                              In the

United States Court of Appeals
                For the Seventh Circuit

Nos. 08-2736, 08-2751, 08-2752, 08-2824 & 08-2905

U NITED A IR L INES, INC.,
                                                   Plaintiff-Appellee,
                                                    Cross-Appellant,
                                  v.



R EGIONAL A IRPORTS IMPROVEMENT
C ORPORATION AND UMB B ANK, N.A.,

                                             Defendants-Appellants,
                                                   Cross-Appellees.


            Appeals from the United States District Court
        for the Northern District of Illinois, Eastern Division.
        Nos. 07 C 5888 & 5890—Harry D. Leinenweber, Judge.



        A RGUED A PRIL 16, 2009—D ECIDED M AY 5, 2009




 Before E ASTERBROOK, Chief Judge, and B AUER and
M ANION, Circuit Judges.
  E ASTERBROOK, Chief Judge. When United Air Lines left
bankruptcy, its plan of reorganization marked some
issues for later resolution. One was how much United
2         Nos. 08-2736, 08-2751, 08-2752, 08-2824 & 08-2905

owes to lenders that put up the money for improve-
ments at several air terminals. We concluded that the
transaction supplying the funds used to improve United’s
space at Los Angeles International Airport should be
treated as a secured loan rather than as a lease. United
Airlines, Inc. v. U.S. Bank N.A., 447 F.3d 504 (7th Cir. 2006),
applying the approach of United Airlines, Inc. v. HSBC Bank
USA, N.A., 416 F.3d 609 (7th Cir. 2005). As a result, United
must pay the lenders the full value of the assets that serve
as security; any excess is unsecured debt. 11 U.S.C.
§§ 506(a), 1129(b)(2)(A). United’s plan of reorganization
provides that the valuation decision may be made after
confirmation, and that United then will pay accordingly.
  Valuation would be straightforward if there were a
market for improved space at airports. An asset’s value
depends on the price that could be agreed by willing
buyers and sellers negotiating for a replacement. See
Associates Commercial Corp. v. Rash, 520 U.S. 953 (1997). But
there is no liquid market for this asset. Every airport has
different forces of supply and demand, and United leases
rather than owns space at airports. Although some
carriers may sublease space to others, the record does not
contain evidence of the prices at which these transac-
tions occur. So the bankruptcy court decided to value
the collateral by a discounted-cash-flow analysis. It deter-
mined that 345,167 square feet of improved space are
subject to the security agreement and set an annual value
of $17 per square foot for that space as of 2004. The court
projected increases in these rents at a rate reflecting
experience in the business, added up the imputed
rentals through 2021 (when the loan comes due), and
Nos. 08-2736, 08-2751, 08-2752, 08-2824 & 08-2905             3

discounted the result at 10% per annum. That produced
a present value of roughly $35 million for the lenders’
security. United owes the lenders roughly $60 million, so
$25 million was treated as unsecured debt and written
down according to the plan of reorganization. The
district judge affirmed. 2008 U.S. Dist. L EXIS 48738 (N.D. Ill.
June 25, 2008).
   Both the lender (the Regional Airports Improvement
Corp. or RAIC ) and the Trustee (UMB Bank) for the in-
vestors who put up RAIC ’s money, challenge every step
of the bankruptcy court’s procedure. (We refer to RAIC
and the Trustee collectively as “the Lenders.”) The Lenders
also contend that they did not receive appropriate “ade-
quate protection” payments under 11 U.S.C. §363 to
compensate for the diminution in the collateral’s value
while the litigation continued. That argument is a
nonstarter, because it conflicts with the confirmed plan
of reorganization. Whatever rights the Lenders may
have had under §363 had to be liquidated as part of the
plan. All that matters now is whether the bankruptcy
court has implemented the plan correctly. We can be
similarly brief in dealing with the Lenders’ contention
that the collateral includes all of Terminals 7 and 8, which
United uses. The bankruptcy court’s negative finding
is not clearly erroneous.
  Two questions remain: what is the annual rental rate, and
what is the appropriate discount rate? The bankruptcy
court used as the rental rate the price that Los Angeles
Airport charges United (and other airlines) for space in
the terminals. It derived a discount rate by adding the
4         Nos. 08-2736, 08-2751, 08-2752, 08-2824 & 08-2905

Lenders’ proposed rate to United’s proposed rate, and
dividing by two. Neither of these decisions is sound. We
start with the implicit annual rental per square foot.
   United contends, and the bankruptcy judge found, that
$17 per square foot per year is the market rate for
terminal space in Los Angeles because that is what a
willing seller (the airport) charges to willing buyers (the
airlines). The Lenders respond that this is not a “market”
rate but reflects a discount that the airport extended in
the years before the 1984 Olympics to persuade air
carriers to make investments, and that the airport prom-
ised to continue over the long term by tying rentals to
its costs rather than permitting them to rise with
demand for air travel and terminal space. As the Lenders
see things, Los Angeles International Airport could
charge much more than $17 per square foot because the
demand for air travel (and thus for gates) has gone up,
while the airport has been unable to expand. This is a
seller’s market—or could be, if the airport were allowed
by its contracts to take advantage of the air carriers’
demand—and the Lenders say that they, as secured
creditors, are entitled to a higher price even if the airport
authority has disabled itself from increasing rents to
market levels.
  A bankruptcy judge might have accepted the Lenders’
argument on this score, but this judge did not commit clear
error (or abuse his discretion) in preferring the evidence
of actual transaction prices over an argument based on
beliefs about what prices could have been. Real transactions
are a vital anchor in litigation. There is no “just price” for
Nos. 08-2736, 08-2751, 08-2752, 08-2824 & 08-2905         5

any asset, and a court is entitled to reject an effort to
show that willing buyers and sellers are “wrong” in
valuing a particular asset.
  Still, it is essential to understand what the price of
$17 per square foot represents. It is a price for unim-
proved terminal space. Air carriers build out terminals
and gates to their own specifications. The airport
promised in the leases not to increase rent to reflect the
value of the improvements made by the air carriers.
(No tenant is willing to pay twice for the same improve-
ments—once to have them built, and a second time to
the landlord through rent reflecting the value of the
improved space.) So the annual rent reflects the value of
basic space in the Los Angeles terminals. Yet the Lenders’
security is in the improved space. A price for unimproved
space does not measure the value of the collateral. If the
Lender foreclosed and took over the space, it could rent
the gates to United or some other airline at more than
$17 a square foot—at perhaps four times that much, to
go by prices at the airport’s one terminal that leases fully
built-out gates. (More on this below.)
   If United had leased bare ground and built a terminal
there from scratch, no one would say that the terminal’s
value is measured by the rental price for the underlying
land. That, however, is fundamentally what the bank-
ruptcy court did here. The Lenders have been told that
their collateral is worth no more than if United had not
made the improvements. If the terminal were unimproved,
it would have a capital value of $35 million (on the bank-
ruptcy court’s methodology); after United borrowed
6        Nos. 08-2736, 08-2751, 08-2752, 08-2824 & 08-2905

$75 million to make improvements, the improved space
was still valued at $35 million. (The original loan was
$75 million; United repaid about $15 million before the
bankruptcy began.) But, if United was rational, it would
not have put in $75 million of improvements unless it
increased the space’s value by at least that much—making
it worth $110 million or more. Any valuation method
that treats improvements as worthless can’t be appropriate.
  United has two responses. One is that the improve-
ments were made more than a decade ago, and that like
other capital investments they wear down. That’s true
enough; the improved terminal may be worth less than
$110 million today. But the improvements surely
have not depreciated to a value of zero. United’s second
response is that it pays $17 a square foot not only for
the space subject to the Lenders’ security interest, but
also for other space that United occupies at the airport.
This must mean that the $17 is the value of improved
space. That understanding assumes, however, that the
other space was built out at the airport’s expense rather
than United’s. As we read the record, however, United
improved all of the space it occupies—not all with the
money furnished by these Lenders, to be sure, but the
improvements were at United’s expense. Other air carriers,
too, have paid for improvements. If this is so, then the
$17 rent per square foot in 2004 is for unimproved space,
as the leases promised carriers. (United has not argued
that the airport is violating its contractual commitment
to set rents based on the value of bare rather than im-
proved terminals.)
Nos. 08-2736, 08-2751, 08-2752, 08-2824 & 08-2905             7

  One telling bit of evidence that the $17 rental reflects
basic rather than improved space is the price charged by
a consortium of airlines that operates the airport’s Termi-
nal 2, which the parties call LAX2. The consortium’s mem-
bers use some of the terminal’s 11 gates and rent others
at a price that in 2004 was $63 per square foot per year.
The bankruptcy judge and district judge thought that
the Trustee, were it to take over United’s gates and rent
them out, could not get as much. They gave this explana-
tion:
   [The Trustee’s] expert concluded that the market
   rental established by LAX2 was $63 per square
   foot. The Bankruptcy Court did not accept the
   expert’s conclusion, and found that “it was inap-
   propriate to use the net revenues as a measure of
   market rent” and that there was no evidence
   submitted of what internal rate of return a hypo-
   thetical LAX2 operator would require. The Court
   also found that there were significant gaps identi-
   fying projected revenues and expenses which
   would make a square footage rental determina-
   tion highly speculative. While the Court agrees
   with the Bankruptcy Court on these criticisms, the
   Court finds that the most persuasive reason for
   discounting the LAX2 model as a comparable is
   scaling: the [collateral] facilities include at most
   7 gates out of the 20 gates in United’s terminal
   facilities (United claims it is only 4 gates). The ratio
   of costs to revenue in operating a few gates in a
   terminal would not be the same as the ratio in
   operating an entire terminal as is the case with
8           Nos. 08-2736, 08-2751, 08-2752, 08-2824 & 08-2905

    LAX2.  Would a bidder on the . . . facilities upon
    which are located either 4 gates out of 20 (United)
    or 7 out of 20 ([the Lenders]) pay the same amount
    as a bidder who would acquire 20 gates if the
    entire United leasehold was for sale? The answer
    is obviously no.
2008 U.S. Dist. L EXIS 48738 at *9–*10. Neither the bank-
ruptcy judge nor the district judge explained why “the
ratio of costs to revenue” or an owner’s target internal rate
of return affects an asset’s market price. An operator
(airline or Trustee) would not charge less than avoidable
cost; it could do better by giving the space back to the
airport authority. But how much more it can get depends
not on some ratio but on the demand for the space and on
the price that its competitors charge. If, as the Lenders
contend, all gates at Los Angeles are in use and building
more is a protracted endeavor, then the price depends
entirely on what airlines will pay: current owners will
receive an economic rent. (An economic rent is the
portion of the price, in excess of the seller’s cost, that
a good fetches because its supply is inelastic, a good
description of gates at Los Angeles International Airport.)
A potential to command an economic rent is part of the
value of the Lenders’ collateral.
  Now it may be that it would be more costly for the
Trustee (after foreclosure) to manage four, or seven, gates
in United’s terminals than it is for the consortium to
manage all 11 gates at LAX2. If so, even though the price
that air carriers would pay is apt to be in the same range,
the net realized by the owner might be smaller. This
Nos. 08-2736, 08-2751, 08-2752, 08-2824 & 08-2905         9

possibility, however, does not justify disregarding the
fact that air carriers willingly pay $63 per square foot
for space at Los Angeles International Airport, the only
estimate in the record of improved space’s going price.
That the Trustee’s net may be somewhat less than the
LAX2 consortium’s hardly justifies using the price for un-
improved space instead. Nor can the $63 figure be
thrown out the window because the LAX2 consortium
provides some services to its customers that the Trustee, as
operator of United’s space, might not provide. The bank-
ruptcy court did not attempt to determine how much of
the $63 is attributable to these services, and it is most
unlikely that they account for half of the price.
  It does not matter whether the Trustee could lease
United’s gates for $63 a foot or only $40. Any potential
rental price higher than $30 would make the collateral
worth at least $60 million, and thus make the loan fully
secured, even with the 10% discount rate that the bank-
ruptcy court selected. The data from LAX2 show that
United’s space could be leased to other air carriers for
at least $30 a foot. The Lenders therefore are entitled to
collect 100¢ on the dollar, plus interest.
   What is more, we conclude that the 10% discount rate
is too high. The Lenders’ expert chose 8% because it is the
rate of return that Los Angeles International Airport
itself pays on general revenue bonds, which are unse-
cured. United’s expert chose 12% as the rate of return that
debt investors in the air transportation business would
demand, given the risks of that business, which is volatile.
The bankruptcy judge added the two estimates and
divided by two. An arbitrator might choose such a method,
10       Nos. 08-2736, 08-2751, 08-2752, 08-2824 & 08-2905

and perhaps a jury would do so behind closed doors, but
a judge should choose the right discount rate rather than
split the difference between the parties. What if United’s
estimate had been 20%, or the Lenders’ estimate 3%?
  The risks of the air terminal business depend in part on
the fate of air carriers. When Eastern Airlines failed, two
entire terminals at Hartsfield Airport in Atlanta were
shuttered, and the airport did not return to full opera-
tions for almost a generation. But for a long time Los
Angeles International Airport has had less capacity than
the airlines prefer. Gates are fully used; takeoff and
landing slots are limited. As far as this record shows, no
gates at the airport are idle today—despite the fluctuating
fortunes of air carriers—and none has been idle for a long
time. Airlines have been clamoring for gates. The airport
is building a new 10-gate terminal, the first addition
since the early 1980s, that is projected to be ready in 2012.
That implies that being the proprietor of terminal space
in this airport is not particularly risky, and that secured
debt investors in United’s space would not demand more
than 8%. Real prices are much more informative than
lawyers’ talk. It would be good to know what investors
were willing to accept in 2004 (or today) on secured loans
to Los Angeles International Airport, or its air carriers
borrowing to improve their space, but it is unnecessary
to track down that detail. The fact that the airport is
operating at capacity, and can raise money at 8% with-
out giving security, is all we need to know to conclude
that the discount rate cannot exceed 8%.
  In a discounted-cash-flow analysis, the discount rate
has a powerful effect on the present value. See Interna-
Nos. 08-2736, 08-2751, 08-2752, 08-2824 & 08-2905       11

tional Federation of Accountants, Project Appraisal Using
Discounted Cash Flow (2007); Aswath Damodaran, Invest-
ment Valuation: Tools and Techniques for Determining the
Value of Any Asset (1996). A lump sum of $146 million,
payable in 2021, is worth $35 million in 2006 when dis-
counted to present value at 10% per annum. (The bank-
ruptcy court’s actual calculation is more complex,
because the collateral would have been rented over time
rather than sold for a lump sum, but we simplify.) The
same $146 million in 2021 would have a present value
of $46 million in 2006 at an 8% discount rate, and
$27 million at 12%. Thus simply changing the discount
rate from 10% to 8% would mean that an extra
$11 million of the loan is secured, even holding the rental
rate at $17 per square foot. With the discount rate at 8%,
a rental of roughly $23 per square foot is enough to
make the Lenders fully secured. Because improved space
in Terminal 2 fetches almost three times the price needed
to make these loans against space at Terminals 7 and 8
fully secured, the Lenders are entitled to a full recovery.
  The judgment is reversed, and the case is remanded
for further proceedings consistent with this opinion.




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