In Re Heritage Highgate, Inc.: Timing Is Everything To Secured Creditors Facing Valuation Issues

On May 14, 2012, the United States Court of Appeals for the Third Circuit upheld a ruling by the Bankruptcy Court for the District of New Jersey that the fair market value of a creditor's collateral as of the plan's confirmation date is the proper method of valuing a secured creditor's claim pursuant to section 506(a) of the Bankruptcy Code. The Third Circuit also adopted a "burden-shifting framework," finding that a secured creditor will bear the ultimate burden of proving the extent to which its claims are secured pursuant to section 506(a).

Background

Debtors Heritage Highgate, Inc. and Heritage-Twin Ponds II, L.P. entered into a series of construction loan agreements to fund the development of a residential subdivision in Lehigh County, Pennsylvania, including: (i) a senior secured loan agreement with a group of banks, outstanding in the amount of $12 million as of the petition date, and (ii) a junior secured loan agreement with the Cornerstone Investors, outstanding in the amount of $1.4 million as of the petition date. Both groups of lenders' claims were secured by substantially all of the Debtors' assets, which consisted mainly of the residential subdivision.

After building and selling only a quarter of the planed units at the residential subdivision, the Debtors filed voluntary petitions for chapter 11 relief on January 20, 2009.

During a contested cash collateral hearing at the beginning of the cases, the Debtors submitted an appraisal of the fair market value of the residential subdivision that was based on two well-accepted appraisal methodologies. The Bankruptcy Court accepted the appraiser's fair market valuation of approximately $15 million, which exceeded the $13.4 million of secured debt outstanding as of the petition date.

Subsequently, the Official Committee of Unsecured Creditors filed a motion to value and determine the extent of the Cornerstone Investors' junior secured claims pursuant to section 506(a) of the Bankruptcy Code and Bankruptcy Rule 3012. The Committee argued that the Cornerstone Investors' secured claims should be valued at zero because interim sales had reduced the fair market value of the Debtors' residential subdivision from $15 million to approximately $9.54 million. This amount, the Committee asserted, would be insufficient to cover the approximately $12 million outstanding senior secured claims, and would render the Cornerstone Investors' claims unsecured.

The Cornerstone Investors objected to the...