Shifting Burden of Proof Held To Apply in Valuing Secured Claims in Bankruptcy

May 16, 2012 – In The News
New Jersey Law Journal

The U.S. Court of Appeals for the Third Circuit ruled Monday in a precedential decision that a debtor has the initial burden to overcome the presumption of validity of a secured claim, and then the burden shifts to the creditor.

The ruling involved the development of 411 townhouses and single-family homes by developers, Heritage Highgate Inc. and Heritage-Twin Ponds II, in Lehigh County, Pa. 101 units had been built and sold by the time the developers filed for bankruptcy in January 2009.

The reorganization plan the developers submitted to the bankruptcy court in June 2009 proposed that they complete the development and projected revenue from the sale of the remaining units would enable them to pay off both secured creditors in full, while unsecured creditors would receive 20 cents on the dollar.

The plan relied on an appraisal pegging the project's fair market value at around $15 million, enough to pay off Wachovia Bank's primary lien of about $12 million and Cornerstone Investors' secondary lien of about $1.4 million.

The Official Committee of Unsecured Creditors, however, concluded that the fair market value was only $9.54 million or so, not even enough to pay Wachovia.

So it asked U.S. Bankruptcy Judge Gloria Burns, who sits in Camden, to value Cornerstone's secured interest at zero and treat it as an unsecured creditor.

Burns granted the motion, and U.S. District Judge Jerome Simandle, also in Camden, affirmed, finding the $15 million figure was not the present fair market value but merely a projection meant to show that the plan was feasible.

The attorney for the unsecured creditors' committee, Michael Viscount Jr., says what was at stake was who would benefit from an increase in the collateral's value: the unsecured creditors or Cornerstone.

If the projections hold, the unsecured creditors, including Cornerstone, will receive 45 percent rather than 20 percent and will be paid about 13 months sooner, he says.

Joshua Klein says "these valuation principles and ability to contest the secured nature of a second lien secured creditor" apply broadly not just to developers but to any going enterprise in Chapter 11.