."
Momentive is instructive for bankruptcy courts called upon to determine whether the interest rate on replacement debt instruments issued to secured creditors under a nonconsensual chapter 11 plan satisfies the "fair and equitable" test in section 1129(b)(2)(A). Still, the ruling leaves some important questions unanswered. For example, assuming a lending market exists in a given chapter 11 case, the Second Circuit provided very little guidance on what it means for such a market to be "efficient." However, it did cite to an example from a Fifth Circuit case—In re Texas Grand Prairie Hotel Realty, L.L.C., 710 F.3d 324, 337 (5th Cir. 2013)—where the court explained that markets are efficient if they "offer a loan with a term, size, and collateral comparable to the forced loan contemplated under the cramdown plan."
In the Momentive bankruptcy court’s proceedings, the indenture trustees offered evidence to establish the existence of an efficient market, including expert testimony regarding the accepted characteristics of an efficient market and an analysis of the current market conditions for exit financing available to MPM, including the proposed exit facilities. In addition, MPM’s restructuring advisor testified that the proposed exit facilities resulted from a "competitive process" characterized by "good faith, hard bargaining by all interested parties," including three of the largest institutional providers of debtor-in-possession and exit financing.
The bankruptcy court expressed skepticism, however, as to whether the process that led to the quoted exit facilities’ rates was produced by an efficient market. Because the bankruptcy court applied the formula approach before ascertaining whether such a market in fact existed, the Second Circuit remanded the case below, directing the courts to "engage the American HomePatient analysis in earnest." Thus, the dispute in Momentive over the cramdown interest rate on the replacement notes is far from over.
On November 3, 2017, the indenture trustees asked the Second Circuit to reconsider its ruling upholding the lower courts’ disallowance of their make-whole claims. According to the indenture trustees, the decision squarely conflicts with the Third Circuit’s ruling in Del. Tr. Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 842 F.3d 247 (3d Cir. 2016), in which, the indenture trustees claim, the court concluded that a chapter 11 refinancing triggered make-whole provisions under "substantively identical" conditions.