Daily Development for
Monday, November 11, 1996

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

These two cases were submitted by Jonathan Rivin of San Francisco. They both deal with valuation problems in bankruptcy and appear to make new law in the Ninth Circuit.

BANKRUPTCY; REORGANIZATION; CONFIRMATION OF PLAN; "INDUBITABLE EQUIVALENT": Ninth Circuit tough on debtor's proposal in reorganization plan to transfer to creditor "dirt for debt:" part of original security in exchange for discharge of mortgage claim.

Arnold & Baker Farms v. United States, 85 F.3d 1415 (9th Cir. 1996).

Where a creditor of a Chapter 11 debtor is owed funds secured by land, and the proposed plan of reorganization exchanges a portion of the collateral for full and final satisfaction of the claim, the plan must be found to be "fair and equitable." Under the Bankruptcy Code, one manner of satisfying the "fair and equitable" standard is for the creditor to realize the "indubitable equivalent" of its secured claim. The debtor in this case proposed to transfer less than half the secured acreage to the creditor in satisfaction of its claim, based on a valuation of the property that was much higher than the valuation obtained at the time the lien was secured and almost seven times higher than the value claimed for the land by the secured creditor.

The court concluded the plan unfairly increased the creditor's risk of less than full recovery. The debtor and creditor had bargained that the creditor could foreclose on the entire acreage if the debtor defaulted. Thus, the principal was protected to the extent of the parcel held as security. The proposed plan shifted the burden of sale and the risk of loss as well as the potential for gain from the debtor to the secured creditor. Although the court did not hold that the indubitable equivalent standard can never be met by a "dirt-for-debt" plan that provides a creditor with less than all the collateral it originally bargained for, this case shows that such plans will be subject to close scrutiny.

Comment: Lender's lawyers must marvel at the increasing number of bankruptcy opinions favorable to real estate secured creditors. Bankruptcy judges seem to be simply "out of patience" with the wheels and deals of real estate debtors.

BANKRUPTCY; REORGANIZATION; VALUATION: When fair market value of a Chapter 11 debtor's residence is used for determining the amount of a secured claim, and the debtor keeps possession of the residence, that value is based on the "willing buyer- willing seller" standard and not what the creditor would obtain if it were to make a reasonable disposition of the collateral.

In re Taffi, 96 C.D.O.S. 7079 (9th Cir., 1996).

In October 1995, a divided panel of the Court of Appeals held that fair market value, rather than forced sale value, of a bankruptcy debtor's residence should be used in determining the amount of a secured claim in a Chapter 11 case when the debtor keeps possession of the residence, and that hypothetical costs of sale are not to be subtracted from the valuation of the residence when determining the amount of the secured claim.

The Court of Appeals then took the case en banc, overruling its prior decision to the extent that it held that the value should be based on the amount the creditor would obtain if it were to make a reasonable disposition of the collateral. The court noted that valuation should take into consideration the actual situation presented. Here, the key fact that the debtors were going to remain in possession of the house controlled the valuation. Foreclosure value was not appropriate, as there was no foreclosure. Replacement value was not appropriate because the house was not being replaced. Instead, the fair market value is the price which a willing seller under no compulsion to sell and a willing buyer under no compulsion to buy would agree upon after the property has been exposed to the market for a reasonable time. The court further noted that in reaching this result, the Ninth Circuit is put into harmony with all other circuits except the Fifth that have considered the question.

Comment: This is one of the few circumstances in which a homeowner would prefer that the property be valued at a lower amount.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last five years, these Reports annually have been collated, updated, indexed and bound into the Annual Survey of Developments in Real Estate Law, volumes 1-5, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Laprica Mims at the ABA. (312) 988 6233 or LaPricaMims@staff.abanet.org

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