The U.S. Supreme Court’s plurality decision in the Chapter 13 case, Till v. SCS Credit Corp., could be one of the most significant Supreme Court decisions on reorganization since the passage of the Bankruptcy Code. Many bankruptcy and appellate courts have found the Till decision to be “instructive and informative” in guiding the courts in determining cram down rates for Chapter 11 bankruptcy cases. But the question for experts is: What information do you need to determine the appropriate cram down rate? This article will discuss the Till factors, circumstances of the estate, the nature of the security, and feasibility, which guide experts in their efforts to assessing the appropriate cram down rate.
“The U.S. Supreme Court’s plurality decision in Till v. SCS Credit Corp.[1] could be one of the most significant Supreme Court decisions on reorganization since the passage of the Bankruptcy Code.”[2] In it, the Supreme Court provided a clear path in Chapter 13 (personal) bankruptcy cases for a debtor wanting to provide a lien securing the claim (as in Till, a pickup truck) and a promise to make deferred cash payments in the future “whose total value, as of the effective date of the plan, is not less than the allowed amount of the claim.”[3] Rather than returning the property or obtaining the creditors acceptance of the bankruptcy plan, this alternative offers what is called the “cram down option” because this option may be forced over the claim of the lien holder’s objection.
Plans that involve the cram down power often provide for installment payments over a period of years rather than a single payment. In such circumstances, the amount of each installment must be calibrated to ensure that, over time, the creditor receives disbursements whose total present value equals or exceeds that of the allowed claim. The Till decision discusses the appropriate approach to use when determining the interest rate to be charged on the deferred cash payments. This interest rate in commonly referred to as the cram down rate.
Many bankruptcy and appellate courts have found the Till decision to be “instructive and informative” in guiding experts and courts in determining cram down rates for Chapter 11 bankruptcy (business and personal high valued estates) cases.[4]
The Till decision calls for using the formula approach for determining the cram down rate. The decision notes that the formula approach has none of the defects found in the coerced loan, presumptive contract, and cost of funds rate approaches. “Taking a cue from ordinary lending practices, the [formula] approach begins by looking to the national prime rate, reported daily in the press, which reflects the financial market’s estimate of the amount a commercial bank should charge to a creditworthy commercial borrower to compensate for the opportunity costs of the loan, the risk of inflation, and the relatively slight risk of default. Because bankrupt debtors typically pose a greater risk of nonpayment than solvent commercial borrowers, the approach requires a bankruptcy court to adjust the prime rate accordingly.”[5] The Supreme Court decided on a prime plus range between prime plus one percent and prime plus three percent as appropriate for a cram down rate.
But the question for experts is: “What information do you need to make the appropriate adjustment to the prime rate?” The Supreme Court provided guidance in the Till decision. “The appropriate size of that risk premium depends on, of course, such factors as the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization plan.”[6] These factors are particularly important when dealing with commercial real estate bankruptcy. The factors should be taken in the order listed. The expert should then allow each one to build on top of each other the risk assessment of the debtor seeking a cram down solution.
Circumstances of the Estate
The circumstances of the estate may be defined as the specific financial, legal, and personal and/or physical conditions surrounding the person or business’s property, assets, and debts. Commercial real estate bankruptcy matters may range from one property owned by one person or a group of individuals to numerous properties under management by a single firm. Regardless of the size, the same review must be made of the estate.
When receiving such an assignment, the expert will know the debtor has filed for Chapter 11 bankruptcy protection. Therefore, the expert should be prepared to find problems with cash flow and poor loan-to-value ratios. If the estate contains several properties, the expert may need to consider the contingent liabilities. In other words, the debtor may have one property in bankruptcy with others struggling. Should the other struggling properties enter bankruptcy, the debt on those properties may be consolidated into one large bankruptcy case showing greater debt and even worse loan-to-value ratios.[7]
If there are multiple properties, the expert may find that the majority or all the properties have sought Chapter 11 protection. In this situation, each property should be reviewed to assess how its bankruptcy impacts the group.
In some cases, the debtor may have several LLC entities, each one the owner of a specific property. The expert may find that one property may be in bankruptcy while the others are solvent. The expert may also find that the solvent properties are having to transfer funds to the insolvent property as financial assistance. In that situation, the expert should determine how the impact of this one property’s bankruptcy is weakening the entire group of properties.
This process helps the expert understand the circumstances of the overall estate and its ability to manage and move forward out of bankruptcy or not.
Nature of the Security
The nature of the security addresses the collateral securing the creditor’s loan or claim against the debtor. In most situations, the claimant creditor will be a lender; a bank, financial institution, individual, or group of individuals. The creditor will be seeking to foreclose and take the property for future management or sale or seek a greater cram down rate.
In a real estate bankruptcy matter, the condition of the property is critical. The expert should consider the property in its “as is” condition. Then he or she should consider any repairs, renovations, and/or improvements needed to make the property usable or marketable. Most financial experts will need to rely on real estate appraisals which should show values for the property “as is” and “as stabilized.” The information in these appraisals will help in identifying the costs for improving the property (if needed), managing the property, and comparative operating costs for similar properties in the bankrupt property market. The appraisal should also provide current information on leasing or rental rates for comparative properties in the bankrupt property market.
This information can be compared with the data gathered on the bankrupt property. This data can be gathered from the property’s financial and operating information, and projections reported in the bankruptcy reorganization plan. In a recent assignment, it was found that projections for operating costs identified in the appraisal for the bankrupt company, the rental revenue for 100% occupancy under the owner’s current rate structure adjusted for the market’s stabilization rate (average occupancy rate of 97%), and its monthly debt service based on the reorganization plan submitted to the bankruptcy court, the property could not create positive cash flow from its operations. Even with 100% occupancy, its operating costs, ad valorem taxes, and debt service could not be covered.
Taking this information and comparing it to the spreadsheets in the bankruptcy reorganization plan comes as a part of the next factor: feasibility of the reorganization plan.
Feasibility of the Reorganization Plan
Feasibility means how possible, practical, or likely a plan or project is to succeed. To be more specific, it is “a comprehensive analysis of the practicality and potential success of a proposed project that assess costs, benefits, risks, and necessary resources.”[8]
Each debtor provides the court with a bankruptcy reorganization that includes spreadsheets showing their feasibility calculations. These calculations usually run for five years, by the end of which most of the smaller valued claims related to the bankruptcy will be paid. In most cases, the debtor will also provide a disclosure statement which will contain additional information as to the assumptions and adjustments made for the projected five-year payout, and revenue and expenses allowing for a successful ongoing operation.
Based on the information gathered while assessing the circumstances of the estate and the nature of the security, an expert should be ready to analyze the debtor’s projections. If the expert has been hired by the debtor’s attorney(s), he or she may be asked to adjust and enhance the spreadsheets or at a minimum, show areas of concern for the debtor’s projections. If the expert has been hired by the creditor’s attorney(s), he or she may be asked to prepare a report and then testify as to what is wrong with these projections, and in conclusion calculate a greater cram down rate. In the end, the expert may opine that the plan is not feasible and the reorganization plan, relative to the payments to this creditor, should not be approved.
Cram Down Rate
Should the plan appear feasible, the expert will be asked to provide testimony and perhaps a written report as to the appropriate cram down rate. The formula approach used to develop the cram down rate is based on the build-up method commonly used in the financial and business valuation fields. However, in this situation, the expert is expected to begin the build-up with the prime lending rate not the risk-free rate. To the prime lending rate, the expert is expected to add risk factors that will total between 1% and 3% greater than the prime lending rate.
As an example, if the prime lending rate is 5%. The Till range for the cram down rate would be between 6% to 8%. Experts may argue for greater or less cram down rates than those within the range. But it must be remembered, the Supreme Court in its plurality believed that range to be appropriate.
During the period of the COVID-19 pandemic, I argued that the Till range did not reflect current market conditions because the prime lending rate was being kept artificially low. I found some courts accepting this argument, others did not.
Over the past six years, I have begun to show the cram down rate risk premia based on the three factors discussed in this article. I show the current prime lending rate. I then show the circumstances of the estate, nature of the security, and feasibility. Risk percentages are shown next to each factor. In some cases, there may be no or minimal risk with the circumstances of the estate but a large factor with feasibility based on the nature of the security and the projected cash flow in the reorganization plan. When totaled, the sum is my cram down rate.
Conclusion
The expert must follow his or her education, training, and experience to analyze the Till factors and if the data support feasibility, calculate the cram down rate. Not many experts work in the Chapter 11 bankruptcy field. It is a niche market and not one that will fill up an expert’s work schedule. The work can be complicated but fulfilling. In the end, this type of work provides a good addition to an expert’s traditional litigation support package of services and helps separate that person from the crowd.
[1] Till Et Ux. v SCS Credit Corp., 541 U.S. 465 (2004)
[2] American Bankruptcy Institute, Journal Dec/Jan 2005, Adrienne Walker, Richard Mikels
[3] Till, 541 U.S. 465, 468–469, (2004)
[4] In re: Mirant Corp, 334 B.R. 800, (Bankr. N.D. TEX 2005), In re: SJT Ventures, LLC, 441 B.R. 248 (Bankr. N.D. Tex, 2010, In re: Texas Grand Prairie Hoel Realty, LLC, 710 R.3d; 2013 U.S. App. LEXIS 4514; 57 Ct. Dec. 177
[5] Till, 541 U.S. 465, 478–479
[6] Till, 541 U.S. 465, 479
[7] Loan-to-value (LTV) ratios may vary depending on the type of property (multi-family, retail shopping, warehouse). At loan closing, LTV ratios are commonly between 70% and 75%. The lender/creditor expects the LTV ratio for these loans to improve over the life of the loan. In bankruptcy, LTV ratios may increase to greater than 100%.
[8] Feasibility, Investopedia
Allyn Needham, PhD, CEA, is a partner at Shipp Needham Economic Analysis, LLC, a Fort Worth-based litigation support consulting expert services and economic research firm. Prior to joining Shipp Needham Economic Analysis, he was in the banking, finance, and insurance industries for over 20 years. As an expert, he has testified on various matters relating to commercial damages, personal damages, business bankruptcy, and business valuation. Dr. Needham has published articles in the areas of financial and forensic economics, and provided continuing education presentations at professional economic, vocational rehabilitation, and bar association meetings. In 2021, Dr. Needham received a NACVA Outstanding Member Award. He is also a member of NACVA’s QuickRead Editorial Board.
