Within the span of a few days, Judge Patrick Higginbotham
of the Fifth Circuit released two decisions which will ease the way for chapter
11 debtors to confirm their plans. In the first decision, the Court definitively
put a stake through the heart of the artificial impairment doctrine, while in
the second, the Court held that the Till prime + formula, while not
mandatory, was becoming the "default" rule for calculating interest
in chapter 11 plans. The cases are Matter of Village at Camp Bowie I, LP,
No. 12-10271 (5th Cir. 2/26/13), which can be found here,
and Matter of Texas Grand Prairie Hotel Realty, LLC, No. 11-11109 (5th
Cir. 3/1/13), which can be found
Village at Camp Bowie and Artificial
Village at Camp Bowie
involved an oversecured creditor whose claim overshadowed those of other
creditors. Western Real Estate Equities held a debt of $32.1 miliion secured by
property valued by the court at $34 million. The Debtor owed $59,398 to
thirty-eight (38) trade creditors. Under the plan, the Debtor's equity holders
and related parties were to infuse $1.5 million in new equity. As a result, the
Debtor had sufficient funds to simply pay off the trade creditors and leave
their claims unimpaired. This would have allowed Western to veto the plan since
there would not have been another class available to accept the plan.
Western objected that the Debtor's plan had not been
proposed in good faith and that the plan hadn't really been accepted by an
impaired class since the impairment was "artificial." The Bankruptcy Court confirmed the Plan over Western's objections.
The Court noted that the Eighth Circuit requires that
impairment be driven by economic need, while the Ninth Circuit did not
distinguish between "discretionary and artificially driven impairment."
The Court also noted that it had previously rejected the concept
of artificial impairment in Matter of Sun Country, Ltd., 764 F.2d 406
(5th Cir. 1986), but that because the court concluded that the impairment in
that case was economically motivated "we deprived our analysis of
precedential force." On the other hand, the court had
expressed concern over potential artificial impairment in Matter of Sandy
Ridge Development Corp., 881 F.2d 1346 (5th Cir. 1989). (Parenthetically,
it is interesting to note that these cases involved two individuals who went on
to achieve prominence on the Texas bench. Leif Clark was the Debtor's lawyer in
Sun Country, while Wesley Steen was the bankruptcy judge for Sandy
Ridge during the period in which he was a judge in Louisiana).
Judge Higginbotham found that artificial impairment was
inconsistent with the statutory language of the Code, writing:
Today, we expressly reject Windsor [the Eighth
Circuit decision] and join the Ninth Circuit in holding that § 1129(a)(10) does
not distinguish between discretionary and economically driven impairment. As
the Windsor court itself acknowledged, § 1124 provides that "any
alteration of a creditor's rights, no matter how minor, constitutes
'impairment.'" By shoehorning a motive inquiry and materiality requirement into
§ 1129(a)(10), Windsor warps the text of the Code, requiring a court to
"deem" a claim unimpaired for purposes of § 1129(a)(10) even though it plainly
qualifies as impaired under § 1124. Windsor's motive inquiry is also
inconsistent with § 1123(b)(1), which provides that a plan proponent "may
impair or leave unimpaired any class of claims," and does not contain any
indication that impairment must be driven by economic motives.
The Windsor court justified its strained reading
of §§ 1129(a)(10) and 1124 on the ground that "Congress enacted section
1129(a)(10) . . . to provide some indicia of support [for a cramdown plan] by
affected creditors," reasoning that interpreting § 1124 literally would vitiate
this congressional purpose. But the Bankruptcy Code must be read literally, and
congressional intent is relevant only when the statutory language is ambiguous.
Moreover, even if we were inclined to consider congressional intent in divining
the meaning of §§ 1129(a)(10) and 1124, the scant legislative history on §
1129(a)(10) provides virtually no insight as to the provision's intended role,
and the Congress that passed § 1124 considered and rejected precisely the sort
of materiality requirement that Windsor has imposed by judicial fiat.
The Windsor court also reasoned that condoning artificial impairment
would "reduce [§ 1129](a)(10) to a nullity." But this logic sets the
cart before the horse, resting on the unsupported assumption that Congress intended
§ 1129(a)(10) to implicitly mandate a materiality requirement and motive
inquiry. Moreover, it ignores the determinative role § 1129(a)(10) plays in the
typical single-asset bankruptcy, in which the debtor has negative equity and
the secured creditor receives a deficiency claim that allows it to control the
vote of the unsecured class. In such circumstances, secured creditors routinely
invoke § 1129(a)(10) to block a cramdown, aided rather than impeded by the
Code's broad definition of impairment.
Opinion, pp. 8-10.
While the passage quoted above is rather long, I have quoted it in its entirety
because I find its statutory analysis to be spot-on. There is no need to make
things more complicated by delving into the meaning of a provision when the words
used are clear. Congress set the bar for determining impairment quite low. Thus,
when Congress required acceptance by an impaired class, it similarly set an
easily met standard. (Note: when Judge Higginbotham speaks of judicial fiat, I
can't help but think of a small Italian car filled with black-robed judges).
The Court also rejected the argument that Matter of Greystone III Joint
Venture, 995 F.2d 1274 (5th Cir. 1991) embodied a "broad, extra statutory
policy against 'voting manipulation.'" He stated:
Greystone does not stand for
the proposition that a court can ride roughshod over affirmative language in
the Bankruptcy Code to enforce some Platonic ideal of a fair voting process.
Opinion, p. 11. While it is comforting to see Greystone
limited to its actual holding, you also have to admire a judge who can work
"Platonic ideal" into a bankruptcy opinion. (According to Wikipedia,
Platonic idealism refers to universals or abstract objects. Thus, a Platonic
ideal of voting would mean voting according to abstract, universal principles.)
Nevertheless, the Court did point out that good faith was still a relevant
We emphasize, however, that our decision today does not
circumscribe the factors bankruptcy courts may consider in evaluating a plan
proponent's good faith. In particular, though we reject the concept of
artificial impairment as developed in Windsor, we do not suggest that a
debtor's methods for achieving literal compliance with § 1129(a)(10) enjoy a
free pass from scrutiny under § 1129(a)(3). It bears mentioning that Western
here concedes that the trade creditors are independent third parties who
extended pre-petition credit to the Village in the ordinary course of business.
An inference of bad faith might be stronger where a debtor creates an impaired
accepting class out of whole cloth by incurring a debt with a related party,
particularly if there is evidence that the lending transaction is a sham. Ultimately,
the § 1129(a)(3) inquiry is fact specific, fully empowering the bankruptcy
courts to deal with chicanery. We will continue to accord deference to their
Opinion, pp. 12-13.
Texas Grand Prairie and Cram-Down Interest Rates
In the second case, the Court affirmed a bankruptcy court ruling which
confirmed a chapter 11 plan which using a 5% cram-down rate of interest under
the Till decision. In Grand Prairie, the parties agreed that the Till
decision provided the appropriate method for calculating a chapter 11 cram-down
interest rate. The Debtor's expert, faithfully following the Till
approach, concluded that prime + a risk factor of 1.75% was appropriate, so
that the indicated interest rate was 5.0%. Even though the lender stipulated
that Till was the correct approach, its expert did not follow its methodology. Instead,
he opined that the proper rate was 8.8% by "taking the weighted average of
the interest rates the market would charge for a multi-tiered exit financing
package" and then adjusting for risk factors. The Court adopted the 5.0%
rate which had the effect of costing the lender $1,485,000 in interest per year
based on the appraised value of $39,080,000.
On appeal, Wells Fargo sought to exclude the Debtor's expert testimony on the
basis that his "purely subjective approach to interest-rate setting"
violated the Supreme Court's call for an "objective inquiry" in Till.
The Court wisely observed that:
Here, Wells Fargo does not challenge Robichaux's factual
findings, calculations, or financial projections, but rather argues that
Robichaux's analysis as a whole rested on a flawed understanding of Till.
As we read it, Wells Fargo's Daubert motion is indistinguishable from
its argument on the merits. It follows that the bankruptcy judge reasonably
deferred Wells Fargo's Daubert argument to the confirmation hearing
instead of deciding it before the hearing. We pursue the same path and proceed
to the merits.
Opinion, p. 7.
Next, the Court addressed the proper legal standard for calculating an interest
rate under section 1129(b). The court ultimately concluded that the Till
decision was not binding on the court because:
As a result, the Court found that its prior decision in
In re T-H New Orleans Partnership, 116 F.3d 790 (5th Cir. 1997) remained
binding. T-H New Orleans held that the Court would not "establish a
particular formula for determining an appropriate cramdown interest rate,"
but would review the Bankruptcy Court's decision for "clear
error." Having concluded that the Till formula was not
mandatory, the Court nevertheless found that it was becoming the majority
In spite of Justice Scalia's warning, the vast majority
of bankruptcy courts have taken the Till plurality's invitation to apply
the prime-plus formula under Chapter 11. While courts often acknowledge that Till's
Footnote 14 appears to endorse a "market rate" approach under Chapter 11 if an
"efficient market" for a loan substantially identical to the cramdown loan
exists, courts almost invariably conclude that such markets are absent. Among
the courts that follow Till's formula method in the Chapter 11 context,
"risk adjustment" calculations have generally hewed to the plurality's
suggested range of 1% to 3%. Within that range, courts typically select a rate
on the basis of a holistic assessment of the risk of the debtor's default on
its restructured obligations, evaluating factors including the quality of the
debtor's management, the commitment of the debtor's owners, the health and
future prospects of the debtor's business, the quality of the lender's
collateral, and the feasibility and duration of the plan.
Opinion, pp. 14-15.
Under the Fifth Circuit's deferential clear error analysis, a bankruptcy court
which followed the majority approach could not be faulted, even if the court
could have found another approach more persuasive.
The Court found that the Debtor's expert properly followed the Till
We agree with the bankruptcy court that Robichaux's §
1129(b) cramdown rate determination rests on an uncontroversial application of
the Till plurality's formula method. As the plurality instructed, Robichaux
engaged in a holistic evaluation of the Debtors, concluding that the quality of
the bankruptcy estate was sterling, that the Debtors' revenues were exceeding
projections, that Wells Fargo's collateral - primarily real estate - was liquid
and stable or appreciating in value, and that the reorganization plan would be
tight but feasible. On the basis of these findings - which were all
independently verified by Ferrell - Robichaux assessed a risk adjustment of
1.75% over prime. This risk adjustment falls squarely within the range of
adjustments other bankruptcy courts have assessed in similar circumstances.
Opinion, p. 18.
Finally, the Court rejected Wells Fargo's argument that the path taken by the
Debtor's expert produces "absurd results."
Wells Fargo complains that Robichaux's analysis produces
"absurd results," pointing to the undisputed fact that on the date of plan
confirmation, the market was charging rates in excess of 5% on smaller,
over-collateralized loans to comparable hotel owners. While Wells Fargo is
undoubtedly correct that no willing lender would have extended credit on the
terms it was forced to accept under the § 1129(b) cramdown plan, this "absurd
result" is the natural consequence of the prime-plus method, which sacrifices
market realities in favor of simple and feasible bankruptcy reorganizations. Stated
differently, while it may be "impossible to view" Robichaux's 1.75% risk
adjustment as "anything other than a smallish number picked out of a hat," the
Till plurality's formula approach - not Justice Scalia's dissent - has become
the default rule in Chapter 11 bankruptcies. (emphasis added).
Opinion, p. 19. Thus, the Court is not required to apply Till, but if it
does, it is not error to pick a "smallish number" out of a hat.
These two opinions, while both affirming confirmation of chapter 11 plans, take
very different approaches to judging. Village at Camp Bowie is very much
a straightforward application of statutory analysis. While I thought that Sun
Country's statement that "Congress made the cram down available to debtors; use of
it to carry out a reorganization cannot be bad faith" effectively killed the doctrine of artificial impairment, it is nonetheless
heartening to see a judge put the final nail in the coffin. Just as I noted in
my prior post about Spillman Development Group, this is a case of a
judge rejecting magical thinking. In this case, the magical thinking was that Greystone
III Joint Venture can be cited in talismanic fashion for the proposition
that the secured creditor automatically gets a veto.
Texas Grand Prairie is a much more subversive opinion. While ostensibly
following T-H New Orleans' no formula approach, the court gave the green
light to bankruptcy courts to follow the Till plurality's prime +
approach, referring to it as the majority approach and the default rule. On the
other hand, the Court left bankruptcy courts free to reject Till as well.
If anything, this decision gives broad discretion to the factfinder, something
that has been noticeably lacking since the adoption of BAPCPA.
Finally, Texas Grand Prairie may spell the death of expert interest rate
testimony in chapter 11 cases. If the Debtor's expert can pull a "smallish
number" out of a hat, why can't the Debtor's attorney do so without the
intervention of an expert witness? The irony of Wells Fargo's Daubert
argument is that it probably was right, but not for the reason that Wells
Fargo thought. The logical extension of Till is that the fact-finder
does not require "scientific, technical or other specialized knowledge . .
. to understand the evidence or determine a fact in issue" as required by
Fed.R.Evid. 702 so that neither side should have been allowed to tender
an expert witness. This case will probably not preclude courts from considering
experts pontificating on interest rates, but it frees up the court to take it
or trash it.
Post-script: While Judge Higginbotham may not receive as much
recognition as a scholar of bankruptcy law as some of his colleagues, it is
worth noting that he has now authored about 50 bankruptcy opinions, which is
more than some bankruptcy judges. In addition to the opinions discussed in this
post, some of his other influential opinions include Wells Fargo Bank, N.A.
v. Stewart, 647 F.3d 553 (5th Cir. 2011); Milligan v. Trautman, 496
F.3d 366 (5th Cir. 2007); Supreme Beef Processors, Inc. v. USDA, 275
F.3d 432 (5th Cir. 2001); Krafsur v. Scurlock Petroleum Corp., 171 F.3d
249 (5th Cir. 1999); Miller v. J.D. Abrams, Inc., 156 F.3d 598 (5th Cir.
1998); In re Clay, 35 F.3d 190 (5th Cir. 1994); and In re Howard,
972 F.2d 639 (5th Cir. 1992). In my view, this is sufficient to earn him a
place among the leading bankruptcy lights on the court.
subscribers can access enhanced versions of the opinions and annotated versions
of the statutes cited in this article:
Till v. SCS Credit Corp., 541 U.S. 465 (May 17, 2004)
Matter of Village at Camp Bowie I, LP,
No. 12-10271, 2013 U.S. App. LEXIS 3949 (5th Cir. Feb. 26, 2013)
Matter of Texas Grand Prairie Hotel Realty, LLC, No.
U.S. App. LEXIS 4514 (5th Cir. Mar. 1, 2013)
Matter of Sun Country, Ltd.,
764 F.2d 406 (5th Cir. 1986)
Matter of Sandy Ridge Development Corp.,
881 F.2d 1346 (5th Cir. 1989)
11 U.S.C. § 1129
11 U.S.C. § 1124
11 U.S.C. § 1123
Matter of Greystone III Joint Venture, 995
F.2d 1274 (5th Cir. 1991)
In re T-H New Orleans Partnership,
116 F.3d 790 (5th Cir. 1997)
Fed. R. Evid. 702
Wells Fargo Bank, N.A. v. Stewart,
647 F.3d 553 (5th Cir. 2011)
Milligan v. Trautman, 496 F.3d 366 (5th Cir.
Supreme Beef Processors, Inc. v. USDA,
275 F.3d 432 (5th Cir. 2001)
Krafsur v. Scurlock Petroleum Corp.,
171 F.3d 249 (5th Cir. 1999)
Miller v. J.D. Abrams, Inc.,
156 F.3d 598 (5th Cir. 1998)
In re Clay, 35 F.3d 190 (5th Cir. 1994)
In re Howard, 972 F.2d 639 (5th Cir.
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