Assocs Cmercl Corp v. Rash

United States Court of Appeals,
Fifth Circuit.
No. 93-5396.
In the Matter of Elray RASH and Jean Rash, Debtors.
ASSOCIATES COMMERCIAL CORPORATION, Appellant,
v.
Elray RASH and Jean Rash, Appellees.
Sept. 13, 1994.
Appeals from the United States District Court Eastern District of
Texas.
Before REYNALDO G. GARZA, SMITH and PARKER, Circuit Judges.
JERRY E. SMITH, Circuit Judge:
The Associates Commercial Corporation ("ACC") appeals the
district court's confirmation of a reorganization plan under
chapter 13 of the Bankruptcy Code (the "code"). Because the
district court erred as a matter of law in calculating the value of
ACC's secured claim under 11 U.S.C. § 506(a), we reverse.
I.
A.
On March 30, 1989, Elray and Jean E. Rash1 purchased a
commercial truck at retail value of $73,700 by entering into a
sales agreement and related documents ("loan documents") with Janoe
Truck Sales & Service, Inc., d/b/a Janoe Kenworth Trucks ("Janoe").
The truck served as collateral for the loan. Rash owns and
operates the truck as part of his freight hauling business. Janoe
1
For simplicity, the Rashes are referred to simply as
"Rash."
1
assigned the loan documents to ACC, which holds a valid lien on the
collateral.
Under the terms of the loan, Rash was obligated to pay to ACC
$1,610.41 per month for sixty months, maintain the collateral, and
keep it adequately insured. In February 1992, Rash and ACC agree
to reschedule his obligation upon his agreement to pay $1,408.33
for thirty-six months.
B.
In March 1992, Rash filed a petition for bankruptcy under
chapter 13. Rash recognized ACC's superior lien on the collateral.
Pursuant to his chapter 13 plan, Rash proposed that ACC retain its
lien and be paid $607.79 per month for fifty-eight months,
beginning after confirmation, for a principal total of $28,500,
plus interest at nine percent. Rash represented in the plan that
the collateral would remain insured but that the proposed payment
"represent[ed] payment of the value of the Collateral in full with
interest over the life of the Plan," which was for five years.
Rash's plan made ACC a partially unsecured creditor that Rash could
treat as holding a partially unsecured claim. Rash's plan also set
forth that unsecured creditors "shall receive in pro-rata amounts
all amounts remaining after priority and secured debts are paid."
On May 1, 1992, ACC filed a motion for relief from stay,
alleging that Rash had no equity in the collateral. ACC
subsequently filed a proof of claim in the secured amount of
$41,171.01. Rash responded that the value of ACC's collateral was
only $28,500 and that the remainder of ACC's claim was unsecured.
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ACC challenged Rash's plan as inequitable because it did not pay
ACC what it could have received in a chapter 7 liquidation and
infeasible because it did not conform to the requirements of
chapter 13.
At a hearing in bankruptcy court, ACC's expert testified that
the market value of the truck was $41,000. "Market value" was
defined as "what an individual, average individual off the street"
would pay for the truck, or the price that would be received from
a public auction sale. Rash's expert testified that market value
should be determined by the wholesale value of the truck, $31,875.
He applied the wholesale value because he said that the difference
between wholesale and retail value represents the margin between a
dealer's costs of marketing, reconditioning, payment of sales
commissions, and a dealer's profit. Both experts agreed as to the
retail value of the truck; they just disagreed as to whether the
retail or wholesale value should be used.
The bankruptcy court adopted the measurement proffered by
Rash's expert. In line with this value, Rash filed an amended
chapter 13 plan promising to pay $31,875 in fifty-eight
installments plus nine percent interest, with the remaining value
of ACC's claim to be paid pro-rata as an unsecured claim. The
bankruptcy court confirmed this plan, 149 B.R. 430, and the
district court affirmed.
II.
Under § 1325(a)(5)(B) of the code, 11 U.S.C. § 1325(a)(5)(B),
a secured creditor must receive the present value of its allowed
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secured claim under a chapter 13 plan of reorganization. Unless
the creditor's present value is preserved, confirmation cannot
occur over the creditor's objection. The allowed secured claim is
determined by 11 U.S.C. § 506(a), which provides, in pertinent
part:
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....
We first look to the text of the statute, construing its terms
according to their plain meaning. Patterson v. Shumate, --- U.S.
----, ----, 112 S. Ct. 2242, 2246, 119 L. Ed. 2d 519 (1992). Each
term must be given effect so as to avoid rendering an part of the
statute inoperative. United States v. Nordic Village, Inc., ---
U.S. ----, ----, 112 S. Ct. 1011, 1015, 117 L. Ed. 2d 181 (1992);
Reiter v. Sonotone Corp., 442 U.S. 330, 339, 99 S. Ct. 2326, 2331,
60 L. Ed. 2d 931 (1979). If a term is ambiguous, it should be
construed consistently with other terms in the statute so as to
produce a symmetrical whole and avoid creating tension in the
statute. Federal Power Comm'n v. Panhandle E. Pipe Line Co., 337
U.S. 498, 514, 69 S. Ct. 1251, 1260, 93 L. Ed. 1499 (1949).
Cases construing § 506(a) have focused on two different
clauses whose relative emphases lead to differing results. See In
re Green, 151 B.R. 501, 502 (Bankr.D.Minn.1993). One line of cases
rests on the language of § 506(a)'s first sentence, which provides
that the creditor's claim is secured to the extent of the value of
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its interest in the estate's interest in such property. Under this
approach, the secured creditor is entitled to receive, in the
chapter 13 plan, the amount it could have obtained if the
collateral were foreclosed upon and sold by the creditor.
This "foreclosure approach" was followed by the bankruptcy
and district courts in the current case and in In re Mitchell, 954
F.2d 557 (9th Cir.1992), cert. denied, --- U.S. ----, 113 S. Ct.
303, 121 L. Ed. 2d 226 (1992). But see Lomas Mortgage USA v. Wiese
(In re Wiese), 980 F.2d 1279, 1286 (9th Cir.1992), vacated on other
grounds, --- U.S. ----, 113 S. Ct. 2925, 124 L. Ed. 2d 676 (1993)
(suggesting that the decision in Mitchell contradicts the language
of § 506(a) and illogically "allow[s] the debtor to keep the home
but value[s] the secured portion based upon a hypothetical sale of
the residence"). Because the foreclosing creditor is not a dealer
in the property comprising the collateral, it could not resell the
collateral at retail prices. Thus, its interest is the wholesale
price it would receive by selling the property to a retailer.
Green, 151 B.R. at 504. Under this approach, the court will also
generally deduct, from the wholesale price, the costs that would be
incurred in executing the resale.
A second line of cases relies upon the second sentence of §
506(a), which provides that the creditor's lien interest must be
valued in light of the purpose of the valuation and the proposed
disposition or use of the collateral. "Where the debtor proposes
to retain and use the collateral, and the purpose of the valuation
is to determine the amount that an undersecured creditor will be
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paid on its secured claim under the debtor's plan, 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." Green, 151 B.R. at
504.
Under this "replacement model," the "value of the lien should
be based on the retail value of the collateral since such is the
replacement value to the debtor; and the costs associated with
sale of the collateral should not be deducted since no sale is
contemplated." Green, 151 B.R. at 504. See In re Coker, 973 F.2d
258, 260 (4th Cir.1992); Brown & Co. Sec. Corp. v. Balbus (In re
Balbus), 933 F.2d 246, 251-52 (4th Cir.1991). Proponents of the
"replacement cost" approach argue that it is the only one that
gives effect to the entire language of § 506(a), whereas the
foreclosure approach ignores the second sentence of the statute.
We agree that the replacement cost approach is the only one
that gives full effect to the language of § 506(a). Under that
subsection, we must consider the "purpose of the valuation" and
"the proposed disposition or use" of the property by the debtor.
"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 should be determined in light of the
purpose of the valuation and of the proposed disposition or use of
the property, would be surplusage." In re Courtright, 57 B.R. 495,
497 (Bankr.D.Or.1986); see also In re Bergh, 141 B.R. 409, 419
6
(Bankr.D.Minn.1992) (noting that the "key phrase in § 506(a) is
"[s]uch value shall be determined in light of the purpose of the
valuation and of the proposed disposition or use of such
property....' ").
Moreover, § 506(a) instructs us to value the creditor's
interest according to "the estate's interest" in the property. The
"estate's interest in the property" is the ownership and possession
of the vehicle by the debtor, see Mitchell, 954 F.2d at 561
(Noonan, J., dissenting), and thus the creditor's interest is
derivatively defined by the value of the debtor's interest in the
property.
If the debtor retains the property as part of a
reorganization, the proper measurement of the estate's interest in
the property is the "going-concern" value of the collateral to the
debtor's reorganization. The value to the debtor of retaining and
using the property can best be measured by what he would have to
pay to purchase another truck. See id. (Noonan, J., dissenting).
Under § 506(a), the court must value the collateral in light of its
purpose and proposed use in the reorganization. Going concern, or
replacement, value accounts for the debtor's proposed use of the
property, whereas foreclosure value does not. "[W]hen a debtor
intends to continue use of creditor's collateral, the Debtors are
acknowledging the value of the collateral to be greater than if
liquidated. Therefore, creditor's secured claim is entitled to be
valued to the extent of its contribution to the entire estate
vis-a-vis "going concern value'...." In re Penz, 102 B.R. 826, 828
7
(Bankr.E.D.Okla.1989); see also In re Reynolds, 17 B.R. 489
(Bankr.N.D.Ga.1981).
The creditor has a security interest in an income stream
derived from the loan. Thus, the creditor's interest is the full
amount of its debt, limited only by the estate's interest in the
collateral. As the court wrote in Green:
It is true that the plain meaning of the first sentence of
section 506(a) requires a valuation of the creditor's lien
interest in the collateral. However, the fact that a lien in
property gives the lienholder a right to repossess and sell
the collateral does not automatically mean that the value of
the lien is equal to the amount that the creditor would
receive upon disposition of the collateral in satisfaction of
its lien. It must be remembered that a lien is fundamentally
a security interest which secures payment of an obligation.
To value such an interest in property based solely on the
amount that could be realized upon sale of the collateral
ignores the value associated with the right to receive the
stream of payments that the lien secures.
Green, 151 B.R. at 505 (emphasis in original).
The stream of payments in which the creditor has a security
interest will be greater in nominal value than the value of the
collateral alone because it includes the opportunity cost to ACC of
being forced to continue to tie up money in a loan with Rash,
rather than being able to lend this money to someone else. The
loss to the creditor is not just the inability to foreclose and
receive the value of the collateral, but includes the inability to
foreclose and then re-lend the money to someone else. "[I]f he
creditor was not forced to lend to this debtor, then it could lend
those funds to a different borrower. This is the real cost of the
inability to foreclose." Todd J. Zywicki, Cramdown and the Code:
Calculating Cramdown Interest Rates Under the Bankruptcy Code, 19
8
T. MARSHALL L.J. 241, 262 (1994). "[V]aluation based on a
hypothetical sale ignores the purpose of the valuation which is to
determine the amount an undersecured creditor will be paid for the
debtor's continued possession and use of the collateral, not to
determine the amount such creditor would receive if it had to
repossess and sell the collateral." Green, 151 B.R. at 505
(emphasis added).
This foregone loan would have been secured by collateral
valued according to its retail value. When Rash initially borrowed
the money to buy the truck, the loan amount was for the retail
price of the truck, not merely the wholesale amount. Reducing the
security interest to its wholesale value would allow parties to use
bankruptcy to alter their substantive rights as defined outside
bankruptcy. Indeed, a debtor could use bankruptcy to knock-down
the secured creditor's interest to wholesale value, then turn
around and resell the collateral at retail blue-book value and
pocket the difference. Wherever possible, we try to preserve the
terms of the parties' original bargain so that bankruptcy is not
used opportunistically to renegotiate the terms of a voluntary
agreement or to generate a windfall for one party or the other.
See Butner v. United States, 440 U.S. 48, 55, 99 S. Ct. 914, 918, 59
L. Ed. 2d 136 (1979).
Awarding the secured creditor only the wholesale value of the
collateral would undercompensate the creditor in bankruptcy.
Allowing the debtor to decrease the value of its collateral by
filing bankruptcy would lead to inefficient self-protection
9
measures by creditors, such as requiring debtors to put more cash
down at the time of purchase or charging a higher interest rate to
offset the risk that the debtor will file bankruptcy and strip down
the value of the creditor's security interest. Unable to
distinguish between good and bad borrowers, creditors will "alter
their behavior towards debtors as a class." Zywicki, supra, at
263. This will actually harm debtors, for, as a result, "[t]he
apparent pro-debtor effects of the bankruptcy rule will be
eliminated by the increased rate charged to debtors as a class."
Id.
It has been suggested that reinstating the secured creditor's
interest to its full retail value would be counterproductive, as it
would offer the debtor no relief, thereby undermining the
rehabilitative purposes of chapter 13. Any benefit that this would
provide to debtors, however, would be pyrrhic, as any advantage
gained in reorganization would be offset by increases in
downpayments and interest rates at the initial time of the loan.
Moreover, while reorganization of the debtor is an important
policy goal, this goal cannot be pursued by exterminating a secured
creditor's property interest. "Reorganization is not a Holy Grail
to be pursued at any length." United Sav. Ass'n v. Timbers of
Inwood Forest Assocs., Ltd. (In re Timbers of Inwood Forest
Assocs., Ltd.), 808 F.2d 363, 376-77 (5th Cir.1987) (en banc)
(Clark, C.J., concurring), aff'd, 484 U.S. 365, 108 S. Ct. 626, 98
L. Ed. 2d 740 (1988). Secured creditors should not be forced to bear
the burden of the debtor's reorganization. But see United Sav.
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Ass'n v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365, 378-
79, 108 S. Ct. 626, 634, 98 L. Ed. 2d 740 (1988) (noting that even if
secured creditors do not bear one kind of reorganization cost, they
may still bear others).
The replacement approach is consistent with the Supreme
Court's holding in Timbers of Inwood Forest, see Mitchell, 954 F.2d
at 562 (Noonan, J., dissenting). In construing § 362(d)(1), the
Court reviewed the similar language of § 506(a), concluding that
"the creditor's "interest in property' [in § 506(a) ] obviously
means his security interest without taking account of his right to
immediate possession of the collateral on default." 484 U.S. at
372. Thus, the interest being protected by § 506(a) "is merely a
security interest, which is a right to have the collateral applied
in satisfaction of a debt, not a right to immediate possession of
the collateral." Green, 151 B.R. at 505.
Thus, retail value is the proper measurement for purposes of
determining an undersecured creditor's allowed amount of a secured
claim under § 506(a). Both wholesale valuation and techniques that
average wholesale and retail values, see, e.g., In re Carlan, 157
B.R. 324 (Bankr.S.D.Tex.1993), undercompensate the secured creditor
and provide an invalid windfall to the debtor.
Finally, it is argued that profit should be eliminated from
calculations of the value of the creditor's lien. See In re
Miller, 4 B.R. 392 (Bankr.S.D.Cal.1980). This is incorrect, as
what is deemed "profit" is actually the opportunity cost of keeping
ACC's money tied up in Rash's loan and the normal return on
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capital, without which the loan will not be made. See Zywicki,
supra, at 261-62.
III.
The bankruptcy and district courts erred as a matter of law by
using wholesale instead of retail value to calculate the secured
portion of ACC's claim. Thus, we REVERSE the district court's
confirmation of the plan and REMAND for recalculation of the
allowed amount of ACC's secured claim for purposes of the plan.
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