Publications: Bankruptcy and credit bidding

This spring, the 7th U.S. Circuit Court of Appeals will consider whether a secured creditor has the statutory right to credit bid its debt in the sale of assets proposed under a nonconsensual plan of reorganization pursuant to Section 1129(b)(2)(A)(iii) of the Bankruptcy Code.

In In re River Road Hotel Partners, LLC, No. 09 B 3002 (Bankr. N.D.Ill. 2009) [Dkt. No. 500], the Bankruptcy Court for the Northern District of Illinois certified the appeal of the debtors for direct appeal to the court of appeals.

The 7th Circuit’s consideration of the credit bidding issue follows the 3rd Circuit’s decision in Philadelphia Newspapers, which held that, as a matter of law, a debtor may preclude a secured creditor from credit bidding when a debtor sells its assets pursuant to a plan of reorganization and provides the creditor with the indubitable equivalent of its claims. See In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3rd Cir. 2010).

In bankruptcy, a debtor may sell its assets outside the ordinary course of business: (i) under Section 363 of the U.S. Bankruptcy Code, or (ii) pursuant to a plan of reorganization under section 1123 of the Bankruptcy Code.

Under Section 363, a secured creditor may credit bid its claim. Credit bidding is the ability of a secured lender to offset its claim against the purchase price of the property. See 11 U.S.C. §353(k).

For a secured lender, credit bidding ensures that the collateral is not sold for less than the face amount of the debt, and preserves the ability of the secured creditor to participate in any appreciation of the value of its collateral.

Alternatively, a debtor can sell its assets pursuant to a plan of reorganization. A plan of reorganization can be approved over the objection of creditors, including a secured creditor, under the “cramdown” provisions of the Bankruptcy Code. To cramdown a secured creditor, the reorganization plan must be “fair and equitable” to the secured creditor.

The “fair and equitable” standard may be satisfied by showing that the plan provides (1) that the holders of such claims retain the liens securing the claims and receive deferred cash payments having a present value equal to the value of their collateral; (2) for the sale of the collateral free and clear of liens, but subject to the secured creditor’s right to credit bid; or (3) for the realization of the secured creditor’s claim by some means that provides the secured creditor with the indubitable equivalent of its claim.

The 3rd Circuit is the most recent court of appeals to consider the rights of a secured lender to credit bid under a plan of reorganization. It concluded that a secured creditor does not have an absolute right to credit bid if the debtor proposes to sell its assets under a plan of reorganization and seeks confirmation under the indubitable equivalent prong.

In Philadelphia Newspapers, the debtors proposed a plan of reorganization that included a public auction for the sale of substantially all of the debtors’ assets. As part of the sale, the debtors entered into an asset purchase agreement with a stalking horse bidder. The proposed plan prohibited credit bidding and required all bids to be made in cash.

The debtors argued that under the proposed plan the secured creditors would realize the indubitable equivalent of their claim.

Further, the debtors argued, allowing secured lenders to credit bid would chill competitive bidding at the auction, and thus, as a matter of policy, the lenders should be precluded from credit bidding.

The senior lenders, who were significantly underwater, argued that under the Bankruptcy Code’s cramdown provisions, the secured creditors’ right to credit bid is preserved and thus, they were entitled to credit bid their debt.

The bankruptcy court agreed with the secured creditors, finding that although the cramdown provisions are ambiguous, legislative history reflects Congress’ intent that a secured creditor should have the right to credit bid its debt under either Section 363 or a sale of assets pursuant to a plan of reorganization.

The debtors appealed, and the district court reversed, finding that the cramdown provisions provide that a debtor need only satisfy one of the three prongs of the “fair and reasonable” standard. The district court found that the debtors intended to satisfy the indubitable equivalent prong, which does not explicitly provide a secured creditor with a right to credit bid.

The district court did not decide whether the debtors’ proposed plan actually satisfied the indubitable equivalent prong. Rather, the district court held that under a plain reading of the indubitable equivalent prong, a secured lender does not have a right to credit bid.

The secured creditors appealed, but the 3rd Circuit affirmed the district court’s finding that the Bankruptcy Code permits a debtor to proceed with any plan that provides secured lenders with the “indubitable equivalent” of their secured interest in the assets and contains no statutory right to credit bidding.

In the River Road Hotel Partners case, the debtors proposed selling substantially all of their assets, including the InterContinental Hotel Chicago O’Hare, pursuant to a plan of reorganization. As part of its plan, the debtors sought to deny the lenders the ability to credit bid their debt as a matter of law under the indubitable equivalent prong, and for cause under Section 363(k).

In its bid procedures motion, the debtors cited the plain language of 1129(b)(2)(A)(iii) and Philadelphia Newspapers to seek to deny the lenders the ability to credit bid as a matter of law.

Even if the court denied the debtors’ request to preclude lenders from credit bidding under Section 1129, the debtors argued that the lenders should be precluded from credit bidding for cause.

The debtors cited the following factors as establishing cause under Section 363(k): (i) there exist disputes regarding the priority of competing secured creditors; (ii) granting an unsecured creditor the right to credit bid would chill the bidding process; and (iii) the lenders “precipitated” the debtors’ chapter 11 cases by “improperly refusing to provide funding” under the loan agreements.

In October, the bankruptcy court denied the debtors’ bid procedures motion citing Judge Thomas Ambro’s dissent in Philadelphia Newspapers.

In that dissent, Ambro noted that “it seems Pickwickian to believe that Congress would expend the ink and energy detailing procedures in clause (ii) that specifically deal with plan sales of property free of liens, only to leave general language in clause (iii) that could sidestep entirely those procedures.” Philadelphia Newspapers at 329.

Ambro also reasoned that denying the lenders the ability to credit bid would only benefit stalking horse acquirors by allowing such acquirors to potentially acquire assets below market value.

The debtors filed a motion for certification of appeal to the court of appeals and the bankruptcy court granted the motion.

Practitioners should be looking for guidance from the 7th Circuit on this important issue for both secured lenders and debtors.

Reprinted with permission of Law Bulletin Publishing Company.