In the

United States Court of Appeals

For the Seventh Circuit

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

UNITED AIR LINES, INC.,

Plaintiff-Appellee,

Cross-Appellant,

v.

REGIONAL AIRPORTS IMPROVEMENT

CORPORATION AND UMB BANK, 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.

ARGUED APRIL 16, 2009—DECIDED MAY 5, 2009

Before EASTERBROOK, Chief Judge, and BAUER and

MANION, Circuit Judges.

EASTERBROOK, 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 improvements 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 transactions occur. So the bankruptcy court decided to value

the collateral by a discounted-cash-flow analysis. It determined 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. LEXIS 48738 (N.D. Ill.

June 25, 2008).

Both the lender (the Regional Airports Improvement

Corp. or RAIC) and the Trustee (UMB Bank) for the investors 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 “adequate 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 annualrentalrate, 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 promised 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 unimproved 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 improvements—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 bankruptcy 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 bankruptcy 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 improvements 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 improved 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 Terminal 2, which the parties call LAX2. The consortium’s members 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 explanation:

[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 inappropriate 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 hypothetical LAX2 operator would require. The Court

also found that there were significant gaps identifying projected revenues and expenses which

would make a square footage rental determination 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. LEXIS 48738 at *9–*10. Neither the bankruptcy 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 unimproved 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 bankruptcy 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 bankruptcy 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 unsecured. 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 operations 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% without 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, Investment 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 discounted to present value at 10% per annum. (The bankruptcy 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.

5-5-09