It is a unique characteristic of debt restructuring under Chapter 11 of the Bankruptcy Code that a majority of a class of creditors can accept a modification of the terms of the debts owed to the class members, as provided in a plan of reorganization, and thereby bind non-accepting class members. The ordinary route to confirming a Chapter 11 plan is to obtain its acceptance by a majority of every impaired class of creditors and equity holders.
But there is an extraordinary route to confirm a plan over the non-acceptance of an impaired class (or, indeed, the non-acceptance of every impaired class except one) in a process that has been informally referred to for many decades as “cramdown.”
In addition to the numerous requirements for confirming a Chapter 11 plan that has been accepted by the requisite majorities of each impaired class, other requirements must be satisfied to successfully “cram down” a plan that has one or more dissenting impaired classes. Most importantly, the plan must not “discriminate unfairly,” and must be “fair and equitable, with respect to each” dissenting impaired class. The Code provides separate sets of criteria for being “fair and equitable” for classes of secured claims, unsecured claims and equity interests.
For a class of secured claims, “fair and equitable” requires that, unless the collateral is sold and the proceeds devoted to securing and paying the claims or the class members otherwise receive the “indubitable equivalent” of their secured claims, the class members receive a stream of “deferred cash payments” having a present value “of at least the value of” their claims.
Present value . . . is the current worth of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate . . . . Determining the appropriate discount rate is the key to properly valuing future cash flows . . . .
So by what process should a bankruptcy court determine the proper discount rate to be used to determine if the “deferred cash payments” proposed in a Chapter 11 plan to be paid to a dissenting impaired class of secured creditors have the minimum present value needed to be “fair and equitable”? Neither the U.S. Supreme Court nor, until recently, the Court of Appeals for the Second Circuit directly answered that question. Other Courts of Appeals had provided answers, as had lower courts within the Second Circuit. A four-justice plurality of the Supreme Court had provided an answer to an analogous issue in Chapter 13 in Till v. SCS Credit Corp.. The Till plurality considered a number of approaches to selecting the proper discount rate and settled upon what it called the “formula approach,” which--
begins by looking to the national prime rate, reported daily in the press, which reflects the financial market’s estimate of the amount a commercial bank should charge a creditworthy commercial borrower to compensate for the opportunity costs of the loan, the risk of inflation, and the relatively slight risk of default. Because bankrupt debtors typically pose a greater risk of nonpayment than solvent commercial borrowers, the approach then requires a bankruptcy court to adjust the prime rate accordingly. The appropriate size of that risk adjustment depends, of course, on such factors as the circumstances of the [bankruptcy] estate, the nature of the security, and the duration and feasibility of the reorganization plan.
Till’s formula approach did not allow for considering information from the lending-and-borrowing market where obligations comparable to the obligations proposed to be issued under a plan exist and have ascertainable interest and discount rates.
Although Till concerned only one provision of Chapter 13, the plurality opinion pointed out that other sections of the Bankruptcy Code, including Section 1129(b)(2), also mandate the present-valuing of obligations and stated--
We think it likely that Congress intended bankruptcy judges and trustees to follow essentially the same approach when choosing an appropriate interest rate under any of these provisions. Moreover, we think Congress would favor an approach that is familiar in the financial community and that minimizes the need for expensive evidentiary proceedings.
From the outset after Till, some lower courts departed from the Till plurality’s suggestion that the present-valuing process under other provisions of the Code apply a presumed intent of Congress that the courts “follow essentially the same approach when choosing an appropriate interest rate,” namely the formula approach. In the case of In re American HomePatient, Inc., Till had not been decided when the bankruptcy and district courts considered the proper rate for a Chapter 11 plan, but it had been by the time the dissenting creditors’ appeal reached the Sixth Circuit. That court noted that Till’s choice of the formula approach was based in part on the absence of an efficient market for loans to Chapter 13 debtors. However, there are certainly active, efficient debt markets for many emerging Chapter 11 debtors, from which important information about interest and discount rates for comparable obligations could be derived. The court then held:
[T]he market rate [found to be prevailing for comparable obligations] 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.
The situation in In re MPM Silicones, L.L.C. et al. in the Southern District of New York was identical to American HomePatient--an impaired class of senior secured creditors had rejected the plan, which was then crammed down. The bankruptcy and district courts had followed the apparent leading of Till and applied the formula approach in present-valuing the obligations to be distributed to the dissenting class. But the Court of Appeals reversed on this issue, holding:
We adopt the Sixth Circuit’s two-step approach [in American HomePatient], which, in our view, best aligns with the Code and relevant precedent. We do not read the Till plurality as stating that efficient market rates are irrelevant in determining value in the Chapter 11 cramdown context. And, disregarding available efficient market rates would be a major departure from long-standing precedent dictating that “the best way to determine value is exposure to a market.” [citations omitted].
The court remanded the case to the Bankruptcy Court to “ascertain if an efficient market rate exists and, if so, apply that rate, instead of the formula rate.”
Till left considerable ambiguity for cases outside of Chapter 13. The Sixth Circuit in American HomePatient, now followed by the Second Circuit in MPM, went a long way toward resolving that ambiguity for Chapter 11 cases.