Secured Claims in Bankruptcy

• Author: Gregory Germain
• Pages: 213-242

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Chapter 9: Secured Claims in Bankruptcy

9.1. The Section 506(a) Split

Section 506 is an extremely important provision of the Bankruptcy Code and should be

read with great care. It begins with a fundamental concept: a creditor whose collateral is worth less

than the debt is partially secured, and partially unsecured. 11 U.S.C. § 506(a). The undersecured

creditor thus has two claims in bankruptcy that are treated very differently: a secured claim to the

extent of the value of the collateral, and an unsecured claim for the potential deficiency.

Section 506(a) also discusses how the collateral should be valued for purposes of the split.

Originally, the value was governed by the last sentence of Section 506(a) – the collateral should

be valued “in light of the purpose of the valuation and proposed disposition and use of the

property.” Thus, the valuation could change throughout the case depending on why the collateral

was being valued. In Associates Commercial Corp. v. Rash, 520 U.S. 953 (1997), reprinted below,

the Supreme Court established a replacement value standard for reorganization cases where the

debtor sought to keep the collateral. It is important to note the famous footnote 4 from the Rash

decision, which remains a correct and important consideration in the valuation process.

In 2005, Congress added section 506(a)(2) to the Bankruptcy Code. The general rule of

section 506(a)(2) follows Rash, but the new statute differs from Rash in the case of consumer

goods by requiring the use of retail value. The statute thus makes it more difficult for debtors to

keep their consumer goods even though the creditor will not be able to recover retail value after

repossession.

The creditors who pushed for section 506(a)(2)’s overvaluation may not have fully thought

the situation through. If the rule makes it more difficult for debtors to keep their property by

requiring the use of a high retail value, what happens when the debtors throw up their hands and

surrender the collateral back to the secured creditor? The case that follows Rash in the materials,

In re Brown, proves the old adage: “what is sauce for the goose is sauce for the gander.”

9.2. Cases on Valuation and the Section 506(a) Split

9.2.1.1. ASSOCIATES COMMERCIAL v. RASH, 520 U.S.

953 (1997)

JUSTICE GINSBURG

In 1989, respondent Elray Rash purchased for $73,700 a Kenworth tractor truck for use in

his freight-hauling business. Rash made a down payment on the truck, agreed to pay the seller the

remainder in 60 monthly installments, and pledged the truck as collateral on the unpaid balance.

The seller assigned the loan, and its lien on the truck, to petitioner Associates Commercial

Corporation (ACC).

In March 1992, Elray and Jean Rash filed a joint petition and a repayment plan under

Chapter 13. At the time of the bankruptcy filing, the balance owed to ACC on the truck loan was

$41,171. Because it held a valid lien on the truck, ACC was listed in the bankruptcy petition as a

creditor holding a secured claim. Under the Code, ACC's claim for the balance owed on the truck

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was secured only to the extent of the value of the collateral; its claim over and above the value of

the truck was unsecured.

The Rashes' Chapter 13 plan invoked the cram down power. It proposed that the Rashes

retain the truck for use in the freight-hauling business and pay ACC, over 58 months, an amount

equal to the present value of the truck. That value, the Rashes' petition alleged, was $28,500. ACC

objected to the plan and asked the Bankruptcy Court to lift the automatic stay so ACC could

repossess the truck. ACC also filed a proof of claim alleging that its claim was fully secured in the

amount of $41,171. The Rashes filed an objection to ACC's claim.

The Bankruptcy Court held an evidentiary hearing to resolve the dispute over the truck's

value. At the hearing, ACC and the Rashes urged different valuation benchmarks. ACC maintained

that the proper valuation was the price the Rashes would have to pay to purchase a like vehicle, an

amount ACC's expert estimated to be $41,000. The Rashes, however, maintained that the proper

valuation was the net amount ACC would realize upon foreclosure and sale of the collateral, an

amount their expert estimated to be $31,875.

Courts of Appeals have adopted three different standards for valuing a security interest in

a bankruptcy proceeding when the debtor invokes the cram down power to retain the collateral

over the creditor's objection. In contrast to the Fifth Circuit's foreclosure-value standard, a number

of Circuits have followed a replacement-value approach. Other courts have settled on the midpoint

between foreclosure value and replacement value. We granted certiorari to resolve this conflict.

Over ACC's objection, the Rashes' repayment plan proposed, pursuant to § 1325(a)(5)(B),

continued use of the property in question, i. e., the truck, in the debtor's trade or business. In such

a "cram down" case, we hold, the value of the property (and thus the amount of the secured claim

under § 506(a)) is the price a willing buyer in the debtor's trade, business, or situation would pay

to obtain like property from a willing seller. . . .

The second sentence of § 506(a) does speak to the how question. "Such value," that

sentence provides, "shall be determined in light of the purpose of the valuation and of the proposed

disposition or use of such property." § 506(a). By deriving a foreclosure-value standard from §

506(a)'s first sentence, the Fifth Circuit rendered inconsequential the sentence that expressly

addresses how "value shall be determined."

As we comprehend § 506(a), the "proposed disposition or use" of the collateral is of

paramount importance to the valuation question. If a secured creditor does not accept a debtor's

Chapter 13 plan, the debtor has two options for handling allowed secured claims: surrender the

collateral to the creditor, or, under the cram down option, keep the collateral over the creditor's

objection and provide the creditor, over the life of the plan, with the equivalent of the present value

of the collateral. The "disposition or use" of the collateral thus turns on the alternative the debtor

chooses - in one case the collateral will be surrendered to the creditor, and in the other, the

collateral will be retained and used by the debtor. Applying a foreclosure-value standard when the

cram down option is invoked attributes no significance to the different consequences of the debtor's

choice to surrender the property or retain it. A replacement-value standard, on the other hand,

distinguishes retention from surrender and renders meaningful the key words "disposition or use."

Tying valuation to the actual "disposition or use" of the property points away from a

foreclosure-value standard when a Chapter 13 debtor, invoking cram down power, retains and uses

the property. Under that option, foreclosure is averted by the debtor's choice and over the creditor's