Why secured claims matter Because they get paid first!! Out of the value of their “collateral”
Problem 6.1 Assets: $80K home / subject to 2 mortgages (One $70K, Two 15K) / exemption claim of $15K $10K Pontiac / subject to security interest (GMAC $7K) / exemption claim of $3K $5K Volvo $15K household goods & furnishings / subject to exemption claim $15K $15K bank account Debts: $70K Bank One (secured by 1 st mortgage on home) $15K Bank Two (secured by 2 nd mortgage on home) $7K GMAC (secured by security interest in Pontiac) $20K Bush $10K Gore $5K Bubba
Answer 6.1 1 st, secured claims & exemptions : House ($80K): 70K – Bank One 1 st mortgage 10K – Bank Two 2 nd mortgage Balance of $5k for Bank Two is unsecured $15K exemption claim worthless (consensual mortgages beat) Pontiac ($10K): 7K – GMAC security interest 3K - DR (exempt) Household goods & furnishings ($15K) 15K – all to Dr (exempt)
6.1, cont. 2 nd, Balance of estate divided pro rata among unsecured creditors Unencumbered, nonexempt assets (total $20K): $5K Volvo $15K bank account Unsecured creditors (total $40K) $5K Bank Two deficiency (15 -10) $20K Bush $10K Gore $5K Bubba Thus Trustee distributes $20K in assets to $40K unsec debts So each unsecured creditor gets 50% (1/2) on their claim
definition What is a “secured” claim? See 506(a)(1): Allowed claim of a creditor Either Secured by a lien on estate property Or subject to setoff under 553
3 questions 1. does a secured claim exist at all, and if so, to what extent? 2. what is the substantive entitlement of secured creditor? 3. by what procedural means enforce those substantive rights?
1 st Q: existence and extent 4 steps: 1. is the underlying claim “allowed”? 2. is there a valid lien or setoff right under nonbankruptcy law? 3. can bankruptcy trustee avoid the lien? (see chapter 9) 4. what is the value of the secured claim?
Allowed? Secured creditor must have its underlying claim “allowed” – by filing a proof of claim, as we discussed in ch. 5 – if it wants to get paid IN the bankruptcy case itself However, does not have to do so – can stand aloof from bankruptcy case, and lien, unless avoided, will ride through the bankruptcy case and be enforceable after bankruptcy against the collateral See Long v. Bullard, 117 U.S. 617 (1886)
Underlying law controls Bankruptcy law does not create secured claims Look to the underlying law (e.g., state law) to see whether the creditor has a “lien” or a “setoff” right Bankruptcy law then says how that secured claim will be enforced vis-à-vis everyone else
Different sorts of secured claims 1. “security interest” 101(51) All consensual liens, including Article 9 security interests and real estate mortgages 2. “judicial lien” 101(36) Execution liens, etc 3. “statutory lien” 101(53) Example = mechanics liens 4. right of “setoff” 553(a)
Avoiding powers? Trustee in bankruptcy might be able to “avoid” or set aside a lien Will discuss in chapter 9 Most common: 1. “strong-arm” clause, 544(a) If not perfected at time bankruptcy case filed 2. preference, 547 If got lien in 90 days before bankruptcy to secured a preexisting debt
How much is secured claim? 3 steps: 1. Estate’s interest in the collateral E.g., does the estate have the entire interest in the collateral, or does it perhaps share, for ex. as a joint tenant? 2. Secured creditor’s interest in the estate’s interest E.g., 1 st lien? 2 nd lien? 3. value of the collateral Will discuss in Part B. – Rash, 506(a)(1) & 506(a)(2), plus special rule in chapter 13
Problem 6.2(a) “allowed secured claim” Facts: Collateral value = $10K Creditor’s claim = $14K No other liens on collateral Answer: Secured = $10K (collateral value) Unsecured = $4k (deficiency) – see 506(a)(1)
6.2(c) Facts: Collateral value = $10K Debtor owned as tenant in common with sister Creditor claim = $14K Answer: Secured = $5K (the extent of estate’s interest – ½ of 10) Unsecured = $9K
6.2(d) Facts: Collateral value = $20K Creditor’s claim = $14K, plus 10% per annum interest How much after one year in chapter 11? Answer: $15,400 secured $14K principal $1,400 postpetition interest under 506(b)
6.2(e) Facts: Same facts as (d) (e.g., collateral = $20K, creditor principal claim at date of bankruptcy = $14k, plan confirmation one year into case) Except instead of consensual interest, the 10% interest rate is based on a state statutory judgment rate Answer: Same as (d) -- $15,400 -- $14K principal + $1,400 postpetition interest under 506(b) since oversecured Supreme Court so held in Ron Pair
6.2(f) Facts: Collateral value = $15k Creditor claim petition date = $14k 10% interest One year in chapter 11 – how much is secured claim? Answer: $15K $14K principal $1K postpetition interest – up to the collateral value, 506(b), but then disallow postpet. interest 502(b)(2)
6.2(g) Facts: Dr -> Cr $14K on loan Cr -> Dr $10K in checking account Answer: Secured = $10K – amount subject to setoff right (the balance in checking account) In effect the Cr can treat the checking account balance as “collateral” Unsecured = $4K
Substantive entitlement A holder of an allowed secured claim is entitled to receive in bankruptcy the value of their collateral interest This is both as a matter of constitutional law and bankruptcy policy Was tested in a series of Depression-era cases
Procedural means? Holder of an allowed secured claim is NOT, however, entitled to insist in bankruptcy on being able to capture their substantive entitlement via the same procedural means they’d be able to use outside of bankruptcy May be blocked from doing the repo / foreclosure game Because the estate’s interest may dictate otherwise As long as we can preserve the secured creditor’s substantive right to the value of its collateral interest
“adequate protection” Essence of the bankruptcy mechanism for implementing the secured creditor’s substantive rights is via the concept of adequate protection Basic idea is to preserve the secured cr’s value during the pendency of the bankruptcy case Will discuss in more detail in chapter 7 Adequate protection described in 361 Utilized in numerous sections (362(d)(1), stay relief; 363(e), use of property; 364(d), postpetition credit)
Ways secured creditor might get paid 1. Relief from stay, 362(d), go ahead with foreclosure 2. collateral abandoned to sec cr, 554(a) 3. collateral sold by Trustee, 363, proceeds paid sec cr 4. paid under reorg plan – lump sum or over time 5. agrees to reaffirmation, 524(c), Dr keeps collateral and pays sec cr over time 6. indiv dr redeems collateral, 722 – pays off in lump sum – only available for consumer personal property 7. trustee returns collateral to sec cr, 725, also reorgs
“debtor’s choice” – Problem 6.3 Facts: Dr bought Pontiac Grand Am, $16K loan Creditor, sec int May 1, 2006 Dr files ch 7 Owes $8K principal Dr not in default on payments Car has value $10K Loan agreement: (1) bk filing = default; (2) acceleration on default Dr files “statement of intention” (521(a)(2)(A)) – keep car, stay current – but NOT redeem or reaffirm –can Dr do that?
6.3(a) Dr claims her entire interest in Car as exempt. Now what? 1 st – Estate has no interest any more – entire value of car is either subject to secured claim or is exempt So the trustee won’t administer (likely will abandon) – just a matter as between the Dr and the Cr
6.3(a), cont. Dr vs Cr – does Dr have option to neither redeem nor reaffirm, and just keep making payments? This unlisted “option” was called “ride through” or “reinstatement” Note that if Dr can do this, she has the power to convert Cr’s loan into a non-recourse loan, b/c the underlying personal liability of Dr will be discharged Only the Cr’s right against the collateral survives bk But if ends up with deficiency claim post-bk, too bad! Prior to 2005, courts were evenly divided
2005 amendments In 2005, Congress amended several sections to try to make clear that Dr did NOT have the option to just remain current – either had to redeem, reaffirm, or surrender the collateral to sec cr See: 521(a)(2) – (A) must file stmt intention w/in 30 days, if keeping must redeem or reaffirm, & (B) then perform intention within 30 days after 1 st meeting crs Also 521(a)(6) – 45 day period (after Cr meeting) if PMSI, stay terminates, property no longer in estate 362(h)(1) – stay terminates with regard to collateral if Dr doesn’t either (A) file stmt intention or (B) perform it 521(d) – validates bk default clauses if Dr not comply
Answer 6.3(a) Stay terminated 362(h)(1)(A) on May 31, when Dr did not file complying stmt intention under 521(a)(2)(A) After stay terminates, what rights does Cr have vs Dr? Dr argue – you still can’t foreclose under state law b/c I am not in default – making my payments Cr wins – points to bk default clause Even though usually such “ipso facto” clauses are invalidated in bk, in this particular situation they are allowed – 521(d) And once have a default, Cr may invoke acceleration clause Cr also might have an “insecurity” clause to declare default And would be “insecure” b/c Dr no longer has any personal liability, after gets bk discharge
Practical note Even though Cr now clearly has the right to insist on Dr redeeming or reaffirming, failing which Cr will get stay terminated and be able to foreclose, in the real world Cr might well be willing to keep taking Dr’s payments and let Dr keep the car, as long as the Dr stays current
6.3(b) Same facts, except Dr not claim as exempt What does this change? Now the bankruptcy estate DOES have an interest – the $2K in equity in the car (remember, car worth 10, Cr’s claim = 8) So estate doesn’t want Cr to just foreclose – may lose equity Now the Trustee can move (within the 30-day period) to keep the stay in effect, even though DR didn’t file complying stmt of intention – see 362(h)(2), 521(a)(6) Will have to provide adequate protection to Cr
6.3(c) Same facts, except now Dr DOES state intention to reaffirm & keep the car -- BUT Cr refuses to agree to reaffirmation Dueling statutes? 362(h)(1)(B): for Dr – says stay not terminate if Dr fails to perform intention b/c Cr refused to agree to reaffirm Vs 521(a)(6): for Cr? – says stay terminates, property not in estate “if the debtor fails to so act” and no exception for Dr’s failure to act b/c Cr wouldn’t agree to reaffirm
What if “Dr wins” controls? Under 6.3(c), even if say that 362(h)(1)(B) controls, so stay does not terminate, not clear where that leaves the parties as a practical matter For sure Cr is stayed from foreclosing (unless can persuade bk ct to lift the stay) But don’t have a reaffirmation either, b/c that requires the Cr to agree So is there de facto a “reinstatement” option? Who knows??
Value of collateral One of the most important issues on a bankruptcy case is to value collateral Sec cr’s basic substantive entitlement is to receive the value of their collateral In many instances the bk ct has to determine what that value is. Examples: Reorg case, Dr’s plan is to keep collateral, wants to “cram down” sec cr – how much pay? Ch. 7, Dr wants to “redeem” 722 – buying off collateral – how much?
506(a)(1) 1 st sentence: secured claim “to the extent of the value of such creditor’s interest” in the estate’s interest in the collateral 2 nd sentence: “such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property.”
Which sentence controls? Is the valuation decision controlled by: The 1 st sentence, which focuses on the creditor’s interest Or The 2 nd sentence, which focuses on the debtor’s proposed disposition or use? When would it make a difference?
Rash Drs (Elray & Jean Rash) had financed a tractor truck that Elray used in his business Filed chapter 13 Drs wanted to keep the truck Under 1325(a)(5)(B), can “cram down” (i.e., keep the truck even if cr doesn’t like it) the sec cr (Associates) if pay Cr the amount of the “allowed secured claim”, plus interest Replacement cost of similar truck = $41K Foreclosure value = $31K
1 st sentence? If focus on the Cr’s interest, argue should only have to pay the $31K foreclosure value Because that is all that the Cr itself could realize on the collateral If Dr chose instead simply to surrender the collateral to the Cr (another option, see 1325(a)(5)(C)), then indisputably there’s no way Cr could get more than $31K
2 nd sentence? But if focus instead on the 2 nd sentence, and say the “proposed disposition or use” is that the Drs will be keeping the collateral, then argue that they should have to pay replacement value, b/c the “use” is that they’re getting a truck And that would cost them $41K
“bilateral monopoly” or “chicken” Thus, we have a situation where the collateral is worth up to $41K to the Drs if they get to keep it, but only $31K to the Cr if they give it back “Bilateral monopoly”: Cr can make Dr pay up to $41K if Dr wants to keep it But Dr can stick Cr with just $31k if return it Like the old game of “chicken” Given the economic reality, pre-Rash the 7 th Circuit held (per Posner) that the midpoint was the correct value Makes sense given the bargaining dynamic
Rash holding 2 nd sentence rules: key is the proposed disposition or use – and where Drs plan to retain the collateral, they have to pay the replacement value
But “retention” ≠ “ purchasing ” BUT that does not mean, as it turns out, that the Rashes will necessarily have to pay the full $41K replacement value. Why not? The “proposed use” is that Drs retain the truck when Dr retains a truck, they are not getting the same value package as they would if they went out into the market and purchased a truck No warranties from seller Not reconditioned Not have to pay seller’s marketing costs
example assume a simple hypothetical: applying Rash, what is the “value” of a 2005 Honda Accord EX 4-door sedan with 40,000 miles in excellent condition, standardly configured? according to the reputable “Kelley Blue Book” website, this same car has three different possible “values”: (1) a “suggested retail value” of $17,485, see http://www.kbb.com/KBB/UsedCars/PricingReport/2005_ Honda_Accord_859_Retail_Excellent_Sedan.aspx?Mileage =40000&PriceTypePath=Private%20Party&SelectionHistor y=859|29356|61821|0|0| ; http://www.kbb.com/KBB/UsedCars/PricingReport/2005_ Honda_Accord_859_Retail_Excellent_Sedan.aspx?Mileage =40000&PriceTypePath=Private%20Party&SelectionHistor y=859|29356|61821|0|0| (2) a “private party value” of $15,050; and (3) a “trade-in” value of $13,105.
Example, cont. The NADA guide suggests a “clean retail” price of $17,300, and an average trade-in of $13,850. See http://www.nadaguides.com/usedcars.aspx?LI=1-21-1- 5013-0-0- 0&l=1&w=21&p=1&f=5014&m=1195&d=582&y=2005&c=1 6&vi=55630&da=-1&mi=40000 http://www.nadaguides.com/usedcars.aspx?LI=1-21-1- 5013-0-0- 0&l=1&w=21&p=1&f=5014&m=1195&d=582&y=2005&c=1 6&vi=55630&da=-1&mi=40000
Meaning of “retail” value? Kelley: “Suggested Retail Value assumes that the vehicle has been fully reconditioned and has a clean title history. This value also takes into account the dealers' profit, costs for advertising, sales commissions and other costs of doing business.” See http://www.kbb.com/KBB/PopUps/Definition.aspx?C ontentUniqueName=KBBWebContent- 61&ParentView=UsedCarsPricingReport&PriceType=R etail&VehicleClass=UsedCar http://www.kbb.com/KBB/PopUps/Definition.aspx?C ontentUniqueName=KBBWebContent- 61&ParentView=UsedCarsPricingReport&PriceType=R etail&VehicleClass=UsedCar
“private party value”? “Kelley Blue Book Private Party Value is the amount a buyer can expect to pay when buying a used car from a private party. The Private Party Value assumes the vehicle is sold "As Is" and carries no warranty (other than any remaining factory warranty). The final sale price may vary depending on the vehicle's actual condition and local market conditions. This value may also be used to derive Fair Market Value for insurance and vehicle donation purposes.” http://www.kbb.com/kbb/PopUps/Definition.aspx?Conten tUniqueName=KBBWebContent- 60&ParentView=UsedCarsPricingReport&PriceType=Privat e+Party&VehicleClass=UsedCar http://www.kbb.com/kbb/PopUps/Definition.aspx?Conten tUniqueName=KBBWebContent- 60&ParentView=UsedCarsPricingReport&PriceType=Privat e+Party&VehicleClass=UsedCar
Trade-in? “Kelley Blue Book Trade-In Value is the amount consumers can expect to receive from a dealer for a trade-in vehicle, assuming an accurate appraisal of the vehicle's condition, mileage and features. This value will likely be less than the Private Party Value because the reselling dealer incurs the cost of safety inspections, reconditioning and other costs of doing business.” http://www.kbb.com/kbb/PopUps/Definition.aspx?Conten tUniqueName=KBBWebContent- 59&ParentView=UsedCarsPricingReport&PriceType=Trade -In&VehicleClass=UsedCar http://www.kbb.com/kbb/PopUps/Definition.aspx?Conten tUniqueName=KBBWebContent- 59&ParentView=UsedCarsPricingReport&PriceType=Trade -In&VehicleClass=UsedCar
Rash footnote 6 SCOTUS recognized the reality that “replacement” value did not necessarily mean full retail value. In a critical footnote 6, the Court limited its holding: “…Whether replacement value is the equivalent of retail value, wholesale value, or some other value will depend on the type of debtor and the nature of the property. We note, however, that replacement value, in this context, should not include certain items. For example, where the proper measure of the replacement value of a vehicle is its retail value, an adjustment to that value may be necessary: A creditor should not receive portions of the retail price, if any, that reflect the value of items the debtor does not receive when he retains his vehicle, items such as warranties, inventory storage, and reconditioning.” (emphasis added)
Applying footnote 6? If consider footnote 6 in conjunction with the different explanations in KBB, recognize that a Dr who is simply retaining collateral (like the Rashes) would NOT pay the “retail value,” nor would they pay “trade-in,” Looks like “private party value” might actually be pretty close Real world: post-Rash, courts (and parties in their agreements), just split the difference between retail and wholesale! So post-Rash cramdown would have had them pay $36K Just where Posner said it should And this reflects bargaining reality of “chicken” game
2005 amendments In BAPCPA, sec cr lobby got some amendments through partially overrule Rash footnote 6: 1. 506(a)(2) – apply if: personal property, Individual debtor Chapter 7 or chapter 13 2. valuation rule (1 st sentence 506(a)(2)): use replacement value, as of petition date, and no deductions for costs of sale or marketing Thus partially overrules footnote 6 But does NOT kick out other n. 6 deductions –e.g., warranties, reconditioning
2 nd sentence 506(a)(2) In addition, if not only a case involving (i) personal property, (ii) individual debtor, &(iii) chapter 7 or 13, but ALSO is consumer collateral (“acquired for personal, family, or household purposes”), have different (higher) valuation: “replacement value shall mean the price a retail merchant would charge for property of that kind, considering the age and condition of the property” i.e., now have FULL RETAIL, with no fn. 6 deductions
Summary of valuation standards 1. 2 nd sentence, 506(a)(2): full retail Individual Dr; personal property; ch 7/13; consumer purposes 2. 1 st sentence, 506(a)(2): replacement value, no deduction costs sale or marketing; e.g., retail minus warranties, reconditioning, storage costs Same as 2 nd sentence, except business, not personal, use 3. 506(a)(1) (Rash): replacement value, with all footnote 6 deductions Apply if have ANY of: corporate /pship Dr; chapter 11; real property
And special no strip down rule Finally, in chapter 13, if Dr buys a motor vehicle for her personal use within 910 days of bankruptcy and Cr has a PMSI, must pay the full amount of the debt i.e., no ‘strip down” at all
Problem 6.4 Facts: May 1, 2004 Dr buys Chevy Suburban for family use, finances with PMSI to Creditor May 1, 2006 Dr files chapter 7 Debt = $18K Foreclosure value = $12,000 Full retail price = $15,000 Costs of sale and marketing = $500 Warranties, reconditioning = $1,000
6.4(a) How much would Dr have to pay to redeem under 722? Apply 2 nd sentence 506(a)(2): Individual Dr Personal property Chapter 7 Property acquired for personal use So must pay full retail of $15,000, no deductions
6.4(e) Same facts as (a) (chapter 7 case, Dr wants to redeem), except bought for business use Now Dr can’t redeem under 722 at all – only if bought for personal, family, or household purposes
6.4(b) Same facts as (a), except Dr files chapter 13, and wants to retain the car Apply “hanging paragraph” following 1325(a)(5): Motor vehicle 910 days of bankruptcy (here, two years) PMSI Acquired for Dr’s personal use Dr must pay the full debt ($18,000) - says “506 shall not apply” – and that is where bifurcate undersecured claim
6.4(c) Same as (b), except Dr files chapter 13 December 1, 2006 (and remember purchased car May 1, 2004) So now hanging paragraph’s “no strip down” rule n/a, since > 910 days (= 944 days) So back to 2 nd sentence of 506(a)(2) So pay full retail value of $15K (note that Creditor will then have a $3K unsecured claim)
6.4(d) Same as (b) (e.g., chapter 13, filed two years after purchased) except purchased for use in business Again, hanging paragraph n/a, b/c only if personal use So, go to 506, and apply (a)(2) (individual dr, chapter 13, personal property) BUT not 2 nd sentence, b/c = business use Thus 1 st sentence 506(a)(2) applies Pay $14,000 – retail (15K), not deduct costs sale, but by inference CAN deduct $1,000 warranties & reconditioning
6.4(f) Same facts as (b), except Dr filed chapter 11 Now 506(a)(2) not apply, b/c must be a ch 7 or 13 case So back in 506(a)(1) and Rash, with note 6 What pay? Retail ($15,000) minus warranties & reconditioning ($1,000) and possibly minus costs of sale ($500) = $13,500 Which is exactly where we’d be if just split the difference between foreclosure and retail!