Summary of Significant Judicial Developments Affecting Asset-Based Lending: Part Two

Secured Lender, The, Mar/Apr 2006 by Helfat, Jonathan N, Kohn, Richard M

Bankruptcy

In re Prussia Assocs., 322 B.R. 572 (Bankr. E.D. Pa. 2005) ("Formula Rate" instructive but not mandatory in chapter 11 cases.)

In 2004, the Supreme Court, in a 5-4 decision rendered in Till v. SCS Credit Corp., 541 U.S. 465 (reported on in the September/October issue of The Secured Lender), held that the interest rate to be ascribed to a "cram down" installment payment provided for in a chapter 13 plan was the "formula rate," defined as the prime rate to be enhanced by a risk factor typically ranging from 1% to 3%. Till expressly stated that it was not determining how the risk factor premium was to be calculated or whether the formula rate was applicable to a cram down under chapter 11 of the Bankruptcy Code. These two issues were the subject of a recent chapter 11 case, In re Prussia Assocs.

While observing that Till will "make sense" in most chapter 11 cases, Prussia acknowledged the comment in Till that the formula rate would defer to an established market rate. The precise question in Prussia was the rate of interest to be ascribed to a real property mortgage to be restructured under the cram down power of � 1129(b)(2)(A)(i)(II) of the Bankruptcy Code. The debtor contended that the market rate of interest for refinancing for a first mortgage on hotel property ranged from 5% to 6.5%. The secured creditor contended that the market rate was a blended rate consisting of a 6.5% senior mortgage rate and a 16% rate junior debt rate. Under the secured creditor's formula, the interest rate applicable to the revised obligation was 9.72%.

Although finding that there was a strong market for post-confirmation mortgage financing, the court in Prussia held:

although this case presented an occasion upon which it indeed made sense to inquire as to what the relevant market rate of interest might be, the totality of the evidence presented did not permit a sufficiently informed conclusion to be drawn. Put differently, this case demonstrates that the mere existence of an efficient market does not guarantee that the short-comings of the coerced loan approach to rate setting, as described in Till, will automatically be overcome. The Court will thus fall back upon Till, and the formula approach, as the preferred means for setting the interest rate herein.

322 B.R. at 590.

Ultimately, the court fixed 7.25% as the rate of interest, consisting of the prime rate at the effective date of 5.75% plus a 1.5% risk premium.

In concluding that Till's formula rate was "instructive" but not binding in chapter 11 cases, the Prussia court noted that both � 1129(a)(7) (the chapter 11 best interest test) and � 1325(a)(5)(B)(ii) of the Bankruptcy Code refer to present value. It is suggested that a much closer comparison exists between � 1325(a)(5) and its cram down counterpart, � 1129(b)(2)(A)(i)(II). The relevant text of � 1325(a)(5) states:

the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim.

11 U.S.C. � 1325(a).

The comparable text of the � 1129 cram down section states:

that each holder of a claim of such class receive on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder's interest in the estate's interest in such property.

11 U.S.C. � 1129 (b)(2)(A)(i)(II).

While there is some variation in the respective texts of those two sections, the object of each is identical.

Under this circumstance, it is likely the Supreme Court will follow its rule of statutory construction that the same language appearing in different sections of a statute will be given the same meaning. Gen. Dynamics Land Sys., Inc. v. Cline, 540 U.S. 581, 124 S. Ct. 1236, 1245 (2004). Actual precedent for this rule can be found in the Seventh Circuit's using of the cram down power of chapter 13 to interpret an identical provision of chapter 12. Koopmans v. Farm Credit Servs. Of Mid-America, ACA, 102 F.3d 874, 875 (7th Cir. 1996).

The court in Prussia also raised a third issue: whether the prime rate is to be determined as of the effective date of the plan or another date (such as the petition date). With respect to this issue, the court considered the answer to be obvious, because the chapter 11 cram down power of � 1129(b)(2)(A)(i)(II) uses the phrase "of a value, as of the effective date of the plan." 11 U.S.C. � 1129(b)(2)(A)(i)(II). It is submitted that Till likely deemed it unnecessary even to comment on this because of the dominance in statutory construction of the plan meaning rule: "Congress says in a statute what it means and means in a statute what is says there. Connecticut Nat'1 Bank v. Germain, 503 U.S. 249, 254 (1992); Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A7

Although opining that the Till "formula rate" was only instructive and not binding in a chapter 11 case, Prussia held that, absent strong evidence of a market rate, the formula rate would be used to set the cram down interest rate in a chapter 11 case. If a party contends a market rate supplants the formula rate, it must be prepared to introduce specific evidence of that rate.