Chapter 2 Valuation of Collateral
| Jurisdiction | United States |
Chapter 2: Valuation of Collateral
Hon. Mark X. Mullin, David L. Staab and Jarom J. Yates
Valuation constitutes a fundamental cornerstone of the bankruptcy process that arises and permeates throughout every stage in a bankruptcy case. Valuation issues and disputes play a vital role in the strategic and timing decisions made by debtors, creditors and par-ties-in-interest throughout the bankruptcy case process.99 Such disputes can be hotly contested and are becoming more sophisticated.
When addressing valuation, two general and fundamental categories of issues must be thoroughly considered and analyzed. The first category relates to the evidentiary process necessary to prove-up the value determination in question. Such "evidentiary prove-up" issues include the selection of credible and effective witnesses and the application of credible and appropriate methodologies and standards by such witnesses to arrive at the ultimate value determination in question. The second category of valuation issues concerns the application of the court's valuation finding to the ultimate substantive rights and treatment of creditors and parties-in-interest in the bankruptcy case.
This chapter will primarily address the "evidentiary prove-up" category of valuation issues, which includes the selection of witnesses and the common valuation principles, methodologies and standards applied in valuation matters and disputes. The second category of valuation issues, concerning the impact that such valuation determinations play on the substantive rights of debtors, creditors and parties-in-interest, are addressed in other chapters of this book. Such substantive issues include the allowance and amount of a creditor's secured claim,100 adequate protection determinations,101 the allocation of asset sale proceeds,102 credit bid rights,103 confirmation and cramdown determinations,104 solvency issues,105 and many other substantive valuation issues that may arise in any given bankruptcy case.
Prior to selecting a valuation witness or deciding which valuation methodology or standard to apply when proving up the value of any asset, including a secured creditor's collateral, the following question must first be answered: "What is the purpose and objective for the valuation?" In addition, it is important to understand that any given valuation determination made during one stage or phase of a case may be irrelevant or not applicable to a valuation determination made during a different stage or phase of the case. As a result, it is important to recognize that a valuation determination may not constitute res judicata.106 Consequently, to maximize its recovery in a bankruptcy case, a secured creditor may seek to persuade the court that its collateral has different values at different times throughout the case.
A. Valuation Considerations
Inherent in every bankruptcy case is the need to determine (1) the value of assets that constitute property of the bankruptcy estate and (2) the allowed amount of claims being asserted against the estate. Such basic determinations are specifically significant to secured creditors of the debtor. Determining the amount of a creditor's allowed secured claim constitutes one of the most important valuation determinations to be made in a bankruptcy case.
The extent to which a creditor will be treated as having a "secured claim" in a bankruptcy case is addressed by § 506 of the Bankruptcy Code and Rule 3012 of the Bankruptcy Rules.107 The ultimate determination of the secured creditor's collateral value not only impacts the secured creditor's claims and rights, but such value determination can also affect and impact the rights of and strategic decisions made by the debtor, other creditors and parties-in-interest throughout the bankruptcy case.
Although collateral value determinations are critical in bankruptcy cases, the Bankruptcy Code does not address several important valuation questions and issues. For example, the Bankruptcy Code does not define the term "value" or identify specific methodologies or standards to be used for valuing collateral. Rather, § 506(a) provides that the value of a security interest "shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor's interest."108
The legislative history to § 506(a) further confirms the intent of Congress to provide courts with flexibility in determining a secured creditor's collateral value. The legislative history states that collateral valuations are not limited to either foreclosure valuations or going-concern valuations; rather, such valuations will vary on a case-by-case basis, thus permitting the court to take into consideration the facts and competing interests of each case.109 As a result, the Bankruptcy Code accommodates the use of several methods and standards to arrive at value determinations for collateral. In addition, courts have broad flexibility to consider each valuation determination on a case-by-case basis.110 Consequently, courts have recognized and applied varying methodologies and standards to determine collateral value in any given case.111
It is important to note, however, that for individual consumer chapter 7 and 13 cases, the Bankruptcy Code was amended in 2005 to add § 506(a) (2) to create a valuation standard to be applied in such individual consumer cases.112 The term "replacement value" applies in individual chapter 7 and 13 cases involving property acquired for personal, family or household purposes. Section 506(a)(2) defines "replacement value" to mean the price a retail merchant would charge for that particular kind of property taking into consideration the age and condition of such property. The 2005 amendment adding § 506(a)(2) modified the Supreme Court's decision in Associates Commercial Corp. v. Rash, which held that the appropriate value for a debtor's vehicle being retained by the debtor was the replacement value of the vehicle.113
Another critical valuation issue affecting a secured creditor includes the consideration of which date is the appropriate date or point in time at which the collateral value should be assessed and determined. The specific date as of which the valuation determination is made can be very important, particularly when the secured creditor's collateral fluctuates in value during the bankruptcy case.
In individual consumer chapter 7 and 13 cases, the 2005 amendments to the Bankruptcy Code make clear that value is determined as of the petition date.114 In other cases, however, because the Bankruptcy Code does not set a date certain as to when collateral should be valued, the determination date will depend on the particular issue before the court. Different valuation dates have been adopted by courts when determining the appropriate time frame within which to value collateral. For example, when considering adequate-protection payments in automatic stay litigation, courts have found that the valuation determination date for the relevant collateral should be the petition date, whereas in the plan-confirmation context, courts have found that the determination date should be the date of the confirmation or valuation hearing.115
Bankruptcy Rule 3012 provides procedural guidance regarding valuation proceedings. Rule 3012 requires that a valuation contested matter be commenced by the filing of a motion with notice to the secured creditor.116 If the motion is joined by a request to determine the validity, priority or extent of a lien, then the moving party may need to file an adversary pro-ceeding.117
Finally, not all valuation determinations are disputed between the parties. In many cases, the parties stipulate to an asset's value. So long as there is no evidence of fraud, bad faith or prejudice to the rights of other creditors or parties-in-interest, courts generally accept the stipulated value between the parties. In such cases, the stipulations will be binding on the parties to the stipulation.118
B. Valuation Basics
Determining value is not an exact science.119 Before starting any valuation analysis, the valuation expert must understand the nature of the collateral being valued and the bundle of legal rights that impact the valuation analysis. In addition, the valuation expert must also know the purpose and objective of the valuation determination being performed. Finally, it is critical for the valuation expert to apply the correct standard of value, premise of value and methodology to arrive at a credible opinion of value for the collateral that is the subject of the valuation analysis.
A reliable valuation requires the application of generally accepted standards, premises, methodologies and assumptions. The valuation expert must be able to effectively explain the standards considered, the methodologies used and the key assumptions made to arrive at an opinion concerning the value of the collateral. The expert must also keep in mind the unique bankruptcy context within which the valuation is being used. In addition, the expert must be aware that bankruptcy courts have "broad discretion to determine the extent and method of inquiry necessary for a valuation ... depend[ing] on the facts of each case."120 Although valuations performed in the context of a bankruptcy case come with a unique set of challenges, the recognized standards and methodologies typically implemented tend to follow a fairly predictable path.
1. Standard of Value
The expert must first determine and define the standard of value and other key assumptions to be used in the expert's valuation determination. The standard of value represents the identification of the type of value being utilized in a specific valuation engagement. Perhaps the most common standard of value used by valuation experts is fair market value. Fair market value represents the price at which an asset will change hands...
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