Business Restructuring Review

In Brief: On Remand, Momentive Bankruptcy Court Rules That Cramdown Notes Should Bear "Process Efficient" Market Interest Rate

In Momentive Performance Materials Inc. v. BOKF, NA (In re MPM Silicones, L.L.C.), 874 F.3d 787 (2d Cir. 2017), cert. denied, 138 S. Ct. 2653 (2018), the U.S. Court of Appeals for the Second Circuit affirmed a number of lower court rulings on hot-button bankruptcy issues, including allowance (or, in this case, denial) of a claim for a "make-whole" premium and contractual subordination of junior notes. However, the Second Circuit disagreed with the lower courts on the appropriate interest rate for first-lien and 1.5-lien replacement notes ("cramdown notes") issued to secured creditor classes that voted to reject the debtors’ chapter 11 plan. In doing so, it joined the Sixth Circuit in requiring that cramdown notes bear a market rate of interest if an efficient market exists; if no such market exists, the notes may bear interest at the typically below-market formula rate. See In re American HomePatient, Inc., 420 F.3d 559 (6th Cir. 2005). The Second Circuit accordingly remanded the case below for additional findings on whether "an efficient market can be ascertained, and, if so, [to] apply it to the replacement notes."

The Second Circuit faulted the lower courts for applying the "formula approach" articulated by the U.S. Supreme Court in Till v. SCS Credit Corp., 541 U.S. 465 (2004). In Till, the Court ruled that the interest rate on a cramdown loan in a chapter 13 case should follow a simple "formula approach"—a risk-free rate (in that case, the prime rate) plus a premium for the risk of the debtor’s nonpayment of the replacement loan (but excluding any profits, costs, or fees). In a footnote, the Court expressly left open the possibility that the formula approach might not apply in a chapter 11 case, where there is a robust market for debtor-in-possession financing.

In its prior ruling in Momentive, the bankruptcy court reasoned that Till and related precedent establish certain "first principles" which support application of the formula approach in chapter 11 despite Till’s suggestion that the approach might not be appropriate in that context. According to the bankruptcy court’s initial ruling, "there is no meaningful difference between the chapter 11, corporate context and the chapter 13, consumer context to counter Till’s guidance that courts should apply the same approach wherever a present value stream of payments is required to be discounted under the Code." The bankruptcy court also rejected the American HomePatient approach as the kind of unworkable, expensive, and burdensome standard that Till sought to avoid. The district court affirmed the bankruptcy court’s decision on appeal.

The Second Circuit reversed that portion of the lower court rulings regarding the appropriate interest rate for the replacement notes. Relying on the footnote in Till, the court adopted the two-step American HomePatient approach. In doing so, the Second Circuit explained that exposure to the market is the best determinant of value.

The Bankruptcy Court’s Ruling on Remand

On remand, the bankruptcy court issued an order on April 19, 2019 determining the appropriate rate of interest on the cramdown notes issued under the debtors’ chapter 11 plan. See In re MPM Silicones, LLC, No. 14-22503 (RDD) (Bankr. S.D.N.Y. Apr. 19, 2019). In its order, the court noted that "the existence of an efficient market for chapter 11 exit financing with a term, size and collateral comparable to the [cramdown notes] under traditional definitions of market efficiency was not established." However, the court acknowledged that the debtors negotiated "process efficient" back-up exit financing at arm’s-length involving competitive offers for the first-lien cramdown notes. In addition, although there was no similar back-up exit financing negotiated for the 1.5-lien notes, a proposed bridge facility commitment letter and expert testimony employing reasonably reliable methodology enabled the court to determine a "process efficient" market for exit financing of a term, size and collateral comparable to the 1.5-lien cramdown notes.

According to the court, the "process efficient" interest rate for the first-lien cramdown notes should be a floating rate, which "avoids a windfall for either the Debtors or the lenders based on changes to the general interest rate environment that may have occurred after confirmation of the Plan." However, based on expert testimony, the court concluded that a fixed rate for the 1.5-lien cramdown notes was fair.

The court accordingly ruled that: (i) the cramdown interest rate for the first-lien cramdown notes should be LIBOR + 4.50%, including .50% of original issue discount and .375% of "market flex," with a floor of 1.00%; and (ii) the cramdown interest rate for the 1.5-lien cramdown notes should be 7.9%.

The bankruptcy court issued its order in advance of a memorandum decision on the issues presented. The reorganized debtors appealed the bankruptcy court’s order on May 3, 2019.

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