The Present Value of Chapter 13 Discount Rates

By Vijay Malik, Law Student, Creighton University, Omaha, NE

The issue of determining the present value of proposed future payments to creditors in a Chapter 13 plan has long confounded bankruptcy experts.  Whether future payments should be discounted to arrive at a present value is not disputed – in fact, it’s required in the Bankruptcy Code.  The issue that engenders disagreement, however, is what discount rate to use when making a present value calculation.

The Code neither specifies a rate nor the methodology to be used to calculate the rate.

Even our Supreme Court can’t agree.  In the landmark decision Till v. SCS Credit Corp., 541 U.S. 465, 124 S. Ct. 1951 (2004) Justice Steven’s plurality opinion hinges the interest rate used in present value analysis on three components:  opportunity cost, an inflation premium, and a premium for the risk of default.  Accordingly, the plurality concluded that the national prime rate, potentially adjusted upward to account for the risk of nonpayment, is appropriate.  Under this “prime-plus” approach for computing the discount rate, the creditor, whom the plurality believed was the more informed party, has the burden of proof to justify the level of risk.

The dissent, led by Justice Scalia, also believed the discount rate should incorporate a risk premium for potential nonpayment but that the discount rate should presumptively be the contract interest rate, subject to adjustment by the parties.  Justice Scalia noted that certain factors should be taken into account to arrive at the risk premium, including the probability of plan failure, the rate of depreciation of the collateral, the liquidity of the market in which the collateral is sold, and administrative expenses tied to claim enforcement.

Justice Thomas adopted a third approach, arguing that the Code compels the conclusion that the discount rate should not account for the risk of default but rather should be predicated on a risk-free rate.  Focusing on the language of the Code, the Justice explained that the focus of the Chapter 13 cramdown provision is only on the value of the property to be distributed, not on the value of a promise to distribute property.  He asserted that the court’s task is to identify property that the debtor proposes to distribute to the holder of the secured claim over the life of the Chapter 13 plan and then to arrive at a present value of the property with the assumption that the property will actually be distributed.

Bolstering his conclusion, Justice Thomas emphasized that several Chapter 13 confirmation standards already serve to protect creditors:  a Chapter 13 has to be proposed in good faith; a creditor who holds a claim that is crammed down must be allowed to retain a lien securing their claim; and a Chapter 13 plan must be feasible.  Under Justice Thomas’ analysis, the only factor that should be considered in arriving at a discount rate is the time value of money, which accounts for opportunity cost and inflation.  The prime rate, Thomas argued, accurately reflects opportunity cost and should be used to determine present value.  Justice Thomas concurred with the plurality because  the interest rate proposed by the debtor exceeded the risk-free prime rate, thereby providing adequate compensation to the creditor.

So where does all this leave us today?  Washington University School of Law Professor Rafael Pardo’s thoughtful work, Reconceptualizing Present-Value Analysis in Consumer Bankruptcy, offers a compelling alternative approach.  Professor Pardo argues that present value analysis in Chapter 13 cases necessitates use of a discount rate that accounts solely for projected inflation but for neither default risk nor opportunity cost.

Professor Pardo identifies the factors highlighted by the plurality and dissenting opinions in Till as those that should be used when calculating a discount rate to be used in a present value analysis.  Professor Pardo specifically focuses on the considerations of probability of default (Pd) and actual default costs (Cd) incurred, noting that they are irrelevant to a present value analysis because they are taken into account elsewhere in the Code – either in the context of plan confirmation or creditor recovery.  Written as an equation, the expected default costs (Ed) = the probability of default (Pd) multiplied by the actual default costs incurred (Cd).

Professor Pardo argues that the risk of default is an irrelevant consideration when conducting a present value analysis because financial feasibility is a prerequisite to confirmation and distinct from the standard used for cramdown confirmation.  Section 1325(a)(6) only allows a court to confirm a plan if it believes the debtor will be able to make all the payments under the plan, not some of the payments under the plan.  The court must be convinced that the risk of default, or Pd, equals zero.

To analyze the actual default costs incurred, Professor Pardo again turns to Till.  The factors the plurality and dissent identified as producing default costs were the value of the collateral securing the creditor’s secured claim, the illiquidity of repossessed collateral, and the administrative costs associated with claim enforcement in bankruptcy.  Professor Pardo contends that the Code allows for recovery of some of these costs outside of confirmation and prevents recovery of others.

First, in regard to costs related to the value of the collateral securing the creditor’s secured claim, Professor Pardo asserts that the Code already provides for adequately protecting a secured creditor’s interest in collateral the debtor retains by providing periodic cash payments to the creditor equivalent to the value of the creditor’s interest in collateral, granting the creditor an additional lien on the debtor’s property equal in value to the decrease in value of the creditor’s interest in the collateral, or other protection providing the indubitable equivalent of the value of the creditor’s interest in the collateral.

Second, in the context of costs stemming from the illiquidity of repossessed collateral, Pardo argues that because the Code prevents the recovery in Chapter 7 of default costs tied to an asset’s illiquidity, namely the asset is underwater and abandoned by the trustee with the creditor recovering less than his secured claim, such costs should not be subsumed into the calculation of a risk-adjusted discount rate.

Third, in reference to default costs resulting from the enforcement of a creditor’s claim, Professor Pardo argues that the Code provides a mechanism to recover for these costs outside of confirmation through the claim allowance process.  Notably, security agreements typically provide for collection costs incurred enforcing the agreement.  The creditor should be allowed to recover any administrative expenses as a part of their allowed claim.

Citing United Savings Bank Ass’n of Texas v. Timbers of Inwood Forest Associates, Ltd., 484 U.S. 365, 108 S. Ct. 626 (1988), Professor Pardo argues that because the Code prohibits compensation for opportunity cost, the discount rate, not taking into account the risk of default, should take into account only inflation.  He argues that to use the prime rate as suggested by Justice Thomas would overcompensate creditors as it takes into account opportunity cost.  Professor Pardo submits that courts might estimate expected inflation by reducing the prevailing rate on a government bond with a maturity date approximating the Chapter 13 plan’s duration by the real rate for the riskless cost of capital, estimated some to be two percent.

Vijary Malik Mr. Malik is a law student at Creighton University in Omaha, Nebraska. Prior to law school, Mr. Malik worked in real estate private equity and investing banking for various firms in New York and Washington, D.C.
No Author Biography has been linked to this Article.

Related Articles

NBR cropped 2
May 15, 2022
Dear Readers: There are some basic truths. One is that when someone says, “hey, watch this!,” the result is likely to involve blood or stitches. Another is that, when an author describes something with the leadoff word, “interestingly,” it often isn’t. And a third is that one shouldn’t mislead bankruptcy judges. In two wonderfully written cases, bankruptcy judges made this...
May 21, 2023
(The DuPage County Bar Association grants permission to reprint all or part of this article, Chapter 13 Saves the World! by Arthur Rummler, Volume 29, Issue 9, May 2017 edition of the DCBA Brief. Copyright 2017, DCBA Brief, All Rights Reserved.) We are pleased to reprint an article referred to recently by Director Twomey of the Executive Office for United...
Academy Circle Logo Final
February 18, 2024
Judge Raymond Lohier (Second Circuit U.S. Court of Appeals) Shares His Immigration Story and the Diverse Perspective it Brings
July 11, 2021
Kara K. Gendron, Esquire, Mott & Gendron Law (Harrisburg, PA) A “kill switch” is a device which can be used to disable a machine or program. They have been used for years in a myriad of safety measures, such as shutting down machinery in the event of an emergency, or to prevent the theft of a machine or data. Some...
November 24, 2019
By Henry E. Hildebrand, III, Chapter 13 Standing Trustee (Nashville, TN) One of the most confusing elements in consumer bankruptcy practice is the effect of electing the option given in § 1325(a)(5)(C) or § 521(a)(2). Section 521(a)(2) requires every debtor to file a statement of intent that indicates whether the debtor intends to “surrender or retain” estate property which secured...
Copy of Hildebrand-2016
July 30, 2023
By Henry E. Hildebrand, III, Chapter 13 Standing Trustee for the Middle District of Tennessee (Nashville) Post-petition, pre-conversion equity that accrues in a debtor’s residence during the pendency of a Chapter 13 plan is property of the estate in the Chapter 7 estate following conversion.  (Hastings) Goetz v. Weber (In re Goetz), 651 B.R. 292 (8th Cir. BAP, June 1,...
November 29, 2020
By Angela M. Scolforo, Staff Attorney to Herbert L. Beskin, Chapter 13 Trustee for the Western District of Virginia “How long?” is a common plea. When my children were young and we travelled they would ask, “how long before we get there?” In scripture we find David, Habakkuk and Zechariah (none of whom were Debtors’ attorneys) all crying out, “how...
December 10, 2023
“The bankruptcy petition came to my desk for review with no entry for “clothing and wearing apparel”. Funny, I think I’d remember if I’d interviewed any naked people lately.” Although filled with Attorney Moran’s wit, there is an important lesson here! Feel free to add your own ‘naked client’ story in the comments section below the article.
February 19, 2023
At the NACTT 2023 Mid-Year Trustee Meeting in January the presentation that resonated the most with me was one about the dark web. The presenter, Mark Lanterman (CTO Computer Forensic Services), said something that haunts me still: your biggest security risk is your people. Mind blown. We spend so much time, energy, and resources on physical security and network security,...
April 17, 2022
Mark Leffler, of the Boleman Law Firm in Virginia and also the current President of the Academy for Consumer Bankruptcy Education, begins a series of articles describing his firm’s development of a broader practice on behalf of consumer debtors. Look for subsequent parts of this series over the next few weeks. My fellow self-described consumer bankruptcy lawyers: you wield more...

Looking to Become a Member? offers a forum to advance continuing education of consumer bankruptcy via access to insightful articles, informative webinars, and the latest industry news. Join now to benefit from expert resources and stay informed.


These informative sessions are led by industry experts and cover a range of consumer bankruptcy topics.

Member Articles

Written by industry experts, these articles provide in-depth analysis and practical guidance on consumer bankruptcy topics.

Industry News

The Academy is the go-to source for the latest news and analysis in the Chapter 13 bankruptcy industry.

To get started, please let us know which of these best fits your current position: