Bankruptcy
Scratching the Surface of RASH
Submitted by Paul D. Post
- I. Clinical History
- II. Diagnosis of the Condition
- III. Prognosis, Prophylaxis, and Prescriptions
- IV. Rash: Preventing Further Outbreaks.
The Supreme Court's 1997 decision in Associates Commercial Corporation v. Rash, ("Rash"), U.S. , 117 S.Ct. 1879, 138 L.Ed. 3d 148, was decided on June 16, 1997. In that case, the Supreme Court reversed the decision of the U.S. Court of Appeals for the 5th Circuit, and held that a Chapter 13 debtor who wishes to retain the collateral and "cram down" the secured claim, must value the collateral based on its "replacement value" rather than its "foreclosure sale value" or some mid-point value. The decision was an 8-1 opinion written by Justice Ginsberg, with Justice Stevens dissenting. The court's analysis focused on the meaning of the wording of Sec. 506(a), of the Code. Since, as Justice Stevens noted in his dissent, Sec. 506 is a "utility" section applicable to all chapters, the Rash decision appears to set forth a general rule for valuing secured claims in all cases.
Itching to get below the skin of the Rash decision, a number of commentaries and law review articles have since appeared. These commentaries have attempted to parse the Rash decision to determine the court's meaning of the phrase "replacement value." Recent lower court decisions overall have not been particularly helpful in relieving the swelling and redness of Rash, although some have been more successful in resolving the condition than others. For example, a recent decision from the U.S. Bankruptcy Court for the Southern District of Texas, Houston Division (recalling that Rash is a case interpreting Texas law), stated that "the proper measurement of the value to debtors of retaining and using the vehicle . . .is the average retail value of the vehicle," citing Rash.
I. Clinical History
Rash developed as a result of a conflict among the Circuit Courts in interpreting the valuation standard to be applied under 11 U.S.C. Section 506(a), in "cram down" situations in the Chapter 13 context, and specifically, under 11 U.S.C. 1325(a)(5). That section allows a chapter 13 debtor three options with respect to treatment of secured creditors. First, the secured creditor may accept the plan and the proposed treatment thereunder. Second, the debtor may simply surrender the secured property to the creditor. Lastly, the debtor may invoke the so called "cram down" provisions, by retaining the property, and paying the creditor during the course of the plan the value of the allowed amount of the secured claim. It is at this point that Sec. 506(a) comes into play. That section generally establishes that a secured creditor is secured only to the extent of the value of the creditor's interest in the collateral, with the remaining amount being an unsecured claim. The focus of the Rash decision insofar as Sec. 506 is concerned is the meaning of the phrase "value of such creditor's interest in the estate's interest in such property." As the court noted in Rash, that sentence simply defines what property is to be valued, but does not supply directions on how that interest is to be valued.
The facts of Rash are not complicated. In 1989, Elray Rash purchased for $73,700.00 a Kenworth tractor truck for use in his freight hauling business. He made a down payment on the truck, and agreed to pay the seller the remainder in sixty monthly installments, pledging the truck as collateral on the unpaid balance. The seller thereafter assigned the loan and the lien on the truck to Associates Commercial Corporation (ACC). In March, 1992, Elray and Jean Rash filed a joint petition and a repayment plan under Chapter 13 of the Bankruptcy Code. At the time of the filing, the balance owed to ACC on the truck loan was $41,171.00. Because it held a valid lien on the truck, ACC was listed in the bankruptcy petition as a creditor holding a secured claim. However the Rashes' chapter 13 plan invoked the cram down power of 1325(a)(5). The plan proposed that the Rashes retain the truck for use in the freight hauling business and pay ACC, over fifty-eight months, an amount equal to the present value of the truck. That value the petition and the plan alleged, was $28,500.00. ACC objected to the plan and asked the Bankruptcy Court to lift the automatic stay, so ACC could repossess the truck. ACC also filed a proof of claim alleging that its claim was fully secured in the amount of $41,171.00. The debtors filed an objection to ACC's claim.
The Bankruptcy Court held an evidentiary hearing to resolve the dispute over the truck's value. At the hearing, ACC and the Rashes urged different valuation benchmarks. ACC maintained that the proper valuation was the price the Rashes would have to pay to purchase a like vehicle, which ACC's expert estimated to be $41,000.00. The Rashes, in contrast, maintained that the proper valuation was the net amount ACC would realize upon foreclosure and sale of the collateral, an amount their expert estimated to be $31,875.00. The Bankruptcy Court agreed with the Rashes, and fixed the amount owed ACC's secured claim at $31,875.00. The court thereafter approved the plan, and the U.S. District Court for the Eastern District of Texas affirmed.
A panel of the Court of Appeals for the Fifth Circuit reversed. In re: Rash, 31 F.3d 325 (1994). On rehearing en banc, however, the Fifth Circuit affirmed the District Court, holding that ACC's allowed secured claim was limited to $31,875.00, the net foreclosure value of the truck. In re: Rash, 90 F. 3d 1036 (1996). In reaching this decision, the Fifth Circuit highlighted a conflict it perceived between the method of valuation which ACC advanced, and the law of Texas defining the rights of secured creditors. In that court's view, valuing collateral in a federal bankruptcy proceeding under a replacement value standard--an amount generally higher than what a secured creditor would realize under Texas law--would "change the extent to which ACC is secured from what obtained under state law prior to the bankruptcy filing." 90 F.3d at 1041. The Fifth Circuit then determined that the Code provision governing valuation of security interests, 11 U.S.C. 506(a), does not compel a replacement value approach, but rather, required that collateral be valued from the creditor's perspective. The court defined this interest as "the right to repossess and sell the collateral and nothing more." This "foreclosure value" standard, the Fifth Circuit found, was consistent with the other relevant provisions of the Code, economic analysis, and legislative history of the pertinent provisions.
The Supreme Court granted certiorari because the Circuit Courts had adopted three different standards for valuing security interests in a bankruptcy proceeding when a debtor invokes the cram down power to retain collateral over a creditor's objection. In contrast to the Fifth Circuit's foreclosure value standard, a number of Circuits followed a replacement value approach. See In re: Taffi 96 F. 3d 1190 (CA 9 1996); In re: Winthropt Old Farm Nurseries Inc., 50 F. 3d 72 (CA 1 1995); In re: Trimble, 50 F. 3d 530 (CA 1995). Other courts had settled on the mid-point between foreclosure value and replacement value. See In re: Hoskins, 102 F. 3d 311 (CA 7 1996); In re: Valente, 105 F. 3d 55 (CA 2 1997). The third position was that adopted by the Fifth Circuit in Rash, which was the foreclosure value standard. The Supreme Court decision in Rash resolves these differences.
The Court began its analysis by looking at the meaning of value under Sec. 506(a). The court focused on the specific language in that section, which mandated that value "shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property." The Supreme Court stated that by applying a foreclosure value standard, the Fifth Circuit rendered inconsequential the "proposed disposition or use" phrase of that sentence. The court's logic was that if there were two alternatives for a debtor under Sec. 1325, one of which being surrender of the collateral, then the second alternative must be something different than return of the collateral. Yet, application of the foreclosure value standard allowed the debtor to keep the property yet adopt the same value as the creditor would obtain upon surrender and foreclosure. It permitted the debtor to keep the collateral and use it during the life of the plan, which could be for a period of up to five years. Applying this logic, the Supreme Court held that something more than the foreclosure value standard had to apply in cram down situations.
The standard which the court adopted in Rash was the "replacement value" standard. As the court noted, "from the creditor's prospective as well as the debtor's, surrender and retention are not equivalent acts." According to the court, the reason for this is that when a debtor surrenders the property, a creditor obtains it immediately, and is free to sell it and reinvest the proceeds. However, if the debtor keeps the property and continues to use it, the creditor obtains at once neither the property nor its value, and is exposed to double risks: the debtor may again default and the property may deteriorate from extended use.
The court in Rash held that "the replacement value standard accurately gauges the debtor's â ¬Üuse' of the property." The Rashes had elected to use the collateral to generate an income stream. That actual use, rather than a foreclosure sale which would not take place, is the proper guide for valuation in applying the "disposition or use" standard of Sec. 506(a).
The court in Rash also rejected the "mid-point" formula using the median between foreclosure and replacement values. In doing so, the court stated that the Code requires a creditor receive the value which property possess in light of the "disposition or use" proposed by the debtor, and not various or hypothetical dispositions or uses that might be proposed.
Footnotes to the Rash decision contain, perhaps, more insight than the decision itself. For example, footnote 2 states that by using the term "replacement value," the court was not suggesting that a creditor is entitled to recover what it would cost the debtor to replace the collateral brand new. The court stated that the term was consistent with the Ninth's Circuit understanding of the meaning of fair market value. Further, replacement value meant "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." Footnote 6 is even more enlightening. It is as follows:
Our recognition that the replacement value standard, not the foreclosure standard, governs in cram down cases allows the Bankruptcy Courts, as triers of fact, identification of the best way of ascertaining replacement value on the basis of the evidence presented. 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 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 the vehicle, items such as warranties, inventory storage, and reconditioning. Nor should the creditor gain from modifications to the property--e.g., the addition of accessories to the vehicle--to which a creditor's lien would not extend under state law.
II. Diagnosis of the Condition
As previously noted, at least one Bankruptcy Court has stated that the replacement value formula of Rash is fair market value. In re: Juhasz, supra. In contrast, Judge Pusateri, in a recent Chapter 13 decision, applied Rash standards to valuation of a vehicle, with a different result. See In re: Griffin, Case No. 97-40682-13. In that case, the debtors has purchased a 1996 Chevrolet pickup truck which they had financed through GMAC. The purchase price was $19,074.00, which included a credit life insurance contract costing $640.74. Approximately nine months after purchasing the vehicle, the debtors filed Chapter 13 bankruptcy.
In their Chapter 13 schedules, the debtors listed the fair market value of the vehicle at $16,450.00. GMAC filed a proof of claim indicating that the fair market value of the truck was $19,415.74. The debtors, prior to confirmation, modified their plan to increase the value to $17,500.00. Appraisals were submitted by the debtors as well as GMAC, with the debtors' appraiser valuing the truck at $17,500.00, and GMAC's appraiser stating the value to be $20,468.50 (obviously more than the debtors had paid for the vehicle when new).
The court analyzed the facts of this case under the mandate of Rash. It found that the debtors did not use the vehicle for business purposes, but merely as a means of conveyance. The court stated that "this indicates the ordinary vehicle market should be the starting place for determining the value of the truck." The court found the evidence presented by the parties' appraisers to be "less than satisfactory," but was obviously incredulous of GMAC's request for finding that the truck had actually appreciated in value since purchase. The decision also noted that debtors' appraiser had offered no explanation as to his conclusions concerning value. The court concluded from all of this that the debtors had apparently been able to buy the vehicle at substantial discount from the going retail price, which to the court indicated that they would not be willing buyers at the current full retail price but would expect to obtain another discount. The court also deducted the costs of the credit life insurance policy. It concluded that the replacement value of this particular vehicle was $18,500.00.
A search of the database of Kansas decisions disclosed no other opinions interpreting Rash.
III. Prognosis, Prophylaxis, and Prescriptions
What course of treatment might the practitioner utilize to relieve the discomfort caused by Rash? The opinion, itself, suggests several. Any treatment regimen should recall that the court's decision in Rash specifically stated that the definition of "replacement value" was not the equivalent of "brand new."
From the prospective of debtor's counsel, the first inquiry would probably be whether the collateral is being used in any business as a means producing income, or whether the property is merely for personal use. Like as not, most of these cases are going to involve vehicles, but the same standards might well apply to other personal property. The Rash decision suggests that property retained for a business purpose might have a different replacement value than that being used in a non-business setting. Although the decision does not explain why this is so, common sense would dictate that it must be true. A vehicle used in a business would probably be more "utilitarian" than one desired for personal use - - a business purchaser is not seeking the same "amenities" or "features" which the purchaser for personal use desires. Furthermore, the market for business vehicles or equipment may be devoid of such overhead expenses as advertising, high sales commissions, and other similar components of the retail sector. Of course, the opposite argument could be made, to the effect that the mass marketing used to sell vehicles to consumers for personal use actually increases competition and drives down the price.
The Rash decision makes clear that the Bankruptcy Court, as the trier of fact, has wide latitude in determining what is "replacement value" in a given case. In other words, the analysis is essentially fact specific, and must be made on a case-by-case basis. In fashioning discovery questions to determine what is the actual replacement value in any given case, the practitioner will want to carefully consider those factors which the Supreme Court has stated are not included within the definition of replacement value, which include warranties, reconditioning charges, and inventory storage. By using the same reasoning, it would appear that other "overhead" costs or expenses, such as retail sales costs, commissions to salespersons, and advertising or marketing costs are not elements of replacement value. Through discovery, counsel should inquire as to the cost of maintaining and insuring a car lot annually, and then dividing that number by the number of units sold on a yearly basis. Counsel should also inquire as to the average costs of reconditioning a used automobile prior to sale at retail. Questions should be asked concerning the average commission paid to salespersons. Discovery should include the total costs of advertising in a given period, divided by the number of units sold during the period. Questions should be asked as to how many units are sold at "sticker price," or discounted and sold at a lesser price. Counsel should search recent newspaper ads to determine what similar vehicles are selling for in the local market. This information could then be presented to the creditor in the form of requests for admissions concerning the sales information disclosed by these ads.
Most likely, the creditor will be a bank or finance company, rather than a dealer, and the answer to such discovery may be that such information is not available to the creditor. Nevertheless, this information should be available from the dealer where the sale originated, using appropriate discovery tools which are available, for example, a deposition of the dealership's sales manager or a records subpoena to the dealership pertaining to the transaction in question and other similar transactions. On the other hand, if the finance company is one of the loan companies affiliated with automobile manufacturers (GMAC, Ford Credit, or Chrysler Credit), then such objections to proposed discovery may not wash, since these entities undoubtedly have close ties with their parent manufacturing companies.
Although questions such as vehicle mileage, optional equipment, and general condition of the vehicle may be somewhat less important information than under previous value standards, such information should still be gathered and presented to the court. Expert appraisers should focus less on retail value, wholesale value or "blue book" value, since this information is not particularly helpful to a replacement value inquiry. That is not to say that the appraiser should ignore this information, and certainly, it should be included in any thorough appraisal. However, the appraiser should be instructed to focus on what the cost would be to the debtor to obtain a like vehicle in similar condition under current market conditions. The expert should address whether discounts of the "sticker price" are routinely made to purchasers in the local market, and whether the debtor, with his or her current and past credit history, could expect to realize such discounts when entering that market. If differences in pricing exists in the local market between sales to consumers as compared to business purchasers, that line of inquiry should be explored. The expert's report should answer questions concerning the average costs of reconditioning, usual and customary overhead costs including inventory storage, fleet insurance, and similar matters, and the usual sales commissions charged by dealers in the local area. All of this information will be helpful to the court in ultimately deciding the issue of reasonable value.
IV. Rash: Preventing Further Outbreaks.
The former methodology used by debtors, creditors, and the courts in valuing vehicles and other personal property is out the window following Rash. "Splitting the difference" between wholesale and retail is specifically disapproved by the decision. Reliance on "blue book" or other values may only be the starting point for vehicle valuation. Practitioners will be required to fully understand the system in place for selling new and used cars or other personal property in order to develop and present the evidence necessary for courts to correctly assess a vehicle's replacement value.