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Cramdowns and the Uncertain Efficient Market Post-'Momentive'

[caption id="attachment_36847" align="alignnone" width="620"] James H.M. Sprayregen and Madeleine C. Parish[/caption] The U.S. Court of Appeals for the Second Circuit's opinion in In re MPM Silicones LLC, 874 F.3d 787 (2d Cir. 2017) (Momentive), has largely been analyzed with respect to its implications on the enforceability of make-whole provisions. Momentive, however, also had important consequences regarding the Bankruptcy Code’s “cramdown” provision, which is a significant tool for debtors seeking to effectuate a plan of reorganization in the face of non-consenting creditors. Although Momentive provided some clarity with respect to the broad strokes of the process to be used by bankruptcy courts in the determination of cramdown interest rates in Chapter 11, the Second Circuit left unaddressed important nuances in its two-step approach. Namely, the questions of what constitutes an “efficient market,” and whether such a market exists for cramdown debt, remain unanswered, and their resolution poses significant implications for both debtors and creditors alike. As a result of the potential consequences and risks to both debtors and creditors posed by Momentive, there still remain significant opportunity and reasons for why parties should look for consensual resolutions outside of the courtroom when presented with cramdown issues.    

The Second Circuit’s Decision

In Momentive, the Second Circuit addressed the importance of the process used by the bankruptcy court in determining the appropriate interest rate under the cramdown provision of the Bankruptcy Code. By way of background, as a consequence of rejecting the debtor’s plan of reorganization, the senior noteholders received replacement notes that would pay out their claims over time. Under Section 1129(b)(2)(A)(i)(II), debtors are permitted to make such “deferred cash payments” to “cram down” a plan over objecting secured creditors. The Second Circuit noted that those payments must ultimately amount to the full face value of secured creditors’ claims, which requires that the deferred payments must carry an appropriate rate of interest. Despite objections to the plan by certain secured noteholders, the bankruptcy court ultimately approved the debtor’s plan of reorganization under Section 1129(b) of the Bankruptcy Code, the so-called “cramdown” provision.   Under Section 1129(b), a bankruptcy court may approve a plan of reorganization notwithstanding the objections of a secured creditor as long as the court determines the plan is “fair and equitable” to the creditor in question, among other requirements. The bankruptcy court ultimately selected a rate for the replacement notes based on the “formula” rate, which the senior noteholders argued was not “fair and equitable” as required by Section 1129(b). Instead, the noteholders had argued that the bankruptcy court should have applied a market rate of interest. Applying the formula approach articulated by the plurality in Till v. SCS Credit, 541 U.S. 465 (2004), the bankruptcy court concluded that a cramdown interest rate should “not take market factors into account,” and that it is unnecessary to first answer the question of whether an efficient market exists.   The Second Circuit reversed, noting that Till involved a Chapter 13 petition, and that the plurality explicitly stated in footnote 14 that the approach applied to a Chapter 13 case might not be best suited for use in a Chapter 11 context. Specifically, the Till opinion observed that “when picking a cramdown rate in a Chapter 11 case, it might make sense to ask what rate an efficient market would produce.”  Ultimately, the Second Circuit in Momentive endorsed footnote 14, and the Sixth Circuit’s interpretation of Till in Bank of Montreal v. Official Committee of Unsecured Creditors (In re American HomePatient), 420 F.3d 559 (6th Cir. 2005), by adopting a two-step approach for selecting an interest rate in Chapter 11 cramdowns: The market rate should be applied in Chapter 11 cases where an efficient market exists, but where no efficient market exists, the bankruptcy court should employ the formula used by the Till plurality.  

Does a Market for Cramdown Debt Even Exist?

Bankruptcy courts applying Momentive, when facing a Chapter 11 cramdown scenario, must now first ascertain whether an efficient market exists. However, this question is not as straightforward as it may initially appear. For there to be an efficient market, there must be a market for the debt in question. Both economists and financial industry experts have questioned, fundamentally, whether a market for cramdown debt even exists. For example, it can be agreed that established markets exist for car loans and mortgages, wherein day-in and day-out countless loans are given to secure an underlying debt and will be repaid at an agreed-upon interest rate.   In the aforementioned example, the material terms were known at the time of transacting and, more importantly, the transaction was consensual between the parties. The Till plurality, in the now-infamous footnote 14, noted that “because every cram down loan is imposed by a court over the objection of the secured creditor, there is no free market of willing cram down lenders.”  Thus, debtors may advance the argument that “the nonconsensual nature of reorganization debt issued in a cramdown may very well exclude it from markets for loans of similar amount or duration made by non-debtor entities.” (See Bruce A. Markell's "Fair Equivalents and Market Prices: Bankruptcy Cramdown Interest Rates," 33 Emory Bankr. Dev. J. 91 (2017).) At the same time, secured creditors will likely counter that certain other factors, discussed in more detail below, provide sufficient evidence of a market for cramdown debt.

What Exactly Is an Efficient Market?

Determining whether an efficient market exists also requires consideration of what exactly is an efficient market. Although the concept of an “efficient market” has been discussed at length in other areas of law, it is notable that neither Till nor Momentive defined “efficient market” as applied to the bankruptcy context. However, Till, among a handful of other cases, has suggested that the market for debtor-in-possession financing, and, in turn, exit financing, to a Chapter 11 debtor is analogous to a market for cramdown loans in Chapter 11. For a variety of reasons, debtors will likely argue that this is a false equivalency: loans imposed at confirmation resemble more traditional exit financing than debtor-in-possession financing. (See 7 Collier on Bankruptcy Paragraph 1129.05(2)(c)(i).) In turn, secured creditors will likely highlight the presence of exit financing and any quotes the debtor may receive for such financing as evidence that an efficient market does, in fact, exist and further warrant the use of a market rate. Given the likely disagreement surrounding the appropriateness of exit financing as evidence of an efficient market, bankruptcy courts will likely have to rely on market data outside of debtor-in-possession financing when determining efficient cramdown market rates in Chapter 11. This analysis will be that much more difficult in cases where no exit financing is otherwise required or sought by the debtors. Though no courts have been faced with determining whether an efficient market exists post-Momentive (and a hearing on the cramdown issue in Momentive is set for trial in August), there exist factors indicative of an efficient market, generally, that a court may look to when determining Chapter 11 cramdown interest rates. When assessing whether there is an adequately sufficient market based on market data, it is instructive, as a threshold matter, to look at (1) the volume and depth of the market and (2) the nature and complexity of the debt in question. Building upon those two factors, courts will undoubtedly look to multiple other factors, such as the industry-specific outlook for the debtor in question, prevailing interest rates, lien priority, and loan-to-value ratio, among others. (See "Till in Chapter 11 Cases and the Looming 'Efficient Market' Debate," by Louis E. Robichaux IV, Russell A. Perry, Jonathan L. Howell, Am. Bankr. Inst. J., July 2013, at 22, 80.)   Although it remains to be seen how the presence of an efficient market will be evaluated, the aforementioned metrics serve as potential data points that will assist bankruptcy courts in their analysis of market rates under the cramdown provision.         


Following the district court’s affirmation of the bankruptcy court’s Momentive decision, there was a fear not only that debtors would be even more empowered to utilize cramdowns, but that doing so would be to the detriment of secured creditors. Specifically, there was a concern that debtors would follow the path established in Momentive, ultimately using replacement notes and interest rates that would be viewed as below-market by secured creditors.   The real-world implications of the Second Circuit decision in Momentive, however, remain to be seen with respect to the requirement that a determination must be made as to whether an efficient market exists when determining the appropriate interest rate in Chapter 11 cramdowns. For secured creditors, the Second Circuit’s opinion has been largely viewed as a win, as plan proponents in the cases pending in the Second Circuit will be limited in proposing cramdown plans providing take back paper to secured creditors. The lack of guidance, however, by both Till and Momentive surrounding the question of what actually constitutes an efficient market in the context of Chapter 11 cramdowns opens the door for protracted and costly litigation, valuation fights, and conflicting case law across the circuits. As a result of these potential implications and risks to both debtors and creditors, there still remains not only opportunity, but significant reasons for why parties should look for consensual resolutions outside of the courtroom when presented with cramdown issues raised by Momentive. James H.M. Sprayregen is a restructuring partner in the Chicago and New York offices of Kirkland & Ellis, representing major U.S. and international companies in restructurings out of court and in court around the globe. Madeleine C. Parish is a restructuring associate in the New York office of the firm, focusing her practice on financial restructurings, insolvency, and debtors’ and creditors’ rights.