Bob Dremluk’s Article in The Bankruptcy Strategist: Second Circuit Directs ‘Efficient Market Rate’ in lieu of ‘Formula Rate’

Bob Dremluk, a partner in the New York City office of Culhane Meadows, recently published an article in ALM’s The Bankruptcy Strategist about the Second Circuit’s decision in Momentive Performance Materials, Inc. v. BOKF, NA (In re MPM Silicones, L.L.C. ) where the Court instructed the bankruptcy court to apply an “efficient market rate” of interest to the senior secured notes issued under the plan, if such a rate could be ascertained, in lieu of a “formula rate” of interest that had been applied.

The bankruptcy court had rejected the efficient market rate approach, and concluded that a cramdown interest rate should “not take market factors into account.” Viewing itself as largely governed by the principles enunciated by the plurality opinion in Till v. SCS Credit Corp., 541 U.S. 465 (2004), it concluded that the proper rate was what the plurality referred to as the “formula” or “prime-plus” rate. The district court agreed.

The Second Circuit, however, disagreed noting that the applicability of the formula rate approach in Chapter 11 case has not been followed by all courts pointing to the Sixth Circuit’s ruling in in In re American HomePatient, Inc., 420 F.3d 559 (6th Cir. 2005 where it concluded that efficient market rates for cramdown loans cannot be ignored in Chapter 11 cases and developed this two-part test:

[T]he market rate should be applied in Chapter 11 cases where there exists an efficient market. But where no efficient market exists for a Chapter 11 debtor, then the bankruptcy court should employ the formula approach endorsed by the Till plurality.

The Second Circuit adopted this approach stating: “We do not read the Till plurality as stating that efficient market rates are irrelevant in determining value in the Chapter 11 cramdown context. And, disregarding available efficient market rates would be a major departure from long-standing precedent dictating that the best way to determine value is exposure to a market citing Bank of Am. Nat’l Trust and Sav. Assn v. 203 N. LaSalle St. Pship, 526 U.S. 434, 457 (1999); The court concluded “where, 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 [in Till] , that such a rate is preferable to a formula improvised by a court.”

In his article, Bob notes that this decision is generally favorable to secured lenders because it somewhat reduces the risk that a formula rate of interest would be used to cramdown a secured claim and instead directs bankruptcy courts to consider using a market-based rate if such a rate exists.  That said, the decision leaves a number of unresolved matters. First, introducing the concept of an “efficient market” to the analysis is problematic.  One of the key hurdles to overcome is the existence of an efficient market rate –a battle of experts is inevitable.  Litigation risk will be high and costs potentially will skyrocket. In effect, this litigation risk may also have a chilling effect on the timing of exit financing. Forum shopping is also a natural concern as debtors choose where to file their Chapter 11 cases depending on jurisdictions that use only a formula rate approach.

Bob’s article also includes discussion about the Court’s decision on the enforceability of make-whole provisions, the subordination of second lien claims and the applicability of the equitable mootness doctrine— all of which also present some very interesting and timely issues affecting Chapter 11 bankruptcy cases.

View the entire article HERE.

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