

April 3, 1995
                United States Court of Appeals                            United States Court of Appeals
                    For the First Circuit                                For the First Circuit
                                         

No. 94-2025

           IN RE WINTHROP OLD FARM NURSERIES, INC.,

                           Debtor.

                                         

              WINTHROP OLD FARM NURSERIES, INC.,

                          Appellant,

                              v.

         NEW BEDFORD INSTITUTION FOR SAVINGS, ET AL.,

                          Appellees.

                                         

         APPEAL FROM THE UNITED STATES DISTRICT COURT

              FOR THE DISTRICT OF MASSACHUSETTS

        [Hon. Richard G. Stearns, U.S. District Judge]                                                                 

                                         

                            Before

                   Selya, Boudin and Stahl,
                       Circuit Judges.                                                 

                                         

                         ERRATA SHEET                                     ERRATA SHEET

Please make  the following change to  the opinion  issued on March
22, 1995.

      Page 3, first full paragraph, line 3 - change "far" to
      "fair"

                United States Court of Appeals                            United States Court of Appeals
                    For the First Circuit                                For the First Circuit
                                         

No. 94-2025

           IN RE WINTHROP OLD FARM NURSERIES, INC.,

                           Debtor.

                                         

              WINTHROP OLD FARM NURSERIES, INC.,

                          Appellant,

                              v.

         NEW BEDFORD INSTITUTION FOR SAVINGS, ET AL.,

                          Appellees.

                                         

         APPEAL FROM THE UNITED STATES DISTRICT COURT

              FOR THE DISTRICT OF MASSACHUSETTS

        [Hon. Richard G. Stearns, U.S. District Judge]                                                                 

                                         

                            Before

                   Selya, Boudin and Stahl,
                       Circuit Judges.                                                 

                                         

Stephen E.  Shamban with whom Ann  Brennan and  Stephen E. Shamban                                                                              
Law Offices, P.C. were on brief for appellant.                         
Richard M.  Peirce with whom Roberts, Carroll, Feldstein &amp; Peirce,                                                                              
Inc. was on brief for appellees.            

                                         
                        March 22, 1995
                                         

          STAHL, Circuit Judge.   Chapter 11 debtor  Winthrop                      STAHL, Circuit Judge.                                          

Old  Farm Nurseries, Inc.  ("Winthrop"), appeals the district

court order  affirming the bankruptcy  court's decision that,

to determine  the status of the claim  of undersecured junior

mortgagee  New  Bedford  Institution  for   Savings  ("NBIS")

pursuant to 11 U.S.C.   506(a), Winthrop's real property (the

"Property")  should be valued at  its fair market  value.  We

affirm.

                              I.                                          I.                                            

                          BACKGROUND                                      BACKGROUND                                                

          Winthrop   operates  a   retail  garden   shop  and

commercial landscaping business on  the Property, located  at

462 Winthrop Street in  Rehoboth, Massachusetts.  On February

2, 1993, Winthrop  filed a petition for  relief under Chapter

11 of the  Bankruptcy Code (the  "Code").  On July  16, 1993,

Winthrop   filed  its  Disclosure   Statement  and   Plan  of

Reorganization (the "Plan").  The Plan provides that Winthrop

will  retain all of its assets except for the Property, which

is to be transferred to a new entity apparently controlled by

Winthrop's principal,  which will  in turn lease  it back  to

Winthrop.  Thus, under the Plan, Winthrop effectively retains

control of the Property and its use.

          The Property  is encumbered by a  first mortgage in

the  amount of $287,000 held by  Northeast Savings, F.A., and

by tax liens of approximately $20,000.  NBIS, the holder of a

                             -2-                                          2

junior  mortgage  on  the  Property,  is  owed  approximately

$576,000.   The parties stipulated to a liquidation value for

the Property of $300,000 and a fair market value of $400,000.

Winthrop's Plan would transfer the Property to the new entity

free  and clear of all liens except for the Northeast Savings

mortgage.  The Plan  would "strip down" the NBIS  mortgage to

the liquidation  value of the Property,  leaving NBIS's claim

entirely  unsecured.  The  Plan proposes  a payout  of twenty

cents on  the dollar  over a  four-year  period to  unsecured

creditors,    whose    claims,   including    NBIS's,   total

approximately $756,761.

          NBIS  objected  to  the  Plan,  claiming  that  the

Property  should   be  valued  at  fair   market  value,  not

liquidation  value.  If the Property is valued at fair market

value,  NBIS  would have  a secured  claim  in the  amount of

approximately  $100,000,  with  the  remainder  of its  claim

unsecured.

          The  bankruptcy  court,  citing  a  line  of  cases

holding  that  fair  market or  going  concern  value is  the

appropriate standard in valuing  collateral that a Chapter 11

debtor proposes to retain and  use, granted NBIS's motion and

valued  the  Property  at   $400,000.    The  district  court

affirmed, and Winthrop now appeals.

                             II.                                         II.                                            

                      STANDARD OF REVIEW                                  STANDARD OF REVIEW                                                    

                             -3-                                          3

          "In  an  appeal from  district  court  review of  a

bankruptcy  court   order,   we  independently   review   the

bankruptcy court's decision, applying the `clearly erroneous'

standard  to   findings  of  fact  and  de   novo  review  to

conclusions of law."  Grella v. Salem Five Cent Sav. Bank, 42                                                                     

F.3d 26,  30 (1st Cir. 1994).   Thus, our review  is de novo.

The bankruptcy court's interpretation  of   506(a) presents a

question  of  law.   Its application  of  the statute  to the

particular facts of this  case poses a mixed question  of law

and fact,  subject to the clearly  erroneous standard, unless

the  bankruptcy  court's  analysis  was  "infected  by  legal

error."    Williams v.  Poulos, 11  F.3d  271, 278  (1st Cir.                                          

1993).

                             III.                                         III.                                             

                          DISCUSSION                                      DISCUSSION                                                

          Section 506(a) governs the determination of whether

any portion of a  creditor's claim should be classified  as a

secured claim:  

          (a)  An  allowed  claim  of   a  creditor
          secured  by a lien  on property  in which
          the estate  has an  interest, or  that is
          subject  to setoff  under section  553 of
          this  title, is  a secured  claim to  the                                                               
          extent  of the  value of  such creditor's                                                               
          interest in the estate's interest in such                                                               
          property, or  to the extent of the amount                              
          subject  to setoff, as  the case  may be,
          and is  an unsecured claim to  the extent
          that   the   value  of   such  creditor's
          interest  or  the  amount  so  subject to
          setoff  is less  than the amount  of such
          allowed  claim.    Such  value  shall  be                                                               

                             -4-                                          4

          determined in light of the purpose of the                                                               
          valuation and of the proposed disposition                                                               
          or  use   of   such  property,   and   in                                                   
          conjunction  with  any  hearing  on  such
          disposition or use or on a plan affecting
          such creditor's interest.

11  U.S.C.   506(a) (emphasis  added).  The  statute does not

direct courts to choose  any particular valuation standard in

a  given  type  of case.    As  evidenced  by the  emphasized

language   in  the   statute's   second  sentence,   Congress

apparently did  not intend  that  courts would  use either  a                               

liquidation  or  fair  market  value   standard  exclusively,

envisioning instead a flexible approach by which courts would

choose  a  standard  to  fit  the  circumstances.    Relevant

legislative history buttresses this notion.  The House Report

states:

          Subsection  (a) of  [  506]  separates an
          undersecured  creditor's  claim into  two
          parts-he  has  a  secured  claim  to  the
          extent of the value of his collateral; he                                                           
          has an undersecured claim for the balance
          of  his   claim.     "Value"   does   not                                                               
          necessarily  contemplate  forced sale  or                                                               
          liquidation value of the  collateral; nor                                                               
          does it imply a full going concern value.                                                               
          Courts will  have to determine value on a                                                               
          case-by-case  basis, taking  into account                                                               
          the facts of each  case and the competing                                                               
          interests in the case.                                           

H.R.  Rep.  No.  595,  95th  Cong.,  1st  Sess.  356  (1977),

reprinted in 1978 U.S.C.C.A.N.  5787, 6312 (emphasis  added).                        

The  Senate  Report's  commentary  on     506  offers  little

insight, but its commentary on   361 -- the Code section that

provides   for  adequate   protection  payments   to  secured

                             -5-                                          5

creditors in  some circumstances -- is  further evidence that

Congress  intended   that   courts  would   sometimes   value

collateral at something greater than its liquidation price:

               Neither  is  it  expected  that  the
          courts  will construe  the term  value to
          mean,   in   every   case,  forced   sale
          liquidation value or  full going  concern
          value.   There  is wide  latitude between
          those two extremes  although forced  sale                                                               
          liquidation value will be a minimum.                                                         
               In any particular case, especially a                                                               
          reorganization case, the determination of                                                               
          which  entity should  be entitled  to the                                                               
          difference  between   the  going  concern                                                               
          value  and the liquidation  value must be                                                               
          based on equitable considerations arising                                                               
          from the facts of the case.                                                

S. Rep. No. 989, 95th Cong., 2d Sess. 54 (1978), reprinted in                                                                         

1978 U.S.C.C.A.N. 5787, 5840 (emphasis added).  Although this

commentary is not specifically  addressed to   506(a), it  is

nevertheless relevant,  since a valuation for    361 purposes

necessarily  looks to    506(a)  for  a determination  of the

amount  of   a  secured  claim.1     Indeed,  since  adequate

protection payments immediately deplete the estate's assets -

- even before it  is certain that a reorganization  plan will

be confirmed -- one would expect that the  valuation standard

used to determine whether  such payments are justified should

be extremely conservative.  See In re Case, 115 B.R. 666, 670                                                      

                                                    

1.  See United Sav. Ass'n of Tex. v. Timbers of Inwood Forest                                                                         
Assoc., 484  U.S. 365, 371-72 (1988)  (stating that statutory                  
construction is  a "holistic endeavor" and  defining value of
"entity's   interest  in   property"  entitled   to  adequate
protection  under    361 and 362 in light of meaning of value
of "creditor's interest" in property under   506(a)).

                             -6-                                          6

(Bankr. 9th Cir. 1990) (stating in dictum that in a valuation

for  adequate protection purposes,  "forced liquidation would

be  assumed  and  a  deduction for  selling  costs  would  be

logical").  Nevertheless,  the Senate language  suggests that

even in a    361 context, a  court might value  collateral at

something more than its liquidation value.

          We have  not previously  considered this issue.   A

number  of  courts, however,  including four  Circuit Courts,

have adhered to this clear expression of congressional intent

and declined to  value collateral that  a debtor proposes  to

retain  based  on a  hypothetical  foreclosure  sale.   These

courts reason that because  the reorganizing debtor  proposes

to retain  and use the collateral, it should not be valued as                                                            

if it were being liquidated;  rather, courts should value the

collateral  "in light of" the debtor's  proposal to retain it

and ascribe to it its going-concern or fair market value with

no deduction for hypothetical costs of sale.2

                                                    

2.  See,  e.g., In re McClurkin,  31 F.3d 401,  405 (6th Cir.                                           
1994)  (holding that   506(a)  "does not require  or permit a
reduction  in the  creditor's  secured claim  to account  for
purely  hypothetical costs  of sale"  of Chapter  13 debtor's
residence); Matter  of Rash,  31 F.3d 325,  329-31 (5th  Cir.                                       
1994) (holding that truck to be retained by Chapter 13 debtor
must  be  valued  at   replacement  cost  to  debtor  because
foreclosure value fails to  account for debtor's proposed use
of collateral);  Lomas Mortgage USA v. Wiese,  980 F.2d 1279,                                                        
1284-86 (9th  Cir. 1992) (holding  that second sentence  of  
506(a) precludes  deduction of hypothetical costs  of sale in
valuing Chapter 13 debtor's  real property to be  retained by
debtor), cert. granted and judgment vacated on other grounds,                                                                        
113  S. Ct.  2925  (1993) (remanding  for reconsideration  in
light  of Nobleman  v. American  Sav. Bank,  113 S.  Ct. 2106                                                      

                             -7-                                          7

          Other courts, however, have chosen to read   506(a)

as requiring in virtually all cases a valuation of collateral

limited to the net amount a secured creditor could recover if

it  seized or foreclosed on the collateral and disposed of it

in accordance with  applicable state law.3   These courts tie

                                                    

(1993));  In re  Balbus, 933  F.2d 246,  252 (4th  Cir. 1991)                                   
(same); In re Case, 115 B.R.  666, 670 (Bankr. 9th Cir. 1990)                              
(holding  that for  Chapter  12 plan  confirmation  purposes,
hypothetical costs  should not  be deducted from  fair market
value  in valuing collateral to be retained by debtor); In re                                                                         
Arnette, 156 B.R.  366, 368 (Bankr.  D. Conn. 1993)  (holding                   
that  motor  vehicle  to be  retained  by  chapter  13 debtor
"should be valued at the price the debtor could get for it in
a  free and open market, i.e.  its fair market value"); In re                                                                         
Green, 151 B.R.  501  (Bankr. D. Minn.  1993) (valuing car to                 
be retained  by  Chapter 13  debtor  at retail,  rather  than
wholesale  value);  Matter of  Savannah  Gardens-Oaktree, 146                                                                    
B.R. 306, 310 (Bankr. S.D. Ga. 1992) (using fair market value
to value apartment complex  in Chapter 11 adequate protection
context);  In re  Usry, 106  B.R. 759,  762 (Bankr.  M.D. Ga.                                  
1989)  (in light  of  fact that  Chapter  11 and  Chapter  12
debtors plan to retain  collateral to produce income, secured
claim equaled amount of  stipulated fair market value without
deduction  for  hypothetical liquidation  costs);  cf. In  re                                                                         
Davis, 14 B.R. 226  (Bankr. D. Me. 1981) ("Where  a confirmed                 
chapter 11  reorganization plan contemplates retention of the
collateral  by the  debtor for  use in  its ongoing  business
operations, collateral  .  . .  should be  ascribed its  fair
market  value[,]" but  reasonable costs  of sale  deducted in
valuing security interest) (Cyr, J.).  

3.  See, e.g., In re Demakes Enters., Inc., 145 B.R. 362, 365                                                      
(Bankr.  D. Mass.  1992)  (valuing meat  processing plant  at
liquidation  value); In re Ledgemere Land Corp., 125 B.R. 58,                                                           
61  (Bankr. D.  Mass. 1991)  (bank's mortgage  on  Chapter 11
debtor's  real property  that debtor  intended to  retain and
eventually develop "is worth  only what [property] will bring
at foreclosure"); In  re Robbins,  119 B.R. 1,  5 (Bankr.  D.                                            
Mass. 1990) (valuing Chapter 11  debtor's investment property
at foreclosure value); In  re T.H.B. Corp., 85 B.R.  192, 196                                                      
(Bankr. D. Mass. 1988) ("The fact that the  Debtor is a going
concern  is no reason to value the collateral under the going
concern standard  unless it  appears likely that  the secured
party will  actually receive  that value from  its collateral

                             -8-                                          8

their  interpretation  to the  first  sentence  of    506(a),

reasoning that even if the debtor proposes to retain and make

profitable  use   of  the  collateral   in  the   reorganized

enterprise,   the  statute   commands  a  valuation   of  the

"creditor's interest" in the property -- i.e., of the lien --                                                                      

and  that value can only  reflect what the  creditor would be

entitled to recover from  the collateral under non-bankruptcy

law.    Thus, if  the collateral  is  subject to  the Uniform

Commercial  Code, the creditor's  interest would reflect what

it could  recover from  a commercially reasonable  sale under

the U.C.C.;  if real  estate, then from  a foreclosure  sale,

perhaps with some value  added if the creditor has  the right

and the  wherewithal to bid-in, hold and  resell the property

on the open market.  See, e.g., In re Tenney Village Co., 104                                                                    

B.R. 562, 567 (Bankr. D.N.H. 1989) (valuing property  at fair

market value because  mortgage holder had  ability to bid  in

and obtain fair market value through later private sales); In                                                                         

re  Robbins,  119  B.R.   1,  5-6  (Bankr.  D.  Mass.   1990)                       

(recognizing  second  mortgage  holder's  bid-in  rights  but

declining to  ascribe any  value to them  where circumstances

make it "unreasonable to  expect" creditor to exercise them);

see generally James F.  Queenan, Jr., Standards for Valuation                                                                         

of  Security Interests  in Chapter  11, 92  Com. L.J.  18, 60                                                  

                                                    

through a pending sale.")

                             -9-                                          9

(1987) (real estate  mortgage holder's bid-in rights  "should

be valued as an inherent part of his property interest").

          We  are  persuaded that  the  first  line of  cases

correctly  interprets the statute.  This interpretation gives

meaning to both sentences of   506(a), and enables bankruptcy

courts  to exercise  the flexibility  Congress intended.   By

retaining collateral,  a Chapter  11 debtor is  ensuring that

the very event Winthrop proposes to use to value the property

-- a  foreclosure sale -- will  not take place.   At the same

time,  the debtor  should  not be  heard  to argue  that,  in

valuing the  collateral, the court should  disregard the very

event that, according to the debtor's plan, will take place -                                                            

- namely, the debtor's  use of the collateral to  generate an

income stream.   In ordinary circumstances  the present value

of  the income stream would be equal to the collateral's fair

market  value.   Under  such circumstances,  a court  remains

faithful  to  the  dictates  of     506(a)   by  valuing  the

creditor's  interest  in  the  collateral  in  light  of  the

proposed post-bankruptcy  reality:   no foreclosure sale  and

economic benefit  for the debtor derived  from the collateral

equal to or greater than its fair market value.  Our approach

allows the bankruptcy  court, using  its informed  discretion

and applying historic principles of  equity, to adopt in each

case  the   valuation  method  that  is   fairest  given  the

prevailing circumstances.

                             -10-                                          10

          The interpretation championed by the second line of

cases  renders  the second  sentence  of    506(a)  virtually

meaningless.  Moreover, it  would allow a reorganizing debtor

to  reap a windfall by stripping down the lien to liquidation

value  and  quickly selling  the  collateral  at fair  market

value, thus pocketing equity  that would have been completely

beyond reach save  for the filing of the bankruptcy petition.

Cf.  Butner  v.  United  States,  440  U.S.   48,  55  (1979)                                           

(bankruptcy  law should  "prevent  a party  from receiving  a

windfall merely by reason of the happenstance of bankruptcy")

(quotation  omitted).  It is true that the debtor's intention

to reorganize under  Chapter 11 is what  gives the collateral

its going-concern value.   And  while it is  also true  that,

absent a reorganization plan,  the creditor might not recover

the difference -- assuming that there is in fact a difference

-- between the  collateral's fair market value and the amount

recoverable  through  its  state  law rights,  we  would  not

characterize this additional recovery  as a "windfall" to the

creditor,  and  certainly  not  one that  will  spur  secured

creditors  to eschew their state law remedies and seek refuge

in the comfortable confines of the bankruptcy courts.

           We   find  that  the  bankruptcy  court  correctly

interpreted   506(a) as  according it flexibility in choosing

among possible  standards of valuation,  and properly applied

the statute to the  particular facts of this case.   Winthrop

                             -11-                                          11

proposes  in its Plan to  retain control of  the Property and

continue  using it in its nursery and landscaping business to

generate  income.    In  light  of  this  proposed  use,  the

bankruptcy court  committed no error in  valuing the Property

at its stipulated fair market value.

                             -12-                                          12

                             IV.                                         IV.                                            

                          CONCLUSION                                      CONCLUSION                                                

          For  the  foregoing  reasons,  the  order  of   the

district court is

          Affirmed.                      Affirmed                              

                             -13-                                          13
