Ninth Circuit Confirms Replacement-Value Not “Foreclosure Value” Is the Proper Standard When a Chapter 11 or 13 Debtor Opts for a Cram Down

In In re Sunnyslope Hous. Ltd. P’ship, 859 F.3d 637, 640 (9th Cir. 2017), as amended (June 23, 2017), the creditor held a lien on property which pursuant to certain covenants in debtor’s loan agreements was required to be used as low income housing. The requirement that the property be used for low income housing ceased if the property fell into foreclosure. At some point, the debtor defaulted triggering a foreclosure. The debtor then filed a Chapter 11 bankruptcy seeking to “cram down” the property pursuant to 11 U.S.C. § 506(a). The debtor’s proposed plan valued the property according to the property’s actual use, low income housing. The creditor argued the property should be valued according to the foreclosed value, which excluded the requirement that the property be used for low income housing; thereby, significantly increasing the property’s value.

The bankruptcy court agreed with the debtor’s valuation and confirmed the plan. After several appeals, the case finally made its way to the Ninth Circuit. The Court addressed how a property should be valued in a Chapter 11 cram down. The Court was guided by the Supreme Court’s decision in Associates Commercial Corp. v. Rash, 520 U.S. 953, 117 S. Ct. 1879 (1997), which held that value under § 506(a)(1) is “the cost the debtor would incur to obtain a like asset for the same ‘proposed …use.’” Therefore, the Court determined the “actual use” is the proper guide and the  Thus , in a chapter 11 or 13 cram down, the value of the claim is “determined in light of the purpose of the valuation and of the proposed disposition or use of such property”, which means determined based on the property replacement value. Accordingly, the hypothetical foreclosure value  sought by the creditor was irrelevant because in bankruptcy the creditor is not foreclosing .

Because the determination of the property’s replacement value is a determination of fact, the Court reviewed the bankruptcy court’s valuation of the property for clear error. The Court found that as the property’s actual use in this case was low income housing, the proper value was the amount a buyer would pay for a low income housing property. The Court was not swayed by Creditor’s argument that this case was different from In re Rash because in this case the foreclosure value was higher than the actual use value. The Court stated that the Supreme Court in In re Rash recognized that the foreclosure value may be higher than the actual use value at times and still chose to adopt the replacement value standard rather than the highest value standard. Therefore, the Court held the bankruptcy court did not err in valuing the property as low income housing.