On June 28, 2011, the Seventh Circuit Court of Appeals decided In re River Road Hotel Partners, LLC, holding that, absent consent, when a plan of reorganization proposes a sale of encumbered assets free and clear of liens and security interests, the secured creditors cannot be denied the right to credit bid.1 The decision conflicts with recent decisions in the Third and Fifth Circuit Courts of Appeals — In re Philadelphia Newspapers, LLC and In re Pacific Lumber Co.2 In Philadelphia Newspapers, a split panel of the Third Circuit held that the Bankruptcy Code permits a sale of secured creditor collateral free of liens, without providing secured creditors the right to credit bid, when the collateral is being sold pursuant to a plan of reorganization. Similarly, in Pacific Lumber, the Fifth Circuit confirmed a sale of assets under a plan as providing the secured creditors with the indubitable equivalent of their claims, despite a provision in the plan barring the secured creditors from credit bidding. The Seventh Circuit’s decision in River Road is a meaningful victory for secured creditors. It also creates a split in circuit court authority, which presents an opportunity for further review in the United States Supreme Court.
Section 1129(b) of the Bankruptcy Code provides the rules for confirmation of a reorganization plan over the objection of a class or classes of creditors, including secured creditors, in a process generally referred to as “cramdown.” Section 1129(b)(1) requires a court to determine whether a plan’s proposed treatment of an impaired class of claims is, among other things, “fair and equitable.” Section 1129(b)(2)(A), which speaks to secured claims specifically, provides a (non-exclusive) list of three scenarios, any one of which will satisfy the “fair and equitable” treatment standard.3 Subsection (A)(i) provides for secured creditors to retain the liens securing their allowed claims and receive deferred cash payments equal to the present value of their collateral as of the effective date of the plan. Subsection (A)(ii) provides for the sale of property free and clear of liens, so long as the liens attach to sale proceeds and the creditor has an opportunity to credit bid. Subsection (A)(iii) permits a plan to provide secured creditors the “indubitable equivalent” of their secured claims. Unlike subsection (ii), the last subsection makes no reference to a secured creditor’s right to credit bid.
As the Seventh Circuit stated, the appeal presented “a single, relatively straightforward question”: can the debtor sell encumbered assets through a plan, without giving the secured creditor an opportunity to credit bid?4 The Seventh Circuit answered this question in the negative, disagreeing with both Philadelphia Newspapers and Pacific Lumber, and aligning itself instead with what it referred to as the “compelling” statutory analysis articulated in Judge Ambro’s dissent in Philadelphia Newspapers.
The Bankruptcy Court Proceedings
The Debtors in River Road proposed bid procedures for the sale of substantially all of their assets in connection with proposed plans of reorganization. The bid procedures on credit bidding stated that the plan sales were being conducted pursuant to section 1129(b)(2)(A)(iii), and therefore the Debtors’ secured lenders would not have the right to credit bid. The Bankruptcy Court denied the motion, noting that it found Judge Ambro’s “well-reasoned” dissent in Philadelphia Newspapers persuasive. The Debtors would have to proceed under 1129(b)(2)(A)(ii), which expressly preserves a secured lender’s right to credit bid pursuant to section 363(k).5 The orders were certified for direct appeal to the Seventh Circuit.
The Seventh Circuit Decision
The Seventh Circuit affirmed the Bankruptcy Court, holding that cramdown plans which contemplate selling encumbered assets free and clear of liens must comply with the requirements of 1129(b)(2)(A)(ii), which include a secured creditor’s right to credit bid.
The Court thought the statutory text unclear and so looked behind it to determine its meaning. It then held that if subsection (iii) permitted sales of encumbered assets without credit bidding, subsections (i) and (ii) would be superfluous.6 The “infinitely more plausible interpretation of Section 1129(b)(2)(A) would read each subsection as stating the requirements for a particular type of sale and construing each of the subparagraphs as conclusively governing the category of proceedings it addresses.”7 Subsection (i) would apply to a situation in which the secured creditor retains the lien securing its claim, subsection (ii) to a sale free and clear, and subsection (iii) to something else. The Court noted that nowhere else does the Bankruptcy Code “appear to contain any provisions that recognize an auction sale where credit bidding is unavailable as a legitimate way to dispose of encumbered assets.”8
The Debtors rested on a “reliable market” theory: because assets would be sold at an open auction, they argued, and secured creditors would receive the proceeds from those sales, the market would guarantee the “indubitable equivalent” of their secured claims. The Court rejected this argument, noting that the right to credit bid affords secured creditors with the means to “protect themselves from the risk that the winning auction bid will not capture the asset’s actual value.”9 According to the Court, this protection is particularly important in the context of assets sold in bankruptcy auctions, as a number of factors create a significant risk of undervaluation, including the speed with which such auctions are typically conducted and the risk of insufficient notice to interested parties.10 The Debtors’ theory, it concluded, would deprive secured creditors of a “crucial check against undervaluation.”
The Seventh Circuit’s decision in River Road reinvigorates the rights of lenders to credit bid their debt when a debtor proposes a plan of reorganization that would sell encumbered assets free and clear of liens and security interests.
But the controversy is not over. The Seventh Circuit now disagrees with the Third and Fifth Circuits. Because cases brought in Delaware will continue to be governed by Philadelphia Newspapers, debtors seeking more sale powers may elect that jurisdiction. River Road could have broad implications outside of the Third and Fifth Circuits and may lead to further review in the Supreme Court.
For assistance, please contact the following lawyers in the Financial Restructuring Group:
Jeffrey S. Sabin, Co-Chair, Financial Restructuring Group
Edwin E. Smith, Partner, Financial Restructuring Group
This article was originally published by Bingham McCutchen LLP.