The Bankruptcy Code contemplates the valuation of a secured creditor’s collateral for a variety of purposes at different stages of a bankruptcy case. While title 11 of the United States Code (the “Bankruptcy Code”) does not define “value” or determine precisely when to value a secured creditor’s collateral, section 506(a) of the Bankruptcy Code provides some guidance: “Such value 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.”
Indeed, the notion that value of a debtor’s interest in property becomes fixed at any given time including on the date that the bankruptcy case is filed is too narrow of a reading of the Bankruptcy Code. As section 506(a) provides, bankruptcy courts must look to the purpose the valuation and the proposed disposition or use of the property to be valued. For example, if a debtor desires to use the secured creditor’s cash collateral over the creditor’s objection, the debtor must provide the secured creditor with “adequate protection” to protect the secured creditor from diminution in the value of its collateral during the course of the bankruptcy case. Determinations of adequate protection in the context of cash collateral fights usually occur early in the bankruptcy case. Courts look at a variety of factors including whether the debtor has a sufficient “equity cushion” in the collateral to protect the secured creditor from diminution in the value of the collateral during the pendency of the bankruptcy case. Similarly, a secured creditor may file a motion for relief from stay on the grounds that there is no equity in the property and that the property is not necessary for an effective reorganization. The secured creditor has the burden of proof on the issue of value and whether the debtor lacks equity in the property. Motions for relief from stay and adequate protection can occur at any stage of the bankruptcy case. Bankruptcy Courts may also be called upon to determine the value of an interest of the debtor in property in the context of a sale of assets free and clear of liens, claims and interests under section 363 of the Bankruptcy Code. Valuation may also arise in the context of fraudulent transfer litigation where the debtor is alleged to have been insolvent or received less than a reasonably equivalent value in exchange for such transfer. Finally, a debtor may seek to establish the value of a secured creditor’s collateral for both voting purposes and treatment under a Chapter 11 plan of reorganization.
Indeed, it is not unusual for a debtor and the secured creditor to stipulate to value to resolve disputes concerning adequate protection and classification and treatment of a secured creditor’s claim. To complicate matters, different methods of valuation may be employed depending on the purpose of the valuation and circumstances of the case. For example, bankruptcy courts may be asked to apply a “going-concern” value to an operating company, which may take into consideration goodwill. Liquidation value may be more appropriately assigned to the value of assets of failed businesses. Oftentimes, the parties present expert witness testimony to determine valuation of the debtor’s interest in property and whether a creditor is over secured, undersecured or unsecured.
However, what happens when the value of a secured creditor’s collateral increases or decreases during the course of a bankruptcy case? What if the value of collateral differs at the time of the plan confirmation hearing from the value previously determined by the bankruptcy court by agreement or after an evidentiary hearing? The answers to these questions depend in large part on the purpose for which the valuation was previously determined and the jurisdiction of the bankruptcy court.
For example, the author of this blog post represented a secured creditor in a single asset real estate case in Reno, Nevada. At the time the case was filed, the value of the secured creditor’s real estate collateral was indisputably less than the full amount of the secured creditor’s claim. The parties stipulated to value “for plan confirmation purposes” based on the value of the real estate collateral at the time. The secured creditor made an election to have the entirety of its secured claim treated as a fully secured claim under the debtor’s chapter 11 plan of reorganization as authorized by section 1111(b) of the Bankruptcy Code. Ultimately, the Bankruptcy Court denied plan confirmation on the grounds that no plan could be confirmed because the debtor only had two creditors, a secured creditor that would not vote in favor of the plan, and an assignee of an insider claim whose vote could not be counted. The Bankruptcy Court’s ruling was appealed – first to the Ninth Circuit Bankruptcy Appellate Panel, and then to the Ninth Circuit Court of Appeals, and was ultimately decided by the United States Supreme Court on a discreet legal issue concerning the appropriate standard of review unrelated to the value of the property. The case was thereafter remanded back to the Bankruptcy Court.
Approximately seven years after plan confirmation was denied, the debtor sought to rely on the same plan that was previously denied with the same valuation that was agreed upon seven years earlier. The plan projections and values had become stale, and that the secured creditor had since become oversecured due to rising real estate values, entitling the secured creditor to recover post-petition interest and attorney’s fees and costs. Ultimately, the debtor and secured creditor entered into a settlement agreement under which the property was sold and the secured creditor was paid from the proceeds of sale. The key issue that was avoided was whether an agreed upon valuation for plan confirmation purposes seven years earlier was binding on the secured creditor.
As discussed below, the answer depends in large part on where the bankruptcy case is pending. However, the majority view is that valuation of collateral for purposes of plan confirmation must be made at or near the time of plan confirmation.
As a preliminary matter, section 506(a) of the Bankruptcy Code provides that the undersecured creditor’s claim must be bifurcated into a secured claim to the extent of the value of the collateral and an unsecured deficiency claim for the balance of the claim that exceeds the value of the collateral. As noted above, the value of a secured creditor’s collateral “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.” The Bankruptcy Code permits undersecured creditors in a chapter 11 case to bypass the effects of section 506 by making an election to have their entire claim treated as secured under Section 1111(b) of the Bankruptcy Code. This is known as an “1111(b) election” and was employed by the secured creditor in the above example. However, because Section 1111(b) is silent with respect to how to value the secured creditor’s collateral, bankruptcy courts generally look to sections 506(a) and 1129(b)(2)(A) for guidance. Although Section 1129(b)(2)(A) requires the discounting of the value of a secured creditor’s collateral to present value when determining whether a chapter 11 plan provides for adequate payments to creditors, section 506 governs when determining initial valuation. However, section 506 does not specify the date on which collateral should be valued.
The date of valuation for plan confirmation purposes was recently addressed in In re S-Tek 1, LLC, Case No. 20-12241-j11 (Bankr. D.N.M. Dec. 9, 2021). In S-Tek, the secured creditor, Surv-Tek, Inc., filed a motion requesting the Bankruptcy Court to value its collateral comprised of various business assets, including accounts receivable, equipment, general intangibles, and other commercial assets (the “Collateral”) as of the date of the bankruptcy petition. S-Tek filed a Subchapter V plan and a plan modification separately classifying Surv-Tek’s secured claim. The Plan proposed that S-Tek retain the Collateral and use it in the operation of its post-confirmation business. Under the plan, S-Tek proposed to pay Surv-Tek’s claim, if and to the extent the claim is allowed as a secured claim, in deferred cash payments. The valuation motion requested that the Bankruptcy Court value the Collateral pursuant to section 506(a)(1) for purposes of plan confirmation.
Valuation Date for the Purpose of Plan Confirmation
To confirm its subchapter V Plan, and in the event that Surv-Tek did not consent to the proposed treatment under the Plan, S-Tek was required to satisfy the “fair and equitable requirement” set forth in section § 1129(b)(2)(A) with respect to Surv-Tek’s secured claim. See 11 U.S.C. § 1191(b) and (c). Section 1191(b) requires that if all applicable requirements of section 1129(a) are satisfied (other than paragraphs (8), (10) and (15)), the court shall confirm the plan notwithstanding those requirements if “the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.” Section 1191(c) provides that for a plan to be fair and equitable with respect to a class of secured claims, the plan must meet the requirements of section 1129(b)(2)(A).
S-Tek’s Plan provided that if Surv-Tek did not make the section 1111(b) election, its claim would be treated as unimpaired under the Plan, and that if Surv-Tek made the section 1111(b) election, Surv-Tek would not be entitled to vote to accept or reject the plan. If Surv-Tek did not make the § 1111(b) election and voted to reject the plan, S-Tek must meet the requirements of section 1129(b)(2)(A)(i)(II), which requires that “each holder of a claim of such class [must] receive on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder’s interest in the estate’s interest in such property[.]”
As the S-Tek court noted, “Section 1129(b)(2)(A)(i)(II) does not give any guidance regarding the applicable valuation date—whether collateral should be valued, for plan confirmation purposes, as of the petition date, the confirmation date, or at some other time.” All that is required is that “the plan must provide for payments totaling at least the allowed amount of the secured claim and the deferred cash payments must have a present value at least equal to the value of the creditor’s interest in the collateral. For a debtor to achieve the required value of the deferred cash payments, typically the debtor pays the allowed secured claim with interest to account for the time-value of money.”
The S-Tek court recognized that a “large majority of courts that have addressed the issue have held that under § 506(a)(1), for plan confirmation purposes, collateral the debtor will retain for its post-confirmation business operations should be valued as of or near the date of the confirmation hearing S-Tek” rather than the petition date. (Citations omitted). The S-Tek court sided with the majority, concluding that “[j]ustifying a per se petition date valuation for confirmation purposes, on the theory that claims are allowed as of the petition date under § 502(b), ‘conflates the amount of the claim and the value of the collateral securing the claim[.]’” Id. (quoting In re Cahill, 503 B.R. 535, 541 (Bankr. D.N.H. 2013)). As the court noted: “The amount of the allowed claim determined under § 502(b) is fixed as of the petition date, whereas the value of the collateral securing the claim determined under § 506(a) can vary over the life of the case depending on the purpose of the valuation and the proposed use or disposition of the collateral.” Id. (citations omitted).
The S-Tek court followed the Fifth Circuit’s rationale in Houston Reg’l Sports, 886 F.3d 523, 532 (5th Cir. 2018), which “adopted a ‘flexible approach to valuation timing that allows the bankruptcy court to take into account the development of the proceedings, as the value of the collateral may vary dramatically based on its proposed use under any given plan.’” See also In re Dheming, No. 11-56798, 2013 WL 1195652, at *3 (Bankr. N.D. Cal. Mar. 22, 2013) (holding that “the appropriate date for valuing collateral for purposes of fixing a secured creditor’s claim is the confirmation date, or a date close to confirmation”, but leaving open the possibility of using some other date in unusual circumstances). The S-Tek court concluded that “for plan confirmation purposes, collateral the debtor or other plan proponent will retain for its post-confirmation business operations should be valued as of or near the date of the confirmation hearing.” Id. However, the S-Tek court did not “rule out the possibility that a different date might be appropriate in unusual circumstances based on developments during the bankruptcy case.” Id.
While the majority of courts apply a flexible approach to valuation that fixes a secured creditor’s claim at or near the date of plan confirmation, some courts take a more rigid approach to valuation that limits the secured creditor’s claim to the value of its collateral as of the petition date. Parties should carefully consider not only the purpose for which valuation is sought, but whether the bankruptcy court follows the majority or minority rule for determining when a secured creditor’s collateral should be valued for purposes of confirming a chapter 11 plan.