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 recently 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!
[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 New Era Magazine
Myles M. Mattenson © 1998-2002
