September 14, 2009

In a recent decision, Judge Christopher S. Sontchi of the Delaware Bankruptcy Court concluded that "commercially reasonable determinants of value" as referenced in section 562 of the U.S. Bankruptcy Code for purposes of measuring damages resulting from the rejection of a repurchase agreement are not limited to the actual sale or market value of an asset but that a discounted cash flow valuation can also be utilized.  Also of note is the court's analysis of how to value a portfolio of assets in distressed market conditions.


Section 562 of the U.S. Bankruptcy Code, 11 U.S.C. 562, provides for the timing of damage measurements in relation with swap agreements, securities contracts, forward contracts, commodity contracts, repurchase agreements, and master netting agreements that are rejected or terminated in connection with a bankruptcy case. Section 562 provides, in relevant part, that

(a) If the trustee rejects a . . . repurchase agreement, . . . or if a . . . repo participant . . . liquidates, terminates, or accelerates such contract or agreement, damages shall be measured as of the earlier of –

(1)  the date of such rejection; or

(2) the date or dates of such liquidation, termination, or acceleration.

(b) If there are not any commercially reasonable determinants of value as of any date referred to in paragraph (1) or (2) of subsection (a), damages shall be measured as of the earliest subsequent date or dates on which there are commercially reasonable determinants of value.

The transaction at issue was a repurchase agreement between Calyon New York Branch ("Calyon") and certain of the American Home Mortgage Holdings debtors (the "Debtors") relating to mortgage loans or interests in mortgage loans.  Shortly before the Debtors' chapter 11 filings, Calyon served the Debtors with a notice of default by which Calyon accelerated the obligations under the repurchase agreement and terminated the repurchase agreement ("Acceleration Date").  In connection with the termination of the repurchase agreement, Calyon sought to have its damages liquidated by the bankruptcy court and contended that the only appropriate valuation methodology to be used as a "determinant" of value was the asset's market price, i.e., the actual market or sale value, and that Calyon could not have obtained a commercially reasonable price for the loan portfolio on the Acceleration Date because the market was distressed and the marketability of the loan portfolio was therefore affected.

The Debtors countered that, as of the Acceleration Date, at least two different methodologies reflected commercially reasonable values for the loan portfolio – a discounted cash flow analysis and a separate market analysis that Calyon had obtained at the time.  Both of these methodologies valued the loan portfolio on the Acceleration Date at or above the Repurchase Price (i.e., the price at which the Debtors were obligated to repurchase the loans as a result of the acceleration of the repurchase agreement), and consequently the Debtors asserted that Calyon had no deficiency claim and, therefore, no damages claim under section 562.


The bankruptcy court analyzed Calyon's evidence with respect to the quality of the loans and the market valuations.  Calyon's witnesses testified that disputes relating to the quality and ownership of the loans had prevented Calyon from selling the loan portfolio on the Acceleration Date.  In fact, the court found that Calyon had decided internally to sell the loan portfolio only after liquidity in the market had recovered, thereby resulting in higher prices.  Calyon's submissions to regulators for purposes of reporting on outstanding syndicated loan transactions and loan loss reserves supported this finding.  The court concluded, therefore, that Calyon had no intention of selling the loan portfolio "due to the dysfunctional state of the market", and that "[b]ecause Calyon's intent was to hold the loans, and not sell them, testimony regarding the variables that might have had an impact on a sale price [was] not relevant."[1]

With respect to Calyon's market valuations, the court agreed with Calyon that the secondary mortgage market was dysfunctional in August 2007 and that Calyon's internal market valuations for purposes of determining its potential recovery rate on the loans, which showed a value in excess of the Repurchase Price, were based on outdated assumptions and data.  However, the court noted that the mortgage valuation presented by Calyon's expert witness was based in part on questions as to ownership of the loans, which the court had concluded to be irrelevant given Calyon's intent to hold the loan portfolio rather than trying to sell it.


The court concluded that the notion of "commercially reasonable determinants of value" is not limited to the actual sale or market value of an asset.  The court found that when no market exists for an asset, another method of valuation must be used.  In the case at issue, the court considered that the value of a mortgage is the present value of the promised cash flows on the mortgage, discounted at an interest rate that reflects default risk, and held that a discounted cash flow analysis, submitted into evidence by expert testimony, is a "commercially reasonable determinant of value" for a mortgage portfolio.  The court concluded that the Debtor's discounted cash flow analysis was a commercially reasonable determinant of value as of the Acceleration Date.  Consequently, the court held that Calyon had no deficiency claim, since the Repurchase Price on the Acceleration Date was lower than the value of the loan portfolio determined using a discounted cash flow valuation.

Future implications

Judge Sontchi's decision, one of first impression, is limited by the facts of the case.  Calyon's evidence supporting its intent and proposed valuation was partly discredited by the court, and the outcome might have been different had it not been.  The decision nevertheless provides helpful guidance regarding the determination of damages resulting from the termination of a protected contract, such as a repurchase agreement, in distressed market conditions.


In re American Home Mortgage Holdings, Inc., Case No. 07-11047 (CSS) (Bankr. Del. Sept. 8, 2009)

1. Op. at 25-26.

* * * * *

If you have any questions, please contact any of the lawyers listed below or your regular Davis Polk contact.

Donald S. Bernstein
212 450 4092 |

Laureen F. Bedell
212 450 4167 |

Marshall S. Huebner
212 450 4099 |

Timothy Graulich
212 450 4639 |

Damian S. Schaible
212 450 4580 |

Giorgio Bovenzi
212 450 4260 |