Good v RMR Investments, Inc, 428 BR 249 (ED Texas, March 31, 2010)
A secured creditor in a chapter 11 case objected to the confirmation of the reorganization plan of the debtor, arguing that the proper “cramdown” interest rate (court-modified rate) was the pre-petition contractual default rate, rather than the significantly lower cramdown rate. After the debtor appealed, the District Court affirmed, holding that utilizing the contract rate of interest was appropriate because the debtor was solvent.
Legacy Capital Investments, LLC, was in the business of real estate development. RMR Investments, Inc. entered into a promissory note with Legacy, whereby RMR loaned $7.8 million to Legacy. As part of this transaction, Legacy executed a deed of trust in favor of RMR, granting a first priority security interest in certain property and mineral rights.
The interest rate under the note was the higher of the prime rate plus 2.75 percent or 11 percent per annum. In the event of a default, the interest rate would increase by 4 percent. The maturity date of the note was the earlier of one year after the date of the note or upon an event of default.
Legacy filed its chapter 11 petition in June 2008, and shortly thereafter, Legacy filed its plan of reorganization. The plan proposed that the post-confirmation interest rate be set according to the prime rate. The plan also proposed that all Legacy creditors would be paid in full at the end of four years, and that Legacy would have an equity balance of roughly $85 million at that time.
Early in 2009, the Bankruptcy Court entered an order confirming Legacy’s reorganization plan, over the objections of RMR. In that order, the court held that the proper cramdown rate of interest payable to RMR was the prime rate plus 2 percent (5.25 percent at that time), and that the proper length of payments was four years from the date of confirmation.
RMR filed a motion for reconsideration, arguing that – because Legacy was solvent – the proper interest rate was the contractual default rate of 15 percent, and that the proper term of payment was no more than three years. After a hearing, the Bankruptcy Court granted RMR’s motion, amending the interest rate to 15 percent and the repayment term to no more than three years. Legacy then filed its own motion for reconsideration, which the Bankruptcy Court denied. Legacy appealed to the District Court.
While the Bankruptcy Code does permit courts to approve plan terms over the objections of creditors, it does not set forth any methodologies for calculating the appropriate cramdown interest rate. In the absence of statutory direction, courts have used a wide variety of methods in these calculations. While some courts require specific methods for calculation of interest rates in chapter 11 cases, the Fifth Circuit has declined to do so. The Fifth Circuit has explained that such calculations require fact-specific, case-by-case determination to establish the appropriate interest rate. Given this latitude, the bankruptcy court’s determination will not be overturned, absent clear error.
Here, the Bankruptcy Court applied the “presumptive contract” method, which is sometimes used in cases where the debtor is solvent, and is based upon the presumption that the court’s role is “merely to enforce the contractual rights of the parties.” The court noted, however, that the Fifth Circuit has also approved usage of the presumptive contract method in cases of insolvent debtors.
The court found that Legacy was in default of the terms of the note at the time it filed its petition, and that Legacy was solvent. Further, the court noted that payment to RMR at the contractual default rate would not reduce the payment that any other creditor would receive under the plan; it would simply reduce the $85 million in equity that would be available to Legacy at the end of four years. As such, the District Court affirmed the Bankruptcy Court’s ruling and held that the default rate of interest under the loan documents was the appropriate rate of interest due RMR under the plan.
Although full of unusual factual circumstances (i.e., payment of all creditors in full, solvent debtor, $85 million anticipated equity cushion), this opinion demonstrates that a number of factors can be taken into consideration when arguing for a higher rate of interest under a plan of reorganization. Further, although unusual, it is not unprecedented for a secured creditor to be paid its contractual default interest in the context of a chapter 11 plan of reorganization.