In a significant decision affecting the rights of secured creditors in US chapter 11 bankruptcy cases and the ability of borrowers to compel reorganizations over such creditors’ objection, on May 4, 2015, the United States District Court for the Southern District of New York (theDistrict Court) held that a chapter 11 plan of reorganization may be confirmed over the objection of a dissenting class of oversecured creditors – a process known as “cramdown” – where such plan would pay them interest based on below-market rates.
In the chapter 11 bankruptcy cases of MPM Silicones, LLC and certain of its affiliates (collectively, the Debtors), certain secured note holders (the Senior Lienholders) appealed orders of the bankruptcy court (the Bankruptcy Court) confirming the Debtors’ joint plan of reorganization (the Plan). The Bankruptcy Court had held, after a thorough review of existing caselaw, that the Plan could be confirmed over the Senior Lienholders’ objection even if it only paid them interest based on a risk-free, as opposed to a market, rate. On appeal, the District Court affirmed the Bankruptcy Court’s decision, thereby dealing a blow to secured creditors who face chapter 11 debtors in the Southern District of New York (and potentially beyond).
A U.S. chapter 11 plan of reorganization may be confirmed (i.e., approved by the US bankruptcy court) if certain conditions are met, including that each impaired class of claims or interests has accepted the plan. Even if that condition is not satisfied and one or more impaired classes reject the plan, however, the plan may still be confirmed if it meets all other requirements for confirmation and does not unfairly discriminate against, and is fair and equitable with respect to, the rejecting impaired classes. 11 U.S.C. § 1129(b)(1). This process is generally known as confirmation through “cramdown” as the plan will become binding on the dissenting impaired classes if confirmed. For purposes of “cramdown”, a plan is considered “fair and equitable” as to a dissenting class of secured creditors if such creditors will retain the liens securing their claims and receive under the plan deferred cash payments with a present value, as of the effective date of the plan, equal to the value of their secured claims. 11 U.S.C. § 1129(b)(2)(A).
Given the requirement to determine the present values of secured claims, parties in cramdown plans frequently litigate the appropriate discount rate – i.e., the “cramdown rate” – to be used for the purposes of calculating present value. Over the years, courts have developed two principal approaches to resolving the issue: (1) the “coerced loan” or “efficient market” approach, which calculates the appropriate interest rate by determining the market rate of interest a creditor would receive if it were forced to extend a loan to a debtor in similar circumstances on the terms proposed under the plan, and (2) the “prime-plus” or “formula” approach, which calculates the cramdown rate by taking a risk-free rate and making adjustments based on the risk factors of the debtor and the proposed duration of the loan. See e.g. In re American Homepatient Inc., 420 F.3d 559, 568 (6th Cir. 2005) (holding that “the market rate should be applied in Chapter 11 cases where there exists an efficient market”); In re Texas Grand Prairie Hotel Realty LLC, No. 11–11109, (5th Cir. March 1, 2013) (applying the prime-plus approach).
The Momentive Decision
The Debtors are one of the world’s largest producers of silicones and silicone derivatives used to manufacture various industrial and household products, and on April 13, 2014, commenced cases under chapter 11 of the U.S. Bankruptcy Code. Among their substantial debts were $1.1 billion of 8.875% first priority senior secured notes due 2020 (the First Lien Notes) and $250 million of 10% senior secured notes due 2020 (the 1.5 Lien Notes). During the bankruptcy, the Debtors challenged the entitlement of certain noteholders to over $200 million in asserted claims for make-whole premiums, and proposed a plan giving secured note holders an option to: (i) vote in favor of the Plan and receive a cash distribution equal to their claims for principal and interest, and waive any claims for make-whole premiums, or (ii) vote to reject the Plan and choose to litigate the make-whole premium issue in exchange for replacement notes, including amounts in respect of any allowed make-whole claims, bearing interest at the applicable treasury rate, plus a risk premium resulting in effective interest rates of approximately 3.6% for the First Lien Notes and 4.1% for the 1.5 Lien Notes.
The Senior Lienholders, a group comprising certain holders of the First Lien Notes and the 1.5 Lien Notes, argued that the interest rate on the replacement notes should be determined using the coerced loan or efficient market approach, under which the dissenting class of secured creditors would be treated as having extended new financing to the debtors and the cramdown interest rate would be calculated by reference to an equivalent market-priced loan. As evidence of the proper rate under such approach, the Senior Lienholders cited the rates in the committed exit financing obtained by the Debtors, which had minimum effective interest rates of approximately 5% for refinancing the First Lien Notes and approximately 7% for refinancing the 1.5 Lien Notes. By contrast, the Debtors argued for application of the prime-plus approach adopted by the United States Supreme Court in Till v. SCS Credit Corp., 541 U.S. 465 (2004). Till is a case under chapter 13 of the Bankruptcy Code in which the cramdown interest rate was calculated by modifying a risk-free based rate “to account for the risk of nonpayment posed by borrowers in the financial position” of the debtor. Id. at 471.
Both the Bankruptcy Court and the District Court agreed with the Debtors and applied the prime-plus approach. Noting that even though Till was a case decided under chapter 13, the District Court found persuasive Till’s reasoning that the coerced loan approach “overcompensates creditors because the market lending rate must be high enough to cover factors, like lenders’ transaction costs and overall profits, that are no longer relevant in the context of court-administered and court-supervised cramdown loans.” Id. at 477. The Senior Lienholders cited to footnote 14 in Till where the US Supreme Court noted that “when picking a cramdown rate in a Chapter 11 case, it might make sense to ask what rate an efficient market would produce” to distinguish the considerations at issue in a chapter 13 cases where there is unlikely to be a market for debtor loans as compared to chapter 11 cases. Id. at 476 n. 14 (emphasis added). To support their argument, the Senior Lienholders also referenced the ruling from the Sixth Circuit in In re American Homepatient Inc. that applied the coerced loan approach in the context of a chapter 11 case.
However, adopting the Bankruptcy Court’s reasoning, the District Court noted that because Tilldid not mandate an approach to calculate the cramdown rate in chapter 11 cases, the Sixth Circuit had simply applied its pre-Till jurisprudence in In re American Homepatient Inc. Similarly, the District Court noted that prior to Till, the Second Circuit had rejected the “efficient market” approach holding that a cramdown interest rate is meant “to put the creditor in the same economic position that it would have been in had it received the value of its claim immediately. Its purpose is not to put the creditor in the same position that it would have been in had it arranged a ‘new’ loan.” In re Valenti, 105 F.3d 55, 63-64 (2d Cir. 1997). Accordingly, by looking to pre-Till precedent in the Second Circuit, the District Court found the prime-plus approach applicable to chapter 11 debtors, noting “whether the market for a loan is truly efficient or not has no bearing on the Second Circuit’s mandate in Valenti that the Bankruptcy Code does not intend to put creditors in the same position they would have been had they arranged a new loan.”
Finally, the District Court also agreed with the Debtors and the Bankruptcy Court that no make-whole premium was payable under the terms governing the First Lien Notes and the 1.5 Lien Notes, as the obligations thereunder were automatically accelerated upon the bankruptcy filing of the Debtors. This conclusion is consistent with other recent decisions on this issue in the Second Circuit. See In re AMR Corp., 730 F.3d 88, 98 (2d Cir. 2013) (internal brackets omitted), cert. denied, 134 S. Ct. 1888 (2014).
To date, the Senior Lienholders have not filed a notice of appeal of the District Court’s decision to the Second Circuit. Until such time, and unless the decision is overturned on appeal, the decision will encourage debtors to use the threat of below market rates against dissenting over-secured creditors when negotiating and confirming reorganization plans, a risk which prospective secured lenders would be advised to consider at the time of origination.