Fair Equivalents and Market Prices: Bankruptcy Cramdown Interest Rates

• Jurisdiction: United States,Federal
• Publication year: 2016
• Citation: Vol. 33 No. 1

Fair Equivalents and Market Prices: Bankruptcy Cramdown Interest Rates

Bruce A. Markell

FAIR EQUIVALENTS AND MARKET PRICES: BANKRUPTCY CRAMDOWN INTEREST RATES

Bruce A. Markell^*

Introduction................................................................................................92

I. The Concept and Exchange Anticipated by § 1129(b)(1)...........94

A. The History of "Fair and Equitable" .......................................... 95

1. The Statutory Origins: §§ 77 and 77B................................... 96
2. Incorporation of Prior Equity Receivership Practice ........... 97
3. "Fair Equivalence" of Value Under the Statute ................... 97
4. The 1978 Code..................................................................... 100

B. Summary: Of "Fair Equivalents" and § 1129(b)(2)'s Examples ................................................................................... 103

1. Don't Pay Too Little............................................................ 104
2. Don't Pay Too Much ........................................................... 104
3. Don't Expect Precision ........................................................ 104

II. The Process of Property Valuation in Nonconsensual Confirmation..................................................................................105

A. Valuing Income Producing Property ......................................... 106

1. Present Value Analysis ........................................................ 106
2. Present Value Analysis and § 1129(b) ................................ 107
3. Present Value and Finance ................................................. 108

B. Valuing Debt Issued in Reorganizations ................................... 108

III. Till and Discount Rates................................................................109

A. Till v. SCS Credit ...................................................................... 109
B. Till and Chapter 11 ................................................................... 111
C. Till's Reference to Efficient Markets ......................................... 112

1. Is There a Market for Cramdown Debt? ............................. 114
2. If There is a Market, Is it Efficient?..................................... 115

a. "Efficient" as Understood by Non-Economists: The Lay View ....................................................................... 115
b. "Efficient" as Understood by Economists.................... 116

IV. Momentive and Chapter 11 ............................................................ 121

[Page 92]

A. The Debtor................................................................................. 123
B. The Secured Parties................................................................... 123
C. Confirmation and Cram Down .................................................. 124
D. Till Adopted; Market Spurned................................................... 126

V. Policy Considerations in Selecting a Discount Rate............. 130

A. The Rejection of a Market Rate as Conclusive Evidence of a Cramdown Interest Rate ............................................................ 130

1. Evidence That Congress Does Not Always Adopt Market Rates in Reorganization ...................................................... 131
2. Protecting Restrictions on Potential Overpayment............. 132
3. The Role of Precision and Expectations.............................. 135

B. Not Irrebuttable, But Not Irrelevant Either............................... 135

Conclusion.................................................................................................. 138

Introduction

Cramdown¹ is messy. It pits a chapter 11 debtor's stakeholders against each other, in a match in which the main issue is the value of what each is to receive under a plan of reorganization. Because cramdown is nonconsensual, any judicial decision involving cramdown must reconcile deeply-held and diverse views as to the value being offered.

Valuation in bankruptcy, in turn, is also messy. courts are often placed in the position of assigning a monetary value to an asset for which there is either no seller or no buyer, and often no market. To complicate matters, these assets are often nothing more than intangible promises of a reorganized debtor;

[Page 93]

promises from an entity that has already broken most of its past promises to its creditors.

Outside of bankruptcy, such promises are routinely valued in the world of finance. In many cases, markets exist in which such promises are traded. Bond markets, for example, exist to trade the promises of bond issuers to pay sums borrowed. Value in these markets is the prices traders are willing to acquire or release these promises.

In bankruptcy reorganization, plan proponents often craft plans of reorganization that compel creditors to trade a promise made before bankruptcy for a promise forged under the plan. The terms may be quite different. Short-term construction loans can transform into medium- and long-term investments; obligations may become collateralized (and vice versa); and debt instruments may morph into equity interests.

In many cases, these transformations are consensual. Section 1129(a) of the Bankruptcy Code (the "Code") provides the plan proponent² with the ability to confirm a plan by persuading classes of stakeholders to vote to adopt the plan. The plan proponent need not convince every creditor or stakeholder; § 1129(a)(8) requires only unanimity of class acceptance, not unanimity of creditor acceptance.³ As a result, if a plan proponent can obtain the positive votes of more than one-half of those creditors voting in a class, and those creditors hold at least two-thirds of the debt voting in that class, the class accepts.⁴ Outvoted creditors in any class, so long as they will receive at least as much in reorganization as they would have in a liquidation,⁵ must accept the plan's treatment, as plan confirmation will discharge their claims in excess of what they receive under the confirmed plan.⁶

This voting process, however, is not cramdown as it is classically understood. Cramdown in the historic sense consists of confirmation over the dissent of an entire class.⁷ To engage in over-generalization, the Code permits such confirmation only if the dissenting class receives payment in full (but not

[Page 94]

more than in full), or if no class junior in priority receives anything.⁸ The deck is stacked in favor of plan proponents, however, because "payment in full" does not have to be payment in cash. It can consist of any sort of "property," including the types of intangible promises that banks, investors, and markets value on a daily basis.⁹

Whether this daily experience can precisely be transferred to cramdown has vexed many. This Article looks not at the policies behind cramdown—that is for another time and place. Instead, this Article looks at the history and legislative policies behind the current state of cramdown, as well as recent attempts to value the promises of a reorganizing debtor. Along the way, it examines Till v. SCS Corp.,¹⁰ a 2004 Supreme Court case of major contention in this area, and Till's recent application in the cramdown confirmation in Momentive Performance Materials Inc. ("Momentive"),¹¹ a large, public-company chapter 11 case.¹²

This examination reveals a gap between (1) the purposes and policies of cramdown as historically understood, and the current contentions; and (2) expectations of hedge funds and other financial players that cramdown rates should be determined by the market—the rates an actual lender would accept in extending credit to the reorganized debtor. Given the history and precedents in the cramdown area, this Article takes the position that Momentive was correct, and that courts should resist using such market-based discount rates in cramdown calculations.

I. The Concept and Exchange Anticipated by § 1129(b)(1)

Section 1129 of the Code governs confirmation of chapter 11 plans of reorganization. Section 1129(a) sets forth sixteen requirements for

[Page 95]

confirmation,¹³ including the consent of each class of creditors or interest holders under the plan. Confirmation of a plan without the consent of all classes is possible, but heavily circumscribed. Section 1129(b)(1) sets forth the requirements. While paragraph (1) relaxes the requirement of unanimous class consent, all other requirements of § 1129(a) remain in place.¹⁴ Thus, to cram down a nonconsensual plan, the plan proponent must, among other things, still propose the plan in good faith;¹⁵ still pay each impaired creditor at least as much as it would receive in a liquidation;¹⁶ still pay all administrative claims in full;¹⁷ and still establish that the plan is economically feasible.¹⁸

In addition, § 1129(b)(1) requires the plan proponent to show that the plan does not discriminate unfairly against the dissenting class, and is fair and equitable as to that class.¹⁹ unfair discrimination is a horizontal equity test; it ensures that a plan does not unduly favor a class having similar priority to the dissenting class simply because the favored class voted for the plan, and the dissenting class did not.²⁰ Although valuation issues can and do arise in the unfair discrimination analysis, those issues are for another time.

This Article focuses on the vertical equity test of § 1129(b)(1): whether a plan is "fair and equitable" as to the dissenting class. That is, it examines how the concept of "fair and equitable" polices the distribution of reorganization value among stakeholders with different nonbankruptcy priorities.

A. The History of "Fair and Equitable"

Undoubtedly, "fair and equitable" is not a crisp, well-defined standard. An examination of its provenance demonstrates, however, that this vagueness was intentional from the beginning. While the statutory origins of the phrase lie in

[Page 96]

the 1933 and 1934 additions of §§ 77²¹ and 77B²² to the Bankruptcy Act of...