Real Estate

Third Circuit Rejects Wait-and-See Valuation Approach and Accepts Lien Stripping in Section 506(a)

By: Andrew Richmond

St. John’s Law Student

American Bankruptcy Institute Law Review Staff
In In re Heritage Highgate, Inc.,[1] the Third Circuit held that the fair market value of property as of the confirmation date controls whether or not a lien is fully secured.[2]  Additionally, the court held that lien stripping is permissible in a chapter 11 reorganization.[3] The debtors, Heritage Highgate and Heritage-Twin Ponds II, were real-estate developers working on a project that was financed by a group of banks (the “Bank Lenders”) and other entities collectively known as Cornerstone Investors (“Cornerstone”).[4]  Both the Bank Lenders and Cornerstone secured their investments with liens on substantially all of the debtors’ assets but Cornerstone’s claims were contractually subordinated to the Bank Lenders’.[5] After selling a quarter of the project’s planned units, the debtors filed a chapter 11 petition.  The debtors’ joint proposed plan of reorganization proposed paying secured claims in full and paying 20% of the unsecured claims with funds obtained through the sale of the project’s remaining units.[6]  These estimated recoveries were based on the debtors’ appraisal, which valued the project at $15 million.[7] During the course of the case, the debtors continued to build and sell units and, with the consent of its secured lenders, used the sale proceeds to fund ongoing operating losses.[8] As a result, the fair market value of the project was reduced to approximately $9.54 million as of the time of plan confirmation, which was less than the Bank Lender’s $12 million secured claim.[9] Cornerstone argued their $1.4 million claim should still be fully secured and to hold otherwise would constitute impermissible lien stripping.[10] The bankruptcy court disagreed and determined that the proper method of valuing Cornerstone’s secured claim was the fair market value of the project as of the time of plan confirmation.[11]  Therefore, Cornerstone’s claim was unsecured.[12]