In Re Peter Gordon Balbus, Debtor. Brown and Company Securities Corporation v. Peter Gordon Balbus ( 1991 )

ERVIN, Chief Judge:

Peter Gordon Balbus (“Balbus”) filed a voluntary petition for relief under Chapter 13 of the Bankruptcy Code. This petition was challenged by one of Balbus’ secured creditors, Brown and Company Securities Corporation (“Brown”). Brown asserted that hypothetical costs of sale should be deducted when calculating the value of Bal-bus’ real property providing security for his secured debt. If the costs were deducted, Balbus would not be eligible for relief under Chapter 13, title 11, United States Code. See 11 U.S.C. § 109(e).¹ Therefore, Brown filed a motion to dismiss or to convert Balbus’ Chapter 13 filing to Chapter 7. The Bankruptcy Court found that hypothetical costs of sale should not be deducted and, therefore, denied Brown’s motion. The United States District Court for the Eastern District of Virginia affirmed the ruling of the Bankruptcy Court. This appeal followed. We find no error in the district court’s ruling and hereby affirm.

I

On January 13, 1989, Balbus filed a voluntary petition for relief pursuant to Chapter 13, title 11, United States Code. Brown is a secured creditor possessing a judgment lien against Balbus; Brown filed a timely proof of claim.

Chapter 13 is available only to debtors who have noncontingent, liquidated, unsecured debts totalling less than $100,-000 and noncontingent, liquidated, secured debts totalling less than $350,000. 11 U.S.C. § 109(e). In determining whether Balbus has less than $100,000 in unsecured debts under 11 U.S.C. § 109(e), the court must add the amount of unsecured debt and the amount by which secured creditors are undersecured. See 11 U.S.C. § 506(a).²

Balbus filed schedules of assets and liabilities, listing secured debts of $324,050.73 and unsecured debts of $57,968.73. Balbus listed one piece of real property and some personalty as security for the secured debts. The parties agree that the unadjusted fair market value of the real property is $282,500, and the fair market value of the personalty is $4,500. Fair market value of the collateral thus totals $287,000, leaving $37,050.73 of the secured claims undersecured. Adding $37,050.73 of un-dersecured debt to the listed $57,968.73 of unsecured debt results in a total of $95,-019.46 in unsecured debt, which falls within the $100,000 limit in 11 U.S.C. § 109(e).

Brown filed a motion to dismiss or, in the alternative, a motion to convert Balbus’ Chapter 13 filing to a Chapter 7 filing, thus challenging the right of Balbus to proceed under Chapter 13. Brown argues that the amount of security represented by Balbus’ real property should be reduced by the amount of the hypothetical costs of sale of that property. Brown uses a 6% figure for the costs of sale, reducing the dollar amount of Balbus’ real property which is security for his secured debt. As a result of this reduction, Brown asserts that the secured claims are undersecured in the amount of $54,000.73, rather than the $37,-050.73 stated above. Adding $54,000.73 of undersecured debt to the listed $57,968.73 of unsecured debt results in a total unsecured debt of $111,969.46, which exceeds the $100,000 limit of 11 U.S.C. § 109(e).

The Bankruptcy Court determined that the hypothetical costs of sale should not be deducted from the fair market value of the real property. Because the hypothetical costs were not deducted, the total amount of unsecured debt was under the statutory limit. Therefore, the court denied Brown’s motion to dismiss and motion to convert. Brown appealed this determination to the United States District Court for the Eastern District of Virginia. The District Court affirmed the decision of the Bankruptcy Court. Thereafter, the District Court denied Brown’s motion for reconsideration. This appeal followed.

II

In order to resolve this case, we must interpret § 506(a) of the Bankruptcy Code in light of the fact that Balbus intends to keep his real property rather than sell it. Section 506(a) provides:

An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under section 553 of this title, is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property, or to the extent of the amount subject to setoff, as the case may be, and is an unsecured claim to the extent that the value of such creditor’s interest or the amount so subject to setoff 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, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.

11 U.S.C. § 506(a) (emphasis added). We review the interpretation of a statute de novo. In re Malody, 102 B.R. 745, 747 (Bankr. 9th Cir.1989).

Bankruptcy courts confronted with how to interpret “valuation” in § 506(a) when a debtor proposes to keep the secured collateral have reached conflicting results. In re 222 Liberty Assoc., 105 B.R. 798, 802 (Bankr.E.D.Pa.1989); In re Usry, 106 B.R. 759, 760 (Bankr.M.D.Ga.1989). The controversy stems largely from the conflicting language in the above underlined sentences in § 506(a). In re Boring, 91 B.R. 791, 794 (Bankr.S.D. Ohio 1988); In re Claeys, 81 B.R. 985, 990-91 (Bankr.D.N.D.1987). The Bankruptcy Court for the District of North Dakota set out a discussion of the conflicting language in § 506(a) which is often cited. See Claeys, 81 B.R. at 990-91. The court explained:

Whether a valuation is made without regard for potential costs of liquidation depends, it seems, upon the emphasis given to the first and second sentences of section 506(a). The first sentence, providing that the claim is secured to the extent of the value of the creditor’s interest in the property, suggests that since it is the creditor’s interest that is being valued and not the collateral itself, it should not make any difference whether the debtor is retaining the property. Yet, the language of the second sentence suggests that the proposed disposition or use of the collateral itself must be considered when determining that value.

Id.

Some courts have determined that hypothetical costs of sale should be deducted even though the debtor intends to retain the property. See In re Smith, 92 B.R. 287, 291 (Bankr.S.D.Ohio 1988); Claeys, 81 B.R. at 992. Others have determined that the hypothetical costs should not be deducted. See In re Courtright, 57 B.R. 495, 497 (Bankr.D.Or.1986); In re Bellman Farms, Inc., 86 B.R. 1016, 1019 (Bankr.D.S.D. 1988).

The legislative history of § 506(a) indicates that valuation should be done ad hoc and that no fixed approach is correct:

“Value” does not necessarily contemplate forced sale or liquidation value of the collateral; nor does it always imply a full going concern value. Courts will have to determine value on a case-by-case basis, taking into account the facts of each case and the competing interests in the case.

H.R.Rep. No. 595, 95th Cong., 1st Sess. 356 (1977), reprinted in 1978 U.S.Code Cong. & Admin.News 5787, 6312. The Senate Report further clarifies the duty of the court in determining valuation:

While courts will have to determine value on a case-by-ease basis, the subsection makes it clear that valuation is to be determined in light of the purpose of the valuation and the proposed disposition or use of the subject property.

S.Rep. No. 989, 95th Cong., 1st Sess. 68, reprinted in 1978 U.S.Code Cong. & Admin.News 5787, 5854.

As we have noted, one line of cases has determined that when a debtor proposes to retain the secured collateral, the hypothetical costs of sale should be deducted in order to determine the valuation of the creditor’s interest in the collateral. The courts adopting this viewpoint focus on the first sentence of § 506(a). See In re Smith, 92 B.R. 287, 290 (Bankr.S.D.Ohio 1988) (“[Bjecause it is the creditor’s interest in the estate’s interest in property which must be valued, it is appropriate to deduct costs of sale regardless of whether a debtor intends to retain and use the property.”) (emphasis in original); Boring, 91 B.R. at 795 (“Most courts recognize that the debtor’s proposed retention and use of collateral does not emasculate the fact that it is in the first instance the creditor’s interest in the collateral that must be valued.”) (emphasis in original).

The Bankruptcy Court in the Eastern District of Pennsylvania explained the view of the courts which focus on the first sentence of § 506(a):

[T]he fact that the first sentence references “the creditor’s interest in the estate’s interest in such property” causes these courts to conclude that valuation must be calculated from the vantage point of the creditor and what the creditor’s interest would be worth if liquidation were necessary. Sale costs, they reason, would, in liquidation, be deducted from what the creditor would receive for the property.

In re 222 Liberty Assoc., 105 B.R. 798, 803 (Bankr.E.D.Pa.1989) (rejecting this view and holding that hypothetical costs should not be deducted). The Bankruptcy Court in the Southern District of Ohio further explained this view that the proper emphasis is on the creditor’s interest rather than the debtor’s proposed use of the collateral:

The distinction to be drawn is between the value of the property and the value of the creditor’s interest in such property. The latter value is the one that is statutorily-mandated under § 506(a) of the Bankruptcy Code to be used in determining the secured status of a creditor in a bankruptcy case.

In re Ward, 13 B.R. 710, 712 (Bankr.S.D. Ohio 1981).

The Ward court held that hypothetical costs of sale in the amount of 10% should be deducted in determining the value of the property. Id. See also In re Richardson, 82 B.R. 872, 873 (Bankr.S.D.Ohio 1987) (reducing the fair market value of the property by 10% hypothetical costs of sale); Smith, 92 B.R. at 291 (concluding that 10% hypothetical costs of sale deduction was proper). Other courts have held that the amount of hypothetical costs of sale to be deducted should be equal to the costs a creditor would incur “in disposing of property in a commercially reasonable manner.” Claeys, 81 B.R. at 992; In re Davis, 14 B.R. 226, 228 (Bankr.D.Me.1981).

While the Southern District of Ohio and other bankruptcy courts determined that hypothetical costs of sale should be deducted, “a growing number of courts have rejected this line of reasoning, and have refused to deduct the sale costs in rendering a § 506 calculation unless the debtor’s plan contemplates selling the property on the open market.” 222 Liberty Assoc., 105 B.R. at 803. Courts which refuse to deduct hypothetical costs emphasize the second sentence of § 506(a), which dictates that “analysis should be made in light of the Debtor’s intended use of the collateral.” In re Usry, 106 B.R. 759, 761 (Bankr.M.D. Ga.1989).

The Bankruptcy Court for the District of Oregon set out an explanation of the view that hypothetical costs should not be deducted in the following discussion:

If the [first sentence of § 506(a)] were interpreted to mean that the value must be fixed at the amount which the creditor would receive on foreclosure, then the last sentence of the statute which provides that the value shall be determined in the light of the purpose of the valuation and of the proposed disposition or use of the property, would be surplus-age. Such an interpretation would mean that the value should always be fixed at the amount which the creditor would receive upon foreclosure regardless of the purpose of the valuation and of the proposed disposition or use of the property. The test would not depend upon whether the debtor intended to release the property or intended, instead to retain and use the property. It is not appropriate for the court to ignore or give no effect to the language of the last sentence of the statute.

In re Courtright, 57 B.R. 495, 497 (Bankr. D.Or.1986). The Courtright court concluded that when the debtor intends to retain and use the property, the court should not deduct hypothetical costs of sale in determining the valuation of the property. Id.

The Bankruptcy Court for the Northern District of Illinois agreed with the Court-right court in its holding in Matter of Crockett, 3 B.R. 365 (Bankr.N.D.Ill.1980). There, the court explained:

Under a Chapter 13 plan the secured claim should be valued with due regard to the value of the property to the estate. “[T]he proposed disposition or use of such property” (sec. 506(a)) in the instant case is for the debtors’ retention and use. Therefore, the debtors cannot eat with the hounds and run with the hares. Seeking retention of the property, they cannot insist on liquidation values to be paid to the creditor in installments.

Id. at 367. At issue in Crockett was whether the court should use wholesale or retail value in determining the valuation of the secured property consisting of automobiles.

Several recent bankruptcy cases have agreed with the holdings in Courtright and Crockett. See In re Gerhardt, 88 B.R. 151, 15354 (Bankr.S.D.Ohio 1987) (“This Court is of the opinion that when the parties are not actually contemplating the sale of the property, then costs of sale is to be excluded from the valuation analysis.”); In re Usry, 106 B.R. at 761-62 (“This court agrees with the analysis of the Courtright court” and holds that hypothetical costs should not be deducted.); In re Bellman Farms, Inc., 86 B.R. 1016, 1019 (Bankr.D. S.D.1988) (“[I]f the debtor remains in possession of the collateral, these hypothetical costs should not be deducted from the value of the collateral.”).

In this case, the district court determined that the hypothetical costs should not be deducted, basing its ruling in large part upon dicta in the recent Supreme Court decision in United Savings Ass’n v. Timbers of Inwood Forest Associates, Ltd., 484 U.S. 365, 108 S.Ct. 626, 98 L.Ed.2d 740 (1988). Timbers required the Court to determine whether unsecured creditors are entitled to interest on their money under 11 U.S.C. § 362(d)(1) because of the delay in foreclosing on their collateral caused by the automatic bankruptcy stay. Id. at 368, 108 S.Ct. at 628. In order to make this determination, the Court had to interpret “interest in property” as found in § 362(d)(1). The Court looked at the “interest in property” phrase used in other contexts in the Bankruptcy Code for assistance. Id. at 371, 108 S.Ct. at 630. One of those other contexts was the use of the phrase in § 506(a). The Court wrote:

In subsection (a) of [506] the creditor’s “interest in property” obviously means his security interest without taking account of his right to immediate possession of the collateral on default.... The phrase “value of such creditor’s interest” in § 506(a) means “the value of the collateral.”

Id. at 372, 108 S.Ct. at 630 (emphasis added). The Court concluded that “interest in property” under § 362(d)(1) did not include interest during the pendency of the automatic stay. Id.

The Bankruptcy Court in this case seized upon the above language from Timbers and determined that “the better view is that the secured creditor’s interest may be valued for § 506(a) purposes without superimposing a foreclosure or other sale of the collateral where a disposition of the property is not reasonably in the offing.” The Bankruptcy Court thus determined that the hypothetical costs of sale would not be deducted in this case. The District Court affirmed this determination. We agree with the result reached by the Bankruptcy Court and affirmed by the District Court.

If we were to accept the view that hypothetical costs should be deducted in this case, we would be reading the second sentence of § 506(a) out of the statute. “In construing a statute we are obliged to give effect, if possible, to every word Congress used.” Reiter v. Sonotone Corp., 442 U.S. 330, 339, 99 S.Ct. 2326, 2331, 60 L.Ed.2d 931 (1979). The second sentence in § 506(a) requires that we determine the value “in light of the purpose of the valuation and of the proposed disposition or use of such property.” 11 U.S.C. § 506(a).

In this case, the purpose of the valuation is to determine whether Balbus’ unsecured debts are less than the $100,000 limit set out in 11 U.S.C. § 109(e). If they are, then Balbus properly filed a Chapter 13 claim. If not, then Chapter 13 was not available to Balbus. See 11 U.S.C. § 109(e).

The limitations set out in § 109(e) were reached as a result of a compromise between the Senate bill which had higher limits and the House bill which had lower limits. In re Ballard, 4 B.R. 271, 273 (Bankr.E.D.Va.1980). Congress compromised on dollar limitations between the Senate version and the House version. If hypothetical costs were deducted under § 506(a), then these limitations set out in § 109(e) could be manipulated according to the amount of hypothetical costs determined to be reasonable. This ability to manipulate the limits of § 109(e) on which Congress compromised runs contrary to the purpose of setting specific dollar limitations. That purpose was to “permit the small sole proprietor, for whom a chapter 11 reorganization is too cumbersome a procedure, to proceed under chapter 13.” H.R.Rep. No. 595, 95th Cong., 1st Sess. 320 (1977), reprinted in 1978 U.S.Code Cong. & Admin.News 5787, 6277. The purpose of the valuation in this case is to determine whether Balbus met the § 109(e) requirements, and this weighs in favor of consistent interpretation of the dollar limitations of § 109(e). Therefore, the purpose of valuation supports the view that hypothetical costs should not be deducted from the value of the property.

In addition to looking at the purpose of the valuation, the second sentence of § 506(a) directs us to look at the “proposed disposition or use of” the property at issue. 11 U.S.C. § 506(a). Indeed, the Senate Report underscores that requirement. See S.Rep. No. 989, 95th Cong., 1st Sess. 68, reprinted in 1978 U.S.Code Cong. & Admin.News 5787, 5854. Here, the proposed use or disposition of the real property is that Balbus plans to continue to live in his house and not sell it. Courts which have focused on the intended use of the property have generally held that when a debtor retains the property, hypothetical costs should not be deducted. See Courtright, 57 B.R. at 497; 222 Liberty Assoc., 105 B.R. at 803; Usry, 106 B.R. at 761. Those courts which hold that hypothetical costs should be deducted generally do so by focusing on the first sentence of § 506(a), virtually ignoring the debtor’s proposed disposition of the collateral and the requirements of the second sentence of § 506(a).

The proposed disposition of the property in this case is that Balbus will not sell his house. Therefore, this factor indicates that there is no need to subtract the hypothetical costs of sale as they are just that— hypothetical.

Ill

The second sentence of 11 U.S.C. § 506(a) requires that we determine the value of a creditor's interest “in light of the purpose of the valuation and of the proposed disposition or use of such property.” We find that we cannot ignore the direction of that sentence and thus cannot follow those courts which have chosen to focus on the first sentence of § 506(a). In this case, the purpose of valuation, to determine whether the dollar limits of 11 U.S.C. § 109(e) have been exceeded, counsels that hypothetical costs should not be deducted. Balbus intends to continue living in his house, so the proposed disposition of the property also counsels that hypothetical costs should not be deducted. Finally, the dicta in Timbers indicates that the proper interpretation of valuation in § 506(a) is the value of the collateral, not the value of the collateral minus the hypothetical costs of sale. See Timbers, 484 U.S. at 372, 108 S.Ct. at 630. Each of these factors supports the view that the district court properly refused to deduct hypothetical costs of sale from the value of Balbus’ property. Therefore, we hold that the district court’s ruling was not in error, and we affirm.

AFFIRMED.

1 . 11 U.S.C. § 109(e) provides in pertinent part: Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $100,000 and noncontingent, liquidated, secured debts of less than $350,000, ... may be a debtor under chapter 13 of this title.

2 . 11 U.S.C. § 506(a) provides in pertinent part:

An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under section 553 of this title, ... is an unsecured claim to the extent that the value of such creditor’s interest or the amount so subject to setoff is less than the amount of such allowed claim.