Decoding Chapter 12 Bankruptcy: Navigating the 20-Year Treasury Bond Rate vs. National Prime Rate Dilemma in Determining Discount Rates on Secured Creditor Claims

Michael Kleinman

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

Under chapter 12 of title 11 of the United States Code (the “Bankruptcy Code”), a family farmer or fisherman can restructure its debts. In a Chapter 12 bankruptcy, the debtor generally proposes a plan for repaying creditors from future earnings.[1] Under a Chapter 12 plan, secured creditors will generally be paid in full, while unsecured creditors will often receive less than full payment.[2] A court may confirm a Chapter 12 plan if, among other things, all impaired classes of creditors vote in favor of the plan.[3] Under certain circumstances, a court may confirm or “cram down” a Chapter 12 plan over the dissent of an objecting class of creditors.[4] The plan may address secured creditors, including methods such as acceptance or property surrender.[5] Moreover, the plan might encompass providing a lien, along with future property distributions meeting the allowed claim value, an approach often considered a crucial element in the context of a cramdown.[6] This ensures complete repayment, covering both the principal loan amount and accrued interest, in accordance with the United States Code.[7]

In Farm Credit Services of America v. William Topp, the United States Court of Appeals for the Eighth Circuit (“Eighth Circuit”) concluded that the appropriate interest rate to ensure that a secured creditor receives full payment is the twenty-year treasury bond rate and not the national prime rate.[8] William Topp (“Topp”) is a farmer who raises crops and livestock. Facing financial distress, Topp filed a voluntary petition for relief under Chapter 12 of the Bankruptcy Code.[9] Prior to the bankruptcy filing, Farm Credit Services of America (“Farm”) financed Topp’s farm operation through five loans, each with different repayment periods and interest rates spanning from 3.5% to 7.6%.[10]These loans were secured by $1.45 million worth of real estate owned by Topp.[11] Topp's proposed plan provided a 20-year repayment period.[12] Farm objected to the plan, primarily disputing the proposed interest rate for future payments.[13] Topp favored a 1.87% 20-year treasury bond rate with a 2% risk adjustment, while Farm preferred the 3.25% national prime rate with the same risk adjustment.[14] The bankruptcy court sided with Topp, and concluded that a 4% rate was appropriate.[15] On appeal by Farm, the district court agreed, which led Farm to appeal to the United States Court of Appeals for the Eighth Circuit.[16]

According to the Eighth Circuit, Till v. SCS Credit Corp., 541 U.S. 465 (2004), where the Supreme Court held that the national prime rate was the appropriate starting point in a Chapter 13 case, did not explicitly analyze the merits of starting with the prime rate versus the treasury rate.[17] However, Till's principles guide the determination of the appropriate interest rate for debt repayment in a Chapter 12 case.[18] The Eighth Circuit highlighted that the bankruptcy court considered various factors, including collateral nature, over-secured claim status, maturity period, and nonpayment risk. The Eighth Circuit emphasized the significance of opting for either a 'market rate' or 'formula' approach, offering flexibility in the initial selection between the prime rate or the treasury rate.[19] The court explicitly clarified that the ultimate focus should be on the final discount rate, underscoring that factors beyond the initial choice are pivotal.[20] The court favored the treasury rate as the base rate given that it was the appropriate rate for real estate transactions, particularly those involving extended financing terms.[21] This approach allows for more adaptable determination of the final discount rate.[22] Thus, the Eighth Circuit upheld the 4% rate (treasury rate plus 2% for risk) as reasonable.[23]

In a Chapter 12 plan, a debtor will typically be required to refinance secured credit by extending the term and providing a new interest rate. The interest rate may be the subject of dispute. However, in the Eighth Circuit, the starting rate will likely be the treasury rate because of its suitability for real estate transactions characterized by extended financing terms. In addition, a court will likely require the payment of additional interest to cover the risk associated with ensuring the present value of future payments meets or exceeds the allowed value of the claim, providing clarity on interest rate determination within the context of Chapter 12 cases.