Some have described the term "Market Rate of Interest" as being similar to pornography: You can't define it, but you know it when you see it. The courts have been struggling with the application of market rate of interest to undersecured claims since the Sixth Circuit initially spawned the term.² In In re Kidd, 315 F.3d 671, (6th. Cir. 2003), the Sixth Circuit has further explained and clarified its prior holding and has set forth its methodology for arriving at the proper rate of interest in cramdown situations.

In the Kidd case, the debtors purchased a pickup truck and financed it through Household Automotive Finance Corp. over 60 months at 20.95 percent. The debtors filed chapter 13 after only two payments, proposing an interest rate of 8 percent. The parties stipulated that the claim was undersecured. At trial, the testimony before the bankruptcy court consisted of the following:

1. Household advertised on the web that it offered rates for its best customers as low as 10.95 percent;
2. A local bank lent to high-risk borrowers such as the debtors at 16.25 percent;
3. The average rate for all motor vehicle loans, both new and used, for all borrowers at the local bank was 9.3 percent; and
4. Household had agreed to interest rates in other chapter 13 cases between 10.5 and 11.0 percent.

After considering the foregoing facts, the bankruptcy court found that the market rate of interest would be 10.3 percent based on the average rate for all motor vehicle loans of 9.3 percent plus 1.0 percent added to reflect rising interest rates. The district court affirmed.

The creditor further appealed to the Sixth Circuit, specifically asking the court to rule that only the contract rate of interest between the parties would satisfy the requirements of §1325(a)(5)(B). That provision states as follows:

§1325. Confirmation of plan.
(a)...the court shall confirm a plan if—

(5) with respect to each allowed secured claim provided for by 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 allowed amount of such claim...

The creditor argued that the contract rate was the result of negotiations between the parties and more accurately reflected the "market" for the particular loan.

The court initially dealt with the issue of the standard of review. The court concluded that the methodology used to calculate the rate is a question of law to be reviewed de novo, thereby leaving the resulting applicable rate as a fact issue reviewed on the clearly erroneous standard. In Memphis Bank & Trust, the Sixth Circuit recognized that §1325(a)(5)(B) in effect required the creditor to make a new loan for the value of the collateral. In Kidd, the court rejected the notion that "the coerced loan" takes into consideration the applicable rate for "borrowers identical to the Kidds in all relevant respects." Such methodology would effectively be "tantamount to endorsement of the automatic application of a contract rate of interest, a principle clearly at odds with the clear language of Memphis Bank and Trust."

The court also recognized, as many commentators have observed, that the coerced loan concept has resulted in the determination of a rate of interest for a "market" of 100 percent loans to debtors in bankruptcy proceedings—a market that does not exist.

The Sixth Circuit rejected the notion of a "case-by-case" analysis and concluded that the proper methodology of determining the rate is the "current conventional market rate used for similar loans in the region" without regard to "any particular debtor's credit rating," but involving "a more objective determination of the value of money over time so as to compensate a creditor according to the present value of its secured claim."

The Sixth Circuit's analysis appears to be at great odds with most courts' interpretation of the Memphis Bank and Trust case, which has been followed by virtually every appeals court considering the matter.³

The method of calculation of the interest rate to place the secured creditor in the same position it would be in if it was paid the value of the collateral has been, and will continue to be, the subject of much debate and litigation.

The Sixth Circuit found that the most "germane" evidence presented to the bankruptcy court consisted of the testimony of the local banker concerning what the weighted average for all conventional motor vehicle loans were in that particular region. The court was not concerned with the debtor's particular credit risk. The court was not concerned with the age of the motor vehicle or whether it was new or used when bought. The court was not concerned with the particular creditor or its contract rates. Rather, the court looked solely at the type of collateral in question and applied the average conventional rate for that type of collateral applicable in the community.

It would seem under this approach that once the bankruptcy court determines the conventional rate of interest for a particular type of collateral, then that would be the applicable rate to all undersecured loans for similar collateral unless and until market conditions sufficiently changed to justify altering that rate.

The Sixth Circuit appears to be refocusing the debate upon the deferred value of the collateral rather than the "forced-loan" approach that many courts and commentators have adopted. Considering the fact that the Sixth Circuit was interpreting and commenting on its own case, which has been cited and adopted by so many other circuits, it is predicted that the other circuits will likely follow the Sixth Circuit's interpretation of its own opinion.

The Sixth Circuit has certainly rejected the notions of different rates for automobile loans for different creditors and of different rates for prime vs. subprime borrowers. The dissent's plea that the rate should bear "some real-world relationship to the coerced loan in issue" and that the debtors had made no showing that they had been "transformed into prime borrowers" went unheeded by the majority, which was in search for more uniformity by the utilization of average interest rates for all borrowers to the exclusion of the element of risk of the particular borrower. The majority chose to adopt an approach that will more truly yield a time-price value of money (as the statute indicates), rather than the traditional notion of a forced loan at premium rates.

Footnotes

¹ Board-certified in business and consumer bankruptcy by the American Board of Certification. Return to article

² See Memphis Bank and Trust Co. v. Whitman, 692 F.2d (6th Cir. 1982). Return to article

³ GMAC v. Jones, 999 F.2d 63 (3rd. Cir. 1993); Neufeld v. Freeman, 794 F.2d 149 (4th Cir. 1986); In re Chaffin, 836 F.2d 215 (5th Cir. 1988); In re Fowler, 903 F.2d 694 (9th Cir. 1990); Wade v. Hannon, 968 F.2d 1036 (10th Cir. 1992); contra, see Koopmans v. Farm Credit Services, 102 F.3d 874 (7th Cir. 1996) (adopting a cost-of-funds approach); In re Valenti, 105 F.3d 55 (2nd Cir. 1997) (adopting the U.S. Treasury rate with an added risk premium). Return to article