Parties continue to skirmish over the sufficiency of the “cram-down” interest rate required to confirm a Chapter 11 plan over a secured lender’s objection. Currently bankruptcy courts will give some weight to the “prime plus” formula set forth in Till v. SCS Credit Corp., 541 U.S. 465 (2004)(plurality opinion). The Till plurality opinion suggest the proper analysis starts with the prime rate, then adjusting for factors such as “the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization plan.” The Till opinion was later analyzed by the Fifth Circuit Court of Appeals in In re Texas Grand Prairie Hotel Realty, L.L.C., 710 F.3d 324 (5th Cir. 2013). In Texas Grand Prairie, the Fifth Circuit upheld a bankruptcy court’s approval of a cram-down plan which proposed a spread above prime, but which was significantly lower than a third party lender would be willing to lend in the marketplace. The Texas Grand Prairieopinion declined to tie bankruptcy courts to a specific methodology. Elaborating on the Till factors, the Texas Grand Prairie opinion indicated lower courts should approve a cram-down rate on the basis of a holistic assessment of the risk of the debtor’s default on its restructured obligations, evaluating factors including the quality of the debtor’s management, the commitment of the debtor’s owners, the health and future prospects of the debtor’s business, the quality of the lender’s collateral, and the feasibility and duration of the plan.
The recent bankruptcy opinion issued in In re Couture Hotel Corporation, 14-34874-BJH (Bankr. N.D. Tex Sept. 2, 2015) provides an excellent roadmap for parties contesting cram-down interest rates within the Fifth Circuit and elsewhere. This single asset case involved $9.3 million loan secured by a hotel. The debtor stipulated to the lender’s $8.6 million hotel value. The debtor’s chapter 11 plan proposed to repay the loan with principal and interest amortized over thirty (30) years, repaid monthly for a term of sixty (60) months, with the sixtieth (60th) payment being a balloon payment. The debtor proposed that interest would accrue at the rate of 4.25% interest per annum.
The lender objected to the plan, contending among other things the interest rate was inadequate. Both parties agreed that a formula-based approach was the proper method to determine the appropriate cram-down interest rate.
The debtor’s expert (Lucus) began his analysis by searching for a base rate using a range of interest rates that he felt accounted for the industry risk associated with hotel-based lending. To determine these base rates, Lucas visited the websites for Commercial Loans Direct and United Financial Group to view the currently-offered rates on hotel loans with loan-to-value ratios similar to the proposed restructuring. Thus, as opposed to beginning with the prime rate of 3.25% and making adjustments based upon the Texas Grand Prairie factors, Lucas began with the following base rates: 4.19% (based upon information from a report called “Commercial Loans Direct”) and 4.3% (based upon information from United Financial Group). With those base rates in hand, Lucas made the following “risk adjustments” as organized in the following chart.
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In contrast, the lender’s expert started with the bank prime rate of 3.25%, as suggested by the Till opinion. The lender’s expert then identified a series of adjustments based upon the facts and circumstances captured in the following chart.
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In sum, the debtor proposed a cram-down interest rate of 4.25%, while the lender contended 10.38% was required. This differential represented approximately $500,000 per year of interest.
The bankruptcy court disagreed with each expert’s allocation of risk, finding the debtor’s analysis too lenient and the lender’s too harsh. The sixty-two pageCouture Hotel opinion, rich in factual findings, provides detailed reasons for the court’s rejection of the respective experts’ risk adjustments. Notably the opinion refrains from giving an advisory opinion as to what interest rate would be adequate. Finding the debtor’s proposed rate was too low, the bankruptcy court declined to approve the plan, although the court permitted the debtor to file an amended plan within 20 days to maintain the automatic stay in place.
The Couture Hotel opinion merits review by parties anticipating a full evidentiary hearing on cram-down interest rates. The opinion also provides helpful guidance on the rules of evidence governing admission of expert testimony in the context of a cram-down hearing. Finally, while the expert witness expense incurred by the debtor and lender are not disclosed in the Couture Hotel opinion, it further demonstrates the potential costs and uncertainties of contesting cram-down interest rates. Parties may be required to bear the cost of multiple plan confirmation hearings with their attendant legal and expert witness fees, considerations which should be factored in settlement discussions during the restructuring process.