“Don’t Bet The Farm On It”
When is a million dollar equity cushion not enough? Despite a purported cushion of at least $1.2 million, the Bankruptcy Court for the District of Nebraska recently held that a proposed Chapter 12 plan’s repayment terms were unreasonable because: (i) the plan did not provide any periodic adjustment to the interest rate to provide a secured creditor with the present value of its claims; and (ii) the debtor failed to provide sufficient evidence that a 15 year repayment term of the secured creditors’ claims was justified. In so doing, the Court rejected the debtor’s argument that the “unique circumstances” of the case supported confirmation of the plan.
The relevant facts in In re Elkhorn Crossing, LLC follow. Elkhorn Crossing, LLC, filed a petition for relief under Chapter 12 of the Bankruptcy Code, which is specifically designed for “family farmers.” The principal secured creditors of the debtor were Farm Credit Services of America, FLCA, and its affiliated entity, Farm Credit Services of America, PCA (“Farm Credit”). Farm Credit filed the following proofs of claim against the debtor in respect of their secured claim:
- A secured claim in the amount of $815,435.14, evidenced by a 16 year promissory note secured by the debtor’s real property.
- A secured claim in the amount of $1,191,135.33, evidenced by two separate promissory notes. The first promissory note was an operating loan that was evidenced by a promissory note and loan agreement with a one year term. The second promissory note was an installment term loan that was evidenced by a promissory note with a five year term. The two promissory notes were secured by all of the debtor’s personal property and a junior lien against the debtor’s real property.
The debtor proposed an amended Plan that sought to pay Farm Credit a lump sum of $150,000, allocated separately among the three loans, and then to repay the remaining balances of each loan over a 15 year period with interest at the formula rate of interest (5.5 percent), without adjustment.
Farm Credit objected, asserting that: (i) a 15 year term for each loan was too long; (ii) the interest rate should be adjustable annually, and (iii) that the proposed payments were not feasible, based on the debtor’s projections. The debtor and Farm Credit also disagreed with respect to Farm Credit’s equity cushion in the collateral by a difference of $1 million.
The Court denied confirmation of the debtor’s proposed Chapter 12 plan, based on its determination that: (1) the debtor must provide some reasonable periodic adjustment of the rate to provide Farm Credit with the present value of its claim; (2) the debtor did not provide evidence that a 15 year repayment period was justified in respect of the shorter term loans that were secured by personal property; and (3) the debtor did not provide any analysis of the collateral position of Farm Credit as the personal property depreciated and crops were sold.
Although section 1222(c) of the Bankruptcy Code provides that a Chapter 12 plan must propose to pay claims in no more than five years, secured claims may be paid over longer terms if certain requirements are met. One such circumstance is that 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 property to be distributed by the trustee or the debtor under the plan on account of such claim is not less than the allowed amount of such claim.” 11 U.S.C. § 1225(a)(5).
The essential issue was thus whether the plan’s proposed treatment of Farm Credit’s claims provides for the payment of the claims’ present values. To determine the appropriate discount factor to apply to the proposed payments, the Court relied upon the Supreme Court’s holding in Till v. SCS Credit Corp., 541 U.S. 465 (2004), which held that factors for a court to consider in deciding whether the formula rate is sufficient include the estate’s circumstances, the nature of the security, and the duration and feasibility of the plan. The Court also considered In re Tortelli, 338 B.R. 390 (Bankr. E.D. Ark. 2006), in which the court denied confirmation of a Chapter 12 plan that proposed repayment of a five year, 7.75 percent rate note over 20 years at a rate of 5 percent because the extended term would not provide the lender the “benefit of its bargain by being forced into a new loan of substantially longer term than originally contemplated by the parties.” Id. at 397.
In light of those authorities, the Court held that the proposed plan did not adequately provide for Farm Credit on account of its secured claims. With respect to the 16 year loan securing real property, the Court held that although a 15 year repayment term was not irregular, the formula rate was insufficient, as “some reasonable periodic adjustment of the rate during such a lengthy loan term is necessary to properly provide Farm Credit with the present value of its claim.”
With respect to the shorter-term loans secured by personal property, the Court held that the 15 year repayment schedule would be “far in excess of the terms originally contemplated by the parties.” In so holding, the Court rejected the debtor’s argument that Farm Credit’s $1.2 million equity cushion was cause to confirm the plan because the debtor did not present enough evidence to determine whether the 15 year repayment term was appropriate given the circumstances of the case, and did not provide for periodic adjustments to the interest rates to ensure Farm Credit received present value:
Debtor seems to want to treat the Operating and Term Loans like typical land loans even though they are primarily secured by personal property and equipment while the real estate lien is a subordinate lien. Missing is any analysis of the collateral position of Farm Credit as the years go by and the personal property and equipment depreciate, livestock and crops are sold, etc. There also is no mention of any procedure for payment to Farm Credit if any item of its collateral is sold. All in all, there simply is not enough information to make a determination as to whether under the unique circumstances of this case, a 15-year term should be imposed under a plan for repayment of short-term loans.
For those reasons, the Court denied confirmation of the debtor’s plan.
In re Elkhorn Crossing, LLC provides useful guidance to debtors seeking to confirm a Chapter 12 plan that pays secured claims over an extended period, and to secured creditors opposing such treatment. Of particular note, the case demonstrates that a debtor seeking to confirm a plan with a repayment period far in excess of the underlying loan term should present substantial evidence as to why the extended period is justified, even if the secured creditor purportedly enjoys a significant equity cushion. Moreover, a plan should provide periodic adjustments to interest rates to ensure that secured creditors receive the present value of their claims.