Till, Lee M. v. SCS Credit Corp ( 2002 )

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 00-4167
IN RE:
LEE M. TILL and AMY M. TILL,
Debtors-Appellants.
____________
Appeal from the United States District Court
for the Southern District of Indiana, Indianapolis Division.
No. 00 C 1102—Larry J. McKinney, Chief Judge.
____________
ARGUED APRIL 10, 2002—DECIDED AUGUST 21, 2002
____________
Before RIPPLE, MANION and ROVNER, Circuit Judges.
RIPPLE, Circuit Judge. Lee and Amy Till filed for bank-
ruptcy protection under Chapter 13. SCS Credit Corpora-
tion, a secured creditor, objected to confirmation of the
Tills’ Chapter 13 plan on the ground that the interest rate
SCS would be paid under Chapter 13’s “cramdown”
provision, see 11 U.S.C. § 1325(a)(5)(A)(ii), was insufficient.
The bankruptcy court confirmed the plan over SCS’ objec-
tion; it held that the proper interest rate was the prime
rate plus a risk adjustment of 1.5%. SCS appealed. The
district court reversed the bankruptcy court’s decision;
it concluded that the “coerced loan” theory applied, and,
consequently, that the interest rate should be based on
what SCS would receive for a loan of similar risk and dur-
2 No. 00-4167
ation. The district court stayed remand of its order pending
the Tills’ further appeal to this court. For the reasons set
forth in the following opinion, we vacate the judgment
of the district court and remand the case for further pro-
ceedings with instructions.
I
BACKGROUND
Lee and Amy Till jointly filed for bankruptcy protection
under Chapter 13. SCS Credit Corporation was the only
creditor to object to confirmation of the Tills’ amended
Chapter 13 plan. SCS is a secured creditor and holds a
security interest in an automobile. The vehicle was valued
at $4,500. SCS is a sub-prime lender, which means that it
services borrowers with credit histories too poor to qualify
for prime-rate auto loans. The Tills are such borrowers.
The interest rate on the Tills’ loan was 21%. The Tills’ plan
invoked the “cramdown” provision of Chapter 13.
Under Chapter 13’s cramdown provision, a bankruptcy
plan will be confirmed over the objection of a secured
creditor if the creditor retains its lien on the collater-
al, and the creditor receives cash payments over the
course of the plan that are equivalent to the value of the
collateral on the plan’s effective date. See 11 U.S.C.
§ 1325(a)(5)(B). To achieve this statutory requirement,
the bankruptcy court must determine the value of the
collateral, and the debtor must pay interest to account for
the time value of money. Under the Tills’ reorganiza-
tion plan, the interest rate on SCS’ secured claim would
be 9.5%. SCS contended that this rate would not pro-
vide SCS with the present value of its collateral, as re-
quired by the cramdown provision. SCS submitted that
the rate should be 21%, the interest rate it would have
No. 00-4167 3
earned if SCS had foreclosed on the vehicle, sold it and
then reinvested the proceeds in another sub-prime auto
loan.
The bankruptcy court conducted a hearing to consider
SCS’ objection. The Tills presented the testimony of a
finance professor who testified that an interest rate of 9.5%,
which he based on the prime rate plus a risk premium
of 1.5%, would be sufficient. He admitted, however, that
he had no experience working for a creditor and only a
limited understanding of the sub-prime auto lending
market. SCS presented the testimony of its general man-
ager, Neil Bird, and the sales manager of Instant Auto
Finance, which had written the loan to the Tills and then
had assigned it to SCS. Both witnesses testified that SCS
had received 21% interest on all of its loans because borrow-
ers like the Tills are poor credit risks. Bird also testified
that SCS usually did not get paid the full amount under
Chapter 13 plans because the debtors often cannot fulfill
their obligations under the plan.
The bankruptcy court interpreted our decision in
Koopmans v. Farm Credit Services of Mid-America, 102 F.3d
874 (7th Cir. 1996), to endorse a prime rate plus a risk
premium method of calculating the proper cramdown
interest rate. The court rejected the “coerced loan” theory
of the cramdown provision advocated by SCS. Following
what it believed to be the holding of Koopmans, the bank-
ruptcy court confirmed the Tills’ plan with an interest rate
of 9.5% applied to SCS’ claim.
SCS then appealed to the United States District Court
for the Southern District of Indiana. SCS reasserted its
argument that it was entitled to 21%, the rate it would
earn on a loan if it had foreclosed on the collateral and
then had used the proceeds to issue a new loan. The dis-
trict court agreed. The court held that the bankruptcy
court had misread Koopmans and that Koopmans required
4 No. 00-4167
that SCS receive the interest rate it would have earned on
a new loan financed by the proceeds from the sale of
its collateral. Based on the record in the bankruptcy court,
the district court concluded that 21% was the proper rate
and accordingly reversed the bankruptcy court’s decision.
The Tills now appeal that decision to this court.
II
DISCUSSION
A.
The issue before us—the appropriate approach to deter-
mine the applicable interest rate under Chapter 13’s
cramdown provision—first presents us with a question of
statutory interpretation. We review this question de novo.
The application of that method to the particular facts of
this case is reviewed for clear error. See In re Smithwick, 121
F.3d 211, 215 (5th Cir. 1997).
The Tills submit that we should reverse the district court
and reinstate the bankruptcy court’s decision. In their view,
a “market formula” method, such as the one adopted by
the bankruptcy court in this case, appropriately imple-
ments the statutory mandate. SCS, however, contends
that the “coerced loan” method, adopted by several Courts
of Appeals and by the district court in this case, more
accurately reflects the statutory intent.
When a petition is filed under Chapter 13 of the Bank-
ruptcy Code, a bankruptcy court confirms the plan if sev-
1
eral conditions are met. See 11 U.S.C. §§ 1325(a)(1)-(6). For
1
The statute provides:
Except as provided in subsection (b), the court shall confirm
a plan if—
(continued...)
No. 00-4167 5
secured creditors, this provision offers three possible
prerequisites to confirmation, one of which must be sat-
isfied before a Chapter 13 plan can be confirmed. If the
secured creditor consents, see 11 U.S.C. § 1325(a)(5)(A), or
the debtor surrenders the collateral, see id. § 1325(a)(5)(C),
1
(...continued)
(1) the plan complies with the provisions of this chapter
and with the other applicable provisions of this title;
(2) any fee, charge, or amount required under chapter
123 title 28, or by the plan, to be paid before confirma-
tion, has been paid;
(3) the plan has been proposed in good faith and not
by any means forbidden by law;
(4) the value, as of the effective date of the plan, of
property to be distributed under the plan on account
of each allowed unsecured claim is not less than the
amount that would be paid on such claim if the estate
of the debtor were liquidated under chapter 7 of this
title on such date;
(5) with respect to each allowed secured claim provided
for by the plan—
(A) the holder of such claim has accepted the plan;
(B)(i) the plan provides that the holder of such
claim retain the lien securing such claim; and
(ii) the value, as of the effective date of the plan,
of property to be distributed under the plan
on account of such claim is not less than the al-
lowed amount of such claim; or
(C) the debtor surrenders the property securing
such claim to such holder; and
(6) the debtor will be able to make all payments un-
der the plan and to comply with the plan.
11 U.S.C. § 1325(a).
6 No. 00-4167
or if the plan invokes 11 U.S.C. § 1325(a)(5)(B), known
colloquially as Chapter 13’s “cramdown” provision, a
Chapter 13 plan will be confirmed, as long as the other
conditions of confirmation are met. See Todd J. Zywicki,
Cramdown and the Code, 19 T. Marshall L. Rev. 241, 242-43
(1994). The cramdown provision permits a bankruptcy
court to confirm a debtor’s Chapter 13 plan over a se-
cured creditor’s objection if “the plan provides that the
holder of such claim retain the lien securing such claim;
and the value, as of the effective date of the plan, of prop-
erty to be distributed under the plan on account of
such claim is not less than the allowed amount of such
2
claim.” 11 U.S.C. § 1325(a)(5)(B). Both Chapter 11, see 11
U.S.C. § 1129(b)(2)(A)(i)(II), and Chapter 12, see 11 U.S.C.
§ 1225(a)(5)(B)(ii), contain analogous cramdown provi-
sions. Courts have considered all three provisions to be
3
similar and have analyzed them interchangeably.
2
The allowed amount of a secured creditor’s claim is the value
of the collateral. The Code divides a secured creditor’s claim
into two portions, a secured portion and an unsecured por-
tion. The secured portion is equal to the value of the collateral
(for undersecured creditors) on the plan’s effective date, the
unsecured portion is the amount of the debt still owed to the
creditor over and above the value of the collateral. See United
States v. Ron Pair Enters., 489 U.S. 235, 239 (1989). With respect
to this excess amount, the secured creditor is treated like an
unsecured creditor. See id.3
See, e.g., Koopmans v. Farm Credit Servs. of Mid-America, ACA,
102 F.3d 874, 875 (7th Cir. 1996) (citing cases interpreting Chap-
ter 13’s cramdown provision in a Chapter 12 case); In re
Smithwick, 121 F.3d 211, 213 (5th Cir. 1997) (describing the
cramdown provisions of Chapter 11 and Chapter 12 as analo-
gous and citing to Chapter 11 cramdown cases in Chapter 12
(continued...)
No. 00-4167 7
Before a plan invoking the cramdown provision can
be confirmed, a bankruptcy court must make two determi-
nations. First, it must determine the value of the collateral
as of the effective date of the plan. See Assocs. Commercial
Corp. v. Rash, 520 U.S. 953, 960-62 (1997). Once that value
is determined, the bankruptcy court must then decide up-
on a stream of payments over the course of the plan that
will provide the creditor with “value . . . not less than the
allowed amount of such claim.” 11 U.S.C. § 1325(a)(5)(B)(ii).
To compensate a secured creditor for its delay in receiv-
ing the value of the collateral, the creditor must receive
interest to account for the time value of money. See John K.
Pearson, et al., Ending the Judicial Snipe Hunt: The Search
for the Cramdown Interest Rate, 4 Am. Bankr. Inst. L. Rev. 35,
36-38 (1996). Thus, the second determination a bankrupt-
cy court must make is the rate of interest to be charged.
This issue has caused significant disagreement among
the courts of appeals, bankruptcy courts and commenta-
tors. See Monica Hartman, Comment, Selecting the Correct
Cramdown Interest Rate in Chapter 11 and Chapter 13 Bankrupt-
cies, 47 U.C.L.A. L. Rev. 521, 532-44 (1999) (discussing
the dominant approaches and the criticism each has re-
ceived); David G. Epstein, Don’t Go and Do Something Rash
About Cram Down Interest Rates, 49 Ala. L. Rev. 435, 443-59
(1998) (discussing the divisions among courts of appeal);
Matthew Y. Harris, Comment, Chapter 13 Cram Down Inter-
est Rates, 67 Miss. L.J. 567, 569-80 (1997) (discussing the cur-
rent approaches and their critics).
3
(...continued)
case); In re Fowler, 903 F.2d 694, 697 (9th Cir. 1990) (finding that
analysis in Chapter 11 cramdown cases also applied to Chap-
ter 12 case); United States v. Arnold, 878 F.2d 925, 928 (6th
Cir. 1989) (finding cramdown provisions of Chapter 12 and Chap-
ter 13 to be identical).
8 No. 00-4167
B.
Our ultimate task is to ascertain the policy decision
made by Congress in enacting this statutory provision. This
task requires that we understand the command of the
statute. We therefore begin, as we always must, with the
text of the statute. We focus on the plain wording of the
provision before us and on the statutory structure of which
4
that provision is a part. Examining both the text of the
cramdown provision and the structure of the statute, we
think it is clear that Congress intended that, under
§ 1325(a)(5)(B)(ii), the secured creditor, who is being forced
to accept the debtor’s plan and to forfeit his right to fore-
close and sell the collateral, is to be compensated for the
diminution of his present interest in the collateral. In short,
from the debtor’s perspective, it is necessary to pay for the
continued use of the collateral at a rate that will preserve
the value of the creditor’s interest.
In ascertaining the precise obligation of the debtor un-
der the cramdown provision, it is helpful to compare
4
In the case of an ambiguity in the statute, we sometimes
find helpful, as long as it is read with prudence and caution,
the legislative history of the provision. Although we have no
need to resort to this device here, we note in passing that it is
not very helpful to the task at hand. The House Report accom-
panying the 1978 Bankruptcy Act states that “[v]alue as of
the effective date of the plan . . . indicates that the promised
payment under the plan must be discounted to present value
as of the effective date of the plan. The discounting should be
based only on the unpaid balance of the amount due under
the plan, until that amount, including interest, is paid in full.”
H.R. Rep. 95-595 at 408, reprinted in 1978 U.S.C.C.A.N. 5963,
6364. The report does not address the appropriate method of
calculating the interest rate.
No. 00-4167 9
its requirements to the other provisions of § 1325(a)(5)
that offer alternative ways of protecting the interest of a
secured creditor in a Chapter 13 plan. We think it is rea-
sonable to presume that Congress intended that each of
these options afford the secured debtor somewhat equiva-
lent protection. Certainly, none of the three was designed
to provide the debtor or the creditor with a windfall.
The three possibilities are straightforward: (1) a cred-
itor consents to the plan; (2) the debtor turns over the
collateral to the creditor; or (3) the debtor invokes the
cramdown. A creditor will only consent if the plan ade-
quately protects its interests. See Pearson, supra, at 49-50
(describing the efforts of creditors and debtors to come to
an agreement to avoid bankruptcy litigation). If the cred-
itor receives the collateral, then its rights under state law
are vindicated and its contract with the debtor is fulfilled;
in such a circumstance, the secured creditor’s rights are
not impaired by the Bankruptcy Code. The creditor may
still seek the unsecured portion of its claim in bankruptcy,
but it proceeds as an unsecured creditor and without the
preference the Code gives to secured creditors. Given
these two alternate modes of protection afforded by the
statute, it is logical to conclude that the interest rate under
the cramdown provision must put the creditor in a posi-
tion reasonably equivalent to the position it would be in
had it consented to the plan or had it received and then
sold the collateral. There seems to be a consensus on this
point among courts of appeal that have addressed this is-
sue. All agree that the rate should compensate the cred-
itor for its delay in receiving the value of the collateral.
See, e.g., Koopmans v. Farm Credit Servs. of Mid-America,
ACA, 102 F.3d 874, 874 (7th Cir. 1996); In re Smithwick,
121 F.3d 211, 214 (5th Cir. 1997); In re Valenti, 105 F.3d 55,
59-60 (2d Cir. 1997); GMAC v. Jones, 999 F.2d 63, 66-67
(3d Cir. 1993); United Carolina Bank v. Hall, 993 F.2d 1126,
10 No. 00-4167
1129-30 (4th Cir. 1993); In re Fowler, 903 F.2d 694, 696-97
(9th Cir. 1990); In re Hardzog, 901 F.2d 858, 859-60 (10th
Cir. 1990); United States v. Arnold, 878 F.2d 925, 928-29
(6th Cir. 1989). “If the debtor chooses to maintain posses-
sion of the secured collateral . . . then the debtor must
compensate the creditor for the full value of the allowed
secured claim.” In re Valenti, 105 F.3d at 59.
C.
Despite the consensus on the objective of the statute,
courts have developed divergent formulae for calculat-
ing the interest rate. Even here, however, there is consen-
sus about a starting point. Courts agree that a “market” rate
of interest should apply. See Koopmans, 102 F.3d at 874-75;
In re Smithwick, 121 F.3d at 214; In re Valenti, 105 F.3d at 63;
GMAC, 999 F.2d at 66-67; United Carolina Bank, 993 F.2d
at 1129-30; In re Fowler, 903 F.2d 694, 697 (9th Cir. 1990);
In re Hardzog, 901 F.2d at 859-60; Arnold, 878 F.2d at 927-28;
see also Pearson, supra at 40-41; Epstein, supra at 443. There
is disagreement, however, about what rate of interest will
adequately ensure that the creditor receives full value of
his secured claim.
1.
Under one approach, known as the “cost of funds meth-
od,” the interest rate is set at the rate the creditor would
have to pay to borrow the amount equal to the col-
lateral’s value. See In re Valenti, 105 F.3d at 64 (holding that,
although cost of funds approach “more appropriately re-
flects the present value of a creditor’s allowed claim,” it
is difficult to administer, and therefore the interest rate
should be “fixed at the rate on a United States Treasury
No. 00-4167 11
instrument with a maturity equivalent to the repayment
schedule under the debtor’s reorganization plan”); 8
Lawrence P. King et al., Collier on Bankruptcy, ¶ 1325.06[3][B]
(15th ed. 2001) (advocating cost of funds approach). No
court of appeals has adopted the cost of funds method
without further refinement. In In re Valenti, the Second
Circuit expressed the view that this method was the best
of the approaches employed by the various federal
courts, but chose to adopt, for the sake of efficiency and
ease of administration, a standard rate for all cramdown
cases. See In re Valenti, 105 F.3d at 64. As we shall discuss
in more detail later, under the Second Circuit approach,
the Chapter 13 plan ought to set the interest rate at the
rate for Treasury instruments with a maturity equivalent
to the repayment schedule set forth in the plan of reor-
ganization. This rate ought then to be adjusted to take into
account the creditor’s risk in not receiving the payments
scheduled under the plan. See id. The cost of funds’ ap-
proach is advocated by Collier on Bankruptcy and has been
adopted by some bankruptcy and district courts.
The cost of funds method is not without its flaws. First,
as the Ninth Circuit has observed, charging an interest
rate equal to the creditor’s borrowing rate forces the cred-
itor to make a firm commitment to borrow (and repay)
funds secured only by the risky stream of payments un-
der the debtor’s Chapter 13 plan and the creditor’s continu-
ing lien on a depreciating piece of collateral. See In re Camino
Real Landscape Maint. Contractors, Inc., 818 F.2d 1503, 1506
(9th Cir. 1987). Such a rate does not give the secured cred-
itor value equivalent to his allowed claim. Second, “it is
doubtful that the secured creditor has an unlimited sup-
ply of credit.” Michael E.S. Frankel, The Emerging Fixed
Cramdown Rate Regime, 2 U. Chi. L. Sch. Roundtable 643,
647 (1995). The cost of funds method presupposes that
a creditor will opt to exhaust some of its own credit in or-
12 No. 00-4167
der to replace the liquid capital it would have received af-
ter foreclosure and sale. Many Chapter 13 creditors are
not in a financial position to take on such a commit-
ment and, consequently, the imposition of such terms on
them would not afford them the full value of their secured
interest and would deprive them of the protection of the
cramdown provision. Third, the cost of funds approach is
likely to provide a windfall to the debtor. As a practical
matter, it allows the debtor to step into his creditor’s
shoes and pay interest for use of the collateral on the terms
that he would enjoy if he were the secured creditor. This
approach does not compensate the creditor for the risk
that the Chapter 13 plan will fail and leave the creditor
with only the remedy of foreclosure and sale of depre-
ciated collateral.
2.
A second approach, which is an adaption of the cost of
funds method, is the formula method. The Second Cir-
cuit, see In re Valenti, 105 F.3d 55, 63 (2d Cir. 1997), has
adopted the formula method; the Ninth Circuit, see In re
Fowler, 903 F.2d 694, 698 (9th Cir. 1990), and Eighth Circuit,
see United States v. Doud, 869 F.2d 1144, 1146 (8th Cir. 1989),
have endorsed the formula method but have not adopted
an exclusive, strict formula; instead those courts have
vested significant discretion in the bankruptcy courts.
“[T]he formula approach requires the court to adopt a risk-
free market rate as a base, and then add a risk premium
corresponding to the court’s determination of the risk-
iness of the reorganization plan.” Pearson, supra, at 50. As
we have noted earlier, the Second Circuit uses the “rate on
a United States Treasury instrument with a maturity equiv-
alent to the repayment schedule under the debtor’s re-
No. 00-4167 13
organization plan” and a risk premium of one to three
percent. In re Valenti, 105 F.3d at 64.
The formula method as adopted by our colleagues in
the Second Circuit has the advantage of being clear and
predictable. The base rate is readily ascertainable, and
there is a small range of risk adjustment. We do not be-
lieve, however, that the formula approach necessarily will
produce an interest rate that complies with the statutory
requirement that the creditor receive “value . . . [which is]
not less than the allowed amount of such claim” over
the course of the plan. 11 U.S.C. § 1325(a)(5)(B)(ii). Con-
gress sought to protect the secured creditor who is forced
into the cramdown situation with protection against sev-
eral factors: (1) the possibility that his continued credit to
the now-bankrupt debtor would not be repaid; (2) the
reality that the collateral will continue to depreciate either
at the same rate as it has in the past or at a different rate,
depending on the nature of the collateral and the prevail-
ing market conditions; (3) the cost of continuing to ser-
vice the loan in question. Congress left to the bankruptcy
courts the task of ascertaining the appropriate rate which
would protect against all of these factors. As this court
noted in Koopmans, market participants may choose differ-
ent methods of calculating the market rate of interest for
the new situation precipitated by the debtor’s invocation
of the cramdown provision. See Koopmans, 102 F.3d at 875.
There are a multitude of possible creditor/debtor relation-
ships subject to the cramdown provision. Each presents its
own risks; to adopt a standard interest rate with limited
discretion vested in the bankruptcy court only to take into
consideration the contingency of nonpayment would not
necessarily fulfill the statutory command that the creditor
be afforded the full value of his interest at the time the
reorganization plan becomes effective. The statutory pro-
vision necessarily leaves the particular questions of valua-
14 No. 00-4167
tion to the informed discretion of the bankruptcy court.
Our adoption of a rigid formula would unduly restrict
that discretion. The statute contemplates a more partic-
ularized inquiry, and we are bound by Congress’ policy
choice in this regard.
3.
A third approach, and the one that we adopted in
Koopmans, has been described as the “coerced loan” or the
“forced loan” method. Courts taking this view conceptual-
ize the cramdown provision as forcing creditors to extend
a new line of credit to the debtor. Consequently, “the
creditor is entitled to the rate of interest it could have
obtained had it foreclosed and reinvested the proceeds in
loans of equivalent duration and risk.” Koopmans, 102
F.3d at 875. This approach views § 1325(a)(5)(B)(ii) as
“seek[ing] to put the secured creditor in an economic
position equivalent to the one it would have occupied had
it received the allowed secured amount immediately, thus
terminating the relationship between the creditor and the
debtor.” GMAC, 999 F.2d at 66-67; see also In re Smithwick,
121 F.3d at 214.
Koopmans was decided under the cramdown provision
of Chapter 12, which applies to family farms. See Koop-
mans, 102 F.3d at 874. We wrote that in a cramdown, “the
secured creditor is entitled to the ‘indubitable equivalence’
of its property interest, which means a stream of pay-
ments including interest that adds up to the present value
of its claim.” Id. at 874 (quoting In re Murel Holding Corp.,
75 F.2d 941, 942 (2d Cir. 1935) (L. Hand, J.)). The ques-
tion there, as here, is: “At what rate of interest will [the
secured creditor] be as well off in the reorganization as if
No. 00-4167 15
it had been allowed to foreclose on and sell the [collat-
eral].” Id. We held that “the creditor is entitled to the rate
of interest it could have obtained had it foreclosed and
reinvested the proceeds in loans of equivalent duration and
risk.” Id. at 875. We so held “[w]ithout implying that ‘prime-
plus’ is the only way to approximate the market rate of
interest—for participants in the market may use other
methods . . . .” Id.
Some courts, including the bankruptcy court in this
case, have read our holding in Koopmans to endorse the
formula method discussed above. It is true that we affirmed
the decision of the bankruptcy court, which had:
approximated this by starting with the prime rate of
interest, which it found prevalent for new 20-year well-
secured agricultural loans at the time, and adding 1.5
percent because it deemed this extension of credit
more risky than the norm in light of the Koopmans’
sorry repayment record. This produced a floating rate,
10.5 percent (9 percent + 1.5 percent) at the time the
bankruptcy court approved the plan.
Koopmans, 102 F.3d at 875 (emphasis added). However,
“this” was the “market rate of interest, at the time of the
hypothetical foreclosure, for loans of equivalent dura-
tion and risk.” Id. at 874-75. In Koopmans, the forced loan
approach produced a 10.5% interest rate based upon the
prime rate plus a risk factor; this result was a realistic
approximation of the interest rate that the creditor would
have received on a new loan of the same duration and
risk because the secured creditor in Koopmans was over-
secured, and the chosen rate was the one for well-secured
agricultural loans. See id. at 874-75. Koopmans did not
endorse a formula approach and should not be read to
have endorsed such an approach. As we emphasized in
Koopmans, “[o]n this record, the market’s approach is prime-
16 No. 00-4167
plus.” Id. at 875. It is clear that Koopmans did not adopt the
prime-plus rate; it adopted the coerced loan method, the
specific application of which led to the prime-plus rate.
See id.Only the Second Circuit has explicitly rejected the forced
loan method. See In re Valenti, 105 F.3d at 64. The court
in Valenti thought the coerced loan method inapprop-
riate because it computes “ ‘present value’ to include
the profit that the creditor would have generated had
the creditor received the value of the collateral immedi-
ately.” Id. at 63. The court elaborated: “The objective
of § 1325(a)(5)(B)(ii) is to put the creditor in the same
economic position that it would have been in had it re-
ceived the value of its allowed claim immediately. The
purpose is not to put the creditor in the same position
that it would have been in had it arranged a ‘new’ loan.”
Id. at 64. The court also opined that “the value of the credi-
tor’s allowed claim does not include any degree of profit.”
Id. Like several other circuits, we respectfully decline
to adopt this analysis. Like the Third Circuit, see GMAC,
999 F.2d at 69, and the Fifth Circuit, see Smithwick, 121 F. 3d
at 214, we believe that to exclude the element of profit
from the fixing of the market rate would violate the statu-
tory directive that the creditor be placed in the same
position as the one in which it would have been if it had
been allowed to end the lending relationship by repossess-
ing the collateral.
By determining the rate that the creditor in question
would obtain in making a new loan in the same indus-
try to a debtor who is similarly situated, although not in
bankruptcy, see GMAC, 999 F.2d at 67 n.4, we acknowl-
edge that we are approximating, not necessarily duplicat-
ing precisely, the present value of the collateral to the
creditor as that statute requires. The continuation of the
No. 00-4167 17
old contract rate to the bankrupt debtor under the super-
vision of the bankruptcy court will involve some risks
that would not be incurred in a new loan to a debtor not
5
in default and also result in some economies. Neverthe-
less, like our colleagues in the Third Circuit, see GMAC,
999 F. 2d at 68-69, and Fifth Circuit, see Smithwick, 121 F.3d
at 214, we believe that the old contract rate will yield a rate
sufficiently reflective of the value of the collateral at the
time of the effectiveness of the plan to serve as a presump-
tive rate. Therefore,
[i]n the absence of a stipulation regarding the creditor’s
current rate for a loan of similar character, amount
and duration, we believe it would be appropriate for
bankruptcy courts to accept a plan utilizing the con-
tract rate if the creditor fails to come forward with
persuasive evidence that its current rate is in excess of
the contract rate. Conversely, utilizing the same
rebuttable presumption approach, if a debtor proposes
a plan with a rate less than the contract rate, it would
be appropriate for a bankruptcy court to require the
5
As the Third Circuit noted in GMAC, an extension of the old
loan will not involve the usual initiation costs and the bankrupt-
cy trustee will assume some, although not all of the monitor-
ing functions that must be undertaken in the administration
of the loan. Other “relational costs” will also be less. See GMAC,
999 F.2d at 68. On the other hand, the usual “equity cushion”
accompanying loans of this sort may be absent in the case of
a coerced extension. See id. “An equity cushion exists when
the appraised value of the collateral is greater than the val-
ue of the loan.” Id. In a free market, uncoerced by the cram-
down provision, a lender might well insist on a sizable equity
cushion that is missing here. In a free market, the lender of an
extension also might insist on a higher rate.
18 No. 00-4167
debtor to come forward with some evidence that the
creditor’s current rate is less than the contract rate.
GMAC, 999 F.2d at 70-71. The approach we endorse to-
day will, in most cases, provide the best approximation
of the proper rate. Thus, the bankruptcy courts are vested
with significant discretion in the application of the meth-
od described in this opinion.
The district court properly determined that our earlier
decision in Koopmans determined that the correct approach
in ascertaining the appropriate interest rate in a cramdown
situation is the coerced loan approach. Nevertheless, be-
cause our decision today sufficiently elaborates on that
methodology and gives further guidance to the bankruptcy
courts on this matter, we believe that the best course is
to remand the case to the district court with instructions
that the judgment of the bankruptcy court be vacated
and that further proceedings consistent with this opinion
be held in the bankruptcy court. We believe that fairness
requires that both parties be afforded an opportunity to
address the factors that we have identified in this opin-
ion and that the bankruptcy court be given the oppor-
tunity to employ the methodology that we have set forth
today.
Conclusion
Accordingly, the judgment of the district court is vacated
and the case is remanded with instructions. The parties
shall bear their own costs of this appeal.
VACATED and REMANDED
No. 00-4167 19
ROVNER, Circuit Judge, dissenting. My colleagues hold
that section 1325(a)(5)(B)(ii) entitles a creditor to the
same interest rate that it would charge on a new loan to
someone who is situated similarly (except for the bank-
ruptcy) to the debtor. By its own account, the interest
rate that SCS charges its customers for sub-prime, used
car loans is whatever the market will bear. In re Till, No. 99-
13425-13, Transcript of Continued Hearings on Trustee’s
Motion to Dismiss, etc., at 34, 38 (Bankr. S.D. Ind. Feb. 29,
2000). In the Tills’ case, that was an eye-popping 21 per-
cent. Compelling a debtor to pay such a burdensome rate
of interest diminishes the feasibility of the Chapter 13
plan, see § 1325(a)(6); C. Frank Carbiener, Present Value in
Bankruptcy: The Search for an Appropriate Cramdown Dis-
count Rate, 32 S.D. L. REV. 42, 43 (1987), reduces the likeli-
hood that unsecured creditors will receive any remunera-
tion, see In re Scott, 248 B.R. 786, 793 (Bankr. N.D. Ill. 2000),
and is inconsistent with the fresh start that Chapter 13
was intended to provide to debtors, see Local Loan Co. v.
Hunt, 292 U.S. 234, 244, 54 S. Ct. 695, 699 (1934); H. Rep. No.
95-595, at 117 (1977), reprinted in 1978 U.S.C.C.A.N. 5963,
6078. First and foremost, however, I believe it is contrary
to the language and purpose of the statute.
Chapter 13+s “cram down” provision obligates the debtor
over the life of the plan to pay his creditor an amount
of money “not less than the allowed amount” of the claim.
11 U.S.C. § 1325(a)(5)(B)(ii). Of course, a claim can only
be allowed to the extent that it is secured, see 11 U.S.C.
§ 506(a), and so, when the creditor is under-secured as
SCS was, the “allowed amount” of the claim corresponds
to the value of the collateral underlying the loan (here,
the automobile), id. See ante at 6 n.2; Associates Com-
mercial Corp. v. Rash, 520 U.S. 953, 961, 117 S. Ct. 1879,
1884-85 (1997). This means that the debtor must commit
to a stream of payments that ultimately will compensate
20 No. 00-4167
the creditor for the present value of the collateral that
the debtor has chosen to keep. Ante at 7. Furthermore,
because the debtor will be paying the creditor for the
collateral over the three- to five-year life of the plan, the
statute obligates the debtor to pay interest to compensate
the creditor for the delay. E.g., G.M.A.C. v. Jones, 999 F.2d
63, 66 (3d Cir. 1993); United Carolina Bank v. Hall, 993 F.2d
th
1126, 1129-30 (4 Cir. 1993); In re Bellamy, 962 F.2d 176, 185-
86 (2d Cir. 1992), abrogated on other grounds by Nobelman
v. American Sav. Bank, 508 U.S. 324, 113 S. Ct. 2106 (1993).
In this way, the statute recognizes the time value of
money and attempts to place the creditor in the same
position it would have been in had the debtor surrendered
the collateral, enabling the creditor to liquidate it and
reinvest the proceeds. See Rash, 520 U.S. at 962, 117 S. Ct.
at 1885; Hall, 993 F.2d at 1130; Jones, 999 F.2d at 66. As for
the rate of interest, courts are virtually unanimous in
the view that the interest rate imposed under section
1325(a)(5)(B)(ii) should be a “market” rate. Ante at 10;
Monica Hartman, Comment, Selecting the Correct Cram-
down Interest Rate in Chapter 11 and Chapter 13 Bankruptcies,
47 UCLA L. REV. 521, 528 (1999); Matthew Y. Harris,
Comment, Chapter 13 Cram Down Interest Rates: Another
Day, Another Dollar—A Cry for Help in Ending the Quest for
the Appropriate Rate, 67 MISS. L. J. 567, 569 (1997); Todd J.
Zywicki, Cramdown and the Code: Calculating Cramdown
Interest Rates Under the Bankruptcy Code, 19 T. MARSHALL L.
REV. 241, 245 (1994). They are divided, however as to which
among several market rates most fairly compensates the
creditor for the delay in receiving the value of its collat-
eral—the rate at which the creditor could borrow money to
replace the collateral that the debtor has chosen to keep
(the “cost of funds” approach), the prime rate or a U.S.
Treasury rate adjusted upward for the risk of nonpay-
No. 00-4167 21
ment (the “formula” approach), or the rate at which the
creditor would make the same type of loan to someone like
the debtor (the “coerced loan” approach).
The coerced loan approach that my colleagues embrace
posits that the debtor’s decision to keep the collateral in
effect compels the creditor to extend a new loan to the
debtor for the value of the collateral. Ante at 14; see
Jones, 999 F.2d at 67, quoting Memphis Bank & Trust Co. v.
th
Whitman, 692 F.2d 427, 429 (6 Cir. 1982); In re Hardzog,
th
901 F.2d 858, 860 (10 Cir. 1990). It further presumes that
had the debtor instead surrendered the collateral, the
creditor would have converted the collateral into cash
and invested the money in the same type of loan that the
debtor originally obtained—here, a sub-prime used car loan
carrying a high rate of interest. See ante at 14, citing
Koopmans v. Farm Credit Servs. of Mid-America, ACA, 102
th
F.3d 874, 875 (7 Cir. 1996). Based on the notion that the
debtor’s retention of the collateral has deprived the creditor
of this investment opportunity, the coerced loan camp
reasons that the debtor must pay the same rate of interest
the creditor could have earned had it loaned the amount
of the collateral to someone else. Ante at 14.
The sole deprivation that can be charged to the debtor,
however, is the retention of the collateral, not the invest-
ment that the creditor presumably would have made with
the proceeds of that collateral. See In re Valenti, 105 F.3d 55,
nd
63-64 (2 Cir. 1997), abrogated on other grounds by Rash, 520
U.S. 953, 117 S. Ct. 1879. Had the Tills elected to surrender
the collateral, all that SCS would have received is a 1991
Chevrolet S-10 truck, not a new loan package. It would have
been SCS’ responsibility to sell the truck and then make a
new loan with the proceeds of the sale; and, of course, there
would have been costs associated with both of those
transactions. See Hall, 993 F.2d at 1131; see also Koopmans,
22 No. 00-4167
102 F.3d at 874 (deeming the appropriate question to be
“[a]t what rate of interest will [the secured creditor] be as
well off in the reorganization as if it had been allowed to
foreclose on and sell the [collateral]”). Requiring the debt-
or to pay the creditor the same rate of interest that the
creditor would charge on a new loan to another consumer
thus over-compensates the creditor, because it fails to
account for the costs that the creditor would incur in
funding the new loan. See 8 COLLIER ON BANKRUPTCY,
th
¶ 1325.06, p. 1325-35-36 (Lawrence P. King, et al., eds., 15
rev. ed. 2002); In re Ivey, 147 B.R. 109, 116 (M.D.N.C. 1992),
overruled by Hall, 993 F.2d 1126.
In this respect, the costs of funds approach comes clos-
er to recognizing the economic consequences of the debt-
or’s decision to keep the collateral. See Valenti, 105 F.3d
at 64. Strictly speaking, the debtor’s retention of the collat-
eral does not preclude the creditor from making a new
loan, it simply deprives the creditor of an asset that the
creditor could convert into money and use to fund the
new loan. A straightforward way to account for that
deprivation is to ask what it would cost the creditor to
obtain the cash equivalent of the collateral from an alterna-
tive source. 8 COLLIER, ¶ 1325.06, p. 1325-35; In re Benson,
9 B.R. 854, 858 (Bankr. N.D. Ill. 1981); see also Carbiener, 32
S.D. L. REV. at 63 (noting that this is consistent with law’s
general approach to mitigation of damages). Assume,
for example, that SCS could borrow the cash equivalent of
the Tills’ truck at an interest rate of 10 percent and then
lend that money to another consumer at a rate of 21 per-
cent. Under that scenario, the cost of the Tills’ decision to
keep the truck would not be the full 21 percent that SCS
would earn on its investment in another consumer loan,
but the 10 percent that SCS would have to pay to borrow the
money it otherwise would have obtained by liquidating
the truck. Critics of the cost of funds approach point out
No. 00-4167 23
that a creditor is unlikely to have an unlimited supply of
credit and that it may be impractical and unjust to expect
the creditor to borrow the funds necessary to replace the
collateral that the debtor has chosen to keep. See ante at 11-
12; Hall, 993 F.2d at 1130. Whether the creditor can, will,
or should borrow to replace the funds it otherwise would
realize from the collateral is entirely beside the point,
however. The task at hand is to decide what rate of inter-
est will reasonably compensate the creditor for the delay
in receiving the value of the collateral from the debtor.
See Zywicki, 19 T. MARSHALL L. REV. at 257. The cost of
funds approach better approximates this rate by examin-
ing what it would cost the creditor to replace the col-
lateral with money from another source.
The principal disadvantage of the cost of funds method
is that it calls for an individualized inquiry that will bur-
den the parties and the court and may lead to disparate
results depending on an individual creditor’s cost of
borrowing. Valenti, 105 F.3d at 64; Hardzog, 901 F.2d at 860.
Given the relatively small amounts of money that are
involved in a Chapter 13 proceeding, any approach that
invites litigation and adds to the cost of the proceeding
is undesirable. See Carbiener, 32 S.D. L. REV. at 59-60. The
rate that ought to prevail under section 1325(a)(5)(B)(ii)
is one that is predictable to the parties, and thus readily
susceptible to agreement between them without court
intervention. See § 1325(a)(5)(A).
In those respects, a formulaic approach that employs
as a base rate of interest an easily referenced rate like the
prime rate or the rate on U.S. Treasury instruments, and
which allows for modest enhancements to the base to
account for the risk of nonpayment, is superior, and I
would commend it to the court. See Valenti, 105 F.3d at 64;
th
United States v. Doud, 869 F.2d 1144, 1145 (8 Cir. 1989);
24 No. 00-4167
Carbiener, 32 S.D. L. REV. at 63-65. The Treasury rate and the
prime rate are both easily ascertainable rates that spare the
court and the parties of the need for a potentially time-
consuming and expensive inquiry into prevailing market
rates of interest available to either the debtor or creditor.
Each reflects two of the three components of a market
interest rate—expected inflation, and “real” interest. See
Hartman, 47 UCLA L. REV. at 531. The prime rate also
includes the third component—the risk of nonpayment
(see id.)—and in that sense may represent a better start-
ing point than the Treasury rate. See Koopmans, 102 F.3d
at 875; Hartman, 47 UCLA L. REV. at 545. At the same
time, because the prime rate is available to only the most
credit-worthy borrowers, its risk component is arguably
too small to compensate the creditor for the risk of non-
payment by a Chapter 13 debtor. See Koopmans, 102 F.3d
at 875. Either rate, in any event, can be adjusted upward
to account for the greater risk of nonpayment by a debtor
in bankruptcy. Id. Courts employing the formula approach
recognize that enhancements of one hundred to three
hundred basis points would normally suffice for this pur-
pose. E.g., Valenti, 105 F.3d at 64. What level of enhance-
ment is called for in the individual case is a question wisely
left to the bankruptcy court, which is better situated to
assess the risk of nonpayment and may adjust the rate
accordingly without extensive evidentiary hearings. See
Hartman, 47 UCLA L. REV. at 545-46; Harris, 67 MISS. L.J. at
1
582.
1
This is essentially the approach that the bankruptcy court
followed here, albeit after hearing testimony as to the prime
rate and the prevailing rates of interest in the market for auto-
mobile loans. See In re Till, No. 99-13425-FJO-13, Order Confirm-
ing Amended Plan (Bankr. S.D. Ind. June 27,2000). A formula
(continued...)
No. 00-4167 25
The lower interest rate produced by the formula approach
(or for that matter by the cost of funds approach)—seem-
ingly piddling by comparison with the rate produced by
the coerced loan approach in a sub-prime loan case like
this one—may at first blush appear inadequate to com-
pensate the creditor for the costs that the involuntarily
extended lending relationship imposes, including in
particular the risk that the debtor will be unable to dis-
charge his obligations under the reorganization plan.
See ante at 13; see also Jones, 999 F.2d at 67, 68-69; In re
Camino Real Landscape Maintenance Contractors, Inc., 818
th
F.2d 1503, 1506 (9 Cir. 1987). But courts should consider
the extent to which the creditor has already been com-
pensated for this risk in the rate of interest that it charged
to the debtor in return for the original loan. Sub-prime
lenders charge exorbitant rates of interest precisely be-
cause there is a high risk that their borrowers will default
on their loan obligations. See Kathleen C. Engel and Patricia
A. McCoy, A Tale of Three Markets: The Law and Economics
of Predatory Lending, 80 TEX. L. REV. 1255, 1265-66 (2002);
Mavis W. Kennedy, Don’t Let Your Client Be Labeled a
Predatory Lender, 89 ILL. B. J. 595, 597 (2001). These lenders
understand that a significant number of their borrow-
ers will not make good on their obligations—may, in fact,
end up in bankruptcy. Yet, they continue to make high-
risk loans because the money they receive from non-
defaulting borrowers is enough to offset that risk; they
would not remain in business otherwise. In short, the
1
(...continued)
approach that starts with an easily referenced prime or Trea-
sury rate and calls for an enhancement commensurate with the
risks posed by the debtor’s reorganization plan would largely
obviate the need for such testimony. See Hartman, 47 UCLA L.
REV. at 546-47.
26 No. 00-4167
high interest rate on the Tills’ used car loan already ac-
counted for the very possibility of bankruptcy (and with
it, the Tills’ ability to keep their truck rather than surren-
der it) that has come to pass. Awarding SCS a sec-
ond risk premium pursuant to section 1325(a)(5)(B)(ii)
may well be unnecessary and inappropriate.
Courts must also have in mind the ways in which bank-
ruptcy law and procedure also work to compensate the
creditor for the risk of nonpayment. Insofar as the typical
automobile loan is concerned, the manner in which the
loan collateral is valued for purposes of the bankruptcy
itself provides the creditor with substantial compensa-
tion. Because the automobile typically is the only
collateral securing the loan, and because automobiles
depreciate relatively quickly, the creditor typically finds
itself under-secured. That brings into play section 506(a)
of the Code, which, as I noted at the outset, limits the
amount of the creditor’s allowed secured claim to the value
of the automobile itself. In Rash, however, the Supreme
Court held that for purposes of section 506(a), that value
is to be determined by asking not how much the creditor
could be expected to realize upon foreclosure and liquida-
tion of the collateral, but by how much the debtor would
have to pay in order to replace the collateral. 520 U.S.
at 965, 117 S. Ct. at 1886. As Chief Judge Wedoff has
pointed out, the replacement value of an automobile to the
debtor will normally be significantly higher than the whole-
sale value that the creditor typically could expect to realize
if it repossessed and liquidated the vehicle. Scott, 248
B.R. at 792. So by requiring the debtor who keeps the
collateral to pay his creditor an amount equal to the re-
placement cost of the vehicle, the Supreme Court has
already ensured that the creditor will be afforded significant
compensation for the risk of non-payment. Id.; see also
David G. Epstein, Don’t Go and Do Something Rash About
No. 00-4167 27
Cram Down Interest Rates, 49 ALA. L. REV. 435, 455 n.79
(1998). Consequently, “applying a rate of interest that fully
reflects risk of nonpayment—like the contract rate in the
present case—to a secured claim amount that already
includes substantial ‘risk protection’ results in a windfall
for the secured creditor, to the detriment of unsecured
creditors.” Scott, 248 B.R. at 792, 793. Other provisions of
the Code also operate, albeit more modestly, to reduce
the risk of non-payment along with the costs occasioned
by the debtor’s election to retain the collateral: (1) Before
confirming the Chapter 13 plan, the Bankruptcy Court
must be convinced that it is feasible in the sense that
the debtor has the resources to meet his obligations,
§ 1325(a)(6); (2) wage orders can be used to ensure that the
debtor does not inadvertently miss payments; (3) unsecured
debt can be reduced or restructured; and (4) collection
costs to the creditor are eliminated, while administra-
tive costs are borne primarily by the Chapter 13 trustee.
See In re Carson, 227 B.R. 719, 724 (Bankr. S.D. Ind. 1998); see
also Jones, 999 F.2d at 69 & n.8; Carbiener, 32 S.D. L. Rev.
at 60-62.
I believe that my colleagues are correct to read this court’s
opinion in Koopmans as a nod in the direction of the coerced
loan theory that they have elected to adopt; still, Koop-
mans ought not to be viewed as dispositive of the ques-
tion we decide today. See Epstein, 49 ALA. L. REV. at 454
(“[Koopmans] can better be described as a case . . . that
does not require bankruptcy courts to use any particular
approach to determine the market rate.”); Carson, 227 B.R.
at 721 n.5 (noting that Koopmans “does not fit neatly into
any of the three categories”). Although the language of
the Koopmans opinion endorses the coerced loan ap-
proach, 102 F.3d at 875, the decision actually affirms the
bankruptcy court’s decision to use the prime rate with
an appropriate risk enhancement, id. Indeed, courts and
28 No. 00-4167
commentators have had some difficulty deciding where
in the ongoing debate over the appropriate interest rate
Koopmans came down, as evidenced by the fact that we
have been credited with endorsing all three of the major
approaches. See, e.g., In re Smithwick, 121 F.3d 211, 214
th
(5 Cir. 1997) (construing Koopmans as adopting the co-
erced loan approach), cert. denied, 523 U.S. 1074, 118 S. Ct.
1516 (1998); Epstein, 49 ALA. L. REV. at 454 (noting that
Koopmans actually approved the bankruptcy court’s use
of the formula approach); Harris, 67 Miss. L. J. at 580
& n.74 (construing Koopmans as approving cost of funds
approach); Timothy D. Moratzka, Chapter 13 Interest Rate
Pegged to Treasury Rate in Second Circuit, 14 AM. BANKR. INST.
J. 16, 16 (1997) (same). In truth, the consequences of the
choice were modest in Koopmans, because the nature of
the debt at issue in that Chapter 12 case (an over-secured
farm mortgage) rendered the gap between the prime
rate and the prevailing market rate for comparable agri-
cultural loans small—indeed, once the bankruptcy court
had enhanced the prime rate for additional risk, the two
rates were roughly equivalent. See 102 F.3d at 875; Koopmans
v. Farm Credit Servs., 196 B.R. 425, 428 (N.D. Ind. 1996). By
contrast, the disparity here (as in many other Chapter 13
cases involving sub-prime consumer loans) is dramatic,
so that use of a market rate for a comparable consumer
loan will have adverse consequences that we did not
address in Koopmans.
The search for a “market” rate that will place the creditor
in the same position that it would have been in had it been
able to foreclose on the loan is in a sense futile, because
given a choice, a creditor would almost always prefer
to take possession of the collateral immediately rather
than accept a stream of payments over time for the
value of that collateral. See Rash, 520 U.S. at 962-63, 117 S.
Ct. at 1885; see also Ivey, 147 B.R. at 117-18. That choice
has been taken away from the creditor, however, by opera-
No. 00-4167 29
tion of a statute that aims to help the debtor by allow-
ing him to keep an asset—like an automobile—which may
be vital to his ability to generate income and attend to
his family’s day-to-day needs. Because this situation is a
creature of legislation rather than the market, the policy
considerations reflected in the statute cannot be ignored.
A creditor is entitled to interest sufficient to compensate
it for the delay in receiving the value of the collateral
securing the loan, and the rate at which interest is ordered
must reflect the risk of non-payment. To some extent, as I
have noted, SCS has already been compensated for that
risk through the high rate of interest it originally charged
the Tills and other borrowers like them; that rate took into
account the very possibility of default that came to pass. To
the extent that the Tills’ retention of the truck imposes
new risks on SCS, the valuation of collateral at its replace-
ment cost provides a substantial cushion to account
for those risks. Overcompensating the creditor by demand-
ing that the debtor pay interest as high as the market
for high-risk loans will bear greatly increases the burden
on the debtor, and far from the fresh start that Chapter
13 was intended to give him, puts him back in the very
situation that brought him into bankruptcy. That bur-
den works to the detriment not only of the debtor, but to
that of his other creditors, secured and unsecured.
I respectfully dissent.
A true Copy:
Teste:
_____________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-97-C-006—8-21-02