The

Proper Valuation Date of Residential Property for a 506(a) Lien Strip

Written by: Richard L. Ngo1 San Diego Superior Court; San Diego rngo-10@sandiego.edu he foreclosure crisis during the Great Recession has been given increasing scrutiny as the U.S. economy crawls back from the economic brink. Without fail, during the throes of the crisis, local and national media were replete with stories of families who had their houses foreclosed on when their property values went underwater.2 Prior to the foreclosure crisis, financing was, to put it lightly, easy to obtain. It was not uncommon for homeowners to mortgage their homes two, three, even four times in order to pull out all of their equity in the property. Inevitably, these homeowners would not be able to keep up with the payments and defaulted. Faced with the prospect of losing their homes, many homeowners have turned to chapter 13 for relief. Under chapter 13, a homeowner can file a plan to keep Richard L. Ngo their residence and strip off any liens exceeding the current value of the home, thereby only paying back mortgages, which are secured by equity, and stripping off all unsecured mortgages pursuant to 506(a).3 This is an extremely powerful provision and essential to any successful chapter 13 plan. However, for all the value this gives to the client, nowhere does the Bankruptcy Code define what date the valuation of the residence will be for purposes of a lien strip under 506(a). The valuation date for a 506(a) lien strip is significant as it will determine which mortgages are secured, thereby enabling a lien strip. With property values generally on the upswing around the nation, a valuation done presently will generally be higher, and potentially secure more liens and prohibit a lien strip. However,
1 The views expressed in this article are solely those of the author. 2 Perhaps the most notorious story to come out of the foreclosure crisis is the story of Addie Polk, 90, of Akron, Ohio. In 2008, in an effort to stop the foreclosure of her home, she shot herself repeatedly in the chest in an apparent suicide attempt after defaulting on a 30-year mortgage she had taken out in 2004. See www.cnn.com/2008/US/10/03/eviction. suicide.attempt (last accessed on May 23, 2010). 3 Unless otherwise stated, all code sections refer to title 11 of the U.S. Bankruptcy Code.

About the Author

Richard Ngo is a judicial law clerk at the San Diego Superior Court in San Diego. valuations done earlier will generally reflect lower property values, leaving more mortgages unsecured and enabling lien strips. This valuation date is of great significance to mortgage lenders and banks as lien strips essentially destroy their investment in the homeowners property. Consider the following hypothetical. A debtor wishes to file a chapter 13 plan. Central to the plan is stripping off the junior deed of trust (DOT) encumbering the debtors home. The debtor submits a valuation of the property at the time of filing the petition, which shows the junior DOT as completely unsecured. However, when the lien-strip motion is set for hearing six months later, the junior DOT holder claims that the valuation is stale and

Broadly speaking, the rationale behind the petition-date argument is to allow any appreciation of property value to inure to the benefit of a debtor under the fresh start principle.4 These courts argue that after-acquired property is not subject to the claims of pre-petition creditors and therefore appreciation of property value is analogous to after-acquired property, which is attributable to the debtors postbankruptcy efforts. Therefore, if a prepetition creditor is allowed to value a property for after the filing of the petition, the creditor is taking post-petition property and impairing the debtors fresh start.5 Next, the petition-date supporters state that the date the petition is filed is when the debtors and creditors rights and remedies are created under the Code. They argue that since the creditors rights are not created until the filing of the petition, the valuation of the property at the time of the petition is the most fair

Arguments for the Petition Date

Consumer Corner
submits a competing valuation closer to the date of the hearing, showing that its DOT is actually secured, thereby preserving the mortgage and prohibiting a lien strip. The bankruptcy courts ruling on the operative valuation date will be critical to both the financial health of the debtor and the financial institution, as the debtor needs a fresh start to move on with his or her life, but the financial lender needs stability in order to continue the business of lending. This struggle to determine the property lien strip valuation date has been taken up by numerous bankruptcy courts around the nation. Absent any guidance from Congress, the Supreme Court, circuit courts, and bankruptcy courts have been left to fashion their own rules. There is a split of authority as to what the proper lienstrip valuation date should be. The majority of the courts hold that the proper date of valuation should be the date the petition is filed, and the minority believes the proper date is the effective date of the chapter13 plan. This article will make the argument that the effective date of the chapter 13 plan is the proper valuation date. date to fix the creditors secured status under 506(a). 6 They find support in the fact that 502(b) states, if [an] objection to a claim is made, the court, after notice and a hearing, shall determine the amount of such claim...as of the date of the filing of the petition.7 On a policy level, the petition date is initially an attractive choice because, unlike the plan confirmation date, which can vary greatly, it is easily ascertainable and the most judicially economical date, as it takes any uncertainty out of guessing when the effective date of the plan might occur.

Arguments against Petition Date and for Plans Effective Date

The Crain Analysis

Ultimately, the petition-date argument is unpersuasive. First, it is well-settled law that any increase over the judicially determined valuation during bankruptcy rightly accrues to the benefit of the
4 In re Wade, 354 B.R. 876, 881 (Bankr. N.D. Iowa 2006). 5 In re Zlogar, 126 B.R. 53, 57 (N.D. Ill. 1991). 6 Johnson v. GMAC (In re Johnson), 165 B.R. 524, 528 (Bankr. S.D. Ga. 1994). 7 11 U.S.C. 502(b). See also Brager v. Blum (In re Brager), 39 B.R. 441, 443 (Bankr. E.D. Pa. 1984).

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creditor, not to the benefit of the debtor, because the creditor should be entitled to the benefit of their bargain.8 Next, the petition-date supporters reliance on the filing of the petition as a fixed date to determine valuation is confused. A closer reading of 506(a) reveals that the proper date of valuation should be the effective date of the plan. Though 506(a) allows for the valuation of a creditors secured claim, the second sentence of 506(a) states: 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 creditors interest.9 The second sentence shows congressional intent to allow for valuation of secured claims in light of the overall context of what type of case and hearing is taking place. Nowhere does the Code set a hard-and-fast date for the valuation of secured claims such as the petition date. A junior lien can only be stripped upon successful confirmation of the chapter 13 plan pursuant to 1325. Furthermore, for a plan to be confirmed, 1325 states that: [T]he court shall confirm a plan if...with respect to each allowed secured claim provided for by the plan...the plan provides that...the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim.10 Therefore, working backwards from 506(a), since valuation is done in light of the chapter 13 plan confirmation, and in order to confirm a plan secured claims must be determined as of the effective date of the plan per 1325(a), the valuation of a junior lienholders claim must be done on or near the time of the chapter 13 confirmation hearing.11 This analysis w a s a d o p t e d b y Bankruptcy Judge Vincent Zurzolo of the Central District of California in In re Crain.12 The facts of Crain are nearly
8 Dewsnup v. Timm, 502 U.S. 410, 417 (1992). 9 11 U.S.C. 506(a) (emphasis added). 10 11 U.S.C. 1325(a)(5)(B)(ii) (emphasis added). 11 Crain v. PSB Lending Corporation (In re Crain), 243 B.R. 75, 83 (Bankr. C.D. Cal. 1999). See also In re Methin, 11 B.R. 556,557 (Bankr. S.D. Miss. 1981). 12 Crain, 243 B.R. at 83.

identical to the hypothetical and typical to lien-strip situations. The debtor in Crain filed for chapter 13 reorganization. At the time of the filing of the petition, the subject property was worth $125,000, which was subject to two deeds of trusts. At the time of the filing of the petition, the balanced owed on the first deed of trust was $133,933. The balanced owed on the second deed of trust was $42,760, leaving the second deed of trust completely unsecured as of the filing of the petition. However, at the time of the plan confirmation hearing, the subject property now had a fair-market value of $133,000, thereby securing a portion of the second deed of trust holders claim. The parties then litigated whether the correct time of valuation for a chapter 13 lien strip should be the time of the filing of the petition, or the date of plan confirmation. Ultimately, the court adopted the above analysis.13 Next, 502(b) does not support the conclusion that the petition date is the proper valuation date. Section 502(b) states, if [an] objection to a claim is made, the court, after notice and a hearing, shall determine the amount of such claim...as of the date of the filing of the petition. 14 However, 502(b) indicates that the amount of a creditors claim is fixed on the date of the petition filing. There is no language indicating that the value of the secured portion of the creditors claim must also be determined as of the date of the petition filing.15

Cases Disagreeing with Crain

The decision in Crain has not come without controversy. The court in In re Aubain disagreed with the Crain court because it stated that 506(a) did not expressly state that the effective date of the plan should be the valuation date.16 Though the court conceded that valuation should be done in light of the purposes of the valuation, the Aubain court maintained the date of valuation should not be pegged to the plan confirmation date and instead should be more flexible in light of the legislative history of 506(a) and the equities involved.17 The court appealed to the interests of judicial economy, stating that valuations would be delayed by creditor appeals if
13 Id. 14 11 U.S.C 502(b) (emphasis added). 15 Crain, 243 B.R. at 83 (emphasis in original). 16 Aubain v. LaSalle National Bank (In re Aubain), 296 B.R. 624, 636 (Bankr. E.D.N.Y. 2003). 17 Id.

the date of valuation was used because creditors would simply appeal any valuation not favorable to them on the grounds that it was not close enough to the plan confirmation date.18 Next, the Aubain court rehashed the argument that post-petition appreciation is the result of the debtors efforts and should inure to the benefit of the debtor, not the creditor.19 Ultimately, the court decided the petition date was the correct date to use.20 First, the Aubain court is incorrect in stating that post-petition appreciation belongs to the debtor. As previously stated above, the Supreme Court has held in Dewsnup that post-petition appreciation belongs to the creditor.21 Next, Aubains rationale can be distinguished from most typical lien strip motions. The Aubain court went with a flexible approach because the creditor in Aubain challenged the valuation of the property 58 months after the lien-strip hearing. The court found that allowing such appeals so long after the fact would bog down judicial economy.22 The court found that because the creditor wished to value the property at the date of the adversary proceeding nearly five years after the initial valuation hearing, it would not be equitable for the debtor to revalue the house so long after the fact, and after the plan had been confirmed and plan payments made.23 Typical lien-strip motions can be easily distinguished from Aubain. In the typical contested lien-strip hearing, creditors do not wait years before contesting a home valuation. Usually all parties will have sufficient notice and opportunity to revalue the property when the plan confirmation date draws near. Though, admittedly, it is unclear when the plan confirmation hearing would occur, it is the only fair date to use to value a property for a lien strip in light of a strict reading of 506(a), which Crain mandates. Lastly, the legislative history of 506(a) cited by Aubain in support of the contention that the petition date,
18 Id. 19 Id. at 637. 20 Id. at 638-39. See also Dean v. LaPlaya Investments (In re Dean), 319 B.R. 474, 477-78 (Bankr. E.D. Va. 2004) (adopting same Aubain rationale based on legislative history of 506(a) and expressly disagreeing with Crain). 21 Dewsnup, 502 U.S. at 417. 22 Aubain, at 638. 23 Id.

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or even merely a flexible date, is the proper valuation date is not convincing. The cited legislative history states that a valuation early in the case in a proceeding under sections 361 to 363 would not be binding on the debtor or creditor at the time of the confirmation of the plan. 24 This does not speak directly to a lien-strip valuation situation for chapter 13 purposes pursuant to 506(a). It simply stands for the proposition that a valuation done in connection to a relief-fromstay hearing will not bind the court in any later hearing. Trying to force this legislative history to apply to a chapter 13 lien strip is like fitting a square peg into a round hole and merely confuses the analysis at hand.
24 Sen. R. No. 989, 95th Cong., 2nd Sess. 68 (1978), reprinted in U.S.Code Cong. & Admin. News 5787, 5854; cited by Dean, 319 B.R. at 478.

Though it seems clear the proper lienstrip valuation date should be the effective date of the plan, there is no agreement among the courts as to when the effective date of the plan is. The Code does not define when the effective date of the plan is, but some courts state it is when the last amended plan was filed.25 The Crain court held that the appropriate date of valuation for the Subject Property is the effective date of the plan or ten days after entry of the order confirming the plan...[p]ractically speaking, the date of the confirmation hearing will be used.26 Since Congress, the Supreme Court and the circuit courts have not provided any guidance as to when the effective date of the plan would be, and there is no established standard as to how to fix the effective date
25 In re Erwin, 25 B.R. 363, 366 (Bankr. Minn. 1982). 26 Crain, 243 B.R. at 84.

When Is Plans Effective Date?

of the plan. However, this ambiguity should not stop courts from using the effective date of the plan as the operative valuation date for lienstripping purposes.

Conclusion

Since 506(a) states that valuations are done in light of the purpose of the valuation, and this valuation is done for purposes of a lien strip, which can only be effective upon confirmation of the plan, and 1325(a) states in order to confirm a plan, all secured claims must be valued as of the effective date of the plan, the proper date of valuation for a lien strip should be the effective date of the plan. Congress should amend the Bankruptcy Code in order to clearly reflect this as well as define when the effective date of the chapter 13 plan is so the bankruptcy courts can uniformly apply the law in a fair and equitable manner. n

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