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October 2, 2017

Michael L. Cook, Schulte Roth & Zabel LLP[1]

“Cramdown is messy …. Valuation in bankruptcy, in turn, is also messy. Courts are often placed in the position of assigning a monetary value to an asset for which there is either no seller or no buyer, and often no market.”[2]

The so-called “cramdown” power enables a bankruptcy court to confirm a reorganization plan even when a secured creditor class dissents from its treatment under the plan. Because of the Bankruptcy Code’s “absolute priority” rule, the court may not confirm the plan unless the dissenting secured creditor class is paid in full.[3] For a secured lender to be fully paid does not require a cash payment, but may consist of a promise to pay.[4] As the Supreme Court noted 20 years ago, the cramdown power poses “double risks” for lenders: “The debtor may again default and the property may deteriorate from extended use.”[5]

Earlier this summer, the Ninth Circuit Court of Appeals refined cramdown valuation rules with In re Sunnyslope Hous. Ltd Partnership. The en banc court held that the Bankruptcy Code (“Code”) “requires the use of replacement value rather than a hypothetical [foreclosure] value … that the reorganization is designed to avoid.”[6]

The en banc opinion affirmed the bankruptcy court’s confirmation of the Chapter 11 debtor’s reorganization plan that valued a lender’s collateral (an apartment complex) based on the debtor’s “continued use after reorganization as low-income housing.”[7]The lender had unsuccessfully argued for a higher foreclosure value that would have eliminated restrictive use covenants, which depressed the collateral’s value.


In re Sunnyslope Hous. Ltd Partnership Facts

The debtor owned an apartment complex subject to secured loans from a lender ($8.5 million – first priority), the City of Phoenix (second priority) and the State of Arizona (third priority). The U.S. Department of Housing and Urban Development guaranteed the lender’s loan.

The secured financing and tax benefits associated with the apartment complex required that it be used for low-income housing. When the debtor defaulted on the lender’s first priority $8.5-million loan, another institution (“Bank”) bought the loan for $5.03 million subject to “covenants, conditions and restrictions” requiring the complex to be used for low-income housing.[8]  If the Bank were to foreclose, however, the restrictions would end.

The debtor’s filing of a Chapter 11 petition stayed the Bank’s pending foreclosure proceeding. The debtor later proposed a cramdown plan providing for it to retain the apartment complex, treating the Bank’s claim as secured “to the extent of the value of such creditor’s interest” in the collateral, consistent with Code § 506(a)(1).[9]  When the debtor argued that the apartment complex should be valued as low-income housing with its pre-existing use restrictions, the Bank countered that the low-income housing restriction should be disregarded for purposes of valuation under Code § 506(a)(1), reasoning that its collateral would have a much higher value if the property were not subject to these restrictions.

The bankruptcy court valued the apartment complex as low-income housing,[10] and declined to include tax credits available to the debtor in valuing the property. The court later confirmed the debtor’s reorganization plan, “which provided for payment in full of the [Bank’s] claim over 40 years, at an interest rate of 4.4%.”[11]  The district court affirmed the bankruptcy court’s valuation with the low-income housing restrictions, but held that the tax credits should have been included in the analysis.[12]

A split panel of the Ninth Circuit reversed the bankruptcy court’s confirmation order in Sunnyslope I. It held that the court should have valued the apartment complex based on its foreclosure value, i.e., without the restrictive “affordable housing requirements,” which lowered the property’s value.[13]  The Ninth Circuit vacated the panel opinion in Sunnyslope I when it granted the debtor’s petition for rehearing en banc.


En banc Opinion

The Ninth Circuit relied on Rash, where the “Supreme Court adopted a ‘replacement-value standard’ for § 506(a)(1) cram-down valuations,” holding that “replacement value, ‘rather than a foreclosure sale that will not take place, is the proper guide under a prescription hinged to the property’s ‘disposition or use.’”[14]  Agreeing with the dissent in Sunnyslope I, the majority in Sunnyslope II reasoned that Rash “compels valuing [the Bank’s] collateral … in light of [the debtor’s] proposed use of the property in its plan of reorganization as affordable housing.”[15]  Thus, it was proper to value “the apartment complex assuming its continued use after reorganization as low-income housing.”[16]

The en banc court reasoned that when a debtor retains property subject to a lien under a reorganization plan, the court must use replacement value, not foreclosure value.[17]  In the words of the court, the debtor is “in, not outside of bankruptcy,” so “[t]he foreclosure value is not relevant” because the creditor “is not foreclosing.”[18] Following Taffi, the Supreme Court held in Rash that “§506(a) directs application of the replacement value standard,” rather “than foreclosure value.”[19]  Because “the debtor will continue to use the collateral, … valuation must therefore occur ‘in light of the proposed repayment plan reality: no foreclosure sale.’”[20]  The “actual use is the proper guide.”[21]  “Absent foreclosure, the very event that the Chapter 11 plan sought to avoid, Sunnyslope cannot use the property except as affordable housing, nor could anyone else.”[22]

The court also rejected the argument made by other banks that “valuing the collateral with the low-income restrictions in place would discourage future lending on like projects.”[23]  Protecting creditors’ interests may be important, but “the Supreme Court has made clear that successful debtor reorganization and maximization of the value of the estate are the primary purposes” in Chapter 11 cases.[24]  Not only is the debtor able to rehabilitate its business and maximize the value of its estate, but the Bank here “bought the Sunnyslope loan at a substantial discount, knowing of the risk that the property would remain subject to the low-income housing requirements,” subjecting it “to no more risk than it cautiously undertook.”[25]



Cramdowns and valuation issues in bankruptcy remain “messy.”  Sunnyslope II, however, provides clarity on the use of replacement value v. foreclosure value in the cramdown context.



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[1] Michael L. Cook devotes his practice to business reorganization and creditors’ rights litigation, including mediation and arbitration.

[2] Bruce A. Markell, “Fair Equivalents and Market of Prices: Bankruptcy Cramdown Interest Rates,” 33 Emory Bankr. Dev. J. 91, 92 (2016).

[3] Markell, at 94, citing 7 Collier, Bankruptcy ¶1129.03 [4][a][ii], at 1129-83 (16th rev. ed 2009).

[4] Markell, at 94.

[5] Associates Commercial Corp. v. Rash, 520 U.S. 953, 962 (1997).

[6] In re Sunnyslope Hous. Ltd. Partnership, 2017 U.S. App. LEXIS 9198, *5 (9th Cir. May 26, 2017) (en banc) (8-3) (Sunnyslope II)).

[7] Id.

[8] 2017 U.S. App. LEXIS 9198, at *6-*7.

[9] Id. at *8.

[10] id. at *8-*9.

[11] Id. at *9.

[12] Id. at *10.

[13] Id. at *11.

[14] Id. at *4, quoting Rash, 520 U.S. at 963.

[15] Id. at *11, quoting Sunnyslope I, 818 F.3d at 950.

[16] Id. at *12.

[17] Id., citing In re Taffi, 96 F.3d 1190, 1192 (9th Cir. 1996) (en banc).

[18] Id.

[19] Id. at *13, quoting Rash, 520 U.S. at 956.

[20] Id. at *13-*14, quoting Rash, 520 U.S. at 963.

[21] Id.

[22] Id. at *15.

[23] Id. at *17.

[24] Id. at *17, quoting In re Bonner Mall P’ship, 2 F.3d 899, 916 (9th Cir. 1993), abrogated on other grounds by Bullard v. Blue Hills Bank, 135 S. Ct. 1686 (2015).

[25] Id. at *17.