Fifth Circuit Affirms Below-Market Interest Rate Used In Cramdown Of Secured Lender In Chapter 11 Plan Based On 'Prime-Plus' Formula Established By Supreme Court In Chapter 13 Case

1. Introduction

   On March 1, 2013, the Court of Appeals for the Fifth Circuit held in In re Texas Grand Prairie Hotel Realty ("Texas Hotel") that a bankruptcy court did not err when it confirmed a "cramdown" chapter 11 plan that proposed to pay a dissenting secured lender interest calculated at the national prime rate plus 1.75%, which resulted in an effective annual rate of 5%.1 Notably, the lender in Texas Hotel stipulated that the "prime plus" formula for cramdown interest established by a plurality of the Supreme Court in the chapter 13 case Till v. SCS Credit Corp. would apply.2 As a result, the lender did not argue that the right methodology to calculate its interest rate should be a "market rate" approach in chapter 11 cases where an "efficient market" for exit financing exists (as alluded to as proper in Footnote 14 of the Till decision). Based on the lender's stated agreement to the "prime plus" methodology, the Fifth Circuit concluded that the bankruptcy court committed no reversible error even though, under the Till methodology, the risk adjustment to the prime rate established by Till is nothing more than a "smallish number picked out of a hat."3

   While the Fifth Circuit's decision may be perceived as further endorsement of Till's "prime plus" formula, that endorsement is qualified by the lender's decision to stipulate to that formula in lieu of pursuing a "market rate" approach based on Footnote 14 of Till. Secured lenders may be relieved to know that nothing in the Texas Hotel decision precludes them from arguing for a "market rate" approach in future chapter 11 cases, if an efficient market for such loans exists. Indeed, the Fifth Circuit reaffirmed its prior rulings that bankruptcy courts enjoy "some latitude" in determining the appropriate method for calculating a cramdown interest rate in chapter 11 cases.4 Texas Hotel, therefore, cautions secured lenders that if they accede in a chapter 11 case to the "prime plus" formula established by the Supreme Court in Till, they may be forced to accept a below-market rate. However, the court was clear that in the absence of an efficient market, Till would govern in bankruptcy cases filed in the Fifth Circuit—which is comprised of Texas, Louisiana and Mississippi.

2. Factual Background

   In 2007, Texas Grand Prairie Hotel Realty, Texas Austin Hotel Realty, Texas Houston Hotel Realty, and Texas San Antonio Hotel Realty (the "Debtors") borrowed $49 million from the lender (the "Lender") to purchase four hotels in Texas. The loan was secured by the hotel properties and substantially all of the Debtors' other assets.

   In 2009, the Debtors were unable to make required payments to the Lender and commenced chapter 11 cases in the Northern District of Texas Bankruptcy Court. During the chapter 11 cases, the Debtors proposed a plan of reorganization (the "Plan") that valued the Lender's secured claim at approximately $39 million. The Plan further proposed to pay the Lender's secured claim over a period of ten years, with interest accruing at 5%, a rate that was 1.75% above the prime lending rate in effect at the time the Bankruptcy Court considered confirmation of the Plan.

   Notably, the parties agreed that the rate of interest used in the Plan should be calculated by adding some "plus factor"—or risk adjustment—to the prime rate based on Till. Both parties also agreed that the applicable prime rate was 3.25%. The Lender rejected the Plan, however, on the basis that the Debtors' 1.75% risk adjustment to the prime rate was too low. Therefore, to confirm the chapter 11 plan over the Lender's dissent, the Debtors' needed to satisfy the Bankruptcy Code's "cramdown" provisions in section 1129(b).

3. Legal Background

   Section 1129(b)(2)(A)(i)(II) of the Bankruptcy Code provides that for a Bankruptcy Court to confirm a plan over a secured creditor's objection if the plan proposes to pay the creditor deferred payments, the total of the payments discounted to present value after applying an appropriate interest rate (the "Cramdown Rate") must equal the allowed amount of the secured claim.5 Although section 1129(b) requires a Bankruptcy Court to calculate the present value of the secured claim, it does not specify the method or rate that should be used for that calculation. Rather, the Bankruptcy Code provides that the provisions of the chapter 11 plan must be "fair and equitable" and not "discriminate unfairly."6

   In Till v. SCS Credit Corp., the...