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Nature of Suit Code: 442
Nature of Suit: Civil Rights Employment
Cause of Action: 

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( 

PUBLISH 

FILE'D 

United States Coon of Appeals 

Tenth Circui r 

UNITED STATES COURT OF APPEALS 

APR 19 1990 

.ROBERT L. HOECKER 

Clerk 

TENTH CIRCUIT 

In re: CLARENCE L. (I.O.) HARDZOG; ) 

KATY LOU HARDZOG, ) 

) 

Debtors, ) 

) ----------------------------------------) ) 

CLARENCE L. (I.O.) HARDZOG; KATY LOU ) 

HARDZOG, ) 

) 

Appellees, ) 

) 

V. ) 

) 

THE FEDERAL LAND BANK OF WICHITA, ) 

) 

Appellants. ) 

Nos. 89-6064 and 

89-6065 

ON APPEAL FROM THE UNITED STATES DISTRICT COURT 

FOR THE WESTERN D~STRICT OF OKLAHOMA 

(D.C. No. CIV-87-1448-A) 

B.J. Brockett, Anthony L. Jackson, and J. Mark Spaeth of B.J. 

Brockett, Inc., P.C., Oklahoma City, Oklahoma, on the briefs for 

Appellees. 

G. Blaine Schwabe, III, J. Eric Ivester, and Rob F. Robertson of 

Mock, Schwabe, Waldo, Elder, Reeves & Bryant, Oklahoma City, 

Oklahoma, on the briefs for Appellant. 

Before SEYMOUR, MOORE, and BRORBY, Circuit Judges. 

BRORBY, Circuit Judge. 

Appellate Case: 89-6064 Document: 01019626883 Date Filed: 04/19/1990 Page: 1 
This appeal was set for oral argument during the March Term 

of this court. Counsel were unable to be present due to blizzard 

conditions. This court has therefore examined the briefs and 

appellate record and has determined unanimously that oral argument 

would not materially assist the determination of this appeal. See 

Fed. R. App. P. 34(1); 10th Cir. R. 34.1.9. The cause is 

therefore ordered submitted without oral argument. 

This appeal concerns the validity of a Bankruptcy Chapter 12 

debt adjustment plan. 

The significant facts are neither complex nor disputed. 

Appellant (Bank) made a loan to Appellees (Debtors) and secured 

this debt with a mortgage upon Debtors' real property. After 

paying on this loan for approximately twelve years, Debtors 

commenced a Chapter 12 Bankruptcy proceeding. At that time, the 

mortgage called for approximately eighteen years of payments at 

12.5 per cent per annum. The unpaid principal amounted to 

approximately $193,000. The total amount of the Bank's allowed 

claim was approximately $204,000. 1 The fair market value of the 

real property was approximately $230,000. The debtors filed their 

debt adjustment plan and proposed to pay the amount of the allowed 

claim in fifteen years 2 with interest at 7.5 per cent per annum. 

1 Interest was allowed at the contract rate up to 

date of the plan. 

the effective 

2 The parties do not present any issues to this court concerning 

the fifteen-year repayment, nor the effect thereof, if any, upon 

the subsequent question of·p~esent value. 

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Appellate Case: 89-6064 Document: 01019626883 Date Filed: 04/19/1990 Page: 2 
The Bank objected to the plan and asserted it was entitled to 

interest at 12.5 per cent per annum, which was the agreed upon 

rate contained in the contract. 

The Bankruptcy Court ultimately approved a modified plan, 

which called for payment of the allowed claim in fifteen years at 

an annual interest rate of ten per cent. The Bankruptcy Court 

established the interest rate by computing what it determined to 

be the Bank's cost of funds. 3 It set the cost of Bank's funds at 

9.3 per cent and the cost of Bank's risk factor at .7 per cent, 

thus yielding a total interest rate of 10 per cent. 

Bank appeals, assertirig: (1) the debt adjustment plan does 

not propose to pay the value of its claim; (2) if an interest rate 

other than the contract rate is applied, the Bank would then be 

deprived of its property without just compensation; and (3) 

numerous arguments contending that the Bankruptcy Court either 

should not have used the cost of funds approach or that the 

Bankruptcy Court miscomputed the cost of funds. 

A broad, loose and generalized summary of Chapter 12 of the 

Bankruptcy Code will help place Bank's arguments into perspective. 

Generally speaking, an eligible family farmer may obtain relief 

from debts and continue to reside upon and operate the farm if the 

Bankruptcy Court approves a debt adjustment plan. The debt 

3 The Bankruptcy Court and United States District Court decisions 

are reported at 74 B.R. 701 (Bankr. W.D. Okla. 1987) and 77 B.R. 

840 (Bankr. W.D. Okla. 1987), respectively. 

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Appellate Case: 89-6064 Document: 01019626883 Date Filed: 04/19/1990 Page: 3 
adjustment plan may affect the rights of the holders of the debt. 

After the debt adjustment plan has been approved, the debtor pays 

the trustee who in turn pays the holders of the debt. To be 

confirmed, a debt adjustment plan must meet certain requirements 

specified by the Bankruptcy Code. One of these requirements is 

that the holder of an allowed claim must receive property under 

the plan which has a value of no less than the amount of its 

allowed claim. 4 

Bank contends it will not receive the allowed amount of its 

claim as it will not ·receive the agreed upon interest rate. 

Stated somewhat differently, Bank contends it cannot receive the 

value of its claim unless it receives its contract rate of 

interest. 5 

What becomes immediately obvious is that .the Bankruptcy Court 

must determine the present value of a series of future cash flows; 

otherwise it cannot determine whether Bank will receive less than 

the allowed amount of the claim. This necessarily dictates that 

the Bankruptcy Court must arrive at a discount factor or interest 

rate. Once the unpaid principal, due date, payment periods, and 

payment amounts are determined, the problem still cannot be solved 

4 11 U.S.C. § 1225(a)(5)(B)(ii) provides that the holder of each 

secured claim shall receive "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." 

5 It is important to note that Bank is an over-secured creditor, 

which is to say that its collateral has a value in excess of the 

amount of the allowed claim. 

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Appellate Case: 89-6064 Document: 01019626883 Date Filed: 04/19/1990 Page: 4 
I 

until the interest rate or discount factor is determined. Only 

with all of these figures known does the solution then become one 

of mathematical computation. The precise question before us is 

how to determine the interest rate to be applied to the formula. 

Congress, in enacting Chapter 12, gave us no guidance in how 

to determine the applicable interest rate. 

The Bankruptcy Code contains other provisions setting forth a 

present value requirement.£ Court~, in interpreting these similar 

statutes, have not been uniform in their results. As one 

authority on Bankruptcy has stated: 

While the cases considering the issue are fairly uniform 

in agreeing that a market rate of interest is 

appropriate, the cases differ drastically in their 

interpretation of how a "market rate" is to - be 

determined. 

5 Collier on Bankruptcy§ 1225.03 at 1225-21 (1989). 

A review of court decisions determining an appropriate 

interest rate under Chapter 12 likewise reveals diverse results 

which include using the interest rate charged by the sedured 

creditor;7.using the legal rate on judgments in the absence of 

evidence concerning market rates; 8 using the contract rate after 

6 See 11 u.s.c. §§ 1129(a)(9)(B)(i) and (C), 1129(b)(2)(A)(i)(II) 

and---r325(a)(5)(B)(ii). 

7 In re Citrowske, 72 B.R. 613 (Bankr. D. Minn. 1987). 

8 In re Fleshman, 82 B.R. 994 (Bankr. W.D. Mo. 1988). 

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Appellate Case: 89-6064 Document: 01019626883 Date Filed: 04/19/1990 Page: 5 
determining it was below market;9 and of course the case now 

before this court, which holds a cost of funds approach to be 

proper. 

The Eighth Circuit has addressed the problem before us in the 

case of United States v. Doud, 869 F.2d 1144 (8th Cir. 1989). 

This decision endorsed the "market rate" approach while approving 

a method of determination of the "market cost" by first 

determining the rate of a risk-free loan, such as the yield on 

treasury bonds, and adding thereto two per cent as a risk factor. 

In short, this approach determines an appropriate interest rate, 

~hich consists of a ''risk-free rate" plus additional interest to 

compensate a creditor for risks posed by the plane We cannot 

agree that this represents a "market rateo" The advantage to this 

approach is a simplified· and easy method of interest rate 

determinationo The disadvantage is that this approach will 

probably not accurately reflect the market, and thus may unduly 

penalize the lender or borrower. 

Courts are not well situated to craft and determine interest 

rateso Judges are neither bankers nor lenders and do not have the 

expertise to set interest rateso A lender, in establishing 

interest rates to be charged to a borrower, will consider and 

utilize many factors, including what the competition charges, its 

cost of funds, the condition of the local economy, its overhead, 

the character of the borrower, the capacity of the borrower to 

9 In re Turner, 87 B.R. 514 (Bankr. S.D. Ohio 1988). 

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Appellate Case: 89-6064 Document: 01019626883 Date Filed: 04/19/1990 Page: 6 
repay, the value of the collateral, the costs of servicing the 

loan, the status of the lender's loan portfolio, the lender's 

ratio of loans to assets, its liquidity, and a host of other 

factors. We therefore hold that a "cost of funds" approach should 

not be utilized by Bankruptcy Courts in establishing the 

appropriate interest factor. A "cost of funds" approach is not 

susceptible of accurate determination without complex problems of 

proof and may not result in fairness. 

Considering that most courts are utilizing a market rate 

approach and further considering that courts are well equipped to 

determine market rates, we hold that in the absence of special 

circumstances, such as the market rate being higher than the 

contract rate, 10 Bankruptcy Courts should use the current market 

rate of interest used for similar loans in the region. Bankruptcy 

Courts, counsel, lenders, and borrowers should have a familiarity 

with current interest rates on like-type loans and when a dispute 

arises, the market rate should be easily susceptible of 

determination by means of a hearing where each party is given the 

opportunity to submit evidence concerning the current market rate 

of interest for similar loans in the region. We are persuaded to 

adopt this approach by two addi tio'nal factors. Chapter 12 is 

predicated upon the theory that the lender is making a new loan to 

the debtor. It therefore follows that the most appropriate 

interest rate is the current market rate for similar loans made in 

lO We deliberately reserve until the issue is properly before us, 

a definition of the parameters of "such special circumstances." 

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Appellate Case: 89-6064 Document: 01019626883 Date Filed: 04/19/1990 Page: 7 
the region at the time the new loan is madeo 

also tend to assure that both the lender 

This approach should 

and the debtor are 

treated fairly with neither receiving an advantage over the other. 

This decision renders moot the remaining issues raised by 

Bank. 

The decision of the District Court affirming the decision of 

the Bankruptcy Court is therefore REVERSED, and this case is 

remanded for such other and further proceedings to be conducted in 

accordance with the holdings of this opinion. 

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Appellate Case: 89-6064 Document: 01019626883 Date Filed: 04/19/1990 Page: 8