On March 1, 2013, the US Court of Appeals for the Fifth Circuit in Wells Fargo Bank National Ass'n v. Texas Grand Praire Hotel Realty, LLC (In re Texas Grand Prairie Hotel Realty, LLC) affirmed a bankruptcy court's decision to apply a 5% cramdown interest rate pursuant to the "prime-plus" formula, despite acknowledging that the resulting rate had little relation to rates charged in the market for comparable loans. In affirming the application of the prime-plus approach, in which the cramdown interest rate is based on the prime rate of interest plus an adjustment for risk (typically 1% to 3%), the Fifth Circuit valued straightforward calculations of cramdown rates over more complicated methods that require consideration of current debt market conditions.

In 2007, Texas Grand Prairie Hotel Realty, LLC and its affiliates (Debtors) borrowed $49 million to purchase and renovate hotel properties in Texas. Eventually, Wells Fargo (Lender) acquired the loan with the associated security interests in substantially all of the Debtors' property. In 2009, the Debtors defaulted on the loan, and filed for Chapter 11 protection.

The Lender objected to the Debtors' proposed Chapter 11 plan of reorganization. The Debtors then sought to cram down a plan on the Lender. Under section 1129(b)(2)(A)(i) of the Bankruptcy Code, a cramdown plan may be confirmed over the objection of a secured creditor if, among other things, it retains the lien securing its claim and receives deferred cash payments totaling at least the allowed amount of its secured claim. As of the effective date of the plan, these deferred cash payments must have a present value that is at least equal to the value of the collateral. However, the Bankruptcy Code does not specify the proper interest rate to apply to these payments, which has generated much litigation.

In this case, both parties agreed that:

However, the Lender disagreed with the application of the prime-plus approach by the Debtors' expert, which proposed an upward risk adjustment of 1.75% and resulted in an interest rate of 5% on the secured claim. In contrast, the Lender's expert's analysis yielded a 9.3% blended market rate, adjusted downward in accordance with Till to 8.8%.

The bankruptcy court confirmed the Debtors' cramdown plan using a 5% interest rate to pay the Lender's secured claim over a period of ten years. The US District Court for the Northern District of Texas affirmed.

Appealing to the Fifth Circuit, the Lender argued that the prime-plus method was incorrectly applied because footnote 14 in Till endorses a market rate approach in Chapter 11 cases if an efficient market exists for a loan substantially identical to the cramdown loan. Although the expert conceded that there was no efficient market for this loan because no lender would make a single $39 million secured loan to these Debtors, he reasoned that exit financing in this amount would be possible in the market if the loan was comprised of multiple tiers. Therefore, the Lender argued that making the Till risk adjustment to the weighted average of the market interest rates in each tier was an appropriate application of the prime-plus method.

The key issue on appeal was whether a 5% cramdown rate was appropriate under the prime-plus formula in a Chapter 11 case, although it did not reflect market realities.

The Fifth Circuit affirmed the decision of the District Court, holding that the bankruptcy court did not clearly err in its application of the prime-plus approach to arrive at a cramdown rate of 5%. The Fifth Circuit reasoned that the approach of the Debtors' expert was a straightforward application of the Till prime-plus method, which used a 1.75% risk adjustment that was within the range of adjustments assessed by other bankruptcy courts in similar cases. It noted that while the Till formula is not mandatory in Chapter 11 cases, it is becoming the majority approach. Therefore the bankruptcy court's use of it could not be overturned for clear error, even if its "natural consequences" produce "absurd results."

The Fifth Circuit also explained that Till expressly rejected methodologies, such as that of the Lender's expert, which require bankruptcy courts to consider evidence about the market for comparable loans because these require inquiries outside of these courts' expertise.

Further, the market rate approach endorsed in Till's footnote 14 applies only to Chapter 11 cases in which an efficient market exists for exit financing. The Fifth Circuit rejected the reasoning of the Lender's expert that the existence of exit financing "cobbled" together in various tiers establishes an efficient market. Rather, the Fifth Circuit explained that markets are efficient only if they can offer a loan with a term, size and collateral comparable to the contemplated cramdown loan.

However, the Fifth Circuit noted the warnings in Justice Scalia's dissent in Till, which acknowledged that, under the prime-plus formula:

Practitioners should consider the following implications in this case:

For more information on cramdown plans, see Practice Note, Chapter 11 Plan Process: Overview: Confirmation of a Plan: Cramdown Plans.