The Supreme Court, apparently without resort to a calculator, decided the cramdown interest issue by employing a formula approach.
Confronted by the difficult and arcane issue of what interest rate best satisfies the requirements of §1325(a)(5)(B)(ii) that the secured creditor receive “…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 ….”, a plurality of the Court held that the so-called formula approach (the prime rate plus a calculated risk factor) best meets the intent of Congress and the objectives of the Bankruptcy Code.
The debtor’s plan in this case, in dealing with a cramdown of a secured claim that contained a pre-petition contract rate of interest of 21 percent, proposed a three-year plan payout of cash payments equal to the $4,000 value of the collateral (a used truck) with a proposed interest rate of 9.5 percent (based on a national prime rate of 8 percent together with a court determined risk factor of 1.5 percent). The secured creditor countered with a contractual rate of its 21 percent pre-petition rate, because it represented the interest that “…it would obtain if it could foreclose on the vehicle and reinvest the proceeds in loans of equivalent duration and risk as the loan” originally made to petitioners.
Being confronted with four different approaches (the formula rate, the coerced-loan rate, the presumptive-contract rate, or the cost-of-funds rate) to determining the correct and appropriate interest rate, the Court (in an opinion by Justice Stevens, joined by Souter, Ginsberg and Breyer) determined that the least complicated approach and one most consistent with congressional intent and promoting debtor rehabilitation, is the formula approach. The Court began by emphasizing that the Code does not set forth a defined “discount rate” or even the term “interest” in connection with the property to be distributed to the secured creditor over the lifetime of the plan. Rather, the sole command is to provide value of distributable property, as of the plan's effective date, that is “…not less than the allowed amount of such claims.” In arriving at an appropriate discount rate for this “stream of differed payments,” the Court held that “…we think Congress would favor an approach that is familiar in the financial community and that minimizes the need for expensive evidentiary proceedings.” As a second consideration, the court recognized that there is a need to consider all “intervening changes and circumstances” when modifying the original terms of the loan and finally, that the cramdown provision requires resort to an objective rather than a subjective standard.
The analysis necessarily rejects the coerced-loan approach, the presumptive contract rate and the cost-of-funds approach. The court instead adopted the formula approach by explaining that adherence to a “national prime rate” and, after an evidentiary hearing where the parties may present evidence about the “appropriate risk adjustment,” the court concluded that “….there is every reason that a properly risk-adjusted prime rate will provide a better estimate of the creditor’s current cost and exposure than a contract rate set in different times.”
Justice Scalia, writing for four justices in a well reasoned dissent, essentially argues that because all of the judges (excluding Justice Thomas) argue that consideration of the risk premium is mandatory in determining a proper discount rate, adoption of the contract rate will best satisfy this requirement. Justice Thomas, while concurring in the judgment, wrote separately to say that §1325(a)(5)(B)(ii) does not require a debtor-specific risk adjustment. When all is said and done the need for evidence on the critical element of risk will assure that even resort to a formula approach will not eliminate litigation.
(Summary by Hon. Roger Whelan, ABI Resident Scholar)