Chapter 13 Plan Provisions: The Impact of Till on Payment of Secured Claims

Transcription

1 SOUTHEASTERN BANKRUPTCY LAW INSTITUTE Thirty-Third Annual Seminar on Bankruptcy Law and Rules April 12-14, 2007 Atlanta, Georgia Chapter 13 Plan Provisions: The Impact of Till on Payment of Secured Claims April 12, 2007 Michael J. O Connor, Esq. O Connor, O Connor, Bresee & First, PC 20 Corporate Woods Boulevard Albany, New York 12211

2 Introduction The concept of adequate protection is that the debtor must compensate the lender for the loss in value or depreciation that is caused by the debtor s use of the collateral prior to confirmation of the plan. The adequate protection issue covers the period starting with the bankruptcy petition and ending with the confirmation of the plan. 1 Prior to the enactment of BAPCPA, secured creditors routinely voiced concerns about protecting their interest in their collateral during the interim between the filing of the petition and the time they began receiving payments on their secured claim under the plan. Under the terms of many Chapter 13 plans, secured creditors do not begin receiving payments for months. While waiting for payments to commence, there is a substantial risk to the secured creditor of diminution in value of the collateral without any protection. BAPCPA intended to cure this problem. BAPCPA codified the requirement of adequate protection payments to secured creditors to protect against diminution in the value of their collateral until they began receiving payments on their secured claim. 2 The calculation of adequate protection payments can be an inexact and complex science. Reported decisions indicate formulas ranging from.50 percent to 1.50 percent of the value of collateral per month. BAPCPA has rewritten the rule, requiring that debtor make preconfirmation payments. In order to understand the impact of BAPCPA on adequate protection issues, it is important to understand the three sections of the Bankruptcy Code that are relevant in 1 See Richardo I. Kilpatrick, Selected Creditor Issues Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, 79 Am. Bankr. L.J. 817, 836 (2005) U.S.C. 1326(a)(1)(C)). 1

3 analyzing adequate protection payments. They are set forth hereunder, including the hanging paragraph, which was inserted at the end of Section 1325(a)(9) Payments (a)(1) Unless the court orders otherwise, the debtor shall commence making payments not later than 30 days after the date of the filing of the plan or the order for relief, whichever is earlier, in the amount (A) proposed by the plan to the trustee; (B) scheduled in a lease of personal property directly to the lessor for that portion of the obligation that becomes due after the order for relief, reducing the payments under subparagraph (A) by the amount so paid and providing the trustee with evidence of such payment, including the amount and date of payment; and (C) that provides adequate protection directly to a creditor holding an allowed claim secured by personal property to the extent the claim is attributable to the purchase of such property by the debtor for that portion of the obligation that becomes due after the order for relief, reducing the payments under subparagraph (A) by the amount so paid and providing the trustee with evidence of such payment, including the amount and date of payment (b) Before or at the time of each payment to creditors under the plan, there shall be paid- (1) any unpaid claim of the kind specified in section 507(a)(2) of this title Adequate Protection. When adequate protection is required under section 362, 363, or 364 of this title of an interest of an entity in property, such adequate protection may be provided by (1) requiring the trustee to make a cash payment or periodic cash payments to such entity, to the extent that the stay under section 362 or this title, use, sale, or lease under section 363 of this title, or any grant of a lien under section 364 of this title results in a decrease in the value of such entity s interest in such property; (2) providing to such entity an additional or replacement lien to the extent that such stay, use, sale, lease, or grant results in a decrease in the value of such entity s interest in such property; or (3) granting such other relief, other than entitling such entity to compensation allowable under section 503(b)(1) of this title as an administrative expense, as will result in the realization by such entity of the indubitable equivalent of such entity s interest in such property Confirmation of plan. (a) Except as provided in subsection (b) the court shall confirm a plan if U.S.C. 1326(a)(1)-(b)( emphasis added) U.S.C. 361 (emphasis added). 2

4 (5) with respect to each allowed secured claim provided for by the plan... (ii) the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim... 5 The Hanging Paragraph For purposes of paragraph (5), section 506 shall not apply to a claim described in that paragraph if the creditor has a purchase money security interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day [sic.] preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle (as defined in section of title 49) acquired for the personal use of the debtor, or if collateral for that debt consists of any other thing of value, if the debt was incurred during the 1-year period preceding that filing. 6 There has been some decisional law discussing adequate protection payments since BAPCPA was enacted. 7 Impact of Till on Payment of Secured Claims In order to better understand the impact of Till 8 on payment of secured claims, it is important to review the case law prior to Till. Circuit courts were divided. The Bankruptcy 5 11 U.S.C. 1325(a)(5)(ii). 6 See 11 U.S.C. 1325(a)(9). 7 See, e.g. In re Beaver, 337 B.R. 281 (Bankr. E.D.N.C. 2006). In In re Beaver, the secured creditor filed a pre-confirmation adequate protection motion. The creditor had a security interest in two vehicles owned by the debtor. Judge Small analyzed the requirements of 11 U.S.C. 1326(a)(1)(c) and indicated that 1326(a)(1)(c) contemplated that pre-confirmation payments made by a debtor be made directly to the secured creditor as one way of providing adequate protection. However, Judge Small suggested that the pre-confirmation payments made by the Chapter 13 trustee to the creditor with an allowed claim (proof of claim having been filed) is also an acceptable method of providing adequate protection payments. The court noted a preconfirmation payment of 1 percent of the value of the secured creditor s collateral sufficiently protected the secured creditor. See also In re Bufford, 343 B.R. 827 (Bankr. N.D. Tex. 2006); In re Khadijah Muhammad, Slip. Op. (S.D. Ind ); In re Edekawa Brown, 348 B.R. 583 (Bankr. N.D. Ga. 2006); In re Combs, Slip. Op. (N.D. Ga ); In re Mojica, Slip. Op. (S.D. Ga ). 8 Till v. SCS Credit Corp., 541 U.S. 465, 124 S.Ct. 1951, 158 L.Ed.2d 787 (2004). 3

5 Code has several sections requiring that the value, as of the effective date of the plan, be equal to the allowed amount of the claim. 9 Section 1325(a)(5)(B)(ii) provides that a secured creditor be paid over a period of time and that they receive the amount of its claim by deferred cash payments totaling the value of its claim. In Rake v. Wade, 10 the United States Supreme Court stated that a creditor receives the present value of its claim only if the total amount of the deferred payments includes the amount of the underlying claim plus an appropriate amount of interest to compensate the creditor for the decreased value of the claim caused by the delayed payments. 11 In United Savings Assoc. v. Timbers of Inwood Associates, Ltd., 12 Justice Scalia, writing for the unanimous court, noted that the language set forth in Bankruptcy Code 11 U.S.C. 1129(b)(2)(A)(ii), which is substantially identical to the language in 1325(a)(5)(B)(ii) and at issue here, entitles a secured creditor to present value of its collateral. 13 Pre-Till Theories and Case law: I. Coerced Loan Rate/Contract Rate Theory Several circuit decisions embraced what was known as a coerced loan theory. Interestingly, the origin of the coerced loan theory was not developed by case law but, rather, by editorial comment in Collier on Bankruptcy. The editors, with regard to 11 U.S.C. 1129, argued deferred payment of an obligation under the plan is like a coerced loan, and the rate of 9 See 11 U.S.C. 1129(a)(7); 11 U.S.C. 1129(b)(2); 11 U.S.C. 1225(a)(5)(B)(ii); 11 U.S.C. 523(a)(4); 11 U.S.C. 1325(a)(5) U.S. 464, 113 S.Ct. 2187, 124 L.Ed.2d 424 (1993). 11 Id. at n U.S. 365, 108 S.Ct. 626, 98 L.Ed.2d 740 (1988). 13 Id. at

6 return, with respect to such loan, must correspond to the rate which would be charged or obtained by the creditor making a loan to a third party with similar terms, duration, collateral and risk. 14 Prior to Till, GMAC v. Jones, 15 was the most-often cited Circuit Court decision on cramdown interest rates. 16 The GMAC theory follows the creditors argument that by forcing them to make a loan, they should be entitled to an interest rate that not only preserves the time value of their secured claim (i.e., the value of the collateral), but also compensates them for the lost opportunity cost (i.e., profit and loan administrative costs). The Circuit decisions, while adopting the coerced loan theory, for ease of administration, seem to rely on the contract rate. Some of the decisions suggested that if the contract rate is unacceptable, then the coerced loan rate would be adopted, if it is demonstrated by proof that the interest rate on similar loans is higher than the contract rate. 17 In 1981, Congress proposed an amendment to the Bankruptcy Code, which would have identified the contract rate as the appropriate discount rate. 18 II. Market Rate Theory The Second, Eighth and Ninth Circuits adopted a formula or market rate of interest approach as the appropriate standard in a cramdown under 1325(a)(5)(B)(ii). The Second 14 5 Collier on Bankruptcy, (4)(f)(I)(15th ed.1980)(emphasis added) F.2d 63 (3rd Cir. 1993). 16 David G. Epstein, Don t Go and Do Something Rash About Cram Down Interest Rates, 49 Ala. L. Rev. 435, 451 (1988). 17 See, e.g. Koopmans v. Farm Credit Services of Mid-America, 102 F3d 874 (7th Cir. 1996). See also In re Smithwick, 121 F.3d 211 (5th Cir. 1997); GMAC v. Jones, 999 F.2d 63 (3rd Cir. 1993); United States Carolina Bank v. Hall, 993 F.2d 1129 (4th Cir. 1993); In Re Hardzog, 901 F.2d 858 (10 th Cir. 1990); United States v. Arnold, 878 F.2d 925 (6th Cir. 1989). 18 See H.R. 4786, 97th Cong. 1st Sess. 19(2)(A)

7 Circuit was the only Circuit to directly and expressly reject the forced, or coerced, loan rate as a possible resource of the cramdown interest rate, 19 as the Second Circuit adopted a market rate theory of interest, based on treasury instruments, adjusted with an inflation risk. The court noted that this method of calculating interest is preferable to either the cost of funds approach or the forced loan approach because it is very easy to apply, it is objective, and it will lead to uniform results. 20 The Impact of Till on Cramdown Interest Rates Till was an appeal from the Seventh Circuit. 21 The Seventh Circuit precedent for cramdown interest rates prior to Till was Koopmans v. Farm Credit Services of Mid-America, ACA. 22 Koopmans, the Chapter 12 case, determined that the market rate of interest was the appropriate rate that the creditor could obtain if the creditor had foreclosed and reinvested the proceeds in loans of equivalent duration and risk. Koopmans used a prime rate based on a discount factor, but the Seventh Circuit decision made it clear that this was not the only method to compute the market rate. In the Till case, the debtors, Lee and Amy Till, purchased a used truck for $6,395 and financed the loan at 21 percent interest. The Tills produced evidence at the confirmation of their plan suggesting that the appropriate interest rate should be the prime rate plus a risk premium of 1.5 percent, for a total of 9.5 percent. The Bankruptcy Court agreed with this computation; the 19 Id. at See In re Valenti, 105 F.3d 55, (2d Cir. 1997); see also In re Fowler, 903 F2d 694 (9th Cir. 1990); In re Dowd, 74 B.R. 865 (Bankr. S.D. Iowa 1987), aff d 869 F.2d 1144 (8th Cir. 1989) F.3d 583 (7th Cir. 2002) F.3d 874 (7th Cir. 1996). 6

8 District Court rejected the Bankruptcy Court s findings and determined that the rate of interest would be the original 21 percent contract rate. The Tills appealed to the Seventh Circuit. The Seventh Circuit followed the coerced loan approach endorsed by the Third Circuit in GMAC, 23 and the Firth Circuit in In re Smithwick. 24 The Seventh Circuit concluded in absence of a stipulation regarding the creditor s current rate for a loan of similar character, amount and duration, we believe it would be appropriate for the bankruptcy courts to accept a plan utilizing the contract rate if the creditor fails to come forward with persuasive evidence that its current rate is in excess of the contract rate. 25 The Supreme Court granted certiorari and issued its decision reversing the Seventh Circuit in a decision. The plurality of the Supreme Court fixed a discount rate of prime, plus a risk factor based upon the formula approach. The Supreme Court, in adopting the formula approach, indicated that the 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 a creditworthy commercial borrower to compensate for the opportunity costs of the loan, risk of inflation and relatively slight risk of default. 26 The Court added that if the court could somehow be certain a debtor would complete his plan, the prime rate would be adequate to compensate any secured creditors forced to accept cramdown loans Id. at 479 n.18. Otherwise, because there is some risk that the debtor will be unable to pay, the court should add a percentage to reflect the relative risk of nonpayment. The F.2d 63 (3rd Cir. 1993) F.3d 211 (5th Cir. 1997). 25 In re Till, 301 F.3d at 592 (citing GMAC v. Jones, 999 F. 2d 63, (1993)). 26 Till v. SCS Credit Corp., 541 U.S. 465, (2004). 7

9 court did not set a scale for the risk factor, but noted that other courts have generally approved adjustments of 1 % to 3 %. 27 The Impact of Till on BAPCA 910 claims Relevant Statutes and Congressional Intent The enactment of BAPCPA and the addition of the unenumerated paragraph following 1325(a)(9) generally known as the hanging paragraph, has raised questions as to whether a debtor must pay interest to a creditor whose collateral is a motor vehicle purchased by the debtor for personal use within 910 days prior to the filing of the petition. After the implementation of BAPCPA, some creditors took the position that Till was no longer applicable based upon the 2005 amendments to 1325(a). Specifically, creditors argued that the hanging paragraph both abrogates Till and entitles the creditor to a contract rate of interest in the present value calculation. Generally, the extent to which a claim is secured, and thus entitled to interest in a Chapter 13 plan, is determined by Section 506, which is headed, Determination of Secured Status and provides, in relevant part, as follows: An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to set off under 553 of this title, is a secured claim to the extent of the value of such creditor s interest in the estate s interest in such property, or to the extent of the amount subject to set off, as the case may be, and is an unsecured claim to the extent that the value of such creditor s interest or the amount so subject to set off is less than the amount of such allowed claim Id. at 480 (citing In re Valenti, 105 F.3d 55, 55 (2d. Cir.1997)) U.S.C. 506 (emphasis added). 8

10 The issue that the courts are focusing on is the interplay between the hanging paragraph and Section 1325(a)(5), which applies to allowed secured claims, as that term is used in Section 506. The pertinent subsection of Section 1325(a)(5)(B)(ii) reads: (a) except as provided in subsection (b), the court shall confirm a plan if... (5) with respect to each allowed secured claim provided for by the plan (B)(ii) the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim 29 Upon implementation of BAPCPA, many creditors took the position that, because of the addition of the 910 language and the hanging paragraph, the statute clearly prohibits any modification of the 910 claim, including their right to receive the contract rate of interest on their claims during the pendency of a debtor s Chapter 13 case. 30 Conversely, debtors argued that the hanging paragraph plainly states for purposes of 11 U.S.C. 1325(a)(5), 506 shall not apply to a claim... Debtors argue that 506 shall not apply means that such claims are not allowed secured claims as contemplated by Section 1325(a)(5) and, thus, are not included in the purview of Section 1325(a)(5)(B)(ii), 31 which requires that each allowed secured claim must be paid on the basis of a present value. 32 The U.S.C. 1325(a)(5)(B)(ii)(emphasis added). 30 See In Re Robinson, 338 B.R. 70,79 (Bankr. W.D. Mo. 2006); In Re Wright, 338 B.R. 917, 919 (Bankr. M.D. Ala. 2006); In Re Fleming, 339 B.R. 716, ; In Re Desardi, 340 B.R (Bankr. S.D. Tex. 2006); In Re Shaw, 341 B.R. 543, 544 (Bankr. E.D. N.C. 2006); In Re Pryor, 341 B.R. 648, (Bankr. C.D. Ill. 2006); In Re Bufford, 827, 835 (Bankr. N.D. Tex. 2006); In Re Wampler, 345 B.R. 730, 732 (Bankr. D. Kan. 2006); In Re Murray, 346 B.R. 237, 239 (Bankr. M.D. Ga. 2006; In Re Trejos, 352 B.R. 249 (Bankr. D. Nev. 2006). 31 See generally In Re Pryor, 341 B.R. 648 (Bankr. C.D. Ill. 2006); In Re Soards, 344 B.R. 829 (Bankr. W.D. Ky. 2006); In Re Scruggs, 342 B.R. 571 (Bankr. E.D. Ark. 2006); In Re Brill, 350 B.R. 853 (Bankr. E.D. Wis. 2006); In Re Ross, Slip Op. (Bankr. W.D. Tenn). 32 David G. Epstein, Don t Go and Do Something Rash About Cram Down Interest Rates, 49 Ala. L. Rev. 435, 436 (1988). 9

11 debtors argument that the 910 claims are not allowed secured claims entitled to present value finds support in the oft-cited Collier on Bankruptcy treatise, which construes the 910 language as it is written, leaves a creditor with an allowed claim for the entire pre-petition debt that must be paid in full but without post- petition interest through the duration of the Chapter 13 plan if the debtor wishes to retain the collateral. 33 In summary, the debtors argument is that for a creditor to have the benefits of 1325(a)(5), it must hold an allowed secured claim. Under the Bankruptcy Code, one holds an allowed secured claim only through the operation of 506. The hanging paragraph provision specifically excludes the application of 506. Legislative History Unfortunately, the BAPCPA amendments do not provide a clear answer. The amendments are confusing, overlapping and sometimes self-contradictory. They introduce new and undefined terms that resemble, but are different from, established terms that are well-understood. Furthermore, the new provisions address some situations that are unlikely to arise. Deciphering this puzzle is like trying to resolve a Rubik s Cube that arrived with a manufacturer s defect. Fortunately, after many twists and turns, a few patches of solid color emerge. 34 The legislative history, though scant, apparently focuses on valuation of underlying collateral. The house report does not mention an amendment relating to interest rates or Till. S.256's protections for secured creditors include: a prohibition against bifurcating a secured debt incurred within the 910-day period preceding the filing of a Bankruptcy case if the debt is secured by a purchase money security interest in a motor vehicle acquired for the debtor s personal use. Where the collateral consists of any other type of property having value, S.256 prohibits bifurcation of specified secured debts if incurred during the 1-year preceding the filing of the Bankruptcy case. The bill clarifies current law to specify that the value of a claim secured 33 See 8 Collier on Bankruptcy, (1)(a) at (Rev. 15th ed. 2006). 34 In Re Donald, 343 B.R. 524, 529 (Bankr. E.D.N.C. 2006)(Small, J.). 10

12 by personal property is the replacement value of such property without deduction for secured creditor s cost of sale or marketing. Report of the Committee on the Judiciary, House of Representatives, to Accompany S.256, H.R. Rep. No , Pt. 1 (2005) 88,103. Another section of the House Committee Report states: 306(b) adds a new paragraph to 1325(a) of the Bankruptcy Code specifying that the Bankruptcy Code 506 does not apply to a debt secured within the 2 1/2-years preceding the filing of the Bankruptcy case if the debt is secured by a purchase money security interest in a motor vehicle acquired for the personal use of the debtor within 910 days preceding the filing of the petition. Id. H.R. Rep. No , Pt. 1 (2005) (U.S.C.P.C.A.N. 88,103). Establishing the Risk Factor Referenced in Till As previously indicated, Till resolved the split of authority amongst the Circuits regarding how bankruptcy courts should determine cramdown interest rates in Chapter 13 cases. It is clear there has been a shift in the burden of proof in establishing interest rates from the debtors to the secured creditors as a result of Till. The Till decision mandates the formula approach as the appropriate method for determining interest rates on cramdown loans and imposes significant new evidentiary burdens on secured creditors. 35 It has been stated that Till is somewhat troubling from the perspective of lenders. It sets a precedent that allows bankruptcy courts to disregard contractual rates between parties and impose a potentially much lower rate, while placing the burden on the creditor to prove that an increase burden on the creditor to prove that an increase above the base rate is warranted... it places a burden on secured creditors to prove that the debtor s proposed risk premium is artificially low, rather than requiring the debtor to rebut the presumptive contract rate Ronald F. Greenspan & Cynthia Nelson, Untill We Meet Again, 23-JAN Am. Bankr. Inst. J. 48. (2005). 36 Adair Kay Gomelsky, High Court Reduces Contracted Rates in Chapter 13, 11

13 Justice Stevens states in Till that [b]ecause bankrupt debtors typically pose a greater risk of nonpayment than solvent commercial borrowers, the approach then requires a bankruptcy court to adjust the prime rate accordingly. The appropriate size of that risk adjustment depends, of course, on such factors as the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization plan. Starting from a concededly low estimate and adjusting upward places the evidentiary burden squarely on the creditors, who are likely to have readier access to any information absent from the debtor s filing In this passage, Judge Stevens has identified four factors that the risk adjustment is dependent upon, including: (1) the estate s circumstances; 38 (2) nature of the security; 39 (3) the plan s feasibility 40 and (4) the plan s duration. 41 With respect to the size of the risk adjustment, Justice Stevens gave no fixed formula, but noted that other courts, such as In re Valenti, have generally approved adjustments of 1% to 3%. 42 Turnaround Management Association, p. 2 (September 2004). 37 Till v. SCS Credit Corp., 541 U.S. 465, 479 (2004)(emphasis in original). 38 The Supreme Court gave little guidance regarding its intent as to this element of its risk adjustment. It has been suggested that one of the criteria in evaluating this element would be support of the plan or lack of opposition to the plan by creditors and the trustee. What was the proponent s experience, motivation and commitment to repaying the plan? Ronald F. Greenspan & Cynthia Nelson, Untill We Meet Again, 23-JAN Am. Bankr. Inst. J. 48, 70 (2005). 39 With regard to nature of the security, loans with higher-to-value ratios are relatively more risky than those with lower loan-to- value ratios since they leave less cushion should a creditor need to foreclose in the event of default. Id. 40 Feasibility generally addresses the plan s likelihood of success. Stability of employment and income would be factors that could be considered in determining feasibility; also prior filings could be another factor that would provide insight as to the likelihood that the plan would not result in need for further reorganization. 41 The Supreme Court has given very little guidance on this factor. It has been suggested that there is an enhanced risk of nonpayment associated with a longer plan duration. 42 Till v. SCS Credit Corp., 541 U.S. 465, 480 (2004). 12

14 Many creditors position in prior case law was that Chapter 13 debtors are an inherently risky credit risk and the probability of failure weighed heavily on the calculation of the discount adjustment. Justice Stevens noted that Congress intended to create a program under which plans that qualify for confirmation have a high probability of success. Perhaps bankruptcy judges currently confirm too many risky plans, but the solution is to confirm fewer such plans, not to set default cramdown rates at absurdly high levels, thereby increasing the risk of default. 43 Interestingly, Judge Thomas, in a concurring decision, found no evidence in 1325(a)(5)(B)(ii) that supported a view that nonpayment was an element that should be taken into consideration. Judge Thomas would apply a risk-free rate. 44 Does Till Apply in Chapter 11 Cases? In discussing Till, the Supreme Court discusses creditor-specific circumstances relevant to the determination of cramdown interest rates and states, [i]nterestingly, the same is not true in the Chapter 11 context, as numerous lenders advertise financing for Chapter 11 debtors in possession... [t]hus, when picking a cramdown rate in a Chapter 11 case, it might make sense to ask what rate an efficient market might produce. 45 There have been few published decisions that have addressed this question so far Id. at Id. at Id. at n See e.g. In re American Homepatient, Inc., 420 F3d 559, 568 (6 th Cir. 2005)(declining to blindly adopt Till s endorsement of the formula approach for Chapter 13 cases in the Chapter 11 context); In re Prussia Associates, 322 B.R. 572, 589 (Bankr. E.D.PA. 2005)(interpreting Till to mean that other things being equal, the formula approach should be adopted in Chapter 11 just as it is in Chapter 13"); In re Cantwell, 336 B.R.688 (Bankr. D.N.J. 2006)(concluding that 13

15 there was no evidence produced to establish that an efficient market could exist to refinance a debt in the debtor s Chapter 11 that it used the analysis set forth in Till). 14