By: Donald L Swanson
What rate of interest should a debtor pay under a bankruptcy plan?
The Eighth Circuit Court of Appeals addresses this question in Farm Credit Services of America, FLCA v. Topp (In re Topp), Case No. 22-2577 (8th Cir., decided August 2, 2023; Petition for rehearing denied on September 20, 2023).
Facts
Farmer is the In re Topp debtor, raising crops and livestock. After several rough years, Farmer files Chapter 12 bankruptcy.
Creditor files a $595,000 secured claim in the bankruptcy, based on five loans of various durations having interest rates of 3.5% to 7.6%.
Creditor’s claims are fully secured by Farmer’s real estate—valued at $1.45 million.
Farmer’s Chapter 12 plan proposes to pay Creditor’s claim in full from future earnings, in twenty annual payments, with interest. The plan rate of interest is computed as:
- starting with the twenty-year treasury bond rate (1.87% at the time); and
- adding a 2% risk adjustment.
Creditor is ok with the twenty-years term of payments and is even ok with the 2% risk adjustment.
But Creditor objects to starting with the twenty-year treasury bond rate. Creditor insists, instead, that the starting point should be the national prime rate (3.25% at the time).
Legal Standard & Its Application
The legal standard is this:
- To be confirmed, over a creditor’s objection, the plan must pay creditor a total value, as of the effective date of the plan, that is not less than the allowed amount of the claim (see § 1225(a)(5)(B)(ii)).
In applying this standard, the bankruptcy court:
- sides with Farmer on the treasury bond rate v. national prime rate issue;
- rounds 1.87% plus 2% up to 4% — finding this rate to be proper; and
- confirms the plan with its 4% interest, over Creditor’s objection.
Creditor appeals to the District Court, which affirms, and then to the Eighth Circuit Court of Appeals—which also affirms.
What follows is a summary of the Eighth Circuit’s rationale for siding with Farmer in approving the treasury bond rate starting point and adding a 2% risk adjustment.
Statutory Goal
The goal of the Chapter 12 confirmation statute is to ensure that the total present value of future plan payments to Creditor equals or exceeds the allowed value of Creditor’s claim.
Since Creditor’s claim is over-secured, its entire claim is “allowed.” But that doesn’t mean Creditor is entitled to post-confirmation interest at the contract rates.
Interest Function
Money received now is worth more than money received later. So, interest is added to make future payments equal the present value of a claim.
And there are no guarantees in life:
- a lot can happen in twenty years; and
- deferred payments come with risk—e.g., debtor may not be able to pay, market conditions may shift, etc.
So, interest accruals, at a proper rate, adjust and account for both the time value of money and the risk involved.
The Dispute
Farmer and Creditor agree that an interest rate determination calls for a “market rate” or “formula” approach, which says the appropriate interest rate should consist of:
- a low-risk or risk-free rate; plus
- additional interest to compensate for risks posed by the plan.
Where the disputing parties disagree is over the proper low-risk or risk-free starting point: i.e., the treasury bond rate or the prime rate. Both rates are reported daily in such publications as the Wall Street Journal.
The case law cited for the dispute is this:
- Debtor cites United States v. Doud, 869 F.2d 1144, 1146 (8th Cir. 1989), for the treasury rate; and
- Creditor cites Till v. SCS Credit Corp., 541 U.S. 465, 474 (2004) (plurality opinion), for the prime rate.
Choosing Treasury Rate
Neither Doud nor Till chooses between the treasury rate or the prime rate.
–Doud
Doud approves starting with the treasury rate. But Doud does not actually choose between competing starting points:
- Doud affirms the bankruptcy court’s choice of an overall rate beginning with the treasury rate as not clearly erroneous, since the bankruptcy court provides a rational analysis of its preference for starting with the treasury rate; and
- around that time (the late 1980s and early 1990s), many courts are starting with the treasury rate before adjusting upward for risk.
–Till
Till comes later, in 2004. Around that time, some courts take a non-formula approach. But Till’s plurality favors the formula approach—characterized as beginning with the national prime rate and then adjusting upward for the risk of nonpayment in a bankruptcy.
But, like Doud, Till does not consider the merits of starting with the prime rate versus the treasury rate. Till’s plurality discusses the prime rate simply because that is the formula-approach used in that case.
As for the appropriate risk adjustment on top of the prime rate, the plurality does not decide: it merely observes that courts generally approve adjustments of 1% to 3%.
–Starting & Adding
The Eighth Circuit, in Topp, (i) approves the treasury rate as an appropriate starting point for the formula approach, and (ii) adds to that rate for the risk involved.
The treasury rate is entirely risk-free; whereas, the prime rate includes an inherent risk of default in loans to the most creditworthy borrowers.
The error of Creditor’s position is that, while agreeing with the Bankruptcy Court’s 2% adjustment, Creditor wants to start with the more-favorable rate:
- This approach is backwards—the starting point will influence the risk adjustment;
- There is no legal significance in, (i) starting with a risk-free rate and adding a full risk, or (ii) starting with a some-risk rate and adding some more;
- If a court properly follows the formula approach, the ultimate interest rate, not the starting point, is what matters.
In Till’s wake, most courts start with the prime rate—but the treasury rate still persists.
Standard of Review
Creditor, in focusing on Till, is attempting to get a more favorable standard of review:
- Creditor is pitching the starting-rate choice as a purely legal question calling for de novo review; but
- the starting rate choice is, actually, a factual finding about the appropriate interest rate—which choice is reviewed for clear error.
Ruling
In reviewing the bankruptcy court’s factual findings for clear error, the Eighth Circuit sees none. The bankruptcy court:
- studied the Till/Doud relationship and the prevalence of post-Till decisions using the prime rate;
- considered the length of the proposed maturity period, the fact that Creditor’s claim is substantially over-secured, and the overall risk of nonpayment;
- noted that Creditor’s claim is secured by real estate, which is generally financed over a long period of time—justifying the use of the treasury bond as the base rate; and
- in the end, approves a 4% rate—the treasury rate plus 2% for risk, which rate also happens to equal the prime rate of 3.25% plus a modest risk adjustment of 0.75%.
Conclusion
The Eighth Circuit’s In re Topp opinion is instructive and a helpful addition to the body of case law on interest rate provisions in bankruptcy plans.
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