leveraging secured lender bankruptcy cramdown...

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Presenting a live 90-minute webinar with interactive Q&A

Leveraging Secured Lender Bankruptcy

Cramdown Rules and Setting Interest

Rates: Debtor and Lender Strategies

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

WEDNESDAY, JULY 15, 2015

Gary L. Kaplan, Partner, Fried Frank, New York

Benjamin Mintz, Partner, Kaye Scholer, New York

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Cramdown Rules and Setting Interest Rates:

Strategies for Debtors and Lenders

July 15, 2015

These materials were gathered for instructional purposes and do not represent the official position of Kaye Scholer LLP or any of its

partners, counsel, associates, or employees, including the presenters, nor do they constitute legal advice applicable to any specific

matter.

Benjamin Mintz [email protected]

Cramdown Requirements

• A nonconsensual plan can be confirmed through a cramdown if:

• Plan does not discriminate unfairly

• Plan is fair and equitable

• At least one impaired class of creditors has accepted the plan (without counting insiders)

• All of the requirements for confirmation under section 1129(a) have been satisfied, other than the requirement of section 1129(a)(8) that each impaired class accept the plan

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Cramdown Requirements

• 1129(a) confirmation requirements include the following:

– Proper classification of claims (§§ 1129(a)(2), 1122)

– Equal treatment within a class (§§ 1129(a)(2), 1123(a)(4))

– Plan must be proposed in good faith (§ 1129(a)(3))

– Best interests test (§ 1129(a)(7))

– Feasibility (§ 1129(a)(11))

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1129(b) - No Unfair Discrimination

• Plan cannot discriminate unfairly against a dissenting class in relation to similarly situated creditors (in a different class).

• Courts typically apply one of two tests to determine if there is unfair discrimination:

– “Case by Case” Test – whether the proposed discrimination has a reasonable basis, is necessary for reorganization and is proposed in good faith

– “Rebuttable Presumption” Test – there will be a rebuttable presumption that a plan is unfairly discriminatory when there is (1) a dissenting class, (2) another class of the same priority, and (3) a difference in the plan’s treatment of the two classes that results in either (a) a materially lower percentage recovery for the dissenting class (based on net present value of payments) or (b) regardless of percentage recovery, an allocation under the plan of materially greater risk to the dissenting class in regard to its proposed distribution

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Fair and Equitable Requirement

• Plan Must Be “Fair and Equitable” as to Dissenting Class

– Includes statutory requirements – specifying required treatment of dissenting classes of secured creditors, unsecured creditors and equity holders.

– Includes non-statutory requirements:

• Absolute priority rule (subject to new value exception)

• No premium recovery – no distributions in excess of claim amount

• No unfair/unreasonable risk shifting

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Fair and Equitable Requirement – Statutory Treatment of Secured Creditors

• Secured Creditor treatment – 1129(b)(2)(A) provides three ways that a plan can satisfy “fair and equitable” treatment with respect to a dissenting secured creditor class.

– 1) Deferred payments: Payment over time in an amount equal to value of collateral (based on present value of payments), with lien retained on the collateral.

• Enables plan proponent to rewrite loan – i.e., principal amount based on value of collateral, new interest rate, modified market-based covenants and events of defaults.

• Loan may include nonstandard amortization payments, including a balloon payment, subject to feasibility requirements.

• An undersecured creditor receiving a note in the amount of its collateral value would be entitled to assert an unsecured deficiency claim (unless that creditor makes the 1111(b) election).

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• Effect of 1111(b) Election

– Secured creditor waives its unsecured deficiency claim.

– In exchange, the deferred plan payments must, in addition to having a present value equal to the value of the collateral, total (but not on a present value basis) the full allowed amount of the secured creditor’s claim.

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– 2) Collateral Sale: Sale of collateral with proceeds of sale subject to lien of secured creditor; also subject to secured creditor’s credit bid rights.

• Proceeds can be transferred to secured creditor or debtor can create a new loan secured by proceeds.

• In RadLAX Gateway Hotel LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012), Supreme Court held that a plan cannot eliminate credit bid right through indubitable equivalence prong.

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– 3) “Indubitable Equivalence” – plan must be completely compensatory of creditor’s claim, based on conservative valuation; no reasonable doubt of payment in full

• Abandonment or other unqualified transfer of collateral to secured creditor (including delayed transfer if collateral is not sold within specified time period)

• Replacement collateral of value in excess of secured claim

• “Dirt for Debt” or “Partial Dirt for Debt” plans—case by case analysis

• Sale without credit bid right—not indubitable equivalence (RadLAX)

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FINAL REPORT OF ABI COMMISSION – CONFIRMATION RECOMMENDATIONS

• Redemption Option Value – allocation of reorganization value to out of money creditors

• New Value Corollary

• Sections 506(c) and 552(b) – no waivers by trustee

• Cramdown interest rates

• No gifting or other class-skipping distributions

• One creditor/one vote

• No requirement of impaired accepting class

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CASE LAW DEVELOPMENTS

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Artificial Impairment

• Western Real Estate Equities, L.L.C. v. Village at Camp Bowie I, L.P. (In re Village at Camp Bowie I, L.P.), 710 F.3d 239 (5th Cir. 2013)

– Facts: Debtor “impaired” class of trade creditors ($60,000) by delaying payment in full for 3 months in order to cram down a $32 million secured claim with five year note.

– Fifth Circuit permitted artificial impairment, explaining that section 1123(b)(1) of the Bankruptcy Code does not require that impairment must be driven by economic motives; instead, the court would only consider motive in deciding whether the plan was proposed in good faith under section 1129(a)(3).

– Court distinguished its decision in In re Greystone III Joint Venture, 995 F.2d 1274 (5th Cir. 1991), which held that gerrymandering of creditor classes to create an impaired accepting class violates section 1122 classification rules.

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• Ninth Circuit (L&J Anaheim Associates v. Kawasaki Leasing International Inc., 995 F.2d 940 (9th Cir. 1993)) also held that artificial impairment is not prohibited by the Bankruptcy Code.

• Eighth Circuit (Windsor on the River Associates v. Balcor Real Estate Financial Inc., 7 F.3d 127 (8th Cir. 1993)) held that artificial impairment was improper and would nullify the protections of section 1129(a)(10).

– Third Circuit (In re Combustion Engineering Inc., 391 F.3d 190 (3rd Cir. 2004) reached a similar result, in the context of asbestos-related bankruptcies. See also In re All Land Investments L.L.C., 468 B.R. 676 (Bankr. D. Del. 2012) (finding no evidence of business purpose for impairment).

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• Lower courts in Second Circuit and elsewhere have held that artificial impairment is improper. See e.g., In re Fur Creations by Varriale, Ltd., 188 B.R. 754 (Bankr. S.D.N.Y. 1995); In re RYYZ, LLC, 490 B.R. 29, 43 (Bankr. E.D.N.Y. Apr. 4, 2013) (observing that majority view is that artificial impairment is not permitted); see also In re Akinpelu, 530 B.R. 822 (Bankr. N.D. Ga. 2015) (finding that debtor’s plan “improperly attempts to create an impaired assenting class for purpose of confirmation” through separate classification of the undersecured lender’s deficiency claim from other unsecured creditors); Federal Nat’l Mortgage Ass’n v. Village Green I, GP, 483 B.R. 807 (W.D. Tenn. 2012) (delayed cash out of $2,400 unsecured claims found to be improper artificial impairment where debtor sought to cramdown $5.4 million secured claim); Village Green I, GP v. Federal Nat’l Mortgage Ass’n, 523 B.R. 581 (W.D. Tenn. 2014).

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Claim Classification

• Wells Fargo Bank North America v. Loop 76, L.L.C. (In re Loop 76), 465 B.R. 525 (9th Cir. B.A.P. 2012), aff’d 578 Fed. Appx. 644 (9th Cir. 2014).

– Facts: Debtor placed undersecured creditor’s $6 million deficiency claim in a class separate from its other unsecured claims. Debtor justified separate classification because undersecured creditor’s claim was subject to a guaranty (which the undersecured creditor was pursuing in state court at the time). The undersecured creditor argued that the Debtor was improperly gerrymandering by separately classifying its deficiency claim from other unsecured claims.

– Bankruptcy Appellate Panel sustained separate classification, finding that the existence of the guarantee and a third party source of recovery made the undersecured creditor’s deficiency claim dissimilar from the claims of other unsecured creditors.

– On appeal, Ninth Circuit upheld confirmation based on the existence of a separate impaired accepting class and declined to address the issue of whether the separate classification was impermissible gerrymandering.

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• Accord In re RTJJ, Inc., 2013 WL 462003 (Bankr. W.D.N.C. Feb. 6, 2013) (upholding separate classification of undersecured mortgage claim and other unsecured claims, noting personal guaranties in favor of mortgage claim, foreclosure rights and other distinctions justifying separate classification); In re Hyatt, 2014 WL 1652415 (Bankr. D.N.M. Apr. 23, 2014) (upholding separate classification of claim guaranteed by non-debtor and secured by non-debtor collateral, where guarantor was servicing the debt and was not in default); cf. In re NNN Parkway 400 26, LLC, 505 B.R. 277 (Bankr. C.D. Cal. 2014) (guaranty from insolvent debtor cannot support separate classification)

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• Other courts have rejected the view that a third-party source of recovery, as a matter of law, mandates separate classification. See In re AOV Indus., Inc., 792 F.2d 1140 (D.C. Cir. 1986); In re 4th St. East Investors, Inc., 2012 WL 1745500 (Bankr. C.D. Cal. May 15, 2012); In re 18 RVC, L.L.C., 485 B.R. 492 (Bankr. E.D.N.Y. 2012); In re Quigley Co., 377 B.R. 110 (Bankr. S.D.N.Y. 2007).

• In In re Marlow Manor Downtown, L.L.C., 2013 WL 5567171 (Bankr. D. Alaska Oct. 9, 2013), the court rejected separate classification of note, which was to be paid from available cash flow (with balloon payment due at maturity), finding that the claim was substantially similar to claim under separate note and general trade claims.

• In Polite Enters Corp. v. North American Safety Prods., Inc., 2014 WL 321668 (N.D. Il. Jan. 29, 2014), the court upheld separate classification of ongoing trade creditors from other unsecured creditors, even though the same treatment was afforded to both classes.

• In Akinpelu, 530 B.R. 822 (Bankr. N.D. Ga. 2015), the court rejected separate classification of the holder of an unsecured deficiency claim, finding that the debtor had failed to provide a business justification. The court rejected the distinction that the deficiency claim was a business debt in contrast to the other debts which were consumer debts. The court also rejected the fact that the deficiency claim was backed by a third-party guaranty insofar as the debtor had failed to provide facts establishing the viability or character of the subject guaranties.

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Indubitable Equivalence

• In re River East Plaza, LLC, 669 F.3d 826 (7th Cir. 2012)

– Finding that substitute collateral of 30 year Treasury bonds was not indubitable equivalent of mortgage lien on real estate property of equivalent value due to different risk profiles of the collateral.

• In re Investors Lending Group, L.L.C., 489 B.R. 307 (Bankr. S.D. Ga. 2013)

– Holding that partial “dirt for debt” plans can constitute indubitable equivalence, but recognizing that valuation must be conservative.

– Finding that properties proposed to be surrendered were not of sufficient value to satisfy indubitable equivalence, but giving debtor opportunity to amend plan to provide for surrender properties of a greater/sufficient value.

• In re CRB Partners, L.L.C., 2013 WL 796566 (Bankr. W.D. Tex. Mar. 4, 2013)

– Finding that partial “dirt for debt” plan did not satisfy indubitable equivalence, recognizing the importance of providing the creditor with a sufficient collateral cushion.

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Indubitable Equivalence (cont’d)

• In re Sugarleaf Timber, 529 B.R. 317 (M.D. Fla. 2015)

– Approving “dirt for debt” plan in view of equity cushion of $4.6 million (in respect of $30.3 million property value).

• In re Colony Beach and Tennis Club, Inc., 508 B.R. 468 (Bankr. M.D. Fla. 2014), appeal dismissed sub nom. Colony Lender, LLC v. Breakpointe, LLC, 2015 WL 3689075 (M.D. Fla. June 12, 2015)

– Holding that deferred surrender of collateral without compensation for risks arising from the delay do not provide indubitable equivalence.

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Cramdown Rules and Setting Interest Rates:

Strategies for Debtors and Lenders

July 15, 2015

Gary L. Kaplan

212.859.8812

[email protected]

These materials were gathered for instructional purposes and do not represent the official position of Fried, Frank, Harris, Shriver & Jacobson LLP or any of its partners, counsel, associates,

or employees, including the presenters, nor do they constitute legal advice applicable to any specific matter.

In addition, any forms or documents included in these materials should not be considered as models for any particular matter, nor should they be relied on as being applicable to any specific

legal matter.

© 2015 Fried, Frank, Harris, Shriver & Jacobson LLP

VALUATION ISSUES

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Valuation Issues – General

While valuation is present in almost every stage of a bankruptcy case, valuation

is particularly relevant for secured creditors. Under 1129(b)(2)(A), a court may

confirm a plan notwithstanding the rejection of an impaired class of secured

claims if the plan (1) does not discriminate unfairly and (2) is fair and equitable

with respect to each nonaccepting, impaired class.

Valuation is a crucial element of the fair and equitable analysis.

A secured class that fails to receive full payment will often object to confirmation

and argue that the plan is not fair and equitable because the plan proponent’s

valuation undervalued the assets.

In addition, oversecured creditors are entitled to post-petition interest and

payment of reasonable fees and expenses.

Valuation Issues – General

The methods of valuation will necessarily vary based on, among other things,

circumstances of the case,

the company and its business,

the company’s projections,

the industry in which the company competes and

expert testimony regarding each of the above.

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Types of Valuation

Going Concern Value

Going concern refers to a business with some sort of future or a commercial

enterprise actively engaging in business with the expectation of indefinite

continuance.

Assets of a going concern may be valued based on their present or projected

use and their current or future contribution to the production of revenues and

profits and may be discontinued for risk and the time value of money.

Liquidation Value

Assumes no future or a limited future for an asset’s relationship to a business.

Asset is valued at how much it will bring at a sale less the costs and expenses

associated with disposition.

In re SW Boston Hotel Venture, LLC – Timing of Valuation

Prudential Ins. Co. of Am. v. City of Boston (In re SW Boston Hotel Venture,

LLC), 2014 U.S. App. LEXIS 6768 (1st Cir. Apr. 11, 2014).

Court addressed the timing of the valuation of collateral and claims for the

purpose of determining a secured creditor’s entitlement to postpetition interest

under section 506(b) of the Bankruptcy Code.

Section 506 determines the amount of a secured claim and under section

506(b), an oversecured creditor is entitled to postpetition interest and

expenses.

Court stated that “[a]lthough §506(b) dictates how courts should determine

secured status and collateral value, it does not specify the time as of which

these determinations should be made.”

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In re SW Boston Hotel Venture, LLC (cont.)

Court stated that courts have been split between a “single-valuation” approach,

where determination of oversecurity for section 506(b) purposes occurs at a fixed

point in time, and a “flexible” approach, where the bankruptcy court has discretion

to determine the appropriate measuring date based on the circumstances of the

case.

Court agreed with the bankruptcy court and Bankruptcy Appellate Panel’s

(“BAP”) holding that the flexible approach applied for the circumstances

presented in the case and that the hotel sale date was the best evidence of its

value.

However, the court overturned the BAP’s finding that the sale price

established that the creditor was oversecured throughout the pendency of the

bankruptcy and instead held that the creditor was only oversecured and

entitled to post-petition interest from the sale date through the effective date.

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Final Report of the ABI Commission1 – Valuation Recommendations

In its final report, the ABI Commission recommended that the method of valuation be

informed by the overall purpose of the valuation at issue.

For example, the ABI Commission suggested using the following valuation methods

under each of the given purposes:

Adequate Protection – “foreclosure value” of the interest as of the time of the request for

adequate protection or automatic stay relief

Plan Distribution -“reorganization value” of the collateral

the term “reorganization value” means, the enterprise value attributable to the

reorganized business entity, plus the net realizable value of its assets that are not

included in determining the enterprise value and are subject to subsequent disposition

as provided in the confirmed plan.

Sale of Substantially All Assets (“363” Sale) - enterprise sale price

1 Published by the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 (the “ABI Commission”).

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CRAMDOWN INTEREST RATE POST-TILL

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Till v. SCS Credit Corp. – Background

Till v. SCS Credit Corp., 541 U.S. 465 (2004).

In a chapter 13 bankruptcy case, the Supreme Court considered different

methods for calculating the cramdown interest rate, ultimately holding that the

“prime plus” rate (also known as the “formula rate”) best comports with the

purposes of the Bankruptcy Code.

The prime plus rate looks to the national prime rate and adjusts the rate to

account for the greater nonpayment risk that bankrupt debtors typically pose.

Factors courts should look to include

The probability of plan failure,

The rate of collateral depreciation,

The liquidity of the collateral market and

The administrative expenses of enforcement.

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Till v. SCS Credit Corp. – Prime Plus Rate

Courts are required to “hold a hearing at which the debtor and any creditors

may present evidence about the appropriate risk adjustment.”

Court found that 9.5% was an appropriate interest rate in the case, which

consisted of a 1.5% risk adjustment on the 8% national prime rate.

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Till v. SCS Credit Corp. – Efficient Market Rate

In addition, in footnote 14 of the opinion, the court also introduced the

“efficient market rate” when it noted that while there is no free market of willing

cramdown lenders because every cramdown loan is imposed by a court over

the objection of the secured lender, the same is not true in the chapter 11

context, where numerous lenders advertise financing for chapter 11 debtors in

possession.

Specifically, the court noted that in contrast to the chapter 13 context

where there is no market, and therefore courts “ask only what rate will

fairly compensate a creditor for its exposure,” “[w]hen picking a cram down

rate in a Chapter 11 case, it might make sense to ask what rate an efficient

market would produce.”

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Till v. SCS Credit Corp. – Uneven Application

Courts have unevenly applied Till in cramdowns of secured lenders in chapter 11

cases, focusing primarily on the evidentiary requirements suggested in footnote

14 in determining what rate an efficient market would produce.

Due to the difficulties in proving an efficient market, most courts appear to hold

that a formula rate applies unless there exists an efficient lending market for the

proposed exit financing.

Based on the case law, the interest rate determination will ultimately depend on,

among other things, the circumstances of the case, litigation posture and

jurisdiction and expert opinion.

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In re American Homepatient, Inc. – Coerced Loan Theory

Bank of Montreal v. Official Comm. of Unsecured Creditors (In re American

Homepatient, Inc.), 420 F.3d 559 (6th Cir. 2005).

In the initial circuit court case to address Till, the court approved a pre-Till

bankruptcy court finding of an interest rate based on the coerced loan theory.

Under the coerced loan theory, courts “treat any deferred payment of an

obligation under a plan as a coerced loan and the rate of return with

respect to such loan must correspond to the rate that would be charged or

obtained by the creditor making a loan to a third party with similar terms,

duration, collateral and risk.”

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In re American Homepatient, Inc. (cont.)

After the court declined to “adopt Till’s endorsement of the formula approach for

Chapter 13 cases in the Chapter 11 context,” the court took no issue with the

bankruptcy court’s methodology and use of the coerced loan theory, noting that

Till “pointed out that, if anything, the coerced loan theory ‘overcompensates

creditors.’”

The Sixth Circuit declined to “adopt Till’s endorsement of the formula approach

for Chapter 13 cases in the Chapter 11 context.” Instead, the court stated that

the “the market rate should be applied in Chapter 11 cases where there exists

an efficient market” and in the event that there is no efficient market, “then the

bankruptcy court should employ the formula approach endorsed by the Till

plurality.”

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In re Rocky Mt. Land Co. LLC – Two-Step Process

CRE/ADC Venture 2013, LLC v. Rocky Mt. Land Co., LLC (In re Rocky Mt. Land

Co. LLC), 2014 Bankr. LEXIS 1370 (Bankr. D. Colo. Apr. 3, 2014).

Recently, a court reaffirmed the two-step process set forth by In re American

Home Patient for determining the appropriate interest rate in a chapter 11

case:

First, a court should assess whether an efficient market exists.

If it does, the court should apply the market rate.

If it does not, the court should apply Till’s prime-plus formula rate.

The court further noted that “[t]he evidentiary burden for establishing an

appropriate interest rate under Till falls ‘squarely on the creditors.’”

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Good v. RMR Investments, Inc. – Presumptive Contract Approach

Good v. RMR Investments, Inc., 428 B.R. 249 (E.D. Tex. 2010).

Court stated that footnote 14 of Till suggests that “while the formula approach may be

applied in the Chapter 11 context, its application is not required.”

Noting that Till is a plurality opinion “and therefore does not necessarily reflect the rule

for calculating cramdown interest in all circumstances,” court upheld bankruptcy

court’s decision to use the default contract rate to calculate post-confirmation interest

in the case of a solvent debtor.

The bankruptcy court had arrived at the default contract rate by applying the

presumptive contract approach. Under the presumptive contract approach,

“[w]hen a debtor is solvent, [] the presumption is that a bankruptcy court’s role is

merely to enforce the contractual rights of the parties, and the role that equitable

principles play in the allocation of competing interest is significantly reduced.”

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In re North Valley Mall, L.L.C. – Blended Rate Approach

In re North Valley Mall, LLC, 432 B.R. 825 (Bankr. C.D. Cal. 2010).

Court noted that a shopping center “is valued very differently” from a truck in a

chapter 13 case such as in Till and that a “blended rate” approach is “the

approach best utilized in a commercial real estate case.”

Court applied the analysis from a pre-Till case Pacific First Bank v.

Boulders on the River, Inc., 164 B.R. 99 (9th Cir. B.A.P. 1994), which used

a blended rate comprised of two tranches, “a first level comprised of what

could be roughly called ‘market rate’ loans on then standard terms…and

then a mezzanine tranche.”

Drawing upon and analyzing expert testimony, court settled on a rate that

blended the rates of three separate tranches, a senior initial tranche, a

mezzanine tranche and an equity tranche.

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In re Tex. Grand Prairie Hotel Realty, LLC

Wells Fargo Bank N.A. v. Tex. Grand. Prairie Hotel Realty, L.L.C. (In re Tex.

Grand Prairie Hotel Realty, L.L.C.), 710 F.3d 324 (5th Cir. Tex. 2013).

Fifth Circuit applied Till’s prime plus approach, but declined “to tie bankruptcy

courts to a specific methodology as they assess the appropriate Chapter 11

cramdown rate of interest.”

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In re MPM Silicones, LLC (“Momentive”) – Overview

In re MPM Silicones, LLC, 2015 U.S. Dist. LEXIS 66420 (S.D.N.Y. May 4, 2015).

District Court affirmed bankruptcy court opinion that adopted Till’s “formula”

approach using the 7-year U.S. Treasury note rate as the risk-free base rate

and rejected coerced loan theory and efficient market approach.

Noteworthy because decision permits chapter 11 debtor to compel classes of

unwilling secured creditors to receive replacement notes with below-market

interest rates in full satisfaction of their claims.

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In re MPM Silicones, LLC – Formula Approach

Affirmed the bankruptcy court’s use of Till formula approach to determine that present value

test in section 1129(b)(2)(A)(i)(II) is satisfied with an interest rate of (i) a risk-free base rate,

plus (ii) a risk premium that reflects only the repayment risk associated with the debtors (i.e.,

the interest rate need not include any profits, costs or fees).

Rejected efficient market approach reasoning that the approach

Imposes significant evidentiary costs,

Aims to make each creditor whole rather than ensure debtor’s payments have required

present value,

Overcompensates creditors by accounting for factors such as lenders’ transaction costs

and profits that are not relevant in chapter 11 context and should not be reflected in

interest rate.

Affirmed bankruptcy court’s election of 7-year U.S. Treasury note rate as risk-free base rate

instead of national prime rate, finding that bankruptcy court was not required to use national

prime rate as base rate.

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Final Report of the ABI Commission – Cramdown Interest Rate Recommendations

The ABI Commission made the following recommendations:

Courts should not use the Till formula approach (prime rate plus 1-3%) to

determine present value of deferred cash payments.

Instead, if possible, courts should adopt the market rate approach.

If a market rate cannot be determined, courts should use an “appropriate risk-

adjusted rate” reflecting the actual risk of extending credit to the debtor, the

economic realities, cost of capital to comparable companies, etc.

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