Restructuring

Contributed by Elizabeth Hendee
A recent decision out of the United States Bankruptcy Court for the District of New Hampshire shows that not much has changed in the world of cramdown interest rates.  In a blog post last year, we discussed how interest rates are calculated when a debtor is trying to “cram a plan down” over the dissent of an impaired secured creditor.  We noted that whether an interest rate will be approved is unpredictable because the analysis is fact-specific, and different judges find different factors persuasive.  In re Moultonborough Hotel Group, LLC illustrates a recent approach to this tricky issue.
On September 30, 2010, Moultonborough Hotel Group LLC filed for chapter 11 protection in the United States Bankruptcy Court for the District of New Hampshire.  The debtor owned a Hampton Inn and Suites in Tilton, New Hampshire. Its assets were fully encumbered.  The debtor’s largest secured creditor, SFG Ventures LLC, held a mortgage on the debtor’s property.  The remaining secured creditors, including ROK Builders, LLC, held mechanics liens on the debtor’s real property.
The debtor, SFG, and ROK had a contentious history.  After the chapter 11 case commenced, the debtor and ROK contended that SFG either did not have a properly perfected lien on the debtor’s property or, if it did have a lien, did not have a first-priority lien.  The bankruptcy court found, and the district court affirmed, that SFG did have a properly perfected first-priority lien on the debtor’s property.  After the district court decision, the debtor re-aligned its allegiances and began working with SFG to draft a plan of reorganization.  ROK continued its fight solo:  ROK appealed the district court’s decision to the United States Court of Appeals for the First Circuit, and filed its own plan of reorganization and disclosure statement as well as an objection to the debtor’s plan of reorganization.  The First Circuit appeal remains pending, and the bankruptcy court rejected ROK’s disclosure statement.  The recent bankruptcy court decision addresses ROK’s objection to the debtor’s plan.
Under the debtor’s plan, the debtor would transfer all of its real and personal property to SFG, as its designee, in return for full satisfaction of SFG’s allowed claim, waiver of SFG’s deficiency claim and payment of $150,000 cash to the debtor.  If the First Circuit affirms the district court’s decision, ROK will be treated as a general unsecured creditor.  If, however, ROK succeeds on appeal, and its claim is deemed secured, ROK will retain its alleged lien, and ROK’s claim would be paid over seven years with interest calculated at a 3.25% rate with a balloon payment on the seventh anniversary of the plan’s effective date.  3.25% is the current prime interest rate.  The undisputed liquidation value of the debtor’s assets that would secure ROK’s claim is approximately $4 million, over twice the amount of ROK’s claim.
Among other things, the decision addresses whether the interest rate applied to ROK’s alleged secured claim satisfies the cramdown requirements of section 1129(b) of the Bankruptcy Code.  Pursuant to section 1129(b)(2)(A)(i) of the Bankruptcy Code, a plan is fair and equitable as to a class of impaired secured creditors, and can thus be confirmed over their objections, if the creditors retain the liens securing their claims and receive deferred cash payments equal to the present value of their secured claims as of the effective date of the plan.  Present value takes into account the time value of money as well as the chance that a debtor will be unable to make future payments and, accordingly, includes an appropriate interest rate.
In deciding how that interest rate should be calculated, the court followed the two-step analysis outlined in the Sixth Circuit’s decision in Bank of Montreal v. Official Committee of Unsecured Creditors (In re American HomePatient Inc.).  Under that analysis, the court must first ask whether an efficient market exists for cramdown financing.  If there is an efficient market, the market rate will apply.  If not, the court should follow the formula approach outlined in the Supreme Court’s decision in Till v. SCS Credit Corp.  Under Till, the court starts by looking to the national prime rate, which reflects how much interest a commercial bank would charge a creditworthy commercial borrower.  Next, the court looks at various factors such as the nature of the security, the feasibility of the plan, and the length of the payment period to decide how much risk adjustment should be added to the national prime rate.  According to Till, a risk adjustment will almost always be necessary because debtors pose a greater threat of nonpayment than creditworthy commercial borrowers.  Various lower court decisions have added guidance on the factors that should be considered when undertaking this analysis and how much of a risk adjustment tends to be appropriate.  The Supreme Court in Till suggested that the risk adjustments will usually range between 1-3% and lower courts have more or less stayed within this range when calculating adjustments.
Here, the debtor proposed paying ROK at the national prime interest rate because under the debtor’s plan, ROK had a large equity cushion.  ROK objected to the debtor’s proposal and argued that a significantly higher interest rate of 6.2%, or 2.95% over the national prime rate, would be fair and equitable.  ROK believed a higher rate was fair because, under the debtor’s plan, ROK wasn’t receiving creditor protections and controls, such as, for example, covenants regarding the franchise brand and the hotel manager.  The court found that neither rate was appropriate in the case at hand.  Given the financial difficulties the debtor had faced in the past, and notwithstanding the fact that ROK would be oversecured under the debtor’s plan, the court held that the national prime interest rate was too low and did not account for the risk inherent in lending to a bankrupt company.  Further, to satisfy the balloon payment owed to ROK on the seventh anniversary of the effective date under the plan, the debtor would have to refinance the debt obligation.  The court found the possibility that the debtor would not be able to successfully refinance at that time a risk it must consider when determining an acceptable cramdown interest rate.  ROK’s proposed interest rate, however, was too high.  The court found that ROK did not satisfactorily demonstrate why it needed to be paid an interest rate of almost 3% above the prime interest rate when it had such a considerable equity cushion.  The court ultimately concluded that the plan could not be approved at the current interest rate and sent the debtor back to the drawing board to rework the plan to include a more appropriate rate.  Although the court did not suggest a rate that the debtor should use instead of the national prime rate, it did cite favorably to In re Cantwell, where a 1% adjustment was deemed necessary on facts very similar to the facts in Moultonborough.
Although the litigation over the appropriate “cramdown” interest rate continues, it appears that, at least for some courts, the national prime rate will not be considered an acceptable cramdown rate even where the secured creditor has a substantial equity cushion.
Follow this link to view our updated cramdown matrix.