Judge Drain’s recent bench rulings in Momentive Performance Materials in 2014 generated a great deal of controversy in the distressed debt world. Distressed investors, lenders, and commentators have questioned whether the Momentive rulings will lead to an industry trend in which debtors seek to cram down their secured lenders to take advantage of the ability to do so at below market interest rates.
If the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 has anything to do with it, the Momentive rulings would be one less thing for lenders to have to worry about in a distressed context. In the Commission’s Final Report and Recommendations (section VI.C.5) the Commission specifically rejected the Till “prime plus” formula that led to the below market interest rate for the first lien lenders in Momentive. Lest you need to be reminded, Till is a Supreme Court decision on cramdown in the chapter 13 context, that has led to chapter 11 cramdown interest rates being calculated in many cases (including Momentive) using a base rate of a treasury or prime rate, plus a 1-3% upward adjustment to compensate a secured lender for their counterparty risk facing a reorganized debtor. If you’re looking for a primer on secured creditor cramdown, we’ve got one for you here. If you want to read more about the cramdown aspects of the Momentive decision, click here.
The Commission concluded that a general market approach was the preferred method of determining a cramdown interest rate, and that the court should use the cost of capital for similar debt issued to companies comparable to the debtor as a reorganized entity.
Alternatively, if a market rate cannot be determined for a particular debtor, the court should instead opt for a risk-adjusted rate reflecting the reorganized debtor’s risk profile, taking into account factors such as the debtor’s industry, projections, leverage, revised capital structure, and obligations under its plan of reorganization.
As a final stroke of the Commission’s proverbial samurai sword, the Commission opted to kill Till, concluding that the prime plus formula articulated in Till was not appropriate for business chapter 11 cases under any circumstances. Even in the absence of an efficient market, Till’s prime plus formula was found not to be based on the economic realities of a debtor’s particular case, and may undercompensate creditors for the counterparty risk they face with the reorganized debtor. While the Commission’s Final Report and Recommendations would need to be adopted by Congress and enacted in legislation to take effect, the conclusions on Till are interesting reading and a signpost towards where the law on secured creditor cramdown may be headed (much to the delight of secured creditors everywhere).