October 20, 2017 - Almost one year after oral arguments were heard, the United States Court of Appeals for the Second Circuit issued an opinion in the In re MPM Silicones, L.L.C. (“Momentive”) bankruptcy case. While four distinct issues were before the court, one of them, whether a debtor in a bankruptcy can “cram down” senior secured creditors with below-market rate replacement notes, was by far the most critical to loan market participants. The key takeaway: The court’s ruling is an important victory for senior secured lenders. The alternative could have resulted in a road map for debtors to devise bankruptcy reorganization plans that cram down over-secured lenders with below market rate replacement notes rather than paying them in full, in cash.
Following is some background and a brief synopsis of the ruling.
In Momentive, the debtors formulated a confirmation plan that would either pay cash in full to the over-secured holders of $1 billion of first lien and $250 million of so-called “1.5 lien” notes if they agreed to accept the plan and waive their claims for a $250 million “make-whole” premium. Alternatively, it would “cram down” the plan over the noteholders’ objections by satisfying their claims with replacement notes in the amount of their allowed claims. The notes would pay a flat interest at a rate concededly below market.
The secured noteholders rejected the plan, asserted their rights to the make-whole and argued that the treatment afforded them under the plan, i.e., the below-market rate replacement notes, was not “fair and equitable” as required under Section 1129(b) of the bankruptcy code which provides that a plan may be confirmed over a secured creditor’s objection only if it maintains the value of their claims. They argued that the notes should bear a market rate of interest and noted that such a rate was readily ascertainable in this case. The bankruptcy court, relying on a Supreme Court case called “Till”, ruled that it was constrained to impose a risk-free “formula” rate rather than the market rate. The District Court affirmed. On appeal the Court disagreed, ruling that Till did not compel the court to use the formula rate and concluding that if a market rate exists it should be used. The court noted that the Till decision involved a Chapter 13 case where a market rate of interest would be more difficult to ascertain, and referred to an important footnote in the Till decision that stated that the Till approach may not be suited to Chapter 11 cases where market rates do exist. The court stated that “where, as here, an efficient market may exist that generates an interest rate that is apparently acceptable to sophisticated parties dealing at arms-length, we conclude, consistent with footnote 14 [of the Supreme Court decision in Till], that such a rate is preferable to a formula improvised by a court.” The court remanded the case to the bankruptcy court to determine whether the market rate exists and, if so, to apply that rate rather than the formula rate.
The LSTA in September 2015 filed an amicus brief on this issue largely in line with the court’s ruling. Professor Ronald Mann of Columbia Law School represented the LSTA in its amicus brief which was joined by the Managed Funds Association and SIFMA.