United States: Ninth Circuit Reverses Course On Measure Of Collateral Value In Cramdown Confirmation Of Chapter 11 Plan

Last Updated: October 4 2017
Article by Anna M. Wetzel

In First Southern Nat'l Bank v. Sunnyslope Hous. LP (In re Sunnyslope Hous. LP), 2017 BL 216965 (9th Cir. June 23, 2017), the U.S. Court of Appeals for the Ninth Circuit held en banc that, in determining whether a chapter 11 plan may be confirmed over the objection of a secured creditor, the creditor's collateral must be valued in accordance with the debtor's intended use of the property, even if the property would realize more in a foreclosure sale because of the existence of restrictive covenants. According to the Ninth Circuit, this conclusion was mandated by section 506(a)(1) of the Bankruptcy Code and U.S. Supreme Court precedent.

Valuing a Secured Creditor's Collateral in a Cramdown

Section 1129(b) of the Bankruptcy Code provides that a chapter 11 plan may alter the payment terms of an objecting secured lender's loan if, among other things, the plan's treatment of the dissenting secured creditor's claim is "fair and equitable." In such a "cramdown" confirmation, section 1129(b)(2) provides that "fair and equitable" means that: (i) the dissenting secured creditor retains the lien on its collateral and receives deferred payments totaling at least the allowed amount of its secured claim at an appropriate rate of interest; (ii) the collateral is sold and the creditor's lien attaches to the sale proceeds; or (iii) the creditor receives the "indubitable equivalent" of its secured claim.

The Bankruptcy Code does not mandate any specific method for valuing collateral. However, section 506(a)(1) provides that the value of collateral must be "determined in light of the purpose of the valuation and of the proposed disposition or use of such property." In Associates Commercial Corp. v. Rash, 520 U.S. 953 (1997), the U.S. Supreme Court held that, to confirm a chapter 13 plan over the objection of a dissenting secured creditor, section 506(a)(1) requires a "replacement value," rather than a "foreclosure value," standard.

Under a replacement value standard, the value of the collateral equals "the cost the debtor would incur to obtain a like asset for the same 'proposed . . . use.' " Id. at 965 (quoting section 506(a)(1)). By contrast, under a foreclosure value standard, value is determined on the basis of the amount a creditor would realize upon immediate foreclosure and sale of the property. In nearly all cases, replacement value will exceed foreclosure value.

According to the Supreme Court in Rash, only a replacement value standard takes into account the debtor's "proposed disposition or use of such property" because the debtor—by virtue of its bankruptcy filing—opted to avoid foreclosure. The Court also emphasized that the replacement value standard protects creditors from the "double risks" they face when a defaulting debtor opts to retain and continue using collateral instead of allowing the creditor to repossess it. If a debtor retains collateral instead of surrendering it to the secured creditor, the creditor risks: (1) another default by the debtor; and (2) a decline in the value of the property because of extended use. Neither risk is present, the Court noted, if a creditor can repossess the property and immediately realize its value.

Sunnyslope Housing presented the Ninth Circuit with an unusual scenario: mortgaged real property owned by the debtor was subject to certain covenants that reduced the value of the property if the debtor retained ownership, but could be shed in a foreclosure sale.

Sunnyslope Housing

Sunnyslope Housing Limited Partnership ("Sunnyslope") owned an apartment complex in Arizona. Capstone Advisors, LLC ("Capstone") provided $8.5 million in construction financing for the complex. The Capstone loan, which had an annual interest rate of 5.35 percent, was secured by a first-priority deed of trust on the complex and guaranteed by the U.S. Department of Housing and Urban Development ("HUD"). In order to obtain the HUD guarantee, Sunnyslope entered into a regulatory agreement mandating that the complex be used for affordable housing. Sunnyslope also entered into other agreements with state and city agencies that required portions of the complex to be reserved for low-income housing. These covenants ran with the land but terminated upon foreclosure.

In 2009, Sunnyslope defaulted on the Capstone loan. HUD acquired the Capstone loan shortly thereafter and later sold it to First Southern National Bank ("First Southern") for $5.05 million. Although HUD terminated its regulatory agreement as part of the sale, the other low-income housing covenants remained in effect.

First Southern initiated foreclosure proceedings, and a state court appointed a receiver for the apartment complex. A proposed sale of the complex for $7.65 million was pending when Sunnyslope's general partner filed an involuntary chapter 11 petition for Sunnyslope in January 2011 in the District of Arizona.

Sunnyslope proposed a chapter 11 plan under which it would retain the apartment complex and modify the terms of First Southern's secured loan. First Southern objected to the proposed treatment of its claims.

Sunnyslope and First Southern disputed the value of the apartment complex for purposes of confirmation of a cramdown chapter 11 plan. The bankruptcy court ruled that, even though the restrictive covenants lowered the property's value, that value should be "the value of the property as it is owned by the Debtor, which means as low-income property." After the bankruptcy court made its valuation determination, First Southern elected to treat the entirety of its claim as fully secured under section 1111(b) of the Bankruptcy Code.

The bankruptcy court later confirmed Sunnyslope's chapter 11 plan. Under the plan, First Southern's secured claim, valued at $2.6 million (the value of the complex as a low-income housing project), would be paid over 40 years at a 4.4 percent annual rate of interest. Any remaining balance on the claim would be paid through a balloon payment at the end of the 40-year period. The court found the plan to be fair and equitable because First Southern retained its lien, would receive market-rate interest, and maintained the right to foreclose on the property in the event of default.

On appeal, the district court affirmed the bankruptcy court's valuation of the complex. According to the district court, Rash established that "value is based on what a willing buyer in the debtor's trade, business, or situation would pay to obtain like property from a willing seller." Since a willing buyer would be able to operate the complex as affordable housing only while the restrictive covenants were in place, the district court reasoned, the bankruptcy court correctly found that the property's foreclosure value (albeit higher than the replacement value) was irrelevant to the valuation analysis under section 506(a)(1).

The district court ruled, however, that the bankruptcy court erred in omitting certain tax credits from its valuation. On remand, the bankruptcy court adjusted the value of the collateral (with the tax credits applied) to $3.9 million. First Southern then sought to modify its section 1111(b) election so that a portion of its claim would be unsecured. The court denied this request, finding the change to be immaterial and ruling that First Southern was not entitled to a "second bite at the apple" and a new opportunity to reject the plan and unwind the reorganization.

A divided three-judge panel of the Ninth Circuit reversed the bankruptcy court's confirmation order. See In re Sunnyslope Hous. Ltd. P'ship, 818 F.3d 937 (9th Cir.), vacated, 838 F.3d 975 (9th Cir. 2016). The majority ruled that: (i) Rash requires the court to use replacement value in determining the value of collateral; (ii) in accordance with section 506(a)(1), replacement cost "is a measure of what it would cost to produce or acquire an equivalent" parcel of property; and (iii) "the replacement value of a 150-unit apartment complex does not take into account the fact that there is a restriction on the use of the complex." Rash cannot be interpreted, the majority explained, to impose the double risks (debtor default and property deterioration resulting from extended use) on creditors while providing them with "about one-third of what the creditor could obtain if the property were surrendered." By contrast, the dissenting opinion argued that "a straightforward application" of Rash "compels valuing First Southern's collateral . . . in light of Sunnyslope's proposed use of the property in its plan of reorganization as affordable housing."

The Ninth Circuit later agreed to reconsider the panel's decision en banc and vacated the ruling.

The Ninth Circuit's En Banc Ruling

After a rehearing en banc, an 8-3 majority of the Ninth Circuit reversed course and affirmed the lower court rulings. At the outset, the majority recognized that the case was unusual, since the foreclosure value of the apartment complex exceeded the replacement value.

Writing for the majority, circuit judge Andrew Hurwitz stated that the "essential inquiry under Rash is to determine the price that a debtor in Sunnyslope's position would pay to obtain an asset like the collateral for the particular use proposed in the plan of reorganization." Under Rash, Judge Hurwitz concluded, the property must be valued at the debtor's "proposed disposition or use" even if the property could achieve a higher value if used differently.

He cautioned against using a "hypothetical" foreclosure value, because the debtor opted to retain the property in the reorganization: "We cannot depart from [the replacement value] standard without doing precisely what Rash instructed bankruptcy courts to avoid—assuming a foreclosure that the Chapter 11 petition prevented." In this instance, Judge Hurwitz explained, the valuation must take into account the restrictive covenants because the property could be used for no other purpose absent foreclosure.

Judge Hurwitz also responded to various policy arguments by noting that the primary purpose of chapter 11 is to maximize the value of the debtor's estate, not protect creditor interests. He rejected the argument that "valuing the collateral with the low-income restrictions in place would discourage future lending on like projections." According to the judge, First Southern was aware of the restrictions when it purchased the loan at a discount, and thus, the bankruptcy court's valuation subjected First Southern to "no more risk than it consciously undertook."

The majority ultimately held that Sunnyslope's chapter 11 plan was fair and equitable because First Southern would receive payments equal to the present value of its secured claim. It also ruled that the bankruptcy court committed no error by denying First Southern's request to modify its section 1111(b) election on remand because the amended plan adjusted the valuation of the collateral but did not alter First Southern's treatment.

The Dissent

Three judges dissented. According to the dissent, the majority "adopted a test that is not dictated by the letter of Rash and is contradicted by its reasoning." The dissent would instead base the valuation on the "market price of the building without restrictive covenants." Although Rash adopted a replacement value standard, the dissent explained, the Court intended that standard to be flexible and dependent on the "type of debtor and the nature of the property." Otherwise, the debtor's unique preferences could, in some instances, drastically undervalue the property to the detriment of the creditor.


The scope and significance of Sunnyslope Housing are uncertain. It remains to be seen whether other circuits will interpret Rash as mandating that replacement value be used in valuing collateral for purposes of nonconsensual confirmation of a chapter 11 plan, even where replacement value is demonstrably less than foreclosure value. Courts not bound by the Ninth Circuit's ruling may distinguish Sunnyslope Housing because of its unusual facts. However, secured creditors should be aware of the prospect that debtors may rely on the ruling to argue that collateral must be valued on the basis of its proposed use under a plan, even if that valuation is less than foreclosure value.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
13 Dec 2017, Seminar, Cleveland, United States

Jones Day partners Harold Gordon and Tony Dias, and Associate Courtney Snyder will explore the significant role New York's Attorney General and its Department of Financial Services (DFS) play in the financial services industry and why these two state-level agencies will continue to exert significant power over the financial services industry, especially with federal oversight potentially shrinking.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions