Andrew I. Silfen, Partner, Arent Fox LLP
Andrew I. Silfen,
Arent Fox LLP
Beth M. Brownstein,Associate, Arent Fox LLP
Beth M. Brownstein,Associate,
Arent Fox LLP
Manuel Arreaza, Associate, Arent Fox LLP
Manuel Arreaza,
Arent Fox LLP

How a bankruptcy court determines the value of a secured creditor’s claims against multiple debtors liable for the same debt can have a significant impact on a bankruptcy case and creditor recoveries. The chosen valuation method plays a critical role in determining the value of collateral, and thus whether a secured creditor is oversecured and entitled to post-petition interest, fees, costs and charges, or undersecured and entitled to assert deficiency claims.

In multi-debtor bankruptcy cases, one of the valuation questions is whether the value of the secured portion of a creditor’s claim should be determined by aggregating the value of the collateral of all of the debtors that are obligated on the debt, or by valuing the collateral at each debtor separately. Surprisingly few cases address the proper method for valuing collateral in multi-debtor bankruptcy cases. This is unfortunate, because the issue is highly relevant in today’s environment where affiliated Chapter 11 debtors are often all parties to the same loan documents where debt is guaranteed and secured by all of the assets of the affiliated debtors. Indeed, the question of whether aggregation is appropriate to determine the allowed amount of creditors’ secured and deficiency claims was a key dispute in recent cases In re Cengage Learning Inc.1 and In re Residential Capital (ResCap),2 and carried significant implications for creditors of the estates.

If the collateral is valued on a debtor-by-debtor basis, the resulting deficiency claim against each debtor is the amount of the secured creditor’s claim less the value of the collateral at that particular debtor, regardless of the value of collateral held by other debtors or the distributions received from other debtors on account of the creditor’s claim. However, if the value of the collateral is aggregated across all debtors, the resulting deficiency claim asserted against each debtor is the amount of the secured creditor’s claim less the value of the aggregated collateral.

In the recent ResCap decision, the Bankruptcy Court for the Southern District of New York found that aggregation of collateral was appropriate to determine whether certain noteholders were oversecured and entitled to post-petition interest under §506(b) of the Bankruptcy Code.3 The court found that, given the facts that led to the creation of the creditor’s liens, an interpretation of §506 of the Code permitting aggregation best reflected the reality of the business arrangement and comported with the underlying purposes of the Code.4

The ResCap court’s reasoning may provide a basis for aggregating collateral in other contexts where valuation is required under the Code. As a result, a longstanding rule — that a creditor may assert the full amount of its claim against multiple debtors, regardless of payments from third parties or collateral held at other debtors, so long as the creditor does not recover more than it is owed — may be subject to exceptions or simply not apply when valuing a secured claim, particularly when aggregation better reflects the terms of the underlying loan documents and leads to a more equitable result.

Valuing a Secured Creditor’s Claim Under §506(a)

Section 506(a) of the Code governs the extent to which an allowed claim is treated as a secured claim and how a secured claim is valued.5 Valuation of a secured claim pursuant to §506(a) is required in various contexts in a bankruptcy case, including where a secured creditor seeks (i) relief from the automatic stay to foreclose on collateral, (ii) a determination as to the amount of adequate protection required for a debtor to use encumbered property, and (iii) post-petition interest, costs and charges to which it is entitled as an oversecured creditor. Valuation of a secured claim under §506(a) is also required in the context of plan confirmation where the allowed amount of the secured claim must be determined, for example, in order for a secured creditor to receive at least the present value of its secured claim.6

A determination of value pursuant to §506(a) of the Code must be made “in light of the purpose of the valuation” and the proposed disposition or use of the collateral.7 Section 506(a) is designed to accommodate many approaches and provide flexibility for courts to take a case-by-case approach, so long as a creditor receives the benefit of the bargain.8 A valuation ruling is not binding later in the bankruptcy case or for a different purpose under the Code, and the value of the property securing the creditor’s claim may change during the course of a bankruptcy case due to market fluctuations or payments made to the creditor during the bankruptcy case.9

Claims Against Multiple Debtors Liable for the Same Debt

Section 506(a) of the Code provides limited guidance on how to value secured creditors’ claims and collateral vis-à-vis multiple co-debtors liable for the same debt.10 Litigation has primarily developed in cases where a secured creditor seeks to establish that it is oversecured and entitled to post-petition interest under §506(b) of the Code.11 Where the purpose of a §506(a) valuation is to determine whether the secured creditor is oversecured, many courts have aggregated the collateral held by all of the co-debtors.12

In ResCap, the debtors argued that in order to qualify for post-petition interest, certain secured noteholders must be oversecured at each individual debtor, without reference to collateral held by co-debtors in the bankruptcy case. The senior noteholders disagreed and contended that their status as oversecured must be based on the aggregate value of their collateral across the debtors. The bankruptcy court required an evidentiary hearing to consider the appropriate valuation method pursuant to §506(a) to determine whether the senior noteholders were oversecured and entitled to relief under §506(b).13

The ResCap court concluded that aggregation of the collateral “best reflects reality” and that any other reading of the statute “would lead to inequitable and illogical results.”14 The court reasoned that aggregation was consistent with the parties’ expectations under the applicable loan documents, which enabled the movement of collateral across affiliated entities so long as the noteholders maintained their security interests in the collateral and provided for unconditional joint and several liability by the parent and subsidiaries. The court also cited to the debtors’ use of consolidated financial statements to report financial results.15 Further, the court explained that the relevant indenture expressly provided for payment of post-petition interest in the event of bankruptcy, and outside of bankruptcy the secured noteholders could have levied against all of the debtors’ assets to collect interest until the principal was paid in full.16

The ResCap court rejected the argument that aggregation would amount to de facto substantive consolidation and threaten the principles of corporate separateness, and cautioned that a prohibition on aggregation could result in major ripple effects in corporate debt markets, as creditors would negotiate oppressive restrictions on the ability of borrowers to freely move collateral between affiliated entities.17 Several other courts have also viewed debtors’ collateral in the aggregate for purposes of §506(b).18

Aggregation can have significant financial consequences. In ResCap, the court’s aggregate view of the debtor’s collateral was incorporated in a settlement ultimately yielding more than $125 million in post-petition interest, fees, costs, expenses and indemnities.19

ResCap applied aggregation principles to determine whether secured creditors were oversecured for purposes of §506(b). However, the court’s analysis of §506(a) makes no distinction between oversecured and undersecured creditors. As a result, the court’s reasoning may be utilized in other contexts, such as for the valuation of an undersecured creditor’s secured and deficiency claims for plan purposes. But significant barriers to aggregation remain, notwithstanding the fact that a secured creditor’s claims against multiple debtors may arise under loan documents and terms substantially similar to those at issue in ResCap.

Barriers to Aggregation

The U.S. Supreme Court’s decision in Ivanhoe and its progeny set forth the general rule that a creditor can assert the full amount of its claim against a debtor without deducting payments or collateral from third parties — or even co-debtors in related bankruptcy cases — on account of that claim, so long as the creditor does not collect more than it is owed.20 The principle set out in Ivanhoe is a significant barrier to aggregation, particularly for purposes of determining the allowed amounts of a secured creditor’s claim under a plan. The Ivanhoe rule is reinforced by the doctrine of corporate separateness and a presumption against substantive consolidation of affiliated debtors in bankruptcy.21 As applied, the rule allows a secured creditor to assert the full amount of its claim against each debtor and provides an allowed secured claim and deficiency claim at each debtor, depending on the value of the collateral held by each debtor. The secured creditor is generally entitled to distributions from each debtor, without recognizing collateral or distributions received from other debtors, so long as the creditor does not receive more than it is owed. As a result, secured creditors, whether or not fully secured, capture most of the value in multi-debtor cases. Secured creditors argue that this result is consistent with the expectation that each debtor provide a separate guaranty for the debt, and that they are entitled to pursue their claims against each debtor to the fullest extent until paid in full. And although some parties have argued that Ivanhoe did not survive enactment of Code §506, courts have generally held the opposite.22 Some recent decisions may have exposed chinks in Ivanhoe’s armor, but it remains the general rule.23

Nevertheless, the Ivanhoe rule may be subject to a state law exception that results in the application of aggregation-like principles. In the case In re Nat’l Energy & Gas Transmission, the Fourth Circuit found that applicable state law governed the rights of the parties and may lead to a result contrary to the Ivanhoe rule.24 The applicable provision of New York law requires that a co-obligor’s payment to the creditor be counted against the same debt owed by a co-obligor.25 Thus, where the underlying loan documents provide that multiple debtors are primary obligors, and not merely sureties on the debt, New York law may require that the value of collateral received from one debtor reduces the allowed amount of the claim asserted against another debtor — a result similar to aggregation.

Shifts in Valuation Methodology

Changes to valuation methods could have profound effects on debtors, secured creditors and other stakeholders in multi-debtor bankruptcy cases. It appears that some courts are adopting aggregation principles in multi-debtor cases when aggregation is consistent with the circumstances giving rise to the liens and the contractual expectations of the parties. ResCap benefits secured creditors by providing an “aggregation boost” for a secured creditor’s access to post-petition interest and fees, on the basis that aggregation is more consistent with the terms of loan agreements. Applying the aggregation principle and reasoning of ResCap for other valuation purposes under 506(a), such as determining when a creditor is undersecured for plan purposes, could erode the Ivanhoe rule and threaten the ability of secured creditors to assert the full amount of their claims at each debtor without accounting for payments or collateral from co-debtors. In particular, valuation methods that aggregate collateral to determine the value of secured creditor’s claims against multiple debtors could significantly reduce the allowed amounts of a secured creditor’s resulting deficiency claims at each debtor, ultimately diluting those recoveries and potentially increasing recoveries on other unsecured claims. The uncertainty underlying valuation methods will likely continue to encourage parties to resolve these issues consensually and stipulate to the value of creditors’ secured and unsecured claims.26

Andrew I. Silfen is partner at Arent Fox LLP, Beth M. Brownstein is an associate resident in the New York office, and Manuel Arreaza is an associate resident in the Washington D.C., office.

1. See In re Cengage Learning, Inc., Case No. 13-44106, at pp. 44-45 (Disclosure Statement For Debtors’ Joint Plan of Reorganization Pursuant to Chapter 11 of the Bankruptcy Code) [Docket No. 782].
2. See In re Residential Capital, LLC, 501 B.R. 549, 598 (Bankr. S.D.N.Y. 2013).
3. See In re Residential Capital, LLC, 501 B.R. 549, 598 (Bankr. S.D.N.Y. 2013).
4. See id.
5. §506(a)(1) of the Code provides: “An allowed claim of a creditor secured by a lien on property in which the estate has an interest…is 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 interest…is 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, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.” 11 U.S.C. §506(a)(1). This provision does not address whether a lender’s claims are allowed in the first instance or whether the security interests are valid as a matter of state law.
6. See, e.g., 11 U.S.C. §1129(b)(2)(a)(i).
7. 11 U.S.C. §506(a)(1); see also Associates Commercial Corp. v. Rash, 520 U.S. 953, 962 (1997) (holding that the proposed disposition or use of collateral “is of paramount importance to the valuation question”). In Rash, a Chapter 13 case, the U.S. Supreme Court held that the appropriate method of valuation depends on the intended use of the collateral. Id. at 961-65. Thus, where the debtor will surrender collateral to the secured creditor, a foreclosure standard is generally appropriate. Id. Where the collateral will be retained by the reorganized debtor, the appropriate standard is the replacement value relating to the debtor’s continued use of the property — that is, the value of the collateral in the hands of the reorganized debtor. Id.
8. See 4 Collier on Bankruptcy ¶ 506.03[4] (Alan N. Resnick & Henry J. Sommer eds., 16th ed.).
9. See 4 Collier on Bankruptcy ¶ 506.03[7][f].
10.See In re Residential Capital, LLC, 501 B.R. 549, 598 (Bankr. S.D.N.Y. 2013) (“There is a surprising dearth of case law explicitly addressing the issue of valuing the extent of a creditor’s security in multi-debtor cases.”).
11. [1] §506(b) provides that “[t]o the extent that an allowed secured claim is secured by property the value of which…is greater than the amount of such claim, there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement or State statute under which such claim arose.” 11 U.S.C. §506(b).
12. See, e.g., In re SW Hotel Venture, LLC, 460 B.R. 4, 26 (Bankr. D. Mass. 2011), aff’d in part, rev’d in part and remanded sub nom. In re SW Boston Hotel Venture, LLC, 479 B.R. 210 (B.A.P. 1st Cir. 2012), vacated on other grounds, 12-9008, 2014 WL 1399418 (1st Cir. Apr. 11, 2014); In re Gen. Growth Props., Inc., No. 09-11977 (ALG), 2011 WL 2974305,at *1 n.3 (Bankr. S.D.N.Y. July 20, 2011); In re Capmark Fin. Grp. Inc., 438 B.R. 471 (Bankr. D. Del. 2010); In re Urban Communicators PCS L.P., 379 B.R. 232, 244 (Bankr.S.D.N.Y.2008), rev’d on other grounds, 394 B.R. 325 (S.D.N.Y.2008); In re Dana Corp., 367B.R. 409, 412 (Bankr. S.D.N.Y. 2007). In some of these cases, aggregation was arguably premised, in whole or in part, on the substantive consolidation of the debtors’ estates.
13. In re Residential Capital, LLC, 497 B.R. 403, 413 (Bankr. S.D.N.Y. 2013).
14. In re Residential Capital, LLC, 501 B.R. 549, 600 (Bankr. S.D.N.Y. 2013).
15. Id. at 601.
16. Id.
17. Id. at 600.
18. See supra note 11.
19.See In re Residential Capital, LLC, Case No. 12-12020 (MG), Findings of Fact at ¶ 302 (Bankr. S.D.N.Y. Dec. 11, 2013) [Docket No. 6066]. The secured noteholders would have not have been entitled to any interest or fees under §506(b) absent aggregation of the debtors’ collateral.
20. See Ivanhoe Bldg & Loan Assoc. v. Orr, 295 U.S. 243, 246 (1935) (holding, in pre-Bankruptcy Code case, that a lender need not deduct a payment received from a non-debtor from the value of its claim asserted against the debtor); see also In re Realty Assocs. Sec. Corp., 66 F. Supp. 416, 424 (E.D.N.Y. 1946) (same with respect to co-debtors in bankruptcy cases), aff’d 162 F.2d 350, 352 (2d Cir. 1947); In re FWDC, 158 BR 523, 527-28 (Bankr. S.D. Fl. 1993) (rejecting challenge to applicability of Ivanhoe after enactment of the Code).
21. See In re Residential Capital, LLC, 501 B.R. 549, 600 (Bankr. S.D.N.Y. 2013) (discussing argument that aggregating collateral “runs contrary to…the principle of law ‘deeply ingrained’ in American corporate and bankruptcy jurisprudence that corporate separateness must be respected absent extraordinary circumstances.”).
22.See Nuveen Mun. Trust ex rel. Nuveen High Yield Mun. Bond Fund v. WithumSmith Brown, P.C., 692 F.3d 283, 296 (3d Cir. 2012) (applying Ivanhoe rule, notwithstanding that it was “not codified explicitly in the Bankruptcy Code”); In re Del Biaggio, 496 B.R. 600, 602 (Bankr. N.D. Cal. 2012) (“Ivanhoe…is also binding precedent under the current Bankruptcy Code.”).
23.For a thoughtful discussion on the continued application and implications of Ivanhoe, see Daniel J. Bussel, Multiple Claims, Ivanhoe and Substantive Consolidation, 17 Am. Bankr. Inst. L. Rev. 217 (2009).
24.In re Nat’l Energy & Gas Transmission, Inc., 492 F.3d 297 (4th Cir. 2007) (noting a potential limitation on the conclusion of Ivanhoe by providing that if applicable state law would reduce the outstanding debt on account of a payment by a co-obligor, the claim amount that a creditor could assert against a co-obligor debtor would also need to be reduced); see also 11 U.S.C. § 502(b)(1) (Bankruptcy Code provision that a claim is not allowed to the extent it is unenforceable against the debtor and property of the debtor under any agreement or applicable law.) (But see In re Del Biaggio, 496 B.R. 600, 605 n.7 (Bankr. N.D. Cal. 2012) (“[T]he Nat’l Energy & Gas decision…does not suggest that state law can overcome Ivanhoe….[I]ts discussion of state law is at most an alternative holding.”)
25.See N.Y. Gen. Oblig. L. §15-103. That statute provides: The amount or value of any consideration received by the obligee from one or more of several obligors, or from one or more of joint, or of joint and several obligors, in whole or in partial satisfaction of their obligations, shall be credited to the extent of the amount received on the obligations of all co-obligors to whom the obligor or obligors giving the consideration did not stand in the relation of a surety.
26. See generally 4 Collier on Bankruptcy ¶ 506.03[9][b] (“The comparative paucity of valuation decisions in the context of large corporate cases with substantial amounts of property at stake is noteworthy. No doubt, the difficulty of predicting the outcome of a judicial valuation may encourage parties to achieve a negotiated result. In addition, factors such as the expense, delay and difficulty (especially early on in a case) of conducting an evidentiary hearing on the value of substantial amounts of property and a reluctance to be forced to take a position with respect to the value of collateral at one stage of a case that might prove difficult to reconcile at another stage (notwithstanding differences in timing, purpose and circumstances with respect to the valuations), are also likely contributors to the reaching of consensual valuations.”).