First Southern National Bank v. Sunnyslope Housing Ltd. Partnership
859 F.3d 637 (2017)
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Rule of Law:
Under 11 U.S.C. § 506(a)(1), the value of a secured creditor's collateral in a Chapter 11 cram-down reorganization must be determined by its replacement value, which is based on the debtor's proposed use of the property in the reorganization plan, not a hypothetical higher value achievable through a foreclosure that the plan is designed to prevent.
Facts:
- Sunnyslope Housing Limited Partnership owned an apartment complex in Phoenix, Arizona.
- To obtain financing and tax benefits, Sunnyslope entered into several agreements that restricted the property's use to low-income housing.
- These restrictive covenants ran with the land but were structured to terminate upon foreclosure of the primary loan.
- In 2009, Sunnyslope defaulted on its primary loan, which was guaranteed by the United States Department of Housing and Urban Development (HUD).
- HUD took over the loan, released its own regulatory agreement, and sold the loan at a significant discount to First Southern National Bank.
- The loan sale agreement specified that the property remained subject to the other low-income housing covenants.
- First Southern National Bank initiated foreclosure proceedings against the property.
Procedural Posture:
- Sunnyslope filed a Chapter 11 bankruptcy petition.
- The bankruptcy court confirmed Sunnyslope's reorganization plan, which included a cram-down, and valued First Southern's collateral at $2.6 million based on its continued use as low-income housing.
- First Southern, as appellant, appealed to the U.S. District Court.
- The district court affirmed the valuation method but remanded for the bankruptcy court to include the value of tax credits.
- On remand, the bankruptcy court valued the collateral at $3.9 million (including tax credits) and re-confirmed the plan.
- The district court affirmed the re-confirmed plan.
- First Southern, as appellant, appealed to the U.S. Court of Appeals for the Ninth Circuit, and Sunnyslope, as appellee, cross-appealed.
- A divided three-judge panel of the Ninth Circuit reversed, holding the collateral should be valued without the low-income restrictions.
- The Ninth Circuit then voted to grant a rehearing en banc, which vacated the panel's opinion.
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Issue:
Does 11 U.S.C. § 506(a)(1) require a bankruptcy court, in a Chapter 11 cram-down, to value a secured creditor's collateral based on the debtor's proposed continued use of the property, even when a hypothetical foreclosure sale would extinguish use restrictions and result in a higher valuation?
Opinions:
Majority - Hurwitz, Circuit Judge
Yes. In a Chapter 11 cram-down, the collateral's value must be determined based on its replacement value according to the debtor's proposed use in the reorganization plan. The Supreme Court's decision in Associates Commercial Corp. v. Rash established that the 'replacement-value standard,' not a hypothetical foreclosure value, governs cram-down valuations under § 506(a)(1). The statute explicitly directs courts to determine value 'in light of the... proposed disposition or use of such property.' Because the reorganization plan's purpose is to avoid foreclosure and continue operations, the valuation must reflect this reality. Sunnyslope's proposed use is to continue operating the property as low-income housing, and its value must therefore be calculated with the associated use restrictions in place. The fact that foreclosure value is atypically higher than replacement value in this case does not change the governing standard established by Rash.
Dissenting - Kozinski, Circuit Judge
No. The collateral's value should be the market price of the building without the restrictive covenants. The majority's holding misinterprets the logic of Rash, which adopted the replacement-value standard to protect secured creditors from the 'double risks' of cram-downs, not to benefit the debtor at the creditor's expense. Rash intended to use the typically higher replacement value to ensure creditors are adequately protected, and this court's decision does the opposite by locking in a much lower value. The Supreme Court provided flexibility in defining 'replacement value,' and it should not be rigidly tied to the debtor's 'particular use' when it leads to an outcome contrary to the purpose of the Rash decision. The valuation should reflect the property's market value, not the debtor's idiosyncratic and less valuable use.
Analysis:
This decision reaffirms and clarifies the application of the Supreme Court's Rash precedent, holding that the 'proposed disposition or use' standard for collateral valuation must be strictly followed even in the unusual circumstance where it yields a lower value than a hypothetical foreclosure. The ruling solidifies the debtor's power to define the terms of valuation through its reorganization plan, potentially disadvantaging secured creditors whose collateral is subject to use restrictions that would be extinguished upon foreclosure. This may influence future lending decisions for projects with similar covenants, such as affordable housing or environmentally restricted properties, as lenders must account for the risk of a lower bankruptcy valuation. The case underscores that bankruptcy proceedings are fundamentally about reorganization and avoiding liquidation, and legal principles like valuation must reflect that core purpose.
