In large chapter 11 cases, millions of dollars often hinge on the appropriate interest rate. Chapter 11 debtors may not require impaired secured creditors to accept a proposed plan of reorganization unless the plan provides that secured creditors will receive future payments that are equivalent to the value of the creditors’ secured claims. In order to satisfy this requirement, a debtor must propose an interest rate that will compensate these creditors for receiving deferred cash payments in lieu of a lump sum. Given that money has a time value, interest rates play a key role in how much money secured creditors will receive. Congress did not supply any method for calculating the appropriate interest rate; but in 2004, the United States Supreme Court issued an opinion which purported to resolve any dispute as to which approach was the appropriate methodology to use when determining the discount factor for a cramdown plan.
Courts in Florida generally find the riskless interest rate (normally the prime rate) and adjust based on the risks and particular circumstances and factors of a particular estate, or what scholars would call a holistic analysis of the debtor’s affairs. Several judges in Florida have tipped their head to the market rate as the appropriate rate. However, one recent Bankruptcy Court in New York applied the treasury rate as the base rate, thus strengthening a debtor’s ability to force secured creditors to accept a rate that is significantly below the market rate.
This fall, in In re MPM Silicones LLC, the debtors submitted a chapter 11 plan for approval that contemplated that secured replacement notes would have an interest rate of approximately 3.6% and 4.1%. The senior secured noteholders rejected the plan because the proposed interest rate should have reflected market rates. Indeed, the market rate was arguably easily ascertainable because the debtors had obtained commitments for an exit financing facility (ranging from 5% to 6.25%) that would have been used to repay the senior secured noteholders had they voted to accept the plan.
In reaching its decision, the Court relied principally on the decision in Till v. SCS Credit Corp., 541 U.S. 465 (2004), where the United States Supreme Court ruled that the interest rate should not include a profit or cost component since this would be inconsistent with the present value approach contemplated by the Bankruptcy Code’s cramdown provisions. Instead, the interest rate should reflect a risk-free base rate which would then be increased by a risk adjustment factor that reflected the risks associated with the estate, the nature of the collateral security, and the duration and feasibility of the plan. The Court ruled that, generally, such risk adjustment should range from 1% to 3%, and based on those principles, the risk-free rate should be the Treasury rate (not the prime rate) plus a risk-adjusted rate of between 2% and 3 %. In re MPM Silicones, LLC, No. 14-22503-RDD, 2014 WL 4436335, at *24-32 (Bankr. S.D. N.Y. Sept. 9, 2014).
MPM Silicones is a powerful case for debtors and a really scary case for secured creditors. The fact that the interest rate for debt in a cramdown situation is to be calculated using a risk-free rate plus a risk-adjusted factor, increases risks to secured creditors that are considering whether to accept a proposed plan. For debtors, applying the Till formula may result in getting a rate that is below the rate a credit-worthy borrower would get in the market place.