CHAPTER 13
BANKRUPTCY: HOW SECURE IS AN EQUIPMENT DISTRIBUTOR AS A SECURED CREDITOR
In these days of rising costs and
lower profit margins, some operators of coin laundries and dry cleaners
consider seeking relief in bankruptcy.
If the operator intends to continue the operation of the business and seek
the Bankruptcy Court's assistance in reorganization, protection is frequently
sought under Chapter 13 of the Bankruptcy Code.
Under a Chapter 13 plan of
reorganization, secured creditors are fully paid to the extent of the value
of their collateral and unsecured creditors receive a pro rata share of the
balance of monies available. If the
value of a secured creditor's collateral is less than the amount due the
creditor, the difference becomes an unsecured debt.
The period of time during which
the payments are made by a debtor to secured and unsecured creditors in Chapter
13 bankruptcy is governed by the Bankruptcy Code. Under the Code, the plan "may not
provide for payments over a period that is longer than three years, unless the
court, for cause, approves a longer period, but the court may not approve it if
it is longer than five years."
A Chapter 13 reorganization is
similar to that provided in Chapter 11; however, Chapter 13 is designed to
allow the small sole proprietor, for whom the reorganization process under
Chapter 11 may be too cumbersome or inappropriate, to obtain relief under the
Bankruptcy Code. There are limitations,
however, to those who may make use of the Chapter 13 provisions. Under the Bankruptcy Code, "the
availability of Chapter 13 is generally limited to an individual "with
regular income that owes, on the date of filing of the petition, noncontingent,
liquidated, unsecured debts of less than $250,000 and noncontingent,
liquidated, secured debts of less than $750,000 . . . ."
In the published decision of
Ardmor Vending Co. vs. Kim, 130 F.3d 863 (9th Cir. 1997), the Kims, operators
of a drycleaning business, filed a Chapter 13 bankruptcy petition. At the time of filing the Chapter 13
bankruptcy, the Kims owed Ardmor Vending Co., an equipment distributor, about
$98,000 which was secured by both the business equipment and the lease of the
premises. Ardmor Vending Co. had filed a
Uniform Commercial Code Financing Statement with regard to the drycleaning
equipment and also held an Assignment of Lease as Collateral Security executed
by the Kims and their lessor.
In the bankruptcy proceeding, the
Kims initially proposed to treat the company as secured only in the amount of
$34,000, the value of the business equipment if sold "off
location." The Kims thus proposed
to treat the balance of the indebtedness as an unsecured debt. Under the reorganization plan of the Kims
submitted to the Bankruptcy Court, however, the Kims planned to assume their
lease and continue to operate the business.
Ardmor objected to the plan,
contending that the company was fully secured and asserted that the Kims had
failed to take into account the company's security interest in their
lease. The Kims claimed that the lease
had no value because it provided for rent which was above market value.
During the course of bankruptcy
hearings, Ardmor "argued that the Kims had undervalued the collateral by
valuing the equipment and the lease separately, rather than as a so-called
`turn-key' package." The Bankruptcy
Court accepted the "Kims' `off location' value of the equipment, that is,
its value `on the street, not income producing, rather than `on location,' as
part of an income-producing going concern."
Ardmor appealed the decision of
the Bankruptcy Court to the Bankruptcy Appellate Panel which provides review of
Bankruptcy Court decisions by a panel of three bankruptcy judges. The Bankruptcy Appellate Panel, however,
affirmed the decision of the Bankruptcy Court, with one judge dissenting.
Ardmor then appealed to the
United States Court of Appeals for the Ninth Circuit. The Court of Appeals reversed the Bankruptcy
Court's decision, without dissent, and remanded [returned] the case to the
Bankruptcy Court for a determination of the on location, turn-key valuation of
the collateral. The Court held that when
a debtor intends to retain the property, rather than liquidate, "the
proper valuation is fair market value, not foreclosure value." The court stated:
"The Kims are
continuing to operate the business, not removing the equipment and selling
it. Consequently, the valuation should
have been based on the equipment's worth on location, not off location, taking
into account the fact that [the company holds] security interests in both
equipment and the lease."
The Ninth Circuit Court of
Appeals further concluded:
"Holding both
the lease and equipment gave [the company] a package that was worth more than
if the two were valued separately.
Selling the equipment alone (as an off location valuation implies), and
then selling the lease, as vacant premises with no improvements and no
equipment, is impractical and would not maximize the value of the
collateral."
The moral of the story? For operators, Chapter 13 bankruptcy may not
substantially lessen your debt. For
equipment distributors, it may be time to review the documents under which you
obtain a security interest in collateral.
The moral of the story for Ardmor
and this writer, who represented Ardmor in these proceedings? There is a reason why we have appellate
courts!
[Any reader desirous of a copy
of the opinion of the Ninth Circuit Court of Appeals decision in Ardmor vs. Kim
130 F.3d 863 (9th Cir. 1997) may visit the author’s website, www.coinlaundrylaw.com.
[This column is intended to provide general information only and
is not intended to provide specific legal advice; if you have a
specific question regarding the law, you should contact an
attorney of your choice. Suggestions for topics to be discussed
in this column are welcome.]
Reprinted from The Journal
Myles M. Mattenson © 2008
