Fifth Circuit Adopts Flexible Approach to Collateral Valuation in Cramdown Chapter 11 Cases.
Valuation of Collateral in Chapter 11
In situations where a creditor's claim is not fully secured by collateral, Section 506(a) of the Bankruptcy Code provides that the undersecured creditor's claim is bifurcated into a secured claim to the extent of the value of the collateral and an unsecured deficiency claim for the remainder. Section 506(a) further provides that the value of a secured claim "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."
Unless its collateral is of "inconsequential value," an undersecured creditor in a Chapter 11 case may bypass the effects of Section 506 by making an election to have its entire claim treated as secured under Section 1111(b) of the Bankruptcy Code.
If the debtor or other plan proponent attempts to seek confirmation of a Chapter 11 plan over the objection of an electing undersecured creditor, the plan can be confirmed only if it is "fair and equitable." In most cases, by operation of Section 1129(b) (2)(A)(i), this means that the electing creditor must retain its lien on the collateral and receive deferred cash payments "of a value, as of the effective date of the plan, of at least the value" of the collateral.
Because Section 1111(b) is silent with respect to how valuations are to be conducted, courts generally look to Sections 506(a) and 1129(b)(2)(A) for guidance. Although the latter provides that the value of the collateral should be discounted to present value when considering whether a plan provides for adequate payments to a creditor, Section 506 is determinative for the purpose of making the initial valuation. This follows from the language of Section 1129(b)(2)(A), which presumes that the collateral at issue has been assigned value, However, Section 506 does not specify the date on which collateral should be valued.
In 2010, affiliates of Comcast Corporation ("Comcast") loaned $100 million to Houston Regional Sports Network, L.P. (the "Network"). The loan was secured by a lien on substantially all of the Network's assets, including its rights under an agreement (the "Affiliation Agreement") pursuant to which a Comcast subsidiary agreed to carry the Network's content on its cable systems through 2032 in exchange for a monthly fee based on the number of Comcast's subscribers, The Network also entered into a media-rights agreement with the Houston Astros and Houston Rockets (together, the "Teams") for the exclusive right to broadcast their baseball and basketball games, respectively, in exchange for fees, Comcast's liens did not extend to the Teams' media-fee rights.
In 2014, creditors filed an involuntary Chapter 11 petition against the Network in the Southern District of Texas. After the bankruptcy court entered an order for relief, the Network proposed a Chapter 11 plan that contemplated a sale of the Network's equity to AT&T and DirecTV, which would also enter into separate agreements (collectively, the "agreements") to pay the Network for the right to broadcast its content. The plan also provided that the Teams would waive their rights to approximately $107 million in media-rights fees owed to them by the Network.
Prior to plan confirmation, Comcast, which was undersecured, made a Section 1111(b) election and objected to confirmation. Because Comcast opposed confirmation, the bankruptcy court valued Comcast's collateral--principally the Affiliation Agreement--to determine whether the stream of payments proposed under the plan equaled the present value of Comcast's collateral. In doing so, the bankruptcy court based its valuation as of the bankruptcy petition date, relying on In re Stembridge, 394 F.3d 383 (5th Cir. 2004).
Specifically, the court projected the Network's net income through 2032 (the life of the Affiliation Agreement), discounted to present value, and apportioned it among the Network's intangible assets in proportion to the revenue that each would generate. With respect to those agreements that had not yet materialized as of the petition date, the court apportioned income to such agreements based on the probability that such agreements would come to fruition. Comcast and the Teams disagreed as to, among other things, how the $107 million in waived media-rights fees should be factored into the valuation.
The bankruptcy court found that the value of the Affiliation Agreement as of the effective date of the plan would be $54.3 million, but it subtracted the waived media fees from the Network's income because the waiver had not been granted as of the petition date. As a result, the court concluded that Comcast's collateral had no value. Because the collateral was of "inconsequential value," the bankruptcy court held that Comcast could not make an election under Section 1111(b). The bankruptcy court then confirmed the Chapter 11 plan.
Comcast appealed the bankruptcy court's valuation of the Affiliation Agreement. The district court affirmed, and Comcast appealed to the Fifth Circuit.
The Fifth Circuit's Ruling
Before the Fifth Circuit, Comcast argued that its collateral should have been valued not as of the petition date, but as of the effective date of the plan, at which time the media fee waiver had been granted, thereby making its collateral not of "inconsequential value."
The Fifth Circuit disagreed. Looking to the language of Section 506(a), the Fifth Circuit declined to mandate either a petition date or an effective date valuation. Instead, the Fifth Circuit ruled, bankruptcy courts have the flexibility to employ any valuation methodology that takes into account "the purpose of the valuation and the proposed use or disposition of the collateral at issue."
In reaching this conclusion, the Fifth Circuit explained that, as amended in 2005, Section 506(a)(2) provides that valuations of personal property in individual Chapter 7 and Chapter 13 cases "shall be determined based on the replacement value of such property as of the date of the filing of the petition." However, no such directive applies in Chapter 11 cases.
Next, the Fifth Circuit found that applicable case law precedent does not require a specific valuation date in a Chapter 11 cramdown context.
Finally, the Fifth Circuit declined to extend its previous ruling in Stembridge--which addressed confirmation of a Chapter 13 wage earner plan--to Chapter 11 cramdowns. In fact, the Fifth Circuit noted in Houston Regional, "Congress implicitly rejected such an extension when it codified the Stembridge holding in Section 506(a)(2)," which, as noted, applies only in Chapter 7 and 13 cases.
Having concluded that no particular valuation date is mandated in the Chapter 11 cramdown context, the Fifth Circuit found that the bankruptcy court's reliance on Stembridge was harmless because, under the flexible approach, the petition date was a permissible valuation date, However, the Fifth Circuit remanded the case below because the bankruptcy court failed to value the collateral in light of its proposed use when it deducted the waived media fees from the value of the Affiliation Agreement. The Fifth Circuit noted that: (i) the bankruptcy court failed to consider that the reorganized Network could generate revenue under the Affiliation Agreement without having to pay media fees, thereby increasing the value of that agreement to the post-confirmation company; and (ii) subtracting the media fees (an administrative expense) would have been an impermissible surcharge on Comcast's collateral under Section 506(c) of the Bankruptcy Code in the absence of any findings that the waived media fees were necessary, reasonable and incurred for Comcast's benefit.
In declining to establish a bright-line rule mandating the valuation date for a creditor's collateral in cramdown Chapter 11 cases, the Fifth Circuit's ruling, informed by Section 506(a), gives bankruptcy courts the flexibility to consider an appropriate valuation date based on the actual use or disposition of a creditor's collateral and the purpose of the valuation, The principal benefit of this approach is that it recognizes that any valuation in this context should consider developments in a Chapter 11 case which may have an impact on value. Even so, secured creditors should be aware that consideration of the proposed or actual use of collateral under a plan may in some cases mean that collateral may be assigned a lower value1 as of plan confirmation or effectiveness than as of the bankruptcy petition date.
Peter Saba, Esq., is an associate for Jones Day. His practice focuses on complex corporate restructurings and reorganizations and cross-border insolvency proceedings. He regularly represents debtors, court-appointed trustees, creditors and asset purchasers in both in-court and out-of-court proceedings.
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|Date:||Feb 1, 2019|
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