First Circuit Issues a Landmark Opinion on Valuation of Disputed Claims

The First Circuit handed down an important opinion on valuation. When giving value to a disputed claim, the party with the burden of proof must establish the likely validity of the claim and the likelihood of recovery. Showing only the possible damages is not enough.

The April 9 opinion was authored by Circuit Judge Bruce M. Selya. Noted for his use of vocabulary, Judge Selya sent this reader scurrying to the dictionary to learn the meaning of:

• abecedarian: rudimentary
• ukase: edict
• gallimaufry: confused jumble
• aramentarium: collection of resources
• supererogatory: superfluous

Apart from the literary value of the opinion, the merits dealt with the tragedy leading to the bankruptcy and liquidation of Montreal, Maine & Atlantic Railway Ltd., whose runaway train derailed, spilling a flammable type of crude oil. The ensuing fire engulfed Lac-Megantic, Quebec, in July 2013, killing 48. The railroad filed a chapter 11 petition in Maine accompanied by insolvency proceedings in Quebec.

The debtor sued, claiming that the shipper negligently mislabeled the cargo. The complaint made no contract or regulatory claims.

The debtor and the shipper reached a settlement as part of the confirmed chapter 11 plan. The shipper paid $110 million in return for a release of all claims the debtor might have and a bar to claims by anyone else.

With a claim of $6 million, a secured creditor had a perfected security interest in all rights to payment, specifically excluding tort recoveries. The creditor contended that its claim should have been paid in full from the settlement proceeds. According to the creditor, the debtor’s release of potential contract claims meant that some of the proceeds were its collateral.

In a dispute over allowance of the allegedly secured claim, the debtor and the creditor stipulated that the railroad’s gross economic damages were no less than $25 million. Without conceding that the claims existed, the debtor stipulated that the net economic damages for breach of contract by the shipper would not have been less than $10 million after attorneys’ fees and expenses, had the debtor elected to pursue the claims.

The stipulation said nothing about the likelihood of prevailing on the contract claim or the debtor’s ability to collect. At trial in bankruptcy court on allowance of the claim, the creditor did not offer testimony from an expert about the value of the contract claim. According to Judge Selya, the creditor just relied on the stipulation.

The bankruptcy court disallowed the secured claim. First, the bankruptcy court concluded that the debtor had no cognizable, non-tort claims that were released. Alternatively, the bankruptcy court ruled that the creditor had not carried its burden of proof regarding the value of the contract claims, even if they existed.

The district court disagreed in part with the bankruptcy court. The district court believed that the debtor had contract claims. The district court nonetheless upheld disallowance of the claim because the creditor had not proven the value of the contract claim.

The creditor fared no better in the First Circuit. Judge Selya found “no clear error in the bankruptcy court’s finding that [the creditor] failed to carry its burden of proving the value of the non-tort claims.”

The creditor conceded that it carried the burden of proof under Section 506(a)(1), which provides that a claim is secured to the extent of the debtor’s interest in the collateral. The section goes on to say that value is “determined in light of the purpose of the valuation and of the proposed disposition or use of such property.”

Judge Selya assumed that the debtor had contract claims that were released as part of the settlement with the shipper and that part of the value to the shipper was the release of contract claims.

Still, the creditor lost. How is that possible?

Judge Selya said the creditor’s argument was based on the “erroneous premise that the value of a claim is the amount of damages suffered by the claimant, net of prosecution costs. Valuing a claim, at least for settlement purposes, is not so simple.”

To prove damages arising from a disputed claim, the creditor must show several factors, including the strength of the evidence, the viability of defenses, the ability of the defendant to pay a judgment, and the parties’ bargaining leverage.

In other words, Judge Selya said, “even a claim alleging a substantial figure for damages may have no settlement value at all if the cost, difficulty, or uncertainty of litigation makes it not worthwhile to pursue.”

In the case at hand, Judge Selya said that “recovery was far from certain.” Had there been no global settlement, the shipper would have faced enormous claims from wrongful death claimants, leaving the shipper possibly unable to satisfy a judgment in favor of the debtor.

According to Judge Selya, the creditor “offered no evidence that would have allowed the bankruptcy court either to assess this likelihood or to gauge any of the relevant factors other than the estate’s potential recovery that may have affected the settlement value of the non-tort claims.”

Judge Selya pointed out how the creditor did not offer an expert witness to offer a range of value for the settlement of non-tort claims. Instead, the creditor “chose to rely on a plainly insufficient stipulation of “‘net economic damages.’”

Judge Selya upheld disallowance of the secured claim because the “bankruptcy court’s finding that [the creditor] did not carry its burden of proof was not clearly erroneous.”