The Bottom Line

The Fifth Circuit in Houston Sportsnet Finance, L.L.C. v. Houston Astros, L.L.C. (In re Houston Regional Sports Network, L.P.), 886 F.3d 523 (5th Cir. 2018), recently held that a bankruptcy court is not required to use either the petition date or the effective date for purposes of conducting a valuation in a cram-down Chapter 11 plan. Rather, a bankruptcy court has the flexibility to select the valuation date so long as it takes into account the purpose of the valuation and the proposed use or disposition of the collateral at issue.

What Happened?

Houston Regional Sports Network, L.P. (the “Network”) entered into media-rights agreements with the Houston Astros and the Houston Rockets (together, the “Teams”), pursuant to which the Network was granted exclusive rights to broadcast games in exchange for fees. The Network also entered into an Affiliation Agreement (the “Agreement”) with Comcast Cable Communications, LLC (“Comcast”) to carry the Network through 2032, in exchange for a monthly fee. In 2010, a Comcast affiliate provided a loan to the Network, secured by a lien on substantially all of the Network’s tangible and intangible assets, including the Agreement but not the Teams’ media rights. In September 2013, various Comcast entities filed an involuntary Chapter 11 petition against the Network after it had defaulted on consecutive payments to the Astros.

Post-petition, AT&T and DirecTV entered into an agreement with the Teams to acquire all of the equity in the Network and enter into separate agreements to pay the Network for the right to broadcast the Network’s content. The sale agreement was included in the Network’s plan of reorganization (the “Plan”), which was confirmed in October 2014, under which the Teams agreed to waive approximately $107 million in media-rights fees owed by the Network that had accrued during the bankruptcy.

Prior to confirmation, Comcast made a 11 U.S.C. § 1111(b) election, which allows an undersecured creditor to elect to have its claim treated as fully, rather than partially, secured. Because of this election, Comcast was guaranteed the right to receive a stream of payments, the present value of which was equal to the value of the collateral as determined by the bankruptcy court. Comcast’s Section 1111(b) election applied only to the Network’s intangible collateral. See 11 U.S.C. § 1111(b)(1)(B)(ii). The bankruptcy court valued the intangible collateral by projecting the Network’s net income through 2032, discounting it to present value and then allocated that value among the intangible assets based on revenue generation. Notably, the bankruptcy court’s valuation was as of the petition date and therefore took into account agreements that did not exist but could have been entered into postpetition. The bankruptcy court then valued the Agreement as of the effective date of the Plan at $54.3 million, but deducted the $107 million in waived fees, which rendered the value of the intangible assets to be zero. Since a creditor cannot make a Section 1111(b) election if the collateral is of “inconsequential value,” see 11 U.S.C. § 1111(b)(1)(B)(i), Comcast could not make a valid election. After the Plan was confirmed, Comcast appealed the bankruptcy court’s valuation of the Agreement and sought a stay pending appeal. The district court denied the stay and affirmed the valuation, holding that the petition date was the proper date from which to value the Agreement and that expenses incurred by the Network were properly offset against the Agreement’s value.

Comcast appealed to the Fifth Circuit. Comcast advocated for the effective date of the Plan to be the valuation date, while the Teams argued for the petition date, relying upon In re Stembridge, 394 F.3d 383 (5th Cir. 2004).

Under 11 U.S.C. § 506(a)(1), 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.” Here, the sale transaction was being implemented through the Plan. The Fifth Circuit noted that Section 506(a) is often used in conjunction with the cram-down provision in Section 1129(b) of the Bankruptcy Code, which requires valuation of the collateral in the context of plan confirmation when the debtor retains possession of the collateral. The Fifth Circuit concluded that Section 1129(b)(2)(A)(i)(II)’s “fair and equitable” standard requires a discounting to present value, while Section 506 provides guidance to calculate the initial value before discounting.

Rather than mandating a specific valuation date in the Chapter 11 cram-down context, the Fifth Circuit found that case law supports flexibility and Section 506(a) requires consideration of the purpose of the valuation and the proposed use or disposition of the collateral at issue. On the other hand, the Third and Eighth Circuits have held that the confirmation or effective date of the plan is the appropriate valuation date for cram down, even though the Third Circuit recognized Section 506(a) valuations may not always relate to plan confirmation.

The Fifth Circuit stated that its prior decision in Stembridge did not compel a fixed valuation as of the date of the petition for Chapter 11 cram-downs as its holding there was limited to Section 1325 plan confirmations. The court declined to extend the per se valuation date to Chapter 11 cram-downs, stating that Congress implicitly rejected such an extension by enacting Section 506(a)(2), which specifically refers to Chapter 7 and 13 bankruptcies but not Chapter 11. The Fifth Circuit noted that a hard line need not be drawn for plan confirmation collateral valuation and a case-by-case analysis can be employed to determine the appropriate valuation date. The Fifth Circuit cited involuntary bankruptcies (as occurred here) as an example of where a plan may not be filed on the petition date and therefore the use and disposition of the property is not yet established.

While the bankruptcy court had stated that under a flexible approach it would use the petition date to value the Agreement, the Fifth Circuit remanded for a re-valuation of the Agreement because it took issue with the bankruptcy court’s full deduction of the media-rights fees. The Fifth Circuit found that the bankruptcy court improperly valued Comcast’s collateral based on fees that would never be paid because the Teams agreed to waive such fees under the Plan. Additionally, subtracting the media-rights fees, which were an administrative expense, constituted an impermissible surcharge. The Fifth Circuit noted that while it had approved orders requiring payment of expenses incurred, it has never authorized charging a secured creditor for an expense that would never be paid under a reorganization plan.

Why This Case Is Interesting

The Fifth Circuit declined to adopt a bright-line rule for the appropriate valuation date for purposes of Chapter 11 cram-downs, instead following a flexible approach to the timing of valuation, allowing a court to consider the development of the proceedings since the value of the collateral may vary based on its proposed use under any given plan. While this decision is in the context of a Chapter 11 cram-down, it may provide support for courts to apply a flexible approach to Section 506(a) valuations in other contexts as well. Creditors considering whether to make a Section 1111(b) election should be aware that courts may apply a flexible approach to determine collateral value as opposed to a rigid application of one particular date.