United States: Fourth Circuit Approves Partial Dirt For Debt Plan

Last Updated: January 3 2018
Article by Richard A. Prosser

Do you want to own that rural timberland you financed a few years back? Well, what if I told you that not only are you taking ownership, but you're taking it in exchange for a credit of three times its appraised value? The reason is your borrower filed Chapter 11 bankruptcy and convinced the court that timber tract is prime for a new subdivision.

This nightmare scenario is a possible reality in the Eastern District of North Carolina, where "dirt-for-debt" plans are a common strategy of debtors' counsel. And, based on recent guidance from the Fourth Circuit Court of Appeals, you should not expect help on appeal if the trial court does not share your opinion of value.

The dirt-for-debt trend started from practical origins in the wake of the Great Recession, when developers were caught with a surplus of inventory. There was limited or no market for the flood of properties coming into bank REO departments. So, rather than force an auction or foreclosure for a fire sale price, debtors sought to transfer the property to the bank for fair market value. This is permitted under the "cram-down" provisions of the Bankruptcy Code.

Section 1129(b)(2)(A)(iii) allows payment of a creditor's claim through surrender of collateral. In sum, a debtor in the context of a Chapter 11 reorganization can compel a creditor to accept its collateral in full or partial satisfaction of its claim. What makes this treatment "fair and equitable" is the requirement that the surrendered property be the "indubitable equivalent" of the creditor's claim. This means that in situations where less than all of the creditor's collateral is surrendered, the assigned value must be certain to compensate the creditor for the credit the debtor receives in return.

On the surface, this sounds reasonable enough. The creditor is taking its collateral for value and the parties are avoiding the legal process of liquidation. In reality, however, it's not always as it seems. Dirt-for-debt is often employed strategically where the debtor believes it can put on a case for a value that exceeds the creditor's valuation. After all, if the objective was merely to monetize collateral, there are mechanisms to do so under the Bankruptcy Code. The parties are always free to construct a sale procedure.

The debtor, however, prefers to have the court assign a value based on an evidentiary hearing, where it believes it might obtain a more favorable outcome than what might be realized from a sale. And it's through this process that Cinderella meets her fairy godmother. Using expert testimony, the debtor makes the case that the property has substantially appreciated in value because the market has turned in favor of a new "highest and best use" for development.

Under the indubitable equivalent standard, anything less than certain should be rejected. This heightened standard of proof is the check to protect the creditor's interest and requires a conservative valuation. This is what distinguishes a dirt-for-debt analysis from an ordinary valuation analysis, where signs of ambiguity such as widely variant appraisals and disputed uses might be considered with less reservation.

The bankruptcy court in the Eastern District, however, has taken a softened view of this standard in recent rulings. The court references the standard's high bar, but then undertakes an indistinguishable valuation analysis, taking into account all evidence and competing opinions as to possible uses. In doing so, the court strips away the safeguard of certainty and functions, in a sense, as the appraiser itself. This approach has resulted in valuations at multiples of the creditor's appraisal.

In December, the Fourth Circuit reviewed one of these rulings for the first time in In re: Bate Land & Timber LLC. In this case, the debtor successfully convinced the bankruptcy court that vacant timberland should be valued for residential development. On appeal, the creditor argued that the disputed feasibility of this use and the related variance in appraisals could not satisfy the standard of indubitable equivalence. This was based on precedent in this and other jurisdictions finding widely variant appraisals constitute proof of uncertainty.

On appeal, the Fourth Circuit found that "application of the indubitable equivalence standard involves more flexibility than the term suggests" and that "a bankruptcy court, acting as a fact-finder with specialized expertise, is well-equipped to arrive at a valuation that represents the indubitable equivalent of a secured creditor's claim, in the face of disputed valuations." It further found that review on appeal is limited to a "clear error" standard, meaning the bankruptcy court's ruling is reviewed only for overt mistakes.

In sum, the Fourth Circuit refused to adopt a bright-line rule against dirt-for-debt approval and held that the bankruptcy court is sufficiently capable to assess the evidence before it, even in the face of widely disparate opinions of value. It further held that it would not second guess this determination except in the most egregious circumstances. Thus, though indubitable equivalence remains the black letter standard, the Fourth Circuit's ruling affords the bankruptcy court significant discretion in its consideration.

For creditors, the take away from this ruling is that the stakes are higher than ever to win the valuation battle before the bankruptcy court. This phase is critical since the appellate court is unlikely to disturb the outcome. Selection of capable counsel and credible experts are of the utmost importance. Creditors who fail to appreciate this might find themselves the owner of a can't-miss development opportunity . . . ahem, overvalued timberland.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Richard A. Prosser
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions