08/28/2023

Eighth Circuit: Bankruptcy Plan Confirmation Requirements Do Not Mandate Using Prime Rate Or Treasury Bond Rate In Determining Discount Rate For Secured Claims

When a borrower files for bankruptcy, one of the key issues in the case is often whether the borrower’s bankruptcy plan proposes making payments to its secured lender that have a present value of at least the allowed amount of the lender’s secured claim. The need to calculate present value often gives rise to disputes about the appropriate discount rate to be used in making the calculation.

In the recent case of In re William Howard Topp, Case No. 22-2577 (8^th Cir. Slip Op. August 2, 2023), the Eighth Circuit Court of Appeals weighed in on this issue, finding that what matters is not the starting point for the interest rate (e.g., using the Prime Rate vs. the Federal Treasury Bond Rate). Rather, what matters is whether the ultimate rate that is used adequately takes into account the circumstances and the risk involved for the lender.

This issue arises because § 1225(a)(5) of the Bankruptcy Code requires, as a condition to confirmation of a chapter 12 plan, that the payments to a secured creditor must have a present value of at least the allowed amount of the creditor’s secured claim. See 11 U.S.C. § 1225(a)(5)(B)(ii). To make the determination this section requires, the bankruptcy court must adopt a discount rate to use in calculating the present value of the payments.

In the Topp case, bankruptcy court, following the Eighth Circuit’s decision in In re Doud, 869 F.2d 1144,1145 (8^th Circuit 1989), used the “risk-free” Federal Treasury Bond Rate of 1.87% as a starting point and added a risk factor to reach 4% as the ultimate discount rate for calculating the present value of the payments under the plan at issue. On appeal, the lender argued that the bankruptcy court instead should have followed the U.S. Supreme Court’s decision in Till v. SSC Credit Corp., 541 U.S. 465 (2004), in using the Prime Rate of 3.25%, plus a risk factor of 2%, for a total of 5.25%.

The Eighth Circuit affirmed the bankruptcy court’s decision, holding that neither the Prime Rate nor the Federal Treasury Bond Rate is mandated as a starting point in determining the discount rate. Instead, the focus should be on whether the ultimate rate used adequately takes into account the circumstances of the case and the risk involved for the lender. The court found that the bankruptcy court carefully assessed the type of loan involved, the typical term for such loans, and the relative risks associated with the loan, and its determination of a 4% discount rate was within its discretion.

So what does this mean for secured lenders going forward? The Topp case confirms that the approaches used in Till and Doud are permissible starting points in making present-value calculations in connection with the confirmation of chapter 12 plans. This case will no doubt be used by courts considering plans under chapters 11 and 13, as well. In Nebraska, the Till approach is mandated by local court rule, so the Topp case leaves that rule undisturbed. See Neb. R. Bank. P. 3023.1. In Iowa and other jurisdictions without a similar rule, secured lenders should have experienced bankruptcy counsel to assist in assessing and negotiating the appropriate risk factor adjustments to the starting rate and term. The ultimate goal should be to avoid leaving these decisions to a bankruptcy court and to negotiate an agreed rate and term prior to confirmation.

McGrath North has a team of bankruptcy practitioners with years of experience in this area who can advise you on these issues, as well as other bankruptcy related problems. Please contact the authors, Jim Niemeier and Michael Eversden, or any of the attorneys listed below if you would like our assistance.

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