Page 120 - Bankruptcy and Reorganization Services

proaches are (1) the "formula approach," under which a risk premium is added to a base rate of interest,
(2) the "coerced loan approach," under which the market rate of interest is determined based on loans of
a similar quality and maturity as the existing loan, (3) the "presumptive rate approach," which is based
on the existing contract rate between the debtor and a secured creditor, and (4) the "cost of funds ap-
proach," which is based on the interest rate the creditor would pay to borrow the money to replace the
collateral.

The Till matter related to the repayment of a subprime automobile loan on a used truck worth $4,000. At
the time of bankruptcy filing, the unpaid balance on the loan was $4,894.89. Accordingly, $4,000 of the
outstanding claim was considered secured and the balance, in the amount of $894.89, was treated as an
unsecured claim. In their plan, the petitioners (or debtors) proposed to pay interest on the secured por-
tion of respondent’s claim at a rate of 9.5% per year. The 9.5% interest rate was calculated by petition-
ers’ expert under a formula approach, whereby a 1.5% risk adjustment was added to the national prime
rate of 8.0%. The respondent (or creditor) objected, indicating that if the company was allowed to fore-
close on the collateral it could reinvest the proceeds in similar loans at a 21% interest rate (the coerced
loan approach).

The bankruptcy court in the Till matter ruled in favor of the debtors and accepted the 9.5% interest rate
proposed by the petitioners. The district court reversed the bankruptcy court ruling and set the interest
rate at 21%, citing legal precedent within the Seventh Circuit that sets "cram down interest rates at the
level the creditor could have obtained if it had foreclosed on the loan, sold the collateral, and reinvested
the proceeds in loans of equivalent duration and risk." fn 20

The district court’s ruling was appealed to the Seventh Circuit Court of Appeals. On appeal, the Seventh
Circuit essentially endorsed, with one modification, the use of original contract rate as a reasonable
"presumptive" market rate of interest. The modification made by the Seventh Circuit was to remand the
case to the bankruptcy court with instructions to conduct further proceedings and afford the petitioners
and the respondent the opportunity to rebut the "presumptive rate" and present evidence regarding
whether a higher or lower rate should be applied (the presumptive rate approach). fn 21

The question of which approach represents the appropriate method of determining a market rate of inter-
est in the context of a cram down was ultimately addressed in a plurality decision issued by the U.S. Su-
preme Court. The Supreme Court ruled that the most appropriate method for determining a market rate
of interest was the formula approach, using the national prime rate as the base rate. In rejecting the co-
erced loan, presumptive rate, and cost of funds approaches, the Supreme Court stated, "Each of these
approaches is complicated, imposes significant evidentiary costs, and aims to make each individual
creditor whole rather than to ensure the debtor’s payments have the required present value." fn 22 To the
contrary, "the formula approach entails a straightforward, familiar, and objective inquiry, and minimizes
the need for potentially costly additional evidentiary proceedings." fn 23

fn 20 Till v. SCS Credit Corp., 541 U.S. at 472 (2004).

fn 21 Id. (Note: in the Seventh Circuit Court of Appeals opinion and dissenting opinion, the approach endorsed by the Seventh Circuit
is referred to as a modification of the coerced loan approach.)
fn 22 Till v. SCS Credit Corp., 541 U.S. at 477 (2004).

fn 23 Id., at 479.

118 © 2020 Association of International Certified Professional Accountants