Bankruptcy Plans Get a Lift

In Till v. SCS Credit Corp., 124 S.Ct. 1951 (May 17, 2004), the Supreme Court handed down a very favorable ruling for bankruptcy plans of reorganization. A Chapter 13 Bankruptcy Plan does not have to automatically give a secured creditor the contract rate of interest on its debt; but in most cases the debtor’s plan can force the secured creditor to take little more than the prime rate. The Till decision will probably also apply to Chapter 11 Plans, which should lead to increased opportunities for owners of businesses and real estate to negotiate with their secured creditors.

The Supreme Court considered what interest rate a secured creditor is entitled to from a Bankruptcy Reorganization Plan. The Court considered four alternate approaches: (1) The formula approach, which takes the national prime rate and adds on for the risk of non-payment; (2) The coerced loan approach which is the rate the lender loans out its money for this type of risk; (3) The presumptive contract rate approach which starts at the contract rate between the debtor and creditor and gives the debtor and creditor the opportunity to argue it should be less or more; and (4) The cost of funds approach which is what it costs the lender to obtain funds.

In a plurality opinion, Justice Stevens, joined by three other justices, held that the formula approach should govern primarily because that approach is simpler and would impose fewer evidentiary costs on the parties. Justice Thomas going his own way ruled that the Bankruptcy Code did not require any debtor-specific risk adjustment to the prime rate. Thus, there was no clear majority on exactly which approach to apply, and the only clear result from the opinion was that the coerced loan, presumptive contract rate, and cost of funds approaches do not apply. As a practical matter, this means that the formula approach is now the standard in Chapter 13 cases and probably in Chapter 11 cases. Good news for debtors.

The formula approach, by starting with the lower prime rate and placing the burden of proof for an upward risk adjustment on the creditor, reduces a secured creditor’s leverage. A debtor can simply propose a reorganization plan that provides for interest to be paid at the prime rate and force the creditor to prove a higher rate is appropriate.

In cases where a debtor is straddled with high interest rate secured loans, the scales of justice have tipped into debtor’s favor. Unless the creditor can come forward with evidence to adjust upward the interest rate, the debtor wins.

We want to congratulate Richard Reynolds on applying similar arguments in the successful plan of reorganization in IN Re Southbay Dental Services.

If you have any questions please contact Richard J. Reynolds at (949) 474-6900 or Frederick E. Turner at (949) 474-6900.