How Should Property Be Valued in a Cram Down? - Mark E. Beatty

• Citation: Vol. 49 No. 3
• Publication year: 1998

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How Should Property Be Valued In a Cram Down?

I. Introduction

One of the most intriguing topics in bankruptcy law is the valuation of property in cram down cases, specifically Chapter 13 cases. This article will first present and discuss the different methods of valuation employed by the circuit courts before Associates Commercial Corp. v. Rash (Rash III)¹ was decided by the Supreme Court and the reasoning behind these methods. The next section will discuss the opinion in Rash and the chosen method of valuation in Chapter 13 cram down cases. The third section will discuss the implications of the decision in Rash. The Article will conclude with a proposed solution to the problems presented by the decision.

II. The Circuit Courts

A. Rash I

In 1994 the Fifth Circuit Court of Appeals decided the case that fueled this debate.² In March 1989, Rash purchased a Kenworth truck from Janoe Truck Sales and Service, Inc. ("Janoe"), a dealer of Kenworth trucks, at a retail price of $73,700 by entering into sales and related agreements. Rash owned a freight hauling business and intended to use the truck as part of his business. Pursuant to the loan, the truck was to serve as collateral for the loan. After the sale, Janoe assigned the lien to Associates Commercial Corporation ("ACC"), which held a valid lien on the truck.³

In March 1992, Rash filed a voluntary petition for relief under Chapter 13 of the Bankruptcy Code.⁴ At the time of filing, Rash owed $41,171.01 on the balance of the truck. Rash then filed a plan invoking the cram down option of section 1325(a)(5)(B).⁵ Rash proposed to let ACC keep its lien on the truck while he provided fifty-eight monthly payments of $607.79, including nine percent interest, with payment to begin after confirmation, for a principal total of $28,500 plus interest. The remainder of ACC's claim would be treated as unsecured and ACC would receive a pro rata share of all assets remaining after priority and secured claims were paid.⁶

ACC filed a motion for relief from the automatic stay alleging that ACC was fully secured. It subsequently filed a proof of claim in the amount of $41,171.01. Rash responded by alleging that ACC's secured portion of the claim was $28,500 and the remainder was unsecured. At a hearing held by the bankruptcy court, ACC's expert testified that a retail value was more indicative of market value, and that the market value of the truck was $41,000. ACC's expert defined "market value" as the amount that a single, "average individual off the street" would pay for the truck or would bid for the truck at a public sale.⁷ Rash's expert offered that the wholesale value of the truck was more indicative of "market value" because the difference between wholesale and retail value represented the "margin between a dealer's costs of marketing, reconditioning, payment of sales commissions, and a dealer's profit."⁸

The bankruptcy court adopted the wholesale value proffered by Rash's expert.⁹ Rash subsequently filed an amended proof of claim for the agreed upon wholesale value of the truck— $31,875.¹⁰ The bankruptcy court confirmed Rash's plan for reorganization under Chapter 13 of the Bankruptcy Code using the amended proof of claim and the district court affirmed.¹¹

In reviewing which valuation method was proper, the court of appeals first looked to section 506(a) of the Bankruptcy Code for guidance.¹² Section 506(a) provides as follows:

An allowed claim of a creditor secured by a lien on property in which the estate has an interest ... is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property . . . and is an unsecured claim to the extent that the value of such creditor's interest ... is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property[.]¹³

The court noted two lines of case law that have emerged as a result of the two sentences in section 506(a).¹⁴ One line of authority, the wholesale or foreclosure value approach, read the first sentence as operative. Under this approach, the court noted, the creditor's interest is determinative of how the property is to be valued.¹⁵ Because the foreclosing creditor was not a dealer, the foreclosing creditor could not resell the collateral at retail prices and could only receive the wholesale value by selling to a retailer.¹⁶ The court also noted that under this wholesale or foreclosure value approach, courts commonly deduct the costs that would be incurred in executing the resale or foreclosure.¹⁷

Under the other line of authority, the retail or replacement value approach, the first sentence of section 506(a) only gives guidance as to what to value. The second sentence of section 506(a) controls how valuation is to be made. Because the second sentence states that the creditor's lien must be valued in light of the purpose of the valuation and the proposed disposition or use of the collateral, a replacement value is proper.¹⁸ '"Where the debtor proposes to retain and use the collateral, . . . the value of the lien is derived from the stream of payments that the lien secures, rather than the right to foreclose, since no liquidation of the collateral is contemplated.'"¹⁹

The court of appeals selected the replacement value model as the proper method of valuing the secured creditor's claim and reversed the district court.²⁰ The court made two arguments explaining its reasoning. First, the court stated that if the first sentence of section 506(a) tells not only what is to be valued, but also how, then the second sentence is mere surplusage.²¹ Second, the "estate's interest in the property" is that of the debtor's use and possession of the vehicle, and thus the creditor's interest is derived from the debtor's interest.²² If the debtor does not intend a liquidation, neither can the creditor if his interest is truly derived from that of the debtor.²³ Such retainment and use of the collateral is "acknowledging the value of the collateral to be greater than if liquidated."²⁴

B. Winthrop Old Farm Nurseries, Trimble, and Taffi

One of the first major decisions in this area outside of the Fifth Circuit was Winthrop Old Farm Nurseries, Inc. v. New Bedford Institution for Savings (In re Winthrop Old Farm Nurseries, Inc.).²⁵ This case dealt with a business debtor who sought to have a creditor's secured claim valued at liquidation value even though the debtor proposed to keep the property. After the bankruptcy court and the district court agreed that the fair market value or going concern value was the correct method of valuation, Winthrop appealed.²⁶

The First Circuit Court of Appeals first looked to section 506(a) for guidance. After viewing both sentences of the statute, the court found that the statute does not require it to choose any particular valuation method, but instead allows for flexibility.²⁷ The court then looked to the legislative history and found that courts are to "'determine value on a case-by-case basis, taking into account the facts of each case and the competing interests in the case.'"²⁸ Finally, after reviewing both lines of authority for the proper valuation method, fair market or going concern value versus liquidation value, the court held that when a debtor proposes in its plan to retain control of the property and continue using it to generate an income stream, the proper measure of value is fair market value.²⁹ In arriving at this holding, the court specifically mentioned that a per se liquidation value would render the second sentence of section 506(a) virtually meaningless.³⁰ Further, a reorganizing debtor would be able to "reap a windfall by stripping down the lien to liquidation value and quickly selling the collateral at fair market value, thus pocketing equity that would have been completely beyond reach [of the debtor] save for the filing of the bankruptcy petition."³¹ Thus, the First Circuit focused on the plain meaning of the statute and the potential for a debtor windfall.

The next major decision on this topic outside of the Fifth Circuit was Metrobank v. Trimble (In re Trimble)?³² Unlike Winthrop, this case concerned an individual debtor in a Chapter 13 cram down and a vehicle valuation. In Trimble, the debtor, Trimble, purchased a 1988 Ford Ranger Pickup through secured financing with Metrobank. At the time of his filing of the Chapter 13 petition, Trimble owed $6,404.84. Under the proposed plan, Metrobank's secured interest in the truck was valued at $4,000 with interest, and the remainder was classified as unsecured, to be paid pro rata without interest. Metrobank argued that it was fully secured, and for the purposes of a bankruptcy valuation hearing, stipulated with Trimble that the wholesale value of the truck was $4,000 and the retail value was $6,500. The bankruptcy court chose the wholesale value and the district court affirmed the ruling.³³

On appeal, the Eight Circuit Court of Appeals first examined the two lines of authority previously discussed. Under theory one, the foreclosure or wholesale value approach, the court summarized its position:

[B]ecause a lien is simply a right to take possession of the collateral and sell it in satisfaction of an obligation, the value of the lien is equal to the amount the creditor could receive upon sale of the collateral, or, in other words, the wholesale value of the collateral.³⁴

In summarizing the other line of authority, the court stated that "'the value of the creditor's lien is derived from the stream of payments that the lien secures, rather than the right to foreclose, since no liquidation of the collateral is contemplated.'"³⁵ The court followed the majority rule and held that where a debtor proposes to use the collateral, the retail value, with no costs of repossession or sale deducted, is the proper method of valuation instead of a wholesale value based on a...