Redemption Under 722 Possible End-run Around Rash

Redemption Under 722 Possible End-run Around Rash

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In June 1997, the Supreme Court handed down Associates Commercial Corporation v. Rash.1 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,2 wholesale value3 and average value approaches.4 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 §722.5 In the case of In re Donley,6 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)7 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.8 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.9

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:

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 7.10

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:

[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.11

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).12 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."13

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).14 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.


1 520 U.S. 953; 117 S.Ct. 1879; 138 L.Ed.2d 148 (1997). Return to article

2 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). Return to article

3 In re Rash, 90 F.3d 1036 (5th Cir. 1996) (en banc). Return to article

4 In re Hoskins, 102 F.3d 311 (7th Cir. 1996); In re Valenti, 105 F.3d 55 (2nd Cir. 1997). Return to article

5 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. Return to article

6 217 B.R. 1004 (Bankr. S.D. OH 1998). This appears to be the only published post-Rash decision on this issue. Return to article

7 "Section 506(a) provides an allowed claim of a creditor secured by a lien on property in which the estate has an 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 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..." Return to article

8 217 B.R. at 1006. Return to article

9 Id. Return to article

10 Id. at 1006-1007. Return to article

11 Id. at 1007. Return to article

12 117 S.Ct. at 1885. Return to article

13 Id. Return to article

14 Id. at 1883. Return to article

Journal Date: 
Sunday, November 1, 1998