Under §722 of the U.S. Bankruptcy Code, a debtor may redeem collateral from a lien by paying the secured creditor, in a lump sum, the value of the collateral. An increasing number of debtors have been obtaining loans to “redeem” collateral in chapter 7 cases. This article will examine what standard courts should use to determine the value of an asset that the debtor seeks to redeem.
Section 722 of the Bankruptcy Code provides:
“An individual debtor may, whether or not the debtor has waived the right to redeem under this section, 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 §554 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.” (emphasis added)
The statute contains several prerequisites to entitle a debtor to redeem. The primary issue, though, is whether or not the valuation standard for redemption in a chapter 7 case is “replacement value” (i.e. the expense the debtor would incur if the debtor had to obtain like property for the same proposed use) or “liquidation value.” Under §722, this issue turns on the meaning of the term “allowed secured claim.” Most courts have concluded that the standard for valuation is the “liquidation value” of the collateral. In re Donley, 217 B.R. 1004 (Bankr. S.D. Ohio 1998); In re Ard, 280 B.R. 910 (Bankr. S.D. Ala. 2002); In re Tripplett, 256 B.R. 594 (Bankr. N.D. Ill. 2000); In re Williams, 224 B.R. 873 (Bankr. S.D. Ohio 1998); In re Dunbar, 234 B.R. 895 (Bankr. E.D. Tenn. 1999); In re Henderson, 235 B.R. 425 (Bankr. C.D. Ill. 1999).
In Associates Commercial Corp. v. Rash, 520 U.S. 953, 117 S.Ct. 1879, 138 LE.2d 148 (1997), the U.S. Supreme Court held that “the appropriate valuation standard in a chapter 13 case, in which a debtor wishes to retain and use collateral pursuant to his plan over the objection of a secure creditor, is replacement value.” After Rash, creditors argued that the language in Rash (which interpreted §506 of the Bankruptcy Code dealing with the value of a secured claim) supported “replacement value” as the standard for redemption in chapter 7 cases. Unfortunately, the bankruptcy courts interpreting §722 have not agreed.
The leading case holding liquidation value as the appropriate standard is In Re Donley, 217 B.R. 1004 (Bankr. S.D. Ohio 1998). In Donley, the court found support for the debtor’s argument from the legislative history of §722 redemption under §722 “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.” H.R. Rep. No 95-595, at 127 (1977), 1978 U.S. Code Cong. & Admin. News at 6088 (cited by Rash, at 217 B.R., at 1007). The court also cited In re Bell, 700 F.2d 1053 (6th Cir. 1983), a pre-Rash case in which the Sixth Circuit expressed (albeit in dicta) that “a debtor may redeem property by paying the creditor the approximate fair market value of the property which is assessed to a value contemplated by a sale for the benefit of the creditor.” The court in Donley found that a creditor’s allowed secured claim “should be valued by a standard that measures what the [creditor] would receive if the redemption did not occur and it were forced to repossess and to sell the [collateral] in the most beneficial manner it could.” In re Donley, 217 B.R. at 1007. In other words, the value of collateral should be determined by assessing what the creditor could receive at a foreclosure sale, and not by what it would cost the debtor to replace the collateral.
The reported bankruptcy court decisions have followed Donley. For example, in In re Tripplett, the court analyzed the holding in Rash, and pointed out the distinctions between a chapter 13 cramdown (the action being taken in Rash) and a chapter 7 redemption. In a cramdown under §1325(a)(5)(B), a chapter 13 debtor “keeps the collateral over the creditor’s objection and provides the creditor, over the life of the plan, with the equivalent of the present value of the collateral.” 256 B.R. at 597. This subjects the creditor to deprivation of the collateral and its value, exposing the creditor to two risks if the debtor subsequently defaults. The courts have acknowledged these risks in chapter 13, and provide for the creditor to receive replacement cost when assessing the valuation of the collateral. In a chapter 7 redemption, however, the creditor receives an immediate value for the collateral, and does not suffer any damage from a potential depreciation of the collateral or a default by debtor. The courts looking at this issue have reasoned that the Supreme Court in Rash merely intended to benefit a creditor with added protection in cramdown under chapter 13, but did not intend for the same standard to apply in a chapter 7 redemption, where such added protection is not needed.
All of the reported cases have followed Donley. The proposed bankruptcy reform legislation would amend §722 to explicitly provide for “retail replacement value.” Nonetheless, under the current law, liquidation value, and not replacement value, is the standard for determining value in a chapter 7 redemption.