ADEQUATE PROTECTION, THE UNDERSECURED CREDITOR AND DEPRECIATING PROPERTY Sid Diamond, Esq.

El Paso, TX This article is a primer on adequate protection of an undersecured creditor, whose claim is secured by depreciating property, from the beginning of a reorganization through confirmation. Assume there are no cash collateral or financing issues. The goal of adequate protection in this context is an allowed secured claim equal to the value of the collateral at each key valuation date, and an allowed secured claim equal to the value of the collateral at confirmation. An unsecured creditor is entitled to be protected (compensated), during the period that the bankruptcy stay is imposed, typically in the form of monthly cash payments equal to the estimated monthly depreciation, pursuant to 11 U.S.C. 361(1). The undersecured creditor is not entitled to receive any additional compensation, directly or indirectly. United Sav. Ass'n of Texas v. Timbers Of Inwood Forest Assocs., Ltd., 484 U.S. 365, 108 S. Ct. 626, 98 L. Ed. 2d 740 (1988); In re Reddington/Sunarrow, Ltd. P'ship, 119 B.R. 809 (Bankr. D.N.M. 1990). There are six provisions of the Bankruptcy Code that affect the process of providing adequate protection. At the most basic, a creditor is an entity having a claim against the debtor that arose at the time of or before the order for relief. 11 U.S.C. 101(10)(A). Although not without some controversy, upon objection to a claim, the amount of a claim is determined as of the petition date. 11 U.S.C. 502(b). Section 362 provides for the stay, and gives the bases for relief from the stay, including lack of adequate protection. The value of an undersecured creditor's interest in property is determined pursuant to 11 U.S.C. 506(a), and upon such determination its claim is divided into a secured claim equal to the value of that interest and an unsecured claim for the difference. If adequate protection is ordered and the protection afforded fails, the court may, pursuant to 11 U.S.C. 361(3), grant to the creditor, a priority administrative expense claim under 11 U.S.C. 503(b)(1) which becomes a super priority administrative claim, pursuant to 11 U.S.C. 507(b), by making the claim payable before all other administrative expense claims. Confirmation of plans, pursuant to 11 U.S.C. 1129(b)(2), 1225(a)(5) and 1325(a)(5), is affected by adequate protection considerations in a variety of ways. [See Norton Bankr. L. & Prac. 2d 35:3.] The process of obtaining adequate protection is begun by the creditor filing a motion requesting relief from stay or adequate protection. There is ample authority that neglect to seek adequate protection by motion in advance of confirmation is fatal to any claims for adequate protection later. The allegations necessary to raise the issue of adequate protection are simple: The property that is the subject of this motion and which secures the obligation due the Movant from the debtor has declined in value since the petition date due to the debtor's use and will continue to decline in value. The debtor has neither provided adequate protection nor offered to provide adequate protection to Movant. The lack of adequate protection is cause to terminate the stay to allow Movant to exercise its state law remedies. Alternatively Movant requests that the

court order the Debtor to provide adequate protection to Movant and condition the continuation of the stay upon the timely payment by the debtor. At the hearing on the motion, the court will determine the right to adequate protection, based upon: (i) The date at which the property will be valued; (ii) the value of the property at that date; (iii) the decline in value or depreciation that has occurred and will occur in the future; and (iv) the date at which adequate protection payments will commence. Pursuant to 11 U.S.C. 506(a), the court must determine the value of the property and divide the creditor's claim into a secured claim equal to the value of the property and an unsecured claim for the balance. The date at which the value of the property is first determined and from which payments begin can have a substantial impact on the creditor's claim and the total amount of adequate protection payments that it will receive during the case. The date is subject to a variety of interpretations, the most commonly utilized are: (i) The petition date; (2) the date the motion is filed; and (3) the date of the hearing. The petition date appears to be the majority view. Orix Credit Alliance, Inc. v. Delta Res., Inc. (In re Delta Res., Inc.), 54 F.3d 722 (Hlth Cir.), cert. denied, 576 U.S. 980 (1995); In re Duval Manor Assocs., 191 B.R. 622 (Bank. E.D. Pa. 1996); In re Carson, 190 B.R. 917, 929 (Bankr. N.D. Ala. 1995); In re Addison Props. Ltd. P'ship, 185 B.R. 766 (Bankr. N.D. Ill. 1995); In re Thomas, 177 B.R. 750 (Bankr. S.D. Ga. 1995); In re Johnson, 165 B.R. 524 (Bankr. S.D. Ga. 1994); In re Dynaco Corp., 162 B.R. 389, 395 (Bankr. D.N.H 1993); In re Reddington/Sunarrow, Ltd. P'ship, 119 B.R. 809 (Bankr. D.N.M. 1990); In re Ritz-Carlton of D.C., Inc., 98 B.R. 170 (Bankr. S.D.N.Y. 1989); In re Weyland, 63 B.R. 854 (Bank. E.D. Wis. 1986); In re Johnson, 471 B.R. 204 (Bankr. W.D. Wis. 1985); In re Datair Sys. Corp., 42 B.R. 241 (Bankr. N.D. Ill. 1984); In re Sun Valley Ranches, Inc., 38 B.A. 595 (Bankr. D. Idaho 1984); In re Ausherman, 34 B.R. 393 (Bankr. N.D. Ill. 1983); In re Born, 10 B.R. 43 (Bankr. S.D. Tex. 1981). The following cases utilize the date a motion is filed as the date to value the collateral. In re Best Prods. Co., 138 B.R. 155, 157 (Bankr. S.D.N.Y. 1992); In re Continental Airlines, Inc., 146 B.R. 535, 540 (Bankr. D. Del. 1992); In re Landing Assocs., Ltd., 122 B.R. 288 (Bankr. W.D. Tex. 1990) (established the concept and the term "snap shot valuation"); In re Wilson, 70 B.R. 46 (Bankr. N.D. Ind. 1987); In re Haiflich, 63 B.R. 314, 316 (Bankr. N.D. Ind. 1986); In re Hinckley, 40 B.R. 679, 681-82 (Bankr. D. Utah 1984). One of the justifications for using the date the motion is filed is that it encourages a secured creditor to act promptly. Another is that the creditor is not entitled to adequate protection until it is requested by the filing of an appropriate motion. The failure of a creditor to act promptly may adversely effect the amount of the creditor's allowed secured claim and the amount of adequate protection that the creditor is afforded. A creditor that waits several months before filing a motion requesting relief creates an awkward situation. If the court establishes value as of the petition date, it is faced with the prospect of ordering catch up adequate protection payments that the debtor may not be able to make or that would otherwise adversely affect the reorganization. To avoid this problem, some courts time valuation as of the date the motion is filed which in turn reduces the amount of the allowed claim

and the amount of adequate protection payments afforded during the pendency of the case. In re Adams, 2 B.R. 313 (Bankr. M.D. Fla. 1980). Valuation is integral to obtaining adequate protection. "In order to determine whether there is a need for adequate protection, and if so, the extent to which adequate protection is required, valuation of the collateral is required, both to determine the extent of the creditor's interest subject to protection and to determine the extent to which that interest has declined or will decline in value." Eugene R. Wedoff, The Valuation of Collateral In Bankruptcy: A Framework (1999) (unpublished manuscript available from American Bankruptcy Institute). Section 506(a) provides that value is determined in light of the purpose of the valuation and the intended disposition or use of the property. If the property is to be retained, it is valued at replacement value for confirmation purposes. Associates Commercial Corp. v. Rash, 520 U.S. 953, 117 S. Ct. 1879, 1882, 138 L. Ed. 2d 148 (1997), does not necessarily mandate the same valuation in the adequate protection context, according to a number of courts, nor does it establish the methodology to be utilized to arrive at that value. What replacement value means at an adequate protection hearing is the subject of numerous articles and opinions. Among the valuation methodologies in the cases reported since Rash are: (i) Retail value; (ii) average between retail and wholesale values; (iii) market value; and (iv) the flexible or caseby-case approach. The claims of an undersecured creditor having been established for adequate protection purposes, the issue then arises whether the claims are fixed for all purposes without further valuation, for example, at confirmation. There is much disagreement on this issue. The reported decisions reveal a variety of approaches to valuation and adequate protection, among them: (i) single valuation; (ii) dual valuation; (iii) continuous valuation; and (iv) snapshot valuation. This article addresses two of these methods, single valuation and dual valuation. The single valuation method not only establishes the value of the property, it also fixes the allowed secured, and the allowed unsecured claim for all purposes. The collateral is valued, typically as of the petition date, and at confirmation the adequate protection payments are subtracted from that value to establish the amount of the allowed secured claim which must be paid under the confirmed plan. Under the dual valuation method the value of the property is determined at two points in time. It is first determined early in the case for the purpose of providing adequate protection. It is then valued again at confirmation. While the courts and secondary materials discuss a second valuation as if it actually occurs, it has been my experience that it does not happen unless the creditor demands it. Some opinions discuss a second valuation at confirmation as if different results are Being to be obtained because one hearing was conducted for the purpose of adequate protection and the other at confirmation-as if there was no linkage between the two valuations. This makes little sense. The only justification for any separate valuation methodology or difference in outcome would be

if the intended use or disposition of the property changed and the change would require a different result. If the creditor has sought and obtained adequate protection against a decline in value due to depreciation and if the protection afforded the creditor matched the decline in value, a second valuation would produce a value equal to the first valuation, less the adequate protection paid to the creditor. Inasmuch as all of the reported cases, when considering confirmation, apply adequate protection payments made to an undersecured creditor to its allowed secured claim, it serves no purpose to do the math again. The only context in which a second valuation is going to come up is upon the complaint of the creditor that believes the adequate protection payments were inadequate and it wants a super priority administrative expense claim, or to have confirmation denied. In a great number of valuation/adequate protection cases the issue is not so clearly the value of the property itself or even adequate protection payments to protect against a decline in value. Rather, there is a battle over the pot of cash that has developed since the petition, for example, from rents generated by anapartment complex. The argument then is whether the cash is part of the property. In this situation, value must be determined more than once because the value of the collateral is a moving target between filing and confirmation. In the context of property, depreciating over a fixed economic life, that the debtor seeks to retain, none of the multiple valuation approaches makes much sense, especially after Rash. An initial valuation of claims for adequate protection purposes should not differ from valuation of claims at confirmation, after the application of adequate protection payments, because the standard should be the same. The following examples illustrate how different valuation dates impact adequate protection and the amount of secured debt that must be dealt with at confirmation. November 15, 2000 - The Filing Date Amount due Creditor Debtor's estimate of value of equipment Creditor's estimate of value of equipment $600,000.00 $400,000.00 $458,300.00

December 19, 2000 Creditor Files Motion For Relief From Stay Or Alternatively Adequate Protection; Hearing On January 5, 2001 Monthly Adequate Protection Payment Ordered, Beginning January 2001 $20,000.00

Motion To Determine Secured Status Held In March 2001 Determination of Value As Of The Filing Date Allowed Secured Claim Allowed Unsecured Claim Confirmation In February 2002 Amount of allowed secured claim Less Adequate Protection Payments $429,150.00 $170,850.00 $429,150.00

through February 2002 $280,000.00 Amount of allowed secured claim on effective date $149,150.00 Amount of allowed unsecured claim on effective date $170,850.00

The Effect At Confirmation Of Valuation As Of The Date The Motion For Relief From Stay Is Filed Amount of allowed secured claim $409,150.00 Less Adequate Protection Payments through February 2002 $260,000.00 Amount of allowed secured claim on effective date $149,150.00 Amount of allowed unsecured claim on effective date $190,850.00

The Effect At Confirmation Of Valuation As Of The Date The Hearing On The Motion For Relief From Stay Is Heard. Amount of allowed secured claim $389,150.00 Less Adequate Protection Payments through February 2002 $250,000.00 Amount of allowed secured claim on effective date $149,150.00 Amount of allowed unsecured claim on effective $210,850.00 date CONCLUSION When adequate protection is confined to compensating an undersecured creditor for depreciation there appears to be little, if any, justification for not using the single valuation method and determining value and fixing claims of an undersecured creditor as of the petition date.