Fair Market or Value in Use? — GM and the Valuation of Collateral
Although the Chapter 11 bankruptcy of General Motors has all but vanished from the headlines, it is still making waves with an interesting and deceptively simple decision on the valuation of a secured creditor’s collateral.
A dispute arose among General Motors LLC (New GM), the purchaser of Motors Liquidation Corp. f/k/a General Motors Corp.’s (Old GM and collectively with its affiliate debtors, the debtors) assets in a July 2009 sale free and clear of liens (the §363 sale), and certain secured creditors (the TPC lenders). The TPC lenders held liens on two of Old GM’s assets (a plant and a warehouse) prior to the §363 sale and sought a valuation of their collateral to determine the amount distributable from the sale proceeds on account of their secured claims. Years after the §363 sale closed, New GM and the TPC lenders could not agree on which valuation methodology to apply: “fair market value” or the “value in use.”
Included as part of the §363 sale was a transmission manufacturing plant in White Marsh, MD, and a service parts distribution center in Memphis, TN (collectively, the TPC properties). As of the petition date, the TPC lenders held liens on the TPC properties as collateral to secure $90.7 million in debt ($63.9 million as to the Maryland facility and $26.8 million as to the Tennessee facility). In order to resolve the TPC lenders’ prior objections to the §363 sale, a provision was inserted into the sale order that provided that “the TPC Lenders shall have an allowed secured claim in a total amount equal to the fair market value of the TPC Propert[ies] on the Commencement Date under §506 of the Bankruptcy Code.” In addition, as adequate protection for the TPC lenders’ secured claim, New GM agreed to place $90.7 million of the §363 sale proceeds into an interest-bearing escrow account.
Upon the closing of the §363 sale, New GM and the TPC lenders tried, unsuccessfully, to resolve the dispute. New GM obtained an appraisal for the TPC properties utilizing a “fair market value” standard of $30.75 million. The TPC lenders valued the TPC properties at $42 million using the “fair market value” standard and $64.9 million using the “value in use” standard.
To resolve the dispute, the court started with a textual analysis of the sale order, focusing on three terms: 1.) “fair market value,” 2.) “on the Commencement Date” and 3.) “under §506 of the Bankruptcy Code.” The court determined that the term “fair market value” does not by itself deter mine the valuation methodology because it does not specify a market or a means for determining value. Therefore, other components of the §363 sale order had to be examined. Looking to the second component, “on the Commencement Date,” the court held that the language was sufficiently clear and required valuation as of the petition date. The court then held that the third component, “under §506 of the Bankruptcy Code,” incorporates the statutory language and any case law interpreting it.
In determining the value of a secured claim, §506(a) provides that “[s]uch value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.” Looking to this statutory language, the court determined that the “key considerations are 1.) the purpose of the valuation and 2.) the proposed disposition or use of the collateral.”
Both New GM and the TPC lenders agreed that the purpose was to determine the value of the TPC properties so that an amount of cash equal to the TPC lenders’ secured claims can be released from the escrow account and paid to the TPC lenders. Looking to the second factor, “the proposed disposition or use of the collateral,” although the TPC lenders correctly noted that Old GM was operating both TPC properties on the petition date, the court determined that §506 does not refer to the “existing” disposition or use of the property; rather, it refers to the “proposed” disposition or use of the property at the time of valuation. On the petition date, Old GM had already announced its intention to sell the TPC properties to New GM.
New GM argued that the §363 sale constituted a “disposition” for §506 purposes because Old GM and New GM were two distinct legal entities and because Old GM did in fact sell the TPC properties to New GM despite the fact that higher and better bids could have been submitted. The TPC lenders argued that New GM’s appraisals were artificially low because they were based on the fiction that New GM did not retain and continue to operate the TPC properties, but instead abandoned them and attempted to sell the TPC properties as non-operating facilities. Because of Old GM’s relationship with New GM, the TPC lenders argued that the court should acknowledge the “continued use and operation [of the TPC properties] as part of the General Motors business, first under Old GM and then under New GM.”
The court disagreed with the TPC lenders’ arguments because the §363 sale was structured like many other traditional bankruptcy sales where Old GM offered to sell the TPC properties to anyone with a higher and better offer, and therefore, a sale to New GM was not the only potential outcome and Old GM would not continue to operate the properties. The court thus chose the “fair market value” standard, as opposed to the “value in use” standard, which the court felt was inappropriate for a §363 sale. The court did not, however, determine the value of the TPC properties. Consequently, the TPC lenders have sought to appeal the decision.
As the court noted, the decision can be viewed as “simply what normal valuation analyses would yield” in accordance with Collier’s on Bankruptcy:
Once the court has identified the creditor’s interest in the estate’s interest in the collateral, the court must then determine the valuation standard to be applied in valuing the creditor’s interest. In general, the courts agree that the standard is one of fair market value. By itself, however, this reveals relatively little. In virtually every case, the determination of fair market value will depend on the particular market and means selected to gauge the value of the item in question.
The question becomes which market and means establish the most appropriate benchmarks for bankruptcy purposes. As §506(a) instructs, the answer depends in the first instance on (i) the purpose of the valuation and (ii) the proposed disposition of the collateral.
That is an oversimplification, however. The court made it clear that parties are free to stipulate their own valuation techniques and timing, despite §506 and the case law applicable under it. As to valuation techniques, the court started by looking to the text of the “contractual” provisions of the sale order to determine whether the valuation methodology was clearly set forth, and later commented that “[t]he parties presumably could have agreed that if New GM were the winning bidder, the TPC Properties would be valued using the ‘value in use’ mechanism, but they did not do so.” As to timing, the court accepted the parties’ agreement in the “contractual” provisions of the sale order that valuation was to be determined as of the petition date, contrary to the date proposed by Collier’s: “If the collateral is actually sold during the pendency of the case, the determinative date should be the time of disposition for the purposes of measuring entitlements to the proceeds of the disposition.”
Counsel should therefore keep in mind that a court may allow parties to agree on the exact terms and methodology for a valuation of collateral despite §506 and the case law applicable under it; for example, valuing components of a business on a going-concern basis in the hands of the purchaser, with distributable value determined by comparison to the proceeds from the sale of the business as a whole. This would presumably have precluded the dispute on valuation methodology and ensured the TPC lenders a minimum recovery well above what they currently anticipate without a reversal of the decision. Equally interesting is which means and market Hon. Robert E. Gerber will choose in the valuation, the analysis of which will have to await the valuation decision.
Reprinted with permission from the ABI Journal, Vol. XXXII, No. 2, March 2013.
Oscar Pinkas is an associate in the Restructuring and Insolvency Group of SNR Denton in New York.
Richard Corbi is counsel in the Bankruptcy, Financial Reorganization and Creditors’ Rights Department and Specialty Finance Department’s Private Equity Group of Lowenstein Sandler PC in New York.