Restructuring

Contributed by Maurice Horwitz
There has been quite a lot of discussion over the past few months about the bench rulings issued by Judge Drain of the Bankruptcy Court for the Southern District of New York in Momentive Performance Materials (see our extensive coverage in four parts here, here, here, and here), in particular his views on determining a cramdown rate of interest for secured creditors. As we noted before, Judge Drain’s bench ruling suggests that the allowed claim of a secured creditor may be satisfied by a long-dated replacement note with a below-market interest rate. Understandably, the specter of future cramdown scenarios has been spooking many a secured creditor.
But secured creditors should take comfort in knowing that not all cramdowns are the same. Differences in facts sometimes may lead to more favorable outcomes for secured creditors. For example, the Bankruptcy Court for the Northern District of New York in In Re Howe Farms LLC recently denied confirmation of a cramdown plan on the grounds that the plan’s treatment of a secured creditor was not commercially reasonable in light of “customary lending practices” and the debtor’s risk of default.
Unlike Momentive, which is a chapter 11 case, Howe Farms is a case under chapter 12 – that little known chapter that deals with the adjustment of debts of a family farmer or fisherman with regular annual income. Although not a chapter that we frequently discuss on the Weil Bankruptcy Blog, chapter 12 is similar to chapters 11 and 13 in that it permits a debtor (in this case, a family farmer or fisherman) to propose a plan of reorganization and attempt a “cramdown” of that plan on a rejecting class of creditors. Also like chapters 11 and 13, chapter 12 permits a debtor to treat a secured creditor’s claim as a long-term debt payable beyond the length of the plan if the plan provides that the secured creditor will retain its lien and receive payments having a present value equal to the amount of its claim. In cases where the secured creditor refuses to accept the proposed plan, section § 1225(a)(5)(B) of the Bankruptcy Code allows the debtor to retain the collateral and “cram down” a creditor’s allowed secured claim “provided that, among other things, the value of the secured creditor’s claim is demonstrably preserved.”
Because of this, the same case on which Judge Drain based his decision in Momentive – the Supreme Court’s decision in Till v. SCS Credit Corp. (itself a chapter 13 case) – is equally applicable in Howe Farms. As the Supreme Court explains in Till, “Congress likely intended bankruptcy judges and trustees to follow essentially the same approach when choosing an appropriate interest rate under any of the many Code provisions requiring a court to discount a stream of deferred payments back to their present dollar value.”
In Howe Farms, the debtor proposed a chapter 12 plan and sought to cramdown a secured lender that held a first priority, perfected security interest in the farm’s accounts, livestock and farm equipment. There was no dispute between the debtor and its lender that the lender’s secured claims totaled $1,310,473.60 as of the petition date, and that the claims were undersecured by the debtor’s property, which was valued at $367,300. The debtor’s initial plan proposed to repay the lender’s secured claims as long-term debt to be paid in full over thirty years with interest at a rate of 5% in monthly payments of $2,684.11, or $32,209.32 annually. Having conceded that these terms were not commercially reasonable, the debtor revised its plan to provide for a (still rather painful) twelve year amortization period with interest at 6% per annum and a balloon payment at the end of seven years.
The secured lender objected to both the term and rate of the proposed payments under the plan. With respect to the term, the bankruptcy court cited other chapter 12 cases supporting the proposition that “the court can base a ruling on such facts as the preexisting contract length and the customary length of repayment of similar loans.” In this case, the longest term in any of the promissory notes executed by the debtor to the lender was twelve months. Moreover, the court already had expressed concerns about the feasibility of the plan and found that the lender’s expert had expressed “valid concerns regarding depreciation and risk of loss of the collateral given the nature of the collateral.”
Turning to the interest rate, the court noted that “several Bankruptcy Code sections, including Bankruptcy Code § 1225(a)(5)(B)(ii), require a court to discount a stream of deferred payments back to their present value.” Relying upon a line of recent chapter 12 decisions that trace back to the Supreme Court decision in Till, the court observed that these cases direct courts “to begin with and adjust the prime rate based upon factors such as the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization.” Here, the court was concerned not only with the plan’s dubious feasibility, but also the “insufficient equity cushion and lack of other safeguards” available to protect the lender from “collateral loss and diminution in collateral value given the nature of the collateral at issue [i.e., livestock] during the deferred payment repayment.”
Ultimately, the court was mindful of the need to “strike a balance” between adequately compensating the secured lender for the risks associated with the debtors’ plan and an interest rate that is not so high as to “doom Debtors’ reorganization.” Unfortunately for the debtors, that rate proved to be elusive. As the court noted in a footnote, “[s]imple calculations show that the Joint Plan, as filed, is significantly underfunded and infeasible.” As such, rather than propose a more appropriate interest rate, the court denied confirmation altogether and urged the debtors to “reassess their situation to determine whether they have the financial means to continue in Chapter 12.” And for the time being, the secured lender avoided being plowed down by a patently unfair cramdown plan. Although unique in its facts, Howe Farms serves as a reminder to secured creditors that even if a cramdown interest rate does not include a degree of profit (as noted by Judge Drain in Momentive), a secured creditor is nevertheless entitled to the full value of its secured claim and a reasonable prospect of repayment.