Summary of a Recent
Judicial Development in
Bankruptcy

Supreme Court Holds "Formula Rate" Best
for Determining "Cramdown" Interest Rate

Joshua T. Crain
National AgLaw Center Graduate Assistant

Summary of Decision

In Till v. SCS Credit Corporation, 124 S. Ct. 1951 (2004), a plurality of the United States Supreme Court held that the formula rate was the best method for determining the "cramdown" interest rate to be paid a creditor over the course of a Chapter 13 plan.

Background

On October 2, 1998 Debtors Lee and Amy Till purchased a truck from Instant Auto Finance with a 21% annual finance charge. See id. at 1956. The loan was then assigned by Instant Auto Finance to SCS Credit Corporation (SCS). See id. On October 25, 1999 the debtors filed for Chapter 13 bankruptcy. See id. Due to the value of the truck at the time of filing, SCS had a secured claim of $4,000 and an unsecured claim of $894.89. See id. The debtors' proposed plan provided that they would pay interest on the secured portion of the claim of SCS at a rate of 9.5% annually. See id. The debtors "arrived at this 'prime-plus' or 'formula rate' by augmenting the national prime rate of approximately 8% . . . to account for the risk of nonpayment posed by borrowers in their financial position." Id. at 1957. SCS objected and claimed that it was entitled to the 21% contract rate. See id. The bankruptcy court overruled SCS' objection and confirmed the plan. See id. SCS appealed to the district court. See id. The district court reversed and held that SCS was entitled to the 21% rate. See id. The debtors then appealed to the United States Court of Appeals for the Seventh Circuit where it was held that the original 21% contract rate should serve as a presumptive contract rate which either party could then challenge as either too high or too low. See id. The debtors filed an appeal to the United States Supreme Court. See id. The Supreme Court granted certiorari and reversed the Seventh Circuit. See id.

Analysis and Holdings

Plurality

The plurality rejected the coerced loan, presumptive contract rate, and the cost of funds approaches to determining the appropriate cramdown interest rate in a Chapter 13 bankruptcy. See id. The plurality explained that each approach was "complicated, impose[d] significant evidentiary costs, and aim[ed] to make each individual creditor whole rather than to ensure the debtor's payments ha[d] the required present value." Id. at 1960. The plurality explained that these difficulties were not present with the formula approach. See id. The plurality explained that the formula approach began with the national prime rate and that, given the risk posed by bankrupt debtors, the bankruptcy courts would then adjust the national prime rate to account for that increased risk. See id. Justice Thomas concurred with the plurality, but asserted that courts were not required to adjust for the risk of nonpayment. See id.

Dissent

The dissent rejected the plurality's conclusion that the formula rate was the best method of determining what interest rate would be paid to secured creditors under a Chapter 13 plan. See id. The dissent stated that the better approach was the presumptive contract rate. See id. The dissent explained that the national prime rate was already known to be too low and that the contract rate was a good indicator of the risk of nonpayment. See id. The dissent also explained that under the presumptive contract approach there would be infrequent disputes and that it would provide a quick and accurate standard. See id. The dissent further explained that the contract rate could be revised on motion of either party. See id.

The dissent explained that the contract rate approach was based upon two assumptions: (1) subprime lending markets are competitive and efficient, and (2) the expected costs of default under Chapter 13 are no less than at the time of lending. See id. Concerning the first assumption, the dissent explained that the high interest rates charged by lenders was an accurate measure of the risk of doing business with subprime borrowers. See id. Concerning the second assumption, the dissent explained that the high rate of Chapter 13 failures indicated that the risk to the creditors continues in bankruptcy. See id. The dissent explained that because the Bankruptcy Code requires full risk compensation and the contract rate has the ability to provide such a full risk compensation, the plurality was wrong in its reliance on the formula rate approach. See id.

The case was decided on May 17, 2004; this summary was posted Oct. 13, 2004.