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In Re WDH Howell, LLC, et al.2003 U.S. Dist., a district court reversed a bankruptcy court order permitting a Section 363 sale “free and clear” of liens and interests, because the sale price was not greater than the face amount of the encumbering mortgage, i.e., the face amount of the debt secured by the mortgage. The debtor obtained at auction a proposed sale price of $8.38 million for a property encumbered by a mortgage securing a debt of $11.88 million. The debtor contended that it lacked the cash flow necessary to service the mortgage and was unable to maintain the property, hence justifying its sale, and the bankruptcy court, satisfied, without other evidence, that the auction sale produced the best price, agreed with the debtor and approved the sale. The secured creditor appealed and the district court reversed. APPLICABLE CODE PROVISIONS The district court noted that: “Section 363(b) sale can be made ‘free and clear of any interest’ in the property of an entity other than the estate if: (1) applicable non-bankruptcy law permits sale of such property free and clear of such interest; (2) such entity consents; (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property; (4) such interest is in bona fide dispute; or (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.” (Emphasis by the court). The court noted that the parties agreed that subsections (1), (2), (4) and (5) of Section 363 were not at issue. Rather, the requirements of subsection (3) alone were in dispute and the “resolution of this dispute depends upon the meaning of ‘value’ in that section, an issue upon which courts have disagreed.” COMPETING THEORIES OF ‘VALUE’ The court summarized the two schools of interpretation of the meaning of “value.” “Some courts interpret value in Section 363(f)(3) to mean the “face amount” of the claim secured by the lien, i.e. the amount owed to the lien holder (“face value of the liens”). . . . Other courts have interpreted it to mean the economic value of the lien as determined by the fair market value of the property. . . . One court provided in explanatory example: “If the property to be sold has a fair market value of $100,000 and is subject to a lien securing a $150,000 claim, a court reading ‘value’ to mean that portion of the claim secured by property with an economic value would permit a sale for $100,000. A court reading ‘value’ to mean the full-face amount of the claim secured by a lien would only permit a sale for $150,000 or more. “We will refer to the first view as the ‘face value approach’ and the second view as the ‘economic value approach.’” The court then cited a half dozen cases decided by lower courts supporting the “face value” approach and a half dozen lower court cases supporting the “economic value” approach. None of the decisions were controlling. STATUTORY CONSTRUCTION The court noted that proponents of both approaches based their conclusions on a principle of statutory construction that “value” should have the same meaning in Section 363(f)(3) as it has in other code sections. While this is a recognized doctrine, it failed to resolve the dispute. Proponents of the “economic value” approach point to Section 506(a) in which a claim is determined to be secured “to the extent of the value of such creditor’s interest in the estate’s interests in such property” which is an economic value approach. On the other hand, proponents of the “face value” approach point out that whenever the code intends to signify “economic value,” it always refers to a secured party’s “interest,” e.g., in Section 361 (adequate protection), Section 506(a) (determination of secured status) and Section 1129(a)(7)(B) (appropriate treatment of a secured claim under a plan), whereas Section 363 simply refers to the “aggregate value of all liens” on the property and not the aggregate value of all “interests” on the property. This line of reasoning did not persuade the district court. It turned to another principle of statutory construction: construing a statute to avoid treating some of its language as superfluous. The court noted that if Section 363(f)(3) means “face amount” value, then Section 363(k) would be superfluous (providing that the secured creditor can bid the amount of its debtat the sale). But, the district court said: “We disagree with this reasoning; a creditor may have good reason not to bid on the property and instead avail itself of the creditor protections afforded under Chapter 11. . . . In the present case, for example, [the lien holder] does not wish to foreclose or bid on [this] environmentally contaminated property.” Proponents of the “face value” approach argue that if Section 363(f)(3) refers to “economic value,” then Section 363(f)(5) would be superfluous because it implicitly refers to Section 1129(b)(2) (providing that a secured creditor could be compelled to accept the economic value of its lien). The district court was unconvinced. “We disagree; Section 363(f)(5) would not become superfluous because it also applies to unsecured interests in property that could be reduced to a specific monetary value. In re Trans World Airlines, Inc., 322 F.3d 283, 289-91 (3d Cir. 2003) (distinguishing Section 363(f)(5) which applies to any interest in property from Section 363(f)(3) which applies specifically to liens). Accordingly, we disagree with the reasoning of both approaches in their applications of the canon to avoid surplusage.” The court then decided to “conduct our own analysis” employing different principles of statutory constructions, i.e., a “plain language” and “common sense” approach to interpreting the meaning of “value” for the purpose of Section 363(f)(3). The court noted that the code itself does not provide a definition of value. It decided to focus, logically, on the adjacent language requiring that the sale price be “greater than” the aggregate value of all liens on the property. Its analysis was as follows: “However, value in Section 363(f) cannot mean economic value if it is read in the context of the preceding term ‘greater than.’ Economic or ‘fair market’ value is ‘the amount at which property would change hands between a willing buyer and a willing seller.’ “Accordingly, Canonigo, 276 B.R. at 262-63, states ‘the sale price for overencumbered property can never be greater than the aggregate economic value of the liens on the property.’ The Canonigocourt provided an explanatory example: ‘If property encumbered by a senior lien securing a debt of $75,000 and a junior lien securing a debt of $50,000 is proposed to be sold for $100,000, the aggregate economic value of the liens is $100,000. If someone overbids and proposes to buy the property for $125,000, the aggregate economic value of the liens would increase to $125,000.’ “The sale price could be greater than the aggregate economic value of the liens on a piece of property only if the property was underencumbered, i.e. the sale price also exceeded the face value of the liens. Thus, in the Canonigoexample, ‘if the property were sold for $150,000, the aggregate economic value of the liens would still only be $125,000,’ because liens can never be worth more than their face value. “However, in those cases, the sale price would be less than, not greater than, economic value.” DISTRICT COURT’S CONCLUSION Finally, the district court reached its own conclusion as a result of its logical, “common sense” analysis, which was that, under the facts of the case, the sale could not be justified because the sale price was not greater thanthe value of the mortgage valued under either approach. The court stated that this conclusion is supported by the underlying purpose of a sale “free and clear” under Section 363(f): “This conclusion is consistent with the ‘general rule’ that ‘the bankruptcy court should not order property sold free and clear of liens unless the court is satisfied that the sale proceeds will fully compensate secured lien holders and produce some equity for the benefit of the bankrupt’s estate.’” ( Matter of Riverside Inv. P’ship, 674 F.2d 634, 638-41 (7th Cir. 1982).) Comment If, as this district court held, a Section 363 sale price must exceed the face value of encumbering liens, fewer such sales will be approved. Further, the likelihood will increase that secured creditors whose liens are not removed by a Section 363 sale will be granted relief from the automatic stay to conduct their own non-bankruptcy foreclosure sales. A possible justification for permitting a bankruptcy sale that does not fully satisfy the debt which a lien secures, while allowing the lien to attach to the proceeds as far as they go, might be that thereby the bankruptcy court retains a greater measure of control over the disposition of that asset, as part of the overall rehabilitation of the debtor. But the district court’s focus on the requirement of Section 363(f)(3) that the sale price be greater thanthe liens, however valued, would make the “economic value” approach difficult to justify when the face amount of the debt secured is greater than the sale price, because the economic value of the lien would never be greater thanthe sale price, and because the debtor’s estate would not share in any proceeds of the sale. Finally, it is hornbook law that the true value of property is what the marketplace says it is (willing buyer, willing seller), either by private purchase offer exposed to higher and better bids under a Section 363 sale or under a Section 363 auction sale. If the marketplace can trump other evidence of the value of the property, but cannot be used to measure the value of liens secured by the property, the somewhat anomalous result then is that market forces determine value of the debtor’sownership interest in the property but not the value of a secured creditor’slien encumbering the property. We know that Section 506(a) (determination of secured status) states that the value of a secured claim “shall be determined in light of the purpose of the valuation and the proposed distribution and use of the property.” But does this permit two different approaches to value (economic value for the debtor’s interest but face value for the lien holder’s interest) in the very same sale transaction? JOHN FRANCIS GOUGH is of counsel to Montgomery McCracken Walker & Rhoads and is a member of both its business department and its bankruptcy group. He concentrates his practice in business bankruptcies and reorganizations and in business and health-care transactions. He was board certfied in 1992 and recertified in 1998 in business bankruptcy by the American Board of Certification and can be reached at 215-772-7295 or [email protected].

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