The 9th Circuit en banc panel has reversed the three judge panel in Sunnyslope thankfully. The issue was how to value a building that had restrictive covenants that reduced the value of the property to the debtor. The en banc panel said that the words in section 506(a) that the value is “determined in light of the purpose of the valuation and of the proposed disposition or use of such property,” have meaning. The previous panel and the dissent to the en banc ruling tried to squeeze the Supreme Court ruling on valuation of a truck in Rash into the valuation of a building with affordable care covenants.
It took me a while to understand the Rash argument. I had a hard time getting past what seemed to be the obvious and straight forward language of the code.
Suppose there are several 137 unit apartment buildings in a particular neighborhood, all built more less around the same time and all in about the same condition. One of the buildings however is subject to restrictive covenants which require that the building be used for affordable housing. That building is “worth” less than the others because the rent charged for the others is higher. But the debtor owns the building with the covenants. The bank’s argument in Sunnyslope was that Rash requires that valuation be the “replacement value” for the “use of such property.” So if the debtor were going to buy a building to replace the building he has, the cost would be the amount the other buildings are selling for. Stated another way, if I wanted to buy a 137 unit apartment building in that condition in that neighborhood, it would cost the amount the non-restrictive use buildings were worth. I could then use that building for affordable housing if I wanted obviously.
But that takes away the language of the code in my opinion. The debtor would have to replace this building. This building has restrictive covenants. Of course I could buy anything and use it for some purpose. But we can’t talk about the cost of replacing something without considering the debtor’s proposed use of the property that he is keeping. Why, because that’s what the code says.
This comes up in my daily practice but in a different context. The individual chapter 11 debtor often has a corporation that operates his business. The value of the corporation is nothing – the debtor tells me – unless he is there. But – I respond – he is going to keep the corp and so it must be valued with him still there. Why, that is what the code says. The value is “determined in light” of the “proposed disposition or use of such property.” He is not disposing of it. He will continue to use it as he used it before.
My brief on the en banc decision follows:
Issue: What is the proper way to value a building when the cost to replace the building is more than the value of the building as the debtor proposes to use it under its chapter 11 plan?
Holding: The value is “determined in light of the purpose of the valuation and of the proposed disposition or use of such property,” not “the cost the debtor would incur to obtain a like asset for the same ‘proposed . . . use.’” – at least on the facts here.
Appeal from District Court
9th Circuit En Banc
Judge Andrew Hurwitz
The chapter 11 debtor here owned an apartment complex in Phoenix. As part of the financing for the building, the debtor agreed that the property would be dedicated and used for “affordable housing.” The parties here agreed that if the first foreclosed on the property, the affordable housing covenant would be extinguished by the foreclosure sale. The debtor asserted that the building was worth about $2.6 million, as affordable housing, and $7 million if the covenants were extinguished. The bank argued that the “replacement” value was $7.7 million which was still less than what was owed. The bank also made the 1111(b) election. The debtor proposed a plan which would pay the bank the lower amount with 4.4% interest over 40 years “with a balloon payment at the end without interest.” The court confirmed the plan. The district court affirmed although the value was increased by about $1.3 million because of “complex” tax credits.
The 9th Circuit reversed agreeing with the bank that “the replacement value of a 150-unit apartment complex does not take into account the fact that there is a restriction on the use of the complex.” The 9th Circuit then voted to rehear the matter en banc.
The 9th Circuit en banc then affirmed the bankruptcy court ruling with the district court adjustment for the tax credits. Section 506(a) says that the value of the property is “determined in light of the purpose of the valuation and of the proposed disposition or use of such property.” The difficulty here is that the Supreme Court in Rash said “that the value of collateral under § 506(a)(1) is ‘the cost the debtor would incur to obtain a like asset for the same ‘proposed . . . use.’” The bank argued that that means the cost of building that building for use as affordable housing. But the court here responded that it’s the value of that building as proposed to be used by the debtor. “[T]he proposed disposition and use is for low-income housing; indeed, no other use is possible without foreclosure.”
As to the remainder of the cram down issues, the 9th Circuit said there is no clear error. As to the interest rate, “[t]he bankruptcy court conducted a hearing at which it heard expert testimony, applied the Till test, and found that the 4.4% interest rate on the plan payments would result in [the bank’s] receiving the present value of its $3.9 million security over the term of the reorganization plan. The relevant national prime rate was 3.25%, and the bankruptcy court adjusted that rate upward to account for the risk of non-payment.”
In his dissent, Kozinski insists that Rash mandates the higher value. He says, “Rash never adopted today’s strict ‘particular use’ interpretation of replacement value.” In a footnote he comments, “I make no effort to defend Rash, which has been subject to abundant criticism along these lines. But I also see no reason to step beyond it, as today’s majority does.”