In what it called an “easy case,” the United States Supreme Court yesterday ruled in a 12-page unanimous opinion that, in a sale of assets under a Chapter 11 plan of reorganization, a secured lender cannot be stripped of its right to “credit bid” for the assets in which it holds a security interest. This puts to bed a circuit split that has garnered a great deal of attention and caused a corresponding level of heartburn for secured lenders over the past few years.
Credit Bidding and Cramdown
Credit bidding is a right of a secured lender, grounded in state law and codified in section 363(k) of the Bankruptcy Code, in which in any proposed sale of the lender’s collateral, the lender is entitled to bid up to the allowed amount of its secured claim without having to put up any cash. If the secured lender is the highest bidder, it simply offsets all or a portion of its secured claim against the purchase price. The ability to credit bid protects a creditor against the risk that its collateral will be sold at a depressed price, by allowing the creditor to pay what it considers to be the fair market price.1
The right to credit bid also is incorporated into section 1129(b)(2)(A) of the Bankruptcy Code, by which a bankruptcy court may confirm a reorganization plan without the consent of a secured lender as long as certain requirements are met, including that the plan be “fair and equitable” with respect to the secured lender.2 To be “fair and equitable,” section 1129(b)(2)(A) requires that a plan must provide for one of the following: (i) retention of the secured lender’s lien and repayment in cash, over time; (ii) the sale of the secured lender’s collateral, subject to the secured lender’s ability to credit bid under 363(k), and with the secured lender’s lien attaching to any proceeds from the sale; or (iii) the realization of the “indubitable equivalent” of the secured lender’s claims. It is the interpretation of this “fair and equitable” requirement that was the subject of multiple circuit court opinions and was the subject of the Supreme Court’s opinion in RadLax.
The Seventh Circuit decision3 encompassed two consolidated bankruptcy cases — In re RadLAX Gateway Hotel, LLC and In re River Road Hotel Partners, LLC — with similar facts.4 The reorganization plan sought to sell substantially all of RadLAX’s assets free and clear of any liens at a public auction pursuant to bidding procedures which prohibited the lender (which had a lien on all of RadLAX’s assets) from credit bidding. The bankruptcy court rejected the plan. The Seventh Circuit affirmed the bankruptcy court’s decision, holding that both section 363(k) and section 1129(B)(2)(A)(ii) grant secured lenders protection against the undervaluation of their collateral at auction and that the absence of credit bidding would remove a crucial check against undervaluation. The court held that allowing free and clear sales that only meet the provisions of clause (iii) would not provide secured lenders with the types of protections that they are generally accorded elsewhere in the Bankruptcy Code.
In the Pacific Lumber Co.5 and Philadelphia Newspapers6 cases, each of the Fifth and Third Circuits, respectively, held that the right of a secured lender to credit bid could be taken away if the bankruptcy plan provided the secured lender with the “indubitable equivalent” of its claim; that a public auction sale by which the market value of the collateral was established and then paid over to the secured lenders could constitute “indubitable equivalence” of the secured claim; and that the specific inclusion of a right to credit bid under clause (ii) of section 1129(B)(2)(A) did not prevent a plan proponent from proceeding under clause (iii), which contains no such right.
In addition to various statutory construction and legislative history arguments raised by the parties, there were a number of policy arguments raised by the parties. The respondent argued that credit bidding maximizes the value of the estate by increasing competition for the assets, thereby benefitting both debtors and other creditors. The parties submitting amicus briefs also argued that Supreme Court precedent from the 203 North LaSalle7 case demands a market test for the proper valuation of collateral in a chapter 11 plan sale and that for such test to truly be considered “market,” it must allow credit bidding by the party that has the most knowledge about the underlying assets — the secured lender.
Supreme Court Decision
In its unanimous opinion (decided 8-0, as Justice Kennedy did not take part in the decision), the High Court focused on statutory construction, putting aside the numerous policy arguments for and against raised in the various briefs and discussed at oral argument. The Court found the debtor’s reading of the statute (that clause (iii) forgives precisely what clause (ii) requires) to be “hyperliteral and contrary to common sense.”8 The Court noted that clause (ii), which grants the right to credit bid, is a detailed provision that spells out how collateral can be sold free and clear pursuant to a plan, while the “indubitable equivalent” language in clause (iii) is a broad provision that does not say anything about a sale.9 Citing the “general/specific” canon, the Court explained that, although clause (iii) is broad enough to encompass clause (ii), it should not be read to apply to a matter specifically dealt with in clause (ii).10 In describing how each of these three clauses interact, the Court held that:
(i) is the rule for plans under which the creditor’s lien remains on the property, (ii) is the rule for plans under which the property is sold free and clear of the creditor’s lien, and (iii) is a residual provision covering dispositions under all other plans—for example, one under which the creditor receives the property itself, the “indubitable equivalent” of its secured claim.11
In the period of uncertainty leading up to the Supreme Court’s decision, secured lenders began to take measures to protect themselves from the implications of Pacific Lumber and Philadelphia Newspapers. In some cases, they conditioned their willingness to provide debtor-in-possession financing or the consensual use of cash collateral on court orders confirming their right to credit bid in a sale pursuant to a reorganization plan. In others, they simply fronted the cash necessary to win at auction, with the assurance that the purchase price would quickly come back to them as proceeds of their collateral. Nonetheless, RadLax is an important win for secured lenders. First, “round-tripping” of a cash purchase price used to pay the secured claim presents transaction and opportunity costs to the lenders, including the practical difficulties of coordinating cash bids among a syndicate of lenders. In the case of the federal government, as was noted by Justice Scalia in a footnote, round-tripping is not an adequate substitute for credit bidding from the unique standpoint of a government agency. That is because federal law may require specific appropriations to be authorized before the government can assume a monetary obligation.
The Supreme Court’s decision eliminates the need for strategic planning by lenders to preserve credit bid protections, while assuaging the fears for the loss of the credit bid tool among the credit markets that developed over the last several years in the wake of the Pacific Lumber and Philadelphia Newspapers cases in the Third and Fifth Circuits, two of the busiest and most popular bankruptcy court venues in the United States.
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1 Radlax Gateway Hotel, LLC v. Amalgamated Bank, No. 11-166, 2012 WL 1912197, at *4 (U.S. S.Ct. May 29, 2012).
2 The right to confirm a plan against the wishes of an objecting class of creditors is what is commonly referred to as “cram-down.”
3 River Road Hotel Partners, LLC, et al. v. Amalgamated Bank, 651 F.3d 642 (7th Cir. 2011).
4 Only RadLAX was reviewed by the Supreme Court because a plan was confirmed in River Road after the Seventh Circuit ruled on the credit bidding issue.
5 584 F.3d 229 (5th Cir. 2009).
6 599 F.3d 298 (3d Cir. 2010).
7 Bank of America National. Trust and Savings Association v. 203 North LaSalle Street Partnership, 526 U.S. 434, 457 (1999).
8 Radlax Gateway Hotel, LLC, 2012 WL 1912197, at *5.
9 Id. at *7.
11 Id. at 8.
This article was originally published by Bingham McCutchen LLP.