News
Associates v. Rash
On Monday, June 16, 1997, a decision was handed down by the United States Supreme Court which will have monumental implications on the rights of secured creditors in Chapter 13 Bankruptcy cases.
In Associates Commercial Corporation v. Elray Rash, et ux., 1997 U.S. LEXIS 3688, the Supreme Court held that when the Debtor in a Chapter 13 proposes to “cram down” the secured interest of a creditor to equal the value of the collateral, 11 U.S.C. SS506(a) requires Bankruptcy courts to use the “replacement value” standard, rather than the “foreclosure value” standard. [1]
Facts
In 1989, Elray Rash purchased for $73,700 a Kenworth Tractor Trailer for use in his freight-hauling business. Rash made a down payment and executed a note and security agreement to pay the balance of the purchase price in 60 monthly installments. The seller assigned the loan and security interest to Associates.
In March, 1992, Mr. and Mrs. Elray filed a joint Chapter 13 petition. At the time of the filing, the balance on the loan was $41,171. The debtors, however, filed a Plan attempting to cram down the truck’s value at $28,500. At the evidentiary hearing to resolve the valuation dispute, the Bankruptcy Court decided that the proper valuation was the net amount Associates would have received at foreclosure, which the debtors’ expert estimated to be $31,875.
On appeal, the U.S. District for the Eastern District of Texas affirmed, as did the Fifth Circuit, sitting en banc.
Split in the Circuits
Courts of Appeals have utilized three different standards for valuing a security interest when the debtor proposes a cram down:
1. Replacement value (1st, 8th, 9th Circuits): the price a willing buyer in the Debtor’s trade, business, or situation would pay a willing seller to obtain property of like age and condition.
2. Foreclosure value (5th Circuit): what the creditor could realize if it sold the estate’s interest in the property according to the security agreement, by repossessing and selling the collateral.
3. Hybrid approach (2nd, 7th Circuits): the midpoint between replacement value and foreclosure value.
The United States Supreme Court set out to resolve the split in the circuits.
The Decision
The Supreme Court held the value of the secured property in a Chapter 13 cram down case would be determined by the replacement value. This decision was based on a strict reading of SS506(a), which states that the “value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property … ” (emphasis added).
The bankrupt debtor has two choices: either surrender (“dispose”) or retain (“use”) the collateral. If the debtor surrenders or disposes of the collateral, the secured creditor will regain possession of collateral, with foreclosure value. On the other hand, if the debtor chooses to retain or use the collateral, it must provide for more than foreclosure value, otherwise the statute would not have provided for both methods. The Court also reasoned that replacement value would compensate the creditor for the increased risk undertaken when the bankrupt retains the collateral, because the debtor may default on payments again after the property has deteriorated from additional use.
Implications
This decision obviously can increase the value of a creditor’s collateral in future cram down cases. It should also influence the way creditors approach a Chapter 13 Bankruptcy in general, and defend a cram down in particular. For example, an automobile appraisal should specify the replacement value, or what it would cost the debtor to purchase an automobile of similar age and condition. This value, also referred to as the “retail” value, may need adjusted to reflect the value of items the debtor does not receive when it retains the vehicle, such as a warranty. Overall, however, the case is favorable and demonstrates the Court’s recognition of creditors’ rights in Bankruptcy.
The full impact of the decision will not be felt until lower Courts begin to interpret Rash and distinguish or follow it, but this initial review does give us some guidance on how we might utilize it to assist our clients.
[1] Please note that 11 U.S.C. SS1322(b)(2) prevents the Debtor from modifying a claim secured only by real property that is the Debtor’s principal residence, so this claim has no applicability to this situation.
