In First Southern National Bank v. Sunnyslope Housing Limited Partnership, No. 12-17241 (9th Cir. May 26, 2017), the Ninth Circuit Court of Appeals, in an en banc decision, held that, for purposes of confirmation of a plan of reorganization over a mortgagee’s objection, the value of the mortgagee’s secured claim was the value of the property as low income housing not the value the mortgagee would have received on foreclosure free of the low income housing restrictions.

Sunnyslope owned a low income housing project. The project was subject to restrictions that limited the project’s use to low income housing. Sunnyslope sought to confirm a chapter 11 plan of reorganization over the objection of the first mortgagee under section 1129 of the Bankruptcy Code. The issue was how to value the property for the purpose of determining the amount of the mortgagee’s claim under section 506 of the Bankruptcy Code. The value of the property as market rental housing was greater than its value as low income housing. The first mortgagee took the position that the property should be valued at the fair market value for market rental housing because the low income housing restrictions would terminate on foreclosure of the first mortgage. The bankruptcy court valued the property as low income housing. On appeal, the district court affirmed the bankruptcy court’s valuation of the property as low income housing. The mortgagee appealed to the Ninth Circuit. A majority of the three judge panel held that the property should have been valued at the higher value after foreclosure and reversed the lower court decision. The Ninth Circuit voted to hear the appeal en banc and vacated the panel decision.

In an 8 to 3 decision, the Ninth Circuit held that the United States Supreme Court’s decision in Associates Commercial Corp. v. Rash, 520 U.S. 953 (1997) required the use of replacement value rather than foreclosure value. Rash was a chapter 13 case in which the debtor sought to keep a truck subject to a security interest. The debtor sought to use foreclosure value to determine the amount of the creditor’s secured claim. The Supreme Court held that the truck should be valued at the debtor’s cost to replace the truck with a similar truck.

The majority in Sunnyslope looked to the debtor’s actual use of the property, and held that the replacement value was the value of the property assuming its continued use after reorganization as low-income housing. The majority observed that, absent foreclosure, the event that the Chapter 11 plan sought to avoid, Sunnyslope cannot use the property except as affordable housing, nor could anyone else. Therefore, the majority held that the property must be valued in light of its use as low income housing.

The dissent criticized the majority opinion for being formalistic. The dissent argued that Rash did not adopt the majority’s strict “particular use” interpretation of replacement value. Rather, the dissent argued that Rash adopted a more flexible standard, the price a buyer would have to pay on the market for like property. Here, a foreclosure value more closely approximated market value.

Sunnyslope is the first court of appeals decision to decide whether a secured creditor’s collateral should be valued at the value in the hands of the debtor or at the value after a foreclosure sale free of restrictions on use. The distinction will be important in cases where the collateral is subject to restrictions which limit its value and the restrictions terminate upon foreclosure. It will be interesting to see if the secured creditor seeks Supreme Court review of the Ninth Circuit’s decision and if other circuits follow the Ninth Circuit.