Daily Development for
Wednesday, January 21, 1998

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
randolphp@umkc.edu

BANKRUPTCY; CRAMDOWN INTEREST RATE; CHAPTER 13; PRESUMPTIONS: Given the special status of Chapter 13 cases, Bankruptcy Courts should entertain a presumption when setting the plan interest rate that the original contract rate is appropriate for Chapter 13 purposes.

Matter of Smithwick, 121 F.3d 211 (5th Cir. 1997).

The Court of Appeals here settled on what is known as the "rebuttable presumption approach" to solving the Chapter 13 interest (discount) rate problem in section 1325(a)(5)(B)(ii). The decision may have an application in in Chapter 11 cases under analagous section 1129(b)(2)(A)(i)(II). The creditor presumptively gets its contract rate; but, if the creditor wishes, it may argue for a higher rate so long as it carries the burden of proving that its rates have increased. In the opposite event, the debtor may argue for a lower rate so long as it carries its burden of proof to the contrary. While laudable in intent, given that "Chapter 13 cases...are high in volume and low in absolute value" (p. 214), it was error for the Bankruptcy Court to set the rate by Local Rule without considering the facts of each case.

Editor's Comment: For non-bankruptcy specialists, this ruling would apply to situations in which a creditor has proposed a plan to restructure mortgage loans so that the mortgagees are paid the principle on the loan over an extended period. The court can set interest rates other than those in the original contract, thus depriving the creditor, on the surface, of not only the right to accelerate the loan when the debtor originally defaulted but also the right to collect interest at the originally contracted rate when the loan is not paid. The "indubitable equivalent" of the secured interest is simply the right to receive the principle dollar for dollar, but not to recover the time value of a deferred payment.

But if the bankruptcy court uses the contract rate currently charged by the lender, at least the lender does not suffer a further loss in having its funds still committed to this loan without a return consistent with what it could get if it had recouped the funds by realizing on the security through foreclosure.

This case arises in the context of a Chapter 13 bankruptcy. In that context, it is likely that it will not have much significance, since most consumer bankrupts have few real estate mortgage debts other than their home, and home mortgages likely are protected from restructuring under Section 1322(b)(2). (Such Loans with short remaining terms may be restructured.) The ruling will have significance for auto loans and other consumer credit loans.

Reporter's Comment: The approach is flawed to the extent it focusses attention on the characteristics of a particular lender and not on the loan. For example, it would not be possible for the debtor to prove that "the creditor's current rate is less than the contract rate" (p. 214), in a case where "the creditor" in question charged a reprehensibly excessive rate of interest, and still does, to all customers (victims). In that case, why aren't the creditor's contract terms, however egregious, inevitably "the creditor's current rate"?

Editor's Comment 2: A bankruptcy pal reports that he believes that the Supreme Court may have granted certiorari on a case involving this issue, but could not identify the case. Shephard's does not indicate that Smithwick has been taken up.

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