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BANKRUPTCY LAW
The Importance of ‘Till’
By Craig Rankin and Christopher Alliotts
O
n may 17, the U.S. Supreme
Court issued its decision in Till v.
SCS Credit Corp., 124 S. Ct. 1951.
In that case, consumer debtors
had purchased a used truck pur-
suant to a financing agreement by which
they agreed to pay an annual interest rate of
21%. As part of their Chapter 13 plan, the
debtors proposed to pay interest to the
finance company on account of its lien
against the truck, which was worth $4,000,
at the rate of 9.5%. Over the finance
company’s objection that the interest rate
did not accurately reflect the present value of
its security interest in the truck, the
bankruptcy court confirmed the debtors’
plan of reorganization, and the finance
company appealed.
The question presented in this case was
by which method a court should calculate
the rate of interest that must be paid to a
secured creditor when allowing a debtor to
“cram down” a plan of reorganization. A
cram down occurs when the bankruptcy
court confirms a plan of reorganization over
the objection of a secured creditor that it is
being deprived of its contractual right to
possession of the collateral and is, instead,
being provided with the promise of install-
ment payments over time. Such payments
are supposed to equal or exceed the “value,
as of the effective date of the plan,” of the
allowed amount of such claim.
The decision in Till is important for two
Craig Rankin is a partner at Los Angeles-based
bankruptcy boutique Levene, Neale, Bender,
Rankin & Brill. Christopher Alliotts is counsel
to the Menlo Park, Calif., office of Los Angeles-
based SulmeyerKupetz.
MONDAY, SEPTEMBER 6, 2004
reasons. First, even though Till is a consumer
case under Chapter 13 of the Bankruptcy
Code, there is a comparable version of the
cram down provision in Chapter 11, which
applies principally to corporate reorganiza-
tions. Thus, the decision will have a signifi-
cant impact on business cases throughout
the country. Second, interest rates in the
current economic cycle have apparently
bottomed out. With interest rates on the
rise, it is important for debtors and creditors
to know to what extent a court’s interest rate
calculation will affect their claims in a
bankruptcy case.
The Supreme Court’s description of the
decisions by the lower courts demonstrates
the divergence of opinions on the subject.
As the case made its way through the lower
courts, each employed a different approach
for calculating what it believed was the
appropriate interest rate. Like the courts
below, the Supreme Court also failed to form
a consensus. As a result, we are left to
ponder the different approaches set forth in
the plurality opinions.
A review of the approaches
by the various courts
The bankruptcy court applied the
formula rate approach in setting the interest
rate in the debtors’ plan of reorganization.
The starting point in determining this
rate is the national prime rate, which was
8% at the time. The court then augmented
this rate to account for the additional risk
of nonpayment posed by borrowers
in a similar financial condition to the
debtors. After considering evidence (includ-
ing expert testimony) of what those risks
were and the role of the bankruptcy process
in assessing that risk, the court set the
interest rate at 9.5%.
On appeal, the district court reversed.
It held that the 7th U.S. Circuit Court
of Appeals required application of the
forced loan approach. Under that test, the
court must consider what interest rate
the creditor could obtain if it had foreclosed
on its loan, sold the collateral and reinvested
the proceeds in loans of comparable duration
and risk. Based upon the secured creditor’s
unrebutted testimony in the case, the
district court determined that the rate
should be 21%.
On further appeal, the 7th Circuit
adopted the contract rate approach, which
was characterized as a modified forced loan
analysis. Beginning with the forced loan
rate, the court looked to the rate set in the
prebankruptcy contract between the parties.
Either party could then object and seek to
have a higher or lower rate applied based
upon the particular circumstances of the case
and how they affect the risk of nonpayment
under the proposed reorganization plan.
The 7th Circuit’s decision was not
unanimous. The dissenting opinion advocat-
ed utilizing either the formula approach or a
“cost of funds” approach. Under the latter,
the court would have to determine what the
THE NATIONAL LAW JOURNAL
cost would be to the creditor to obtain the
cash equivalent of the collateral from an
alternative source. The dissenter also
thought it appropriate to consider the extent
to which the creditor had already been
compensated for its risk of nonpayment in
making the loan.
On further appeal, a plurality of the
Supreme Court reversed and remanded.
Justice John Paul Stevens delivered an
opinion in which justices David H. Souter,
Ruth Bader Ginsburg and Stephen G.
Breyer joined (and Justice Clarence Thomas
concurred). In determining which approach
to use, these justices were guided by three
considerations. First, the Bankruptcy Code
contains many provisions that require a
present-value analysis and there should be a
uniform method for doing so. Second, the
method should reflect the risks and
protections offered by the bankruptcy
process. Third, it should be familiar to the
financial community, minimize the need for
expensive evidentiary proceedings and
adequately compensate secured creditors on
an objective basis for the time value of their
money and risk of default.
With these considerations in mind, the
plurality adopted the formula approach. It
rejected the other approaches as being too
complicated, imposing significant evidentiary
costs and improperly focusing on the
circumstances of individual creditors as
opposed to an objective present-value analysis.
Indeed, the plurality favored the formula
approach because it begins by looking to the
national prime rate, which is reported daily
in the press and reflects the financial
market’s estimate of the amount a
commercial bank should charge a
creditworthy borrower to compensate for
the opportunity costs of the loan, the risk
of inflation and the relatively slight risk
of default. The bankruptcy court will then
have to adjust the rate to reflect such factors
as the circumstances of the estate, the nature
of the security and the duration and
feasibility of the reorganization plan. The
result is that the analysis will begin with a
low estimate of the proper rate of interest
and place the burden squarely on the
creditor to have that rate adjusted upward.
Thomas concurred in the plurality’s
decision on separate grounds. As a matter of
strict statutory construction, he stated that
there was no requirement in § 1325 of the
Bankruptcy Code that a secured creditor be
compensated for the risk of nonpayment
because such risk is included within the
consideration of the value of its secured
claim. Contrary to the plurality and dissent,
Thomas believed that the statute only
requires a straight present-value analysis and
that the prime rate, without adjustment, was
sufficient to compensate a secured creditor
for the time value of money. Because the
debtor’s plan provided for payments in excess
of this amount, he would have upheld
confirmation of the debtor’s plan.
Even though it was a
consumer case, the
high court decision will
have a major impact on
business cases
throughout the
country.
The dissenting justices
preferred the contract rate
Justice Antonin Scalia, with whom Chief
Justice William H. Rehnquist and justices
Sandra Day O’Connor and Anthony M.
Kennedy joined, filed a dissenting opinion
advocating the contract rate. Their prefer-
ence for the contract rate was premised upon
two assumptions. The first was that financial
markets, including the subprime market
involved in this case, were competitive and
largely efficient. The second was that risks
associated with a Chapter 13 plan are at least
as great as at the time of the initial loan. The
inference to be drawn from these assump-
tions is that the contract rate reasonably
reflects the actual risk at the time of borrow-
ing and that the same risk persists in the
bankruptcy case.
The dissent therefore opined that the
contract rate is a decent estimate, or at least
MONDAY, SEPTEMBER 6, 2004
the lower bound, of the appropriate interest
rate in a cram down and should therefore be
the presumptive rate. Either party would
have the opportunity to prove that a higher
or lower rate should apply. The dissent’s
approach has some appeal to it. Foremost of
its advantages is that the contract rate
presumption would eliminate the need for a
fact-intensive inquiry except in cases in
which one party disputed the actual contract
rate. At the same time, the approach is
flexible enough to allow parties to alter
contract rates based upon significant
changes in the financial markets.
Of course, the contract rate approach
appears to be somewhat draconian when
applied to the debtors in Till. But that is
due in part to the fact that we are in an era
of interest rates that have gone as low as they
could virtually go. Thus, the disparity
between the prime rate and the contract rate
is so great that it is difficult to find a middle
ground. Certainly, 9.5% seems too low under
the circumstances.
With interest rates on the rise, however,
the contract rate approach may provide a
favorable presumption to debtors in the
future. If they continue to rise, many
contract rates will soon be lower than cur-
rent market rates. In that situation, secured
creditors will then bear the burden of
demonstrating that the contract rate is too
low and should be adjusted upward.
As it is, the plurality’s more traditional
formula approach will probably continue
to be the method applied by bankruptcy
courts. However, it should not be forgotten
that the method is only a means of
reaching the ultimate end of accurately
compensating a creditor in a cram down
situation. Keeping that objective in mind,
application of a particular method should
not lead to results as disparate as the 9.5% to
21% spread in Till. NLJ
This article is reprinted with permission from the
December 20, 2004 edition of THE NATIONAL
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