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The coerced loan, presumptive contract rate, and cost of funds approaches should be rejected, since they are complicated, impose significant evidentiary costs, and aim to make each individual creditor whole rather than to ensure that a debtor's payments have the required present value. The formula approach has none of these defects. Taking its cue from ordinary lending practices, it looks to the national prime rate, which reflects the financial market's estimate of the amount a commercial bank should charge a creditworthy commercial borrower to compensate for the loan's opportunity costs, the inflation risk, and the relatively slight default risk.
Petitioners Lee and Amy Till filed a joint Chapter 13 petition for relief. One creditor had a $4,000 allowed secured claim, based on the agreed value of a truck purchased by petitioners prior to filing, under a retail installment contract with a "subprime" interest rate of 21 percent. Pursuant to the cram-down option, the United States Bankruptcy Court for the Southern District of Indiana, over the creditor's objection and after a hearing, confirmed the couple's proposed debt-adjustment plan, which--in providing for installment payments of money to the creditor on this claim--included an interest rate of 9.5 percent, supposedly representing the then national prime rate of 8 percent, plus a "risk adjustment" of 1.5 percent. On appeal, the United States Court of Appeals for the Seventh Circuit, in vacating the District Court's judgment and in ordering a remand, expressed the view that the original 21-percent contract rate of interest ought to serve as the "presumptive" cram-down rate, which either the creditor or the couple could challenge with evidence that a higher or lower rate ought to apply. The debtors challenged the decision, arguing that a lower rate should be applied in order to protect the financial feasibility of the plan.
Should the presumptive contract rate apply to installment payments under a Chapter 13 plan?
A plurality of the United States Supreme Court determined that under § 1325(a)(5)(B)(ii), in such cram-down circumstances, the appropriate interest rate ought to be calculated under a "formula" approach, which would (i) begin by looking to the national prime rate, reported daily in the press, of interest charged to creditworthy commercial borrowers, and (ii) require a bankruptcy court to adjust the prime rate due to the typically greater risk of nonpayment by bankrupt debtors, after the court held a hearing at which the debtor and any creditors might present evidence about the appropriate risk adjustment, with the evidentiary burden on the creditors. According to the Court, the appropriate interest rate to be applied to installment payments under a Chapter 13 plan was the national prime rate as adjusted to reflect the specific risks associated with the debtors. The Court averred that such an approach was familiar in the financial community and minimized the need for expensive evidentiary proceedings, while alternative approaches were complicated, imposed significant evidentiary costs, and aimed to make the creditor whole rather than to ensure that the debtors' payments had the required present value. Further, the formula approach entailed a straightforward and objective inquiry, and depended only on the state of financial markets, the circumstances of the bankruptcy estate, and the characteristics of the loan, rather than the creditor's prior interactions with the debtor.