Cramdown Interest Rate of 1.22% Upheld on Appeal from Confirmation

A dominant creditor might have upset a confirmed plan by devoting resources to a focused attack on the most vulnerable elements of a proposed reorganization. Instead, the creditor took a blunderbuss approach and ended up being stuck with a 1.22% post-confirmation interest rate.

However, the creditor did persuade District Judge A. Joe Fish of Dallas that the confirmation appeal was not equitably moot to the extent that the plan included improper non-debtor releases under Fifth Circuit precedent.

The case involved a typical confirmation fight between a mid-market debtor and a dominant creditor.

Some two years before bankruptcy, the debtor sued to cancel the creditor’s trademark, but the district court in California upheld the mark. Having won, the creditor sought recovery of its counsel fees under the Lanham Act. Eventually, the district court entered a $2.3 million judgment against the debtor.

Immediately after entry of the judgment, the debtor filed a chapter 11 petition and a reorganization plan. All creditors other than the judgment creditor voted for the plan. In relatively short order, the bankruptcy court confirmed the plan, which was designed to pay all unsecured creditors in full, including the holder of the $2.3 million judgment.

To invoke cramdown under Section 1129(b), the plan classified the judgment creditor in a separate class of unsecured creditors. The plan called for amortizing the entire $2.3 million claim in equal payments over 10 years with interest at 1.22%, the federal judgment rate at the time.

After confirmation, the debtor quickly consummated the plan, made initial distributions to creditors, entered into new contracts with suppliers and customers, and took down a $1 million post-confirmation loan. While the plan was on appeal, the Ninth Circuit upheld the $2.3 million judgment for the creditor’s attorneys’ fees.

On appeal, the creditor made nine assignments of error. The debtor responded with a motion to dismiss, contending that the appeal was equitably moot.

In his 65-page opinion on October 19, Judge Fish upheld the plan, aside from ruling that non-debtor releases were impermissible.

On appeal, the creditor made almost every conceivable argument that the plan did not comply with Section 1129. Among other things, the creditor argued that the chapter 11 filing and the plan itself were filed in bad faith. The bankruptcy court, of course, had rejected those arguments.

First ruling on the debtor’s motion to dismiss the appeal for equitable mootness, Judge Fish said that the Fifth Circuit has laid down three factors to consider: (1) was there a stay pending appeal; (2) was the plan substantially consummated; and (3) would relief on appeal affect either the rights of parties not before the court or the success of the plan? Only the third factor was in dispute.

The Fifth Circuit, according to Judge Fish, has held that equitable mootness applies to specific assignments of error, not to the entire appeal. He therefore analyzed each of the creditor’s arguments to determine whether he could fashion relief without “unwinding the entirety of the plan.”

In terms of economic significance, the judgment creditor’s most consequential attack focused on the 1.22% interest rate. The creditor contended that the federal judgment rate was too low to satisfy the fair and equitable test under Section 1129(b)(1).

In substance, Judge Fish ruled that he could adjust the interest rate without “undoing the entire plan.” So, he denied the motion to dismiss to that extent and examined the merits.

Despite a concession that 1.22% was lower than the rate of inflation, the creditor lost the argument as the result of a failure of proof in bankruptcy court, because Judge Fish found “no clear error in the bankruptcy court’s cramdown rate analysis.”

Since the Bankruptcy Code does not prescribe an interest rate, courts interpret Till v. SCS Credit Corp., 541 U.S. 465 (2004), to mean that courts in chapter 11 should adjust the prime rate upwards or find an applicable market rate.

With regard to an adjusted prime rate, “the bankruptcy court concluded that this approach is not controlling precedent in the Fifth Circuit,” Judge Fish said. With regard to a market rate, Judge Fish said the “bankruptcy court determined that it had no credible evidence as to what the market rate would be other than an unsubstantiated statement from [the creditor’s] witness . . . .”

Judge Fish said that neither of the creditor’s arguments based on Till left him “with a definite and firm conviction that a mistake has been committed. The bankruptcy court was under no obligation to apply the prime approach advocated by the plurality in Till.” He went on to say that testimony at the confirmation hearing “corroborates the bankruptcy court’s determination that [the creditor’s] estimate of the market rate was unsubstantiated.”

Finding no guidance from Till, the bankruptcy court settled on the federal judgment rate because it was “objective” and “provided unsecured creditors what they would receive outside of the bankruptcy process,” Judge Fish said.

On the merits, Judge Fish therefore found no mistake in ruling that the federal judgment rate was fair and equitable.

The creditor did succeed in setting aside provisions in the plan that included releases and exculpations for non-debtors such as the debtor’s holding company, officers, directors, shareholders, advisors and attorneys.

The appeal was not equitably moot in that regard, Judge Fish said, because he could set aside the releases without unwinding the plan altogether. Citing Fifth Circuit authority, Judge Fish reversed and remanded with instructions to excise the releases and exculpations from the plan.

On other objections, such as the contention that the plan included impermissible gerrymandering, Judge Fish granted the motion to dismiss for equitable mootness because granting relief would unwind confirmation to the detriment of third parties.

The outcome of the case shows how a successful objection to confirmation requires more than comprehensive legal arguments. On appeal, if not in bankruptcy court, the creditor might have prevailed by investing in expert witnesses to expound on the appropriate rate of interest for a 10-year unsecured loan to a company with a similar financial profile.