Credit (Bid) Where Credit's Due

In In re Pacific Lumber Co., 584 F.3d 229 (5th Cir. 2009), an undersecured class of noteholders (owed approximately $740 million) challenged confirmation of a plan that proposed selling their collateral in a private sale and distributing to them the sale proceeds in cash and giving them an unsecured deficiency claim and a lien on certain litigation proceeds. The plan sponsors funded the plan with $580 million in cash and proposed to pay the noteholders the value of their collateral, which would be determined at a valuation hearing (earlier efforts to hold an auction for the collateral had failed). After an extensive hearing, the bankruptcy court found that the noteholders' collateral was worth $513.6 million and subsequently confirmed the plan. The noteholders then received the $513.6 million in cash pursuant to the plan. The noteholders appealed, arguing that the plan could not be confirmed over their objection because, under ' 1129(b)(2)(A)(ii), the plan had to afford the noteholders an opportunity to credit bid at the sale. The Fifth Circuit affirmed.

The Fifth Circuit's Ruling

The Fifth Circuit found that, because the debtor sought to confirm the plan under ' 1129(b)(2)(A)(iii), the so-called “indubitable equivalent” prong of the cram-down test, and not under ' 1129(b)(2)(A)(ii), the noteholders did not have an automatic right to credit bid at the sale. Because the three prongs of ' 1129(b)(2)(A) are joined by the disjunctive “or,” they often are viewed as alternatives. The court went on to hold that even though the collateral was to be sold under the plan, a situation where ' 1129(b)(2)(A)(ii) typically applies, because the plan provided the noteholders with the judicially determined value of their claim ($513.6 million in cash), the noteholders were receiving the indubitable equivalent of their claim, and the debtors' plan could be confirmed under ' 1129(b)(2)(A)(iii). Typically, courts have found that a secured creditor is provided with the indubitable equivalent of its claim if it receives the collateral in satisfaction of its claim, if it receives replacement liens on similar collateral, or if the creditor retains its liens and is substantially oversecured. By holding that cash in an amount less than the face value of the claim could constitute the indubitable equivalent of a secured creditor's claim, the Fifth Circuit effectively found that the broad sweep of the indubitable equivalent prong constitutes a safe harbor whereby secured creditors can get crammed down by receiving the fair cash value of their secured claims. Among other issues, the Fifth Circuit's holding gives rise to the following question: if a debtor can deliver the indubitable equivalent via fair cash value, can some other form of currency, such as equity or debt instruments, also qualify as indubitably equivalent value under ' 1129(b)(2)(A)(iii)?

When facing a similar issue, the bankruptcy court in In re Philadelphia Newspapers, LLC, 2009 Bankr. LEXIS 3167 (E.D. Pa. Oct. 8, 2009), characterized the Pacific Lumber case as allowing the debtor “to accomplish indirectly a result unavailable by direct application of the statutory scheme,” in that it could be construed to permit an end-run around ' 1129(b)(2)(A)(ii) by shutting a secured creditor out of a sale under a plan and distributing to the secured creditor the cash proceeds from the sale. The bankruptcy court concluded that the debtor had to allow credit bidding.

Philadelphia Newspapers

In Philadelphia Newspapers, the debtors proposed an auction and sale process pursuant to a Chapter 11 plan that did not permit credit bidding by the secured lenders. As in Pacific Lumber, the debtor argued, among other things, that it proposed to cash out the secured lenders' claims under the ' 1129(b)(2)(A)(iii) indubitable equivalent prong. The bankruptcy court first attempted to distinguish Pacific Lumber on the facts, particularly because the bankruptcy court in Pacific Lumber heard extensive evidence on the value of the noteholders' collateral (and the noteholders participated in that process) and also because the noteholders did not raise their credit bidding objection in a timely fashion. The bankruptcy court in Philadelphia Newspapers also suggested that the Pacific Lumber court should not have denied the noteholders the right to credit bid where they could not otherwise make a ' 1111(b) election as a secured creditor with a recourse claim, with collateral subject to sale under a plan. According to the bankruptcy court, even though ' 1129(b)(2)(A) provides (A)(ii) & (A)(iii) as alternative options, given the incongruity of permitting a debtor to deprive a secured creditor of credit bid rights under ' 1129(b)(2)(A)(ii) by invoking the “indubitable equivalent” prong, the court should look beyond the plain text of the statute to harmonize ' 1129(b)(2)(A) with the rest of the Bankruptcy Code.

In this regard, according to the bankruptcy court, ' 1129(b)(2)(A) should be considered together with ' 1111(b) as reflecting congressional intent to allow a lienholder with recourse against a debtor to either credit bid its claims or elect to treat its claim as fully secured. To emphasize this point, the court cited legislative history stating that “[s]ale of property under section 363 or under a plan is excluded from treatment under section 1111(b) because of the secured party's right to credit bid in the full amount of its allowed claim at any sale of collateral under section 363(k) ' .” See Collier on Bankruptcy, App. Pt. 4(f)(iii) (Matthew Bender, 15th ed. rev.). The court reasoned that, where a ' 1111(b) election is not available because of a sale under a plan (pursuant to ' 1111(b)(1)(B)(ii)), it would be unfair and contrary to congressional intent to strip a secured creditor of its right to retain its interest in collateral by not allowing a credit bid. The court stated that “with the exception of [Pacific Lumber], the Court ' is aware of no other decision wherein ' 1129(b)(2)(A)(iii) and the indubitable equivalence alternative were permitted to enable a debtor to cash out a secured creditor via the type of sale contemplated under ' 1129(b)(2)(A)(ii).”

Ultimately, the bankruptcy court in Philadelphia Newspapers rejected the Fifth Circuit's reasoning in Pacific Lumber and sustained the secured lenders' objection to the auction process precluding a credit bid. Thus, the court found that the intent of the integrated provisions of the Bankruptcy Code was to “ensure that where an undersecured creditor's collateral is proposed to be sold, whether under ' 363 or under a plan, the secured creditor is entitled in all events to protect its rights in its collateral, either by making an election under ' 1111(b) or by credit bidding its debt.”

The Debtors' Appeal

The debtors in Philadelphia Newspapers appealed the bankruptcy court decision and, following an expedited appeal, the district court reversed the bankruptcy court, adopting a plain language approach to interpreting ' 1129(b)(2) and noting that cash in the amount of the value of the collateral could constitute the indubitable equivalent of a secured creditor's claim. In re Philadelphia Newspapers, LLC, 2009 U.S. Dist. LEXIS 104706 (E.D. Pa. Nov. 10, 2009). According to the district court, because the statutory language was clear, the court did not need to look beyond the plain language to consider congressional intent or the interplay with other Bankruptcy Code provisions, stating that “a literal application of the plain meaning of section 1129(b)(2)(A) does not produce a result that is either absurd or demonstrably at odds with the intent of Congress.” The district court also embraced the reasoning of the Pacific Lumber decision, citing that case for the proposition that “no statutory right to credit bid exists for a secured creditor whenever the debtor chooses to sell its collateral under the Indubitable Equivalent Prong.” However, the district court also seemed to limit its holding by stating that “the decision of the Court is limited in time to a point prior to confirmation, and limited in effect to a pre-confirmation auction. Therefore, the scope of the Court's decision addresses only a narrow window in the pre-confirmation process.” The district court left open the option for the secured lenders to argue that the auction did not generate fair value for their collateral, and hence that they did not receive the “indubitable equivalent” of their claims. This reasoning appears to create a new burden for secured lenders in sales conducted pursuant to a Chapter 11 plan.

The secured lenders have appealed the district court decision to the Third Circuit. As this article went to press, the Third Circuit has stayed the bankruptcy auction, pending the results of the oral argument held on Dec. 15, 2009.

Recent Developments

A recent case demonstrates that courts will find “cause” to limit credit bidding under ' 363(k) when practical considerations dictate that only cash bidding should be permitted. In In re Fontainebleau Las Vegas Holdings, LLC, No. 09-21481 (AJC) (Bankr. S.D. Fla. Dec. 7, 2009), the bankruptcy court denied an emergency motion to allow credit bidding at a ' 363 sale filed by certain holders (comprised of five different groups) of mechanics' and materialmen's lien claims. The bankruptcy court found that there was insufficient time prior to the scheduled sale to determine the amount and priority of the more than 300 lien claims, all of which were unliquidated and the subject of an adversary proceeding contesting their validity. The bankruptcy court further held that even if the lien claims could be adjudicated as to validity, priority and amount prior to the ' 363 sale, there was no feasible procedure to permit five different groups of lien claimants, plus additional unrepresented lien claimants and dozens of secured bank lenders to bid against cash bidders. Thus, the court found “cause” to deny credit bidding, noting that delaying the
' 363 sale was not in the best interest of creditors because the value of the debtors' property to be sold was eroding at a rate between $100,000 and $200,000 per week.

Conclusion

Following cases such as GWLS and Metaldyne, a secured creditor's right to credit bid under ' 363(k) appears firmly ensconced. Also, lenders may now make greater attempts to specifically address credit bidding in loan documentation. Without specific language on the question in the loan documents, courts are likely to take their cue from Chrysler, finding that an administrative or collateral agent has the authority to drag along a minority group of lenders at the behest of a majority group and distribute the proceeds of the collateral ratably among all lenders, including through a credit bid.

However, in the plan context, courts such as those in Pacific Lumber and Philadelphia Newspapers are struggling with how and whether to provide credit bidding rights in a cram-down scenario, where Congress gave debtors optionality through the three prongs of ' 1129(b)(2)(A). The Pacific Lumber and Philadelphia Newspapers cases provide a road map for debtors to seek to cram down secured creditors with a one-time cash payout less than the face value of the creditors' claims. Other debtors surely will attempt to employ this road map, and secured creditors will litigate to protect the credit bidding rights they see as fundamental. We can expect further appellate guidance on these questions.

James H.M. Sprayregen, a member of this newsletter's Board of Editors, Christopher J. Marcus, and David A. Agay are partners in the Restructuring practice group at Kirkland & Ellis LLP, Chicago. Benjamin J. Steele is an associate in that group. Messrs. Marcus, Agay, and Steele represented the purchasers in the Metaldyne case discussed herein. Mr. Agay represented the purchaser in the Propex case, discussed in Part One of this article.

As we discussed last month in Part One of this article, few commentators foresaw the current issues swirling around an aspect of the Bankruptcy Code ' credit bidding ' that prior to the recent bankruptcy wave rarely drew much attention. This article focuses on the ability of a secured creditor to credit bid its claims at a sale under ' 363(k) or ' 1129(b)(2)(A)(ii). Last month, we discussed credit bidding under the code, and recent drag along cases. The discussion concludes herein.

Indubitable Equivalent Cases

While courts in the cases summarized in Part One generally have upheld structures that allow secured lenders to extract their collateral from bankruptcy through credit bidding, other courts in the cram-down context have sided with debtors proposing Chapter 11 plans that preclude secured creditors from credit bidding at bankruptcy sales.

In In re Pacific Lumber Co., 584 F.3d 229 (5th Cir. 2009), an undersecured class of noteholders (owed approximately $740 million) challenged confirmation of a plan that proposed selling their collateral in a private sale and distributing to them the sale proceeds in cash and giving them an unsecured deficiency claim and a lien on certain litigation proceeds. The plan sponsors funded the plan with $580 million in cash and proposed to pay the noteholders the value of their collateral, which would be determined at a valuation hearing (earlier efforts to hold an auction for the collateral had failed). After an extensive hearing, the bankruptcy court found that the noteholders' collateral was worth $513.6 million and subsequently confirmed the plan. The noteholders then received the $513.6 million in cash pursuant to the plan. The noteholders appealed, arguing that the plan could not be confirmed over their objection because, under ' 1129(b)(2)(A)(ii), the plan had to afford the noteholders an opportunity to credit bid at the sale. The Fifth Circuit affirmed.

The Fifth Circuit's Ruling

The Fifth Circuit found that, because the debtor sought to confirm the plan under ' 1129(b)(2)(A)(iii), the so-called “indubitable equivalent” prong of the cram-down test, and not under ' 1129(b)(2)(A)(ii), the noteholders did not have an automatic right to credit bid at the sale. Because the three prongs of ' 1129(b)(2)(A) are joined by the disjunctive “or,” they often are viewed as alternatives. The court went on to hold that even though the collateral was to be sold under the plan, a situation where ' 1129(b)(2)(A)(ii) typically applies, because the plan provided the noteholders with the judicially determined value of their claim ($513.6 million in cash), the noteholders were receiving the indubitable equivalent of their claim, and the debtors' plan could be confirmed under ' 1129(b)(2)(A)(iii). Typically, courts have found that a secured creditor is provided with the indubitable equivalent of its claim if it receives the collateral in satisfaction of its claim, if it receives replacement liens on similar collateral, or if the creditor retains its liens and is substantially oversecured. By holding that cash in an amount less than the face value of the claim could constitute the indubitable equivalent of a secured creditor's claim, the Fifth Circuit effectively found that the broad sweep of the indubitable equivalent prong constitutes a safe harbor whereby secured creditors can get crammed down by receiving the fair cash value of their secured claims. Among other issues, the Fifth Circuit's holding gives rise to the following question: if a debtor can deliver the indubitable equivalent via fair cash value, can some other form of currency, such as equity or debt instruments, also qualify as indubitably equivalent value under ' 1129(b)(2)(A)(iii)?

When facing a similar issue, the bankruptcy court in In re Philadelphia Newspapers, LLC, 2009 Bankr. LEXIS 3167 (E.D. Pa. Oct. 8, 2009), characterized the Pacific Lumber case as allowing the debtor “to accomplish indirectly a result unavailable by direct application of the statutory scheme,” in that it could be construed to permit an end-run around ' 1129(b)(2)(A)(ii) by shutting a secured creditor out of a sale under a plan and distributing to the secured creditor the cash proceeds from the sale. The bankruptcy court concluded that the debtor had to allow credit bidding.

Philadelphia Newspapers

In Philadelphia Newspapers, the debtors proposed an auction and sale process pursuant to a Chapter 11 plan that did not permit credit bidding by the secured lenders. As in Pacific Lumber, the debtor argued, among other things, that it proposed to cash out the secured lenders' claims under the ' 1129(b)(2)(A)(iii) indubitable equivalent prong. The bankruptcy court first attempted to distinguish Pacific Lumber on the facts, particularly because the bankruptcy court in Pacific Lumber heard extensive evidence on the value of the noteholders' collateral (and the noteholders participated in that process) and also because the noteholders did not raise their credit bidding objection in a timely fashion. The bankruptcy court in Philadelphia Newspapers also suggested that the Pacific Lumber court should not have denied the noteholders the right to credit bid where they could not otherwise make a ' 1111(b) election as a secured creditor with a recourse claim, with collateral subject to sale under a plan. According to the bankruptcy court, even though ' 1129(b)(2)(A) provides (A)(ii) & (A)(iii) as alternative options, given the incongruity of permitting a debtor to deprive a secured creditor of credit bid rights under ' 1129(b)(2)(A)(ii) by invoking the “indubitable equivalent” prong, the court should look beyond the plain text of the statute to harmonize ' 1129(b)(2)(A) with the rest of the Bankruptcy Code.

In this regard, according to the bankruptcy court, ' 1129(b)(2)(A) should be considered together with ' 1111(b) as reflecting congressional intent to allow a lienholder with recourse against a debtor to either credit bid its claims or elect to treat its claim as fully secured. To emphasize this point, the court cited legislative history stating that “[s]ale of property under section 363 or under a plan is excluded from treatment under section 1111(b) because of the secured party's right to credit bid in the full amount of its allowed claim at any sale of collateral under section 363(k) ' .” See Collier on Bankruptcy, App. Pt. 4(f)(iii) (Matthew Bender, 15th ed. rev.). The court reasoned that, where a ' 1111(b) election is not available because of a sale under a plan (pursuant to ' 1111(b)(1)(B)(ii)), it would be unfair and contrary to congressional intent to strip a secured creditor of its right to retain its interest in collateral by not allowing a credit bid. The court stated that “with the exception of [Pacific Lumber], the Court ' is aware of no other decision wherein ' 1129(b)(2)(A)(iii) and the indubitable equivalence alternative were permitted to enable a debtor to cash out a secured creditor via the type of sale contemplated under ' 1129(b)(2)(A)(ii).”

Ultimately, the bankruptcy court in Philadelphia Newspapers rejected the Fifth Circuit's reasoning in Pacific Lumber and sustained the secured lenders' objection to the auction process precluding a credit bid. Thus, the court found that the intent of the integrated provisions of the Bankruptcy Code was to “ensure that where an undersecured creditor's collateral is proposed to be sold, whether under ' 363 or under a plan, the secured creditor is entitled in all events to protect its rights in its collateral, either by making an election under ' 1111(b) or by credit bidding its debt.”

The Debtors' Appeal

The debtors in Philadelphia Newspapers appealed the bankruptcy court decision and, following an expedited appeal, the district court reversed the bankruptcy court, adopting a plain language approach to interpreting ' 1129(b)(2) and noting that cash in the amount of the value of the collateral could constitute the indubitable equivalent of a secured creditor's claim. In re Philadelphia Newspapers, LLC, 2009 U.S. Dist. LEXIS 104706 (E.D. Pa. Nov. 10, 2009). According to the district court, because the statutory language was clear, the court did not need to look beyond the plain language to consider congressional intent or the interplay with other Bankruptcy Code provisions, stating that “a literal application of the plain meaning of section 1129(b)(2)(A) does not produce a result that is either absurd or demonstrably at odds with the intent of Congress.” The district court also embraced the reasoning of the Pacific Lumber decision, citing that case for the proposition that “no statutory right to credit bid exists for a secured creditor whenever the debtor chooses to sell its collateral under the Indubitable Equivalent Prong.” However, the district court also seemed to limit its holding by stating that “the decision of the Court is limited in time to a point prior to confirmation, and limited in effect to a pre-confirmation auction. Therefore, the scope of the Court's decision addresses only a narrow window in the pre-confirmation process.” The district court left open the option for the secured lenders to argue that the auction did not generate fair value for their collateral, and hence that they did not receive the “indubitable equivalent” of their claims. This reasoning appears to create a new burden for secured lenders in sales conducted pursuant to a Chapter 11 plan.

The secured lenders have appealed the district court decision to the Third Circuit. As this article went to press, the Third Circuit has stayed the bankruptcy auction, pending the results of the oral argument held on Dec. 15, 2009.

Recent Developments

A recent case demonstrates that courts will find “cause” to limit credit bidding under ' 363(k) when practical considerations dictate that only cash bidding should be permitted. In In re Fontainebleau Las Vegas Holdings, LLC, No. 09-21481 (AJC) (Bankr. S.D. Fla. Dec. 7, 2009), the bankruptcy court denied an emergency motion to allow credit bidding at a ' 363 sale filed by certain holders (comprised of five different groups) of mechanics' and materialmen's lien claims. The bankruptcy court found that there was insufficient time prior to the scheduled sale to determine the amount and priority of the more than 300 lien claims, all of which were unliquidated and the subject of an adversary proceeding contesting their validity. The bankruptcy court further held that even if the lien claims could be adjudicated as to validity, priority and amount prior to the ' 363 sale, there was no feasible procedure to permit five different groups of lien claimants, plus additional unrepresented lien claimants and dozens of secured bank lenders to bid against cash bidders. Thus, the court found “cause” to deny credit bidding, noting that delaying the
' 363 sale was not in the best interest of creditors because the value of the debtors' property to be sold was eroding at a rate between $100,000 and $200,000 per week.

Conclusion

Following cases such as GWLS and Metaldyne, a secured creditor's right to credit bid under ' 363(k) appears firmly ensconced. Also, lenders may now make greater attempts to specifically address credit bidding in loan documentation. Without specific language on the question in the loan documents, courts are likely to take their cue from Chrysler, finding that an administrative or collateral agent has the authority to drag along a minority group of lenders at the behest of a majority group and distribute the proceeds of the collateral ratably among all lenders, including through a credit bid.

However, in the plan context, courts such as those in Pacific Lumber and Philadelphia Newspapers are struggling with how and whether to provide credit bidding rights in a cram-down scenario, where Congress gave debtors optionality through the three prongs of ' 1129(b)(2)(A). The Pacific Lumber and Philadelphia Newspapers cases provide a road map for debtors to seek to cram down secured creditors with a one-time cash payout less than the face value of the creditors' claims. Other debtors surely will attempt to employ this road map, and secured creditors will litigate to protect the credit bidding rights they see as fundamental. We can expect further appellate guidance on these questions.

James H.M. Sprayregen, a member of this newsletter's Board of Editors, Christopher J. Marcus, and David A. Agay are partners in the Restructuring practice group at Kirkland & Ellis LLP, Chicago. Benjamin J. Steele is an associate in that group. Messrs. Marcus, Agay, and Steele represented the purchasers in the Metaldyne case discussed herein. Mr. Agay represented the purchaser in the Propex case, discussed in Part One of this article.