§ 77.3 — Present Value after Till
Revised: June 14, 2004
On May 17, 2004, in an unusual 4-1-4 decision, the Supreme Court resolved the hopelessly fractured circuit decisions1 with respect to the discount rate at cram down in Chapter 13 cases in Till v. SCS Credit Corp.2 In a nutshell, a plurality of the Supreme Court fixed the discount rate at prime plus a risk factor based on the “formula approach.”
As detailed above,3 the bankruptcy court in Till confirmed a Chapter 13 plan that paid a car lender 9.5 percent interest based on a prime rate of 8 percent and a 1.5 percent risk factor add on. This “formula rate” was rejected by the district court in favor of a “coerced loan rate” of 21 percent drawn from the original contract. On further appeal, the Seventh Circuit affirmed the 21 percent contract rate as the “presumptive rate” that was not rebutted by the debtor’s evidence.
The Supreme Court reversed the Seventh Circuit. Four justices, led by Justice Stevens, rejected the coerced loan and presumptive contract rate approaches adopted by the district court and Seventh Circuit, endorsing instead the formula approach that produced the prime rate plus a risk factor used by the bankruptcy court. Justice Stevens began by stating three governing considerations:
First, the Bankruptcy Code includes numerous provisions that, like the cram down provision, require a court to “discoun[t] . . . [a] stream of deferred payments back to the[ir] present dollar value.” . . . 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. Second, Chapter 13 expressly authorizes a bankruptcy court to modify the rights of any creditor whose claim is secured by an interest in anything other than “real property that is the debtor’s principal residence.” . . . Thus, in cases like this involving secured interests in personal property, the court’s authority to modify the number, timing or amount of the installment payments from those set forth in the debtor’s original contract is perfectly clear. . . . Third, from the point of view of a creditor, the cram down provision mandates an objective rather than a subjective inquiry. That is, although § 1325(a)(5)(B) entitles the creditor to property whose present value objectively equals or exceeds the value of the collateral, it does not require that the terms of the cram down loan match the terms to which the debtor and creditor agreed prebankruptcy . . . . Thus, a court choosing a cram down interest rate need not consider the creditor’s individual circumstances . . . . Rather, the court should aim to treat similarly situated creditors similarly, and to insure that an objective economic analysis would suggest the debtor’s interest payments will adequately compensate all such creditors for the time value of their money and the risk of default.4
Applying these considerations, Justice Stevens found that the coerced loan, presumptive contract rate and cost of funds approaches5 each were too complicated, each imposed “significant evidentiary costs” and these other approaches inappropriately aimed “to make each individual creditor whole rather than to ensure the debtor’s payments have the required present value.6
The formula approach on the other hand “has none of these defects.”7 Stating the plurality’s conclusion, Justice Stevens described the proper discount rate calculation as follows:
Taking its cue from ordinary lending practices, the [formula] approach 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 estate, the nature of the security, and the duration and feasibility of the reorganization plan. The court must therefore hold a hearing at which the debtor and any creditors may present evidence about the appropriate risk adjustment. . . . [S]tarting from a concededly low estimate and adjusting upward places the evidentiary burden squarely on the creditors, who are likely to have readier access to any information absent from the debtor’s filing . . . . [T]he resulting “prime-plus” rate of interest depends only on the state of financial markets, the circumstances of the bankruptcy estate, and the characteristics of the loan, not on the creditor’s circumstances or its prior interactions with the debtor.8
With respect to the size of the risk adjustment, Justice Stevens gave no fixed formula but observed:
We do not decide the proper scale for the risk adjustment, as the issue is not before us. The Bankruptcy Court in this case approved a risk adjustment of 1.5% . . . . [O]ther courts have generally approved adjustments of 1% to 3% . . . . [U]nder 11 U.S.C. § 1325(a)(6), a court may not approve a plan unless after considering all creditors’ objections and receiving the advice of the trustee, the judge is persuaded that “the debtor will be able to make all payments under the plan and to comply with the plan.” Together with the cram down provision, this requirement obligates the court to select a rate high enough to compensate the creditor for its risk but not so high as to doom the plan.9
In response to the car lender’s arguments that Chapter 13 cases were inherently risky, Justice Stevens had this to say about the probability of failure and its bearing on discount rates at confirmation:
Congress intended to create a program under which plans that qualify for confirmation have a high probability of success. Perhaps bankruptcy judges currently confirm too many risky plans, but the solution is to confirm fewer such plans, not to set default cram down rates at absurdly high levels, thereby increasing the risk of default.10
Responding to the dissenters’ view that the contract rate best reflects the market’s evaluation of risk, Justice Stevens characterized this disagreement as a dispute over burden of proof:
We principally differ with the dissent not over what final rate courts should adopt but over which party (creditor or debtor) should bear the burden of rebutting the presumptive rate (prime or contract, respectively). . . . [T]he formula approach, which begins with a concededly low estimate of the appropriate interest rate and requires the creditor to present evidence supporting a higher rate, places the evidentiary burden on the more knowledgeable party, thereby facilitating more accurate calculation of the appropriate interest rate.11
The prime-plus outcome achieved a majority in Till with the concurrence of Justice Thomas. In contrast to the plurality opinion by Justice Stevens, Justice Thomas parsed § 1325(a)(5)(B)(ii) and found no language supporting the view that risk of nonpayment was an element of discount rate at cramdown in a Chapter 13 case. Justice Thomas would apply a “risk-free rate” and, because the 9.5 percent rate adopted by the plurality exceeded that riskless rate, he concurred in the outcome though not the logic of Justice Steven’s opinion.
Unlike Associates Commercial Corp. v. Rash,12 there is guidance in Till with respect to the methodology to determine discount rate at cramdown in a Chapter 13 case. Prime rate (unlike “replacement value”) is a number that is readily and uniformly determined from one day to the next and from one part of the country to the next. It depends on no complicated evidentiary process. The prime rate starting point for all future cramdown discount rate decisions in Chapter 13 cases is substantial relief from the “market rate” chaos that preceded Till.13
Justice Steven’s discussion of risk factors is somewhat less concrete but much can be deduced about the risk factor add on. Fundamentally, the four-member plurality believes it is appropriate to add a risk factor to the prime rate to reach the discount rate at cramdown. The creditor has the burden of proof with respect to the risk factor add on and the focus of that inquiry should be the Chapter 13 estate, the collateral for the loan and the terms of the proposed plan. The creditor’s circumstances or its prior dealings with the debtor are not relevant to the risk determination.
Justice Stevens seems to concede the possibility that the risk of default could be so great in a Chapter 13 case that an “eye-popping” interest rate would be necessary to compensate a lender for its risk.14 In that event, the plan “probably should not be confirmed.”15 On the other hand Justice Stevens states that the feasibility requirement in § 1325(a)(6) together with the cramdown provision “obligates the court to select a rate high enough to compensate the creditor for its risk, but not so high as to doom the plan”—at least suggesting that the range of appropriate risk add ons is constrained by the policy favoring debtor rehabilitation. This ambiguity is sure to fuel arguments by creditors that risk add-ons in excess of the 1–3 percent range referenced by Justice Stevens are sometimes warranted.
Till clearly signals that the evidence appropriate at hearings on discount rates at cramdown in Chapter 13 cases will change from prior practice. The economics professors and investment bankers who testified in some of the pre-Till cases16 will have little of relevance to offer at a post-Till hearing focused not on markets but on the circumstances of the estate, the security and the plan. Perhaps evidence of job insecurity or improper maintenance of the collateral would be relevant to the measure of risk at cramdown. Does a five-year plan justify a higher risk factor than a three-year plan? Or might it be the other way around if the five-year plan requires a lower monthly payment than the three-year alternative? Is a car more or less risky than a washing machine for discount rate purposes? There is room in Justice Steven’s discussion for just such arguments.
1 See § 112.1 [ Interest Rate Anarchy: Present Value Before Till ] § 77.2 Interest Rate Anarchy: Present Value before Till.
2 541 U.S. __, 124 S. Ct. 1951, __ L. Ed. 2d __ (2004).
3 See § 112.1 [ Interest Rate Anarchy: Present Value Before Till ] § 77.2 Interest Rate Anarchy: Present Value before Till.
4 124 S. Ct. at 1958–60.
5 See § 112.1 [ Interest Rate Anarchy: Present Value Before Till ] § 77.2 Interest Rate Anarchy: Present Value before Till for discussion of these approaches and others for determining the discount rate at cramdown in a Chapter 13 case.
6 124 S. Ct. at 1953.
7 124 S. Ct. at 1961.
8 124 S. Ct. at 1953–54.
9 124 S. Ct. at 1962.
10 124 S. Ct. at 1963.
11 124 S. Ct. at 1964.
13 See § 112.1 [ Interest Rate Anarchy: Present Value Before Till ] § 77.2 Interest Rate Anarchy: Present Value before Till.
14 124 S. Ct. at 1962.
15 124 S. Ct. at 1962.
16 See § 112.1 [ Interest Rate Anarchy: Present Value Before Till ] § 77.2 Interest Rate Anarchy: Present Value before Till.