Redemption Under 722 Possible End-run Around Rash

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Nov 1998

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In June 1997, the Supreme Court handed down Associates Commercial Corporation v. Rash.<a href="#1" name="1a">1</a> Certiorari having

been granted to resolve the conflict among the circuits on the issue of valuation in a chapter 13 cramdown, it was

hoped that the court would enunciate a bright-line valuation rule. At the time, the circuits were split among the

retail or replacement value,<a href="#2" name="2a">2</a> wholesale value<a href="#3" name="3a">3</a> and average value approaches.<a href="#4" name="4a">4</a> In ultimately concluding that

replacement value would be appropriate, the Supreme Court, in its reference to the now-famous Footnote 6, then

undercut the bright-line effect of its ruling by clouding the issue of how replacement value is to be determined.

One valuation area in which the Rash decision has been effectively ignored is redemption under §722.<a href="#5" name="5a">5</a> In the case of

In re Donley,<a href="#6" name="6a">6</a> the bankruptcy court discarded the notion that the lengthy Rash analysis of the meaning behind the

Code's valuation provision was controlling on the valuation determination in the redemption setting.

In Donley, the debtor purchased two mobile homes, combined them and essentially rendered them immobile.

American General Finance (AGF) loaned the debtor $7,700 to acquire and combine the mobile homes. AGF was

secured by a security interest in the mobile homes. Subsequently, AGF loaned Donley an additional sum to replace

his roof. Donley filed bankruptcy, apparently in connection with a strike at the plant where he was employed. While

it was his initial intention to reaffirm the debt to AGF, he later opted to redeem the property from AGF. The parties

agreed that the modified mobile homes were worth $10,000 in their current location and condition.

Having previously made a $1,240 "postponement payment," Donley asserted that he was entitled to the application

of this amount, plus an additional nominal amount, in order to redeem the property from AGF. Not surprisingly,

AGF argued that it was entitled to the replacement value of the mobile homes, essentially in their "as is-where is"

condition, and argued the Rash decision in support of its position.

At the outset of its analysis, the court closely followed the §506(a) analysis rendered in Rash. The court correctly

summarized the Supreme Court's finding as to the meaning of the first sentence of §506(a)<a href="#7" name="7a">7</a> that the value of the

collateral is a limitation on an allowed secured claim, as also are the nature and priority of the creditor's claim.<a href="#8" name="8a">8</a>

The basis for determining value is not governed by this part of §506(a). The court continues down the Rash trail by

properly observing that the second sentence of §506(a), "[S]uch value shall be determined in light of the purpose of

the valuation and of the proposed disposition or use of such property," is "instructive" as to how the creditor's

interest is to be valued.<a href="#9" name="9a">9</a>

At this point in its decision, the court suddenly concluded that while the Supreme Court's interpretation of the first

sentence of §506(a) is controlling in a redemption scenario, the interpretation of the second sentence, or value

determination provision of §506(a) is not:

<blockquote>Were the Rash standard, as measured by the second sentence of §506(a) also to apply, the value of [the

creditor's] secured claim would be $10,000 given the debtor's own testimony. There are reasons to believe

that application of the replacement value standard does not reflect the "purpose of the valuation and the

proposed disposition or use of such property" in the context of redemption under chapter 7.<a href="#10" name="10a">10</a></blockquote>

One of the reasons cited for the court's disregard of the Supreme Court's interpretation of §506(a)'s value

determination is a selected portion of the legislative history of §722. The language in the House Report referred to inDonley provides:

<blockquote>[Redemption] amounts to a right of first refusal on a foreclosure sale of the property involved. It allows the

debtor to retain his necessary property and avoid high replacement costs and does not prevent the creditor

from obtaining what he is entitled to under the terms of his contract.<a href="#11" name="11a">11</a></blockquote>

Apparently, the court chose to be guided by a snippet of legislative history rather than by the Supreme Court's

ruling in Rash. As further justification for its foreclosure valuation approach, the court relied upon language in Rash

reciting a chapter 13 creditor's continuing risks of future credit default and collateral depreciation as a reason for

utilizing replacement value in a cramdown. The absence of such "risks" in a redemption is viewed as a sufficient

basis for distinguishing the Rash interpretation of the value determination provision of §506(a). The failure of the

Donley court to consider the remaining reasons cited by the Supreme Court for the imposition of replacement value

undermines its analysis and ultimately its holding.

The proposed disposition or use of the collateral "is of paramount importance to the valuation question" under

§506(a).<a href="#12" name="12a">12</a> Recognizing that "disposition or use" was properly viewed from the debtor's perspective because he was

retaining the collateral, the court also cited the continuing risk of credit default and collateral depreciation as further

justification for the imposition of a replacement value standard.

In exercising his redemption right, the debtor determines the disposition and use of the collateral. The creditor has

no role in the redemption decision. Such retention is clearly recognized in Rash as the lynchpin for determining

which party's perspective value is to be determined. A replacement value standard distinguishes retention from

surrender and renders meaningful the key words of §506(a), "disposition or use."<a href="#13" name="13a">13</a>

Reliance upon §722's legislative history does not alter this conclusion. First and foremost, the statutory language

within §722 refers to payment of the lienholder's "secured claim." The term "secured claim" is not separately

defined under chapter 7; rather the controlling definition is set forth in §506(a).<a href="#14" name="14a">14</a> The Rash decision's

pronouncements on the interpretation of §506(a) therefore cannot be ignored. Second, the portion of the cited

legislative history of §722, i.e., "[it] does not prevent the creditor from obtaining what he is entitled to under the

terms of his contract," is at least somewhat inconsistent with the corresponding reference to "a right of first refusal

on a foreclosure sale of the property involved." Under §9-506 of the Uniform Commercial Code, a creditor is

generally entitled to "...fulfillment of all obligations secured by the collateral, as well as the expenses reasonably

incurred by the secured party..." Accordingly, if redemption is to allow a creditor the benefit of its contract, state law

would generally support a replacement value rather than a foreclosure value. Finally, the Supreme Court gave no

weight to legislative history in its construction of §506(a), therefore it is difficult to reconcile a reference to

legislative history for yet another statutory provision to define a "secured claim."

The Rash decision has been the subject of a great deal of criticism for its failure to establish how replacement value

is to be calculated. The Supreme Court's analysis of §506(a) is, however, both logical and instructive. If the debtor

retains the use of collateral, the value should be based on his intended disposition or use, i.e., some form of

replacement value. By the same token, upon the surrender of collateral or in a motion for stay relief, a foreclosure

value may be appropriate. Reference to the term "secured claim," whether under §722, §1325(a)(5)(B) or

§1129(b)(2), necessitates application of §506(a), the means of which has been provided by the Supreme Court in

Rash.

<hr>

<h3>Footnotes</h3>

<a name="1">1</a> 520 U.S. 953; 117 S.Ct. 1879; 138 L.Ed.2d 148 (1997). <a href="#1a">Return to article</a>

<a name="2">2</a> In re Taffi, 96 F.3d 1190 (9th Cir. 1996) (en banc), 117 S.Ct. 2478 cert. den., (1997); In re Winthrop Old Farm Nurseries Inc., 50 F.3d 72 (1st Cir. 1995); In re Trimble, 50 F.3d

530 (8th Cir. 1995). <a href="#2a">Return to article</a>

<a name="3">3</a> In re Rash, 90 F.3d 1036 (5th Cir. 1996) (en banc). <a href="#3a">Return to article</a>

<a name="4">4</a> In re Hoskins, 102 F.3d 311 (7th Cir. 1996); In re Valenti, 105 F.3d 55 (2nd Cir. 1997). <a href="#4a">Return to article</a>

<a name="5">5</a> Whether or not the debtor has waived the right to redeem under this section, an individual debtor may redeem tangible personal property intended primarily for personal, family

or household use from a lien securing a dischargeable consumer debt, if such property is exempted under §522 of this title or has been abandoned under §544 of this title, by

paying the holder of such lien the amount of the allowed secured claim of such holder that is secured by such lien. <a href="#5a">Return to article</a>

<a name="6">6</a> 217 B.R. 1004 (Bankr. S.D. OH 1998). This appears to be the only published post-Rash decision on this issue. <a href="#6a">Return to article</a>

<a name="7">7</a> "Section 506(a) provides an allowed claim of a creditor secured by a lien on property in which the estate has an interest...is a secured claim to the extent of the value of such

creditor's interest in the estate's interest in such property...and is an unsecured claim to the extent that the value of such creditor's interest...is less than the amount of such

allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property..." <a href="#7a">Return to article</a>

<a name="8">8</a> 217 B.R. at 1006. <a href="#8a">Return to article</a>

<a name="9">9</a> Id. <a href="#9a">Return to article</a>

<a name="10">10</a> Id. at 1006-1007. <a href="#10a">Return to article</a>

<a name="11">11</a> Id. at 1007. <a href="#11a">Return to article</a>

<a name="12">12</a> 117 S.Ct. at 1885. <a href="#12a">Return to article</a>

<a name="13">13</a> Id. <a href="#13a">Return to article</a>

<a name="14">14</a> Id. at 1883. <a href="#14a">Return to article</a>

Journal Authors

David B. Wheeler

Journal Date

Sunday, November 1, 1998 - 12:00