PhaseRx Files Chapter 11: Commitee Formation Meeting Scheduled for December 20 at 11:00 a.m.

Mette K.

2nd Circuit Reverses Course on Cramdown Interest Rates

A simple proposition—that secured lenders are entitled to receive payments with a present value at least equal to the amount of their claim—has proven surprisingly difficult to apply as courts have pondered whether to follow a “formula approach” or a “market approach” to establish an appropriate “cramdown” interest rate. (A primer is available here if you are new to the debate.)

Secured lenders have scored a significant win in the recent Second Circuit decision in the Momentive case, In re MPM Silicones. Siding with the Sixth Circuit, the Second Circuit has decided that the prevailing market rate for comparable debt should be used—if there is an efficient market for such debt—and that the formula approach should be used only if no efficient market exists.

Market-Rate Schmarket-Rate… What’s the Big Deal?

Theoretically, whether you build up from a base rate and fully adjust for the characteristics of a loan or whether you consider comparable market loans to determine an appropriate interest rate, you should end up at roughly the same place. In reality, however, courts applying a formula approach have approved interests rates that are lower than a market rate approach would support… sometimes absurdly so.

By way of analogy, consider an ordinary real estate valuation. A real estate appraiser will consider different valuation methods—market comparables, replacement cost, and income capitalization.  These three approaches will often provide different values for a property, so an appraiser must reconcile the varying results.  Sometimes differences are minor. But depending on the property and the appraisal’s objective, one of the approaches may be more suitable than the others.

Similarly, in the bankruptcy context, the formula approach and market approach can support different interest rates, and one of the approaches may be more suitable in Chapter 11 than the other. And uncertainty over which approach to apply in Chapter 11, combined with courts’ self-imposed reluctance to impose a risk premium of more than 1-3% under the formula approach, has spawned significant litigation with very real consequences.

The Original Momentive Rulings: The Formula Approach

Momentive, one of the world’s largest producers of silicone products, filed a Chapter 11 bankruptcy case in 2014. At the time, it had two outstanding series of senior lien notes, one in the principal amount of $1.1 billion with an 8.875% interest rate and the other in the principal amount of $250 million with a 10% interest rate. Momentive’s plan proposed, in essence, that these claims would be satisfied with long term replacement notes with a below-market rate of interest based on the “formula” approach, e.g., 4.1% and 4.85%, respectively.  This represented a total reduction of approximately $70 million in the amount of interest payments over the life of the notes.

The lower courts approved this plan, expressing concern that a market rate of interest would “overcompensate” cramdown lenders. Why? Because market rates include transaction costs and profits indicative of new loans. By following the formula approach, the lower courts could disregard these add-ons and felt they could truly “put the creditor in the same economic position that it would have been in had it received the value of its claim immediately.” The decisions also reflected a general tendency to limit risk adjustments to a range of between 1-3%.  The result was the approval of new notes that bore interest rates far below the original issue interest rates and current market rates, and an appeal to the Second Circuit.

The 2nd Circuit Reverses Course: A Market Approach Is Preferred

The Second Circuit rejected the lower courts’ reasoning.  Disregarding available efficient market rates, it stated, would be a major departure from long-standing precedent dictating that the best way to determine value is exposure to an efficient market.

“[W]here, as here, an efficient market may exist that generates an interest rate that is apparently acceptable to sophisticated parties dealing at arms-length, we conclude, consistent with footnote 14 [of Till], that such a rate is preferable to a formula improvised by a court.”

And what is an efficient market?  In keeping with the Fifth Circuit, the Court described it as one where, for example, “they offer a loan with a term, size and collateral comparable to the forced loan contemplated under the cramdown plan.” The Second Circuit suggested that an efficient market might exist for notes similar to the replacement notes at issue in Momentive, but it remanded the question to the Bankruptcy Court to decide.

A Cliffhanger Ending…

Will Judge Drain decide that an efficient market exists on the remand?

Judge Drain’s bench ruling suggests he may not, as he noted that “it is highly unlikely that there will ever be an efficient market that does not include a profit element, fees and costs, thereby violating Till’s first principles, since capturing profit, fees and costs is the marketplace lender’s reason for being.”

But the Second Circuit opinion could be read to downplay his concerns, as it approvingly cited the testimony of the first lien noteholders’ expert, who testified that when notes are priced at the market rate noteholders are “being compensated for the underlying risk that they are taking” and not for any “imbedded profit.”

Stay tuned to find out what happens in Episode 4: The Cramdown Rematch.

The Bottom Line

Meanwhile, the Second Circuit’s opinion significantly reduces uncertainty around the application of Till’s formula rate to Chapter 11 cramdown notes in the Second Circuit and appears to be good news for secured creditors, who have been facing threats of cramdown with below-market take-back debt in restructuring negotiations, and a loss for debtors and unsecured creditors who might benefit by extracting value at their expense. Although it is also possible that the two-step approach adopted here could simply shift litigation efforts to focus instead on whether there exists an efficient market in the first instance.

Mette Kurth

Woodbridge Committee Formation Meeting Scheduled for 12/14/17

Woodbridge Group of Companies, LLC, a Sherman Oaks, California-based real estate finance and development company, has filed for Chapter 11 protection in Delaware.  The committee formation meeting is scheduled for December 14, 2017 at 10:00 a.m. at the Doubletree Hotel in Wilmington, Delaware.

The company says it intends to file a plan to substantially reduce its debt and transition its real estate investment business to institutional financing sources. It hopes to reorganize and successfully emerge as a profitable real estate investment before the end of 2018.

Additional information is available here.

Mette K.

 

Procedures for Filing Bankruptcy Claims Changed Today! Read. Learn. Be Prepared.

Details matter.  After years of procedural wrangling, significant changes to the federal procedural rules take effect today.  While the changes are focused principally on streamlining procedures in consumer cases, they include provisions – such as a requirement that secured creditors file proofs of claim – that impact all cases.  Here’s a run through of some key points.  You can find the full text of the amendments here.

Proofs of Claims: Secured Creditors Beware!

  • Secured creditors must now file proofs of claim to have their claims allowed. Although in accordance with Section 506(d), if they don’t, their liens will not be rendered void for only that reason. FRBP 3002(a).

Claim Objections: Who to Serve, Whether to Have a Hearing, Where to Object

  • To object to a claim, you must serve the affected creditor by 1st class mail directed to the name and address on its filed claim form.
  • The Court no longer needs to schedule or hold a hearing on every claim objection.
  • Any party-in-interest may seek a determination of the amount and priority of any claim. Plan proponents in Chapter 12 and 13 may now include these objections in the body of a Plan.  FRBP 3007 & 3012.

Objecting to Liens or Transfers? File a Motion or Put It in a Chapter 13 Plan

  • Parties may now seek to avoid a lien or other transfer of the debtor’s exempt property by motion or in the debtor’s Chapter 13 Plan. FRBP 3012 & 4003(d).

Claim Bar Dates: Time It Right in Chapter 7, 12, and 13

  • Filing a claim in a voluntary Chapter 7 (liquidation), 12 (family farmer), or 13 (individual debt readjustment) case?  You must now file your claim within 70 days after the bankruptcy petition filing date.  For involuntary Chapter 7 cases, you have until 90-days after the order for relief is entered. FRBP 3002.
  • If a case converts to Chapter 7 or 13, the new, 70-day period will run from the date of the order converting the case. If it converts to Chapter 7, a new claims filing deadline starts running.  FRBP 3002.
  • The Court may extend these deadlines if the debtor has not filed a complete list of creditors. FRBP 3002(c)(6).
  • And a new 2-stage deadline is created for filing mortgage claims secured by an interest in the debtor’s principal residence. FRBP 3002(c)(7).

Chapter 13 Plans & Confirmation: Use the Form, Know Your Deadlines

  • An “official,” standardized Chapter 13 plan is created… unless your jurisdiction has adopted its own (consistent) local form.  FRBP 3015(c).
  • A debtor must provide creditors with at least 21 days’ notice of the deadline for objecting to Chapter 13 Plans and 28 days’ notice of the confirmation hearing in Chapter 13 cases. FRBP 2002(a)(9) and (b)(3).

Mette K.

Good News for Committees… Standard Carve Out Provisions Do Not Limit Fee Awards

Over and over again the same story plays out.  A case files.  A lender carves-out a small amount from its collateral to fund Committee professionals and an investigation of the lender’s position.  That amount is inadequate, and the Committee blows past the carve-out amount.

That’s just what happened in Molycorp, where the DIP financing agreement contained a typical $250,000 carve-out provision for the Committee’s investigation of claims.

 After an extensive discovery process resulting in asserted claims, mediation, and a global settlement, the court confirmed a consensual plan and the Committee’s counsel requested payment of $8.5 million in fees.

The lender objected, arguing that the $250,000 carve-out was an absolute cap on fee payments.  The Committee responded that while the carve-out may have limited its fees in an administratively insolvent case, it was irrelevant in a case with a confirmed chapter 11 plan.  The Delaware court agreed.

The court explained that “[t]he carve-out is . . . an agreement by the secured creditor to subordinate its liens and claims to certain allowed administrative expenses, permitting such professionals’ fees to come first in terms of payment from the estate’s assets. . . .  [W]hen there are insufficient unencumbered assets to pay professionals’ fees and no plan has been confirmed, professionals’ only recourse is the carve-out.”

Here, however, a plan was confirmed. In that context, Bankruptcy Code section 1129(a)(9)(A) requires that allowed administrative claims be paid in cash (or as otherwise agreed) on the plan’s effective date.  And nothing in the carve-out language suggested that the fee cap would prohibit the allowance of administrative fees upon plan confirmation.

“If the secured parties desire confirmation, the administration claims must be paid in full in cash at confirmation even it if means invading their collateral.”

A World of Caution….

 The court contrasted the carve-out at issue with one in a DIP financing order entered in another case that stated: “[n]otwithstanding anything to the contrary therein, and absent further Order of the Court, (i) in no event during the course of the Chapter 11 Cases will actual payments in respect of the aggregate fees and expenses of all professional persons retained pursuant to an Order of the Court by the Creditor’s Committee exceed $450,000 in the aggregate (the ‘Creditors’ Committee Expense Cap’) … (iii) any and all claims (A) incurred by the Creditor’s Committee in excess of the Creditor’s Committee Expense Cap or (B) incurred by any professional persons or any party on account of professional fees and expenses that exceed the applicable amounts set forth in the Budget shall not constitute an allowed administrative expense claim for purposes of section 1129(a)(9)(A) of the Bankruptcy Code.”  At the same time, the court offered “no opinion as to whether it would approve a DIP order containing [such] provisions” had it been presented ….

See In re Molycorp, Inc., 562 B.R. 67 (Bankr. D. Del. 2017).