Secured Creditors Secure Win

Credit Bidding

Credit bidding is the practice by which a secured creditor may bid for a debtor's collateral by using the debt it is owed to offset the purchase price. Credit bidding is specifically authorized by ' 363(k) of the Bankruptcy Code, which provides that in a ' 363 sale of property subject to a secured claim, the secured creditor may bid on the property by offsetting its claim against the purchase price of the property being sold, unless the court orders otherwise “for cause.” 11 U.S.C. ' 363(k).

Thus, a creditor with an allowed claim secured by a lien on property that is to be sold pursuant to a ' 363 sale may use some or all of the amount of its allowed claim to bid. The creditor will be required to put up new capital only if the bidding goes above the amount of the creditor's allowed claim. The only exception would be if the court found that cause existed to deny the right to credit bid, which is only appropriate in circumstances where the creditor has been found to have engaged in some type of inequitable conduct.

Cramdown

In most cases, for a debtor to obtain confirmation of a Chapter 11 plan, each impacted class of creditors must vote in favor of the plan. However, in certain circumstances, the bankruptcy court may confirm a plan over the objections of an impaired class so long as the plan is “fair and equitable.” This is commonly referred to as a “cramdown.”

Bankruptcy Code ' 1129(b)(2)(A) provides three avenues by which a debtor may provide fair and equitable treatment and thus cramdown a plan over the objection of a class of secured claims. Section 1129(b)(2)(A)(i) allows for a plan to be crammed down where the holder of the secured claim will retain its lien. Section 1129(b)(2)(A)(ii) allows the debtor to sell property free and clear of a secured creditor's lien, but subject to ' 363(k), which means that the secured creditor retains its right to credit bid. Finally, under ' 1129(b)(2)(A)(iii), a plan can be deemed “fair and equitable” and thus eligible for confirmation if the objecting class of secured creditors receives the “indubitable equivalent” of its claims. 11 U.S.C. ' 1129(b)(2)(A)(i)-(iii).

Until the Third and Fifth Circuit decisions imposing restrictions on secured creditors' rights to credit bid were announced, practitioners generally assumed that if a plan called for a sale of property subject to a lien, the confirmability of the plan with respect to the treatment of the secured creditor would be evaluated under clause (ii) of ' 1129(b)(2)(A), which explicitly incorporates ' 363(k). Clause (i) is clearly not relevant in such a case, because it only applies to situations in which the debtor is planning to retain, rather than to sell, the property. Clause (iii) is essentially a “catch-all” provision for other types of plans, one that requires the debtor to provide indubitable equivalence in order to adequately compensate the secured creditor for its interest in the property. See In re Murel Holding Corp., 75 F.2d 941, 942 (2d Cir. 1935).

Consequently, it was long assumed that if a plan's proponent wanted to successfully cramdown a plan that included a sale of encumbered assets, the plan would have to account for the secured creditor's ability to credit bid. But that view was called into question in light of the Fifth Circuit's decision in Pacific Lumber. It was cast into further doubt with the Third Circuit's decision in Philadelphia Newspapers, which approved sale procedures under Bankruptcy Code ' 1129(b)(2)(A) that denied the secured creditor an opportunity to credit bid.

The RadLAX Case in the Lower Courts

Shortly after the Third Circuit's decision in Philadelphia Newspapers, the Northern District of Illinois bankruptcy court was confronted with the same issue in the case that eventually wound up before the Supreme Court: In re River Road Hotel Partners, LLC, 2010 Bankr. LEXIS 5933 (Bankr. N.D. Ill. Oct. 5, 2010). In this case, prior to their bankruptcy, debtors RadLAX Gateway Hotel, LLC, and RadLAX Gateway Deck, LLC (collectively, the Debtors) purchased the Radisson Hotel at Los Angeles International Airport, as well as an adjoining lot, on which they planned to build a parking lot. The Debtors obtained a $142 million loan to finance the refurbishment of the hotel and to complete construction of the parking lot, pledging substantially all of their assets to secure the loan.

Due to higher than expected construction costs, the Debtors were unable to repay the loan, and eventually they filed petitions for reorganization under Chapter 11. The Debtors thereafter filed a Chapter 11 plan, pursuant to which they proposed to sell substantially all of their assets free and clear of the secured lender's liens. As part of their plan and related auction and bidding procedures, the Debtors sought to eliminate the secured lender's right to credit bid. Given the inevitability that the lender would object to their plan, the Debtors, just like the debtors in Pacific Lumber and Philadelphia Newspapers, sought to cram the lender down by utilizing the cramdown provision of ' 1129(b)(2)(A)(iii).

Despite the Third and Fifth Circuit precedents approving the elimination of the secured creditors' right to credit bid, the bankruptcy court rejected the proposed bidding procedures and held that the Debtors' plan could not be confirmed over the objection of the secured creditor under ' 1129(b)(2)(A). The court relied on the dissenting opinion in Philadelphia Newspapers, which it believed set forth the better reading of the statute. The bankruptcy court also rejected the Debtors' motion to deny credit bidding “for cause” under Bankruptcy Code ' 363(k). The bankruptcy court certified a direct appeal to the Seventh Circuit, which affirmed the bankruptcy court, finding that the Debtors' interpretation of 1129(b)(2)(A)(iii) would effectively nullify the requirements set forth in clauses (i) and (ii) of the section. The Debtors sought review by the Supreme Court, which granted certiorari to resolve the split among the circuits.

The Supreme Court's RadLAX Decision

The Supreme Court, in its unanimous (Justice Kennedy did not participate) and very brief (10 pages) RadLAX opinion, authored by Justice Scalia, affirmed the Seventh Circuit's decision. Rather than engage in a detailed analysis of the purposes of the Bankruptcy Code, pre-Code practices, the relevant legislative history, or the intrinsic merits of credit bidding and related policy considerations ' as the parties and the lower courts had done to varying degrees ' the Supreme Court instead proceeded directly to what it viewed as the crux of the matter, which was purely one of statutory construction.

The Court framed the issue as whether a Chapter 11 plan may be confirmed over the objection of a secured creditor under ' 1129(b)(2)(A) if the plan provides for the sale of collateral free and clear of the creditor's lien, but does not permit the creditor to credit bid at the sale. The Court then answered that question in the negative.

The Court found the Debtors' reading of ' 1129(b)(2)(A), under which clause (iii) allows precisely what clause (ii) forbids, to be “hyperliteral and contrary to common sense.” Relying on the canon of statutory interpretation that the specific governs the general, the Court reasoned that if it accepted the Debtors' argument, the specific provision of clause (ii) would be completely negated by the more general clause (iii). This, in turn, would violate the “cardinal rule that, if possible, effect shall be given to every clause and part of a statute.”

The Court explained that the general language of clause (iii), although broad enough literally speaking to include clause (ii), would not be held to apply to a matter already specifically dealt with in clause (ii). Under well-established canons of statutory interpretation, when the conduct at issue falls under both a general provision and a specific provision, the specific provision presumptively governs, making this case an “easy” one. The Debtors' plan providing for the sale of secured property free and clear of the secured creditor's lien could not be confirmed without affording the secured creditor the right to credit bid for the property under section 1129(b)(2)(A)(ii).

Implications for Chapter 11 Debtors and Secured Creditors

Credit bidding has long been available as an important creditor protection in the context of a Chapter 11 debtor's disposition of collateral. As explained in RadLAX, the ability to credit bid protects a secured creditor against the risk that its collateral will be sold at a depressed price, by enabling the creditor to purchase the collateral for what it considers to be the fair market value of the property.

The recent decisions from the Third and Fifth Circuits created considerable doubt about the availability of credit bidding in the Chapter 11 plan context. But with the Supreme Court's unambiguous rejection of the use of Bankruptcy Code ' 1129(b)(2)(A)(iii) to strip a secured creditor of the right to credit bid, secured creditors have scored a significant win.

Alan Lepene and Andrew L. Turscak, Jr., are partners and James Henderson is an associate in the Business Restructuring, Creditors' Rights & Bankruptcy Group at Thompson Hine LLP in Cleveland. They can be reached at [email protected], [email protected], and [email protected], respectively.

In a major victory for secured creditors, the United States Supreme Court unanimously held that a Chapter 11 plan involving a sale of secured property free and clear of a creditor's lien must afford the secured creditor the right to credit bid for the property under section 363(k) of title 11 of the United States Code (the Bankruptcy Code). RadLAX Gateway Hotel, LLC v. Amalgamated Bank , 566 U.S. __ (2012). In so holding, the Court resolved the split that had emerged among the United States Circuit Courts of Appeals, as illustrated by the Seventh Circuit's decision below ( River Road Hotel Partners, LLC v. Amalgamated Bank , 651 F.3d 642 (7th Cir. 2011)), which contrasted with other recent decisions from the Third and Fifth Circuits, respectively.

Unlike the Seventh Circuit, the Third and Fifth Circuits had held that a plan eliminating the credit bid rights of a secured creditor could be approved over the objection of the secured creditor, as long as that creditor was provided with the indubitable equivalent of its secured claim by some other means. See In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010); and In re Pacific Lumber Co., 584 F.3d 229 (5th. Cir. 2009).

The Intersection of Credit Bidding and Cramdowns Under the Bankruptcy Code

Credit Bidding

Credit bidding is the practice by which a secured creditor may bid for a debtor's collateral by using the debt it is owed to offset the purchase price. Credit bidding is specifically authorized by ' 363(k) of the Bankruptcy Code, which provides that in a ' 363 sale of property subject to a secured claim, the secured creditor may bid on the property by offsetting its claim against the purchase price of the property being sold, unless the court orders otherwise “for cause.” 11 U.S.C. ' 363(k).

Thus, a creditor with an allowed claim secured by a lien on property that is to be sold pursuant to a ' 363 sale may use some or all of the amount of its allowed claim to bid. The creditor will be required to put up new capital only if the bidding goes above the amount of the creditor's allowed claim. The only exception would be if the court found that cause existed to deny the right to credit bid, which is only appropriate in circumstances where the creditor has been found to have engaged in some type of inequitable conduct.

Cramdown

In most cases, for a debtor to obtain confirmation of a Chapter 11 plan, each impacted class of creditors must vote in favor of the plan. However, in certain circumstances, the bankruptcy court may confirm a plan over the objections of an impaired class so long as the plan is “fair and equitable.” This is commonly referred to as a “cramdown.”

Bankruptcy Code ' 1129(b)(2)(A) provides three avenues by which a debtor may provide fair and equitable treatment and thus cramdown a plan over the objection of a class of secured claims. Section 1129(b)(2)(A)(i) allows for a plan to be crammed down where the holder of the secured claim will retain its lien. Section 1129(b)(2)(A)(ii) allows the debtor to sell property free and clear of a secured creditor's lien, but subject to ' 363(k), which means that the secured creditor retains its right to credit bid. Finally, under ' 1129(b)(2)(A)(iii), a plan can be deemed “fair and equitable” and thus eligible for confirmation if the objecting class of secured creditors receives the “indubitable equivalent” of its claims. 11 U.S.C. ' 1129(b)(2)(A)(i)-(iii).

Until the Third and Fifth Circuit decisions imposing restrictions on secured creditors' rights to credit bid were announced, practitioners generally assumed that if a plan called for a sale of property subject to a lien, the confirmability of the plan with respect to the treatment of the secured creditor would be evaluated under clause (ii) of ' 1129(b)(2)(A), which explicitly incorporates ' 363(k). Clause (i) is clearly not relevant in such a case, because it only applies to situations in which the debtor is planning to retain, rather than to sell, the property. Clause (iii) is essentially a “catch-all” provision for other types of plans, one that requires the debtor to provide indubitable equivalence in order to adequately compensate the secured creditor for its interest in the property. See In re Murel Holding Corp., 75 F.2d 941, 942 (2d Cir. 1935).

Consequently, it was long assumed that if a plan's proponent wanted to successfully cramdown a plan that included a sale of encumbered assets, the plan would have to account for the secured creditor's ability to credit bid. But that view was called into question in light of the Fifth Circuit's decision in Pacific Lumber. It was cast into further doubt with the Third Circuit's decision in Philadelphia Newspapers, which approved sale procedures under Bankruptcy Code ' 1129(b)(2)(A) that denied the secured creditor an opportunity to credit bid.

The RadLAX Case in the Lower Courts

Shortly after the Third Circuit's decision in Philadelphia Newspapers, the Northern District of Illinois bankruptcy court was confronted with the same issue in the case that eventually wound up before the Supreme Court: In re River Road Hotel Partners, LLC, 2010 Bankr. LEXIS 5933 (Bankr. N.D. Ill. Oct. 5, 2010). In this case, prior to their bankruptcy, debtors RadLAX Gateway Hotel, LLC, and RadLAX Gateway Deck, LLC (collectively, the Debtors) purchased the Radisson Hotel at Los Angeles International Airport, as well as an adjoining lot, on which they planned to build a parking lot. The Debtors obtained a $142 million loan to finance the refurbishment of the hotel and to complete construction of the parking lot, pledging substantially all of their assets to secure the loan.

Due to higher than expected construction costs, the Debtors were unable to repay the loan, and eventually they filed petitions for reorganization under Chapter 11. The Debtors thereafter filed a Chapter 11 plan, pursuant to which they proposed to sell substantially all of their assets free and clear of the secured lender's liens. As part of their plan and related auction and bidding procedures, the Debtors sought to eliminate the secured lender's right to credit bid. Given the inevitability that the lender would object to their plan, the Debtors, just like the debtors in Pacific Lumber and Philadelphia Newspapers, sought to cram the lender down by utilizing the cramdown provision of ' 1129(b)(2)(A)(iii).

Despite the Third and Fifth Circuit precedents approving the elimination of the secured creditors' right to credit bid, the bankruptcy court rejected the proposed bidding procedures and held that the Debtors' plan could not be confirmed over the objection of the secured creditor under ' 1129(b)(2)(A). The court relied on the dissenting opinion in Philadelphia Newspapers, which it believed set forth the better reading of the statute. The bankruptcy court also rejected the Debtors' motion to deny credit bidding “for cause” under Bankruptcy Code ' 363(k). The bankruptcy court certified a direct appeal to the Seventh Circuit, which affirmed the bankruptcy court, finding that the Debtors' interpretation of 1129(b)(2)(A)(iii) would effectively nullify the requirements set forth in clauses (i) and (ii) of the section. The Debtors sought review by the Supreme Court, which granted certiorari to resolve the split among the circuits.

The Supreme Court's RadLAX Decision

The Supreme Court, in its unanimous (Justice Kennedy did not participate) and very brief (10 pages) RadLAX opinion, authored by Justice Scalia, affirmed the Seventh Circuit's decision. Rather than engage in a detailed analysis of the purposes of the Bankruptcy Code, pre-Code practices, the relevant legislative history, or the intrinsic merits of credit bidding and related policy considerations ' as the parties and the lower courts had done to varying degrees ' the Supreme Court instead proceeded directly to what it viewed as the crux of the matter, which was purely one of statutory construction.

The Court framed the issue as whether a Chapter 11 plan may be confirmed over the objection of a secured creditor under ' 1129(b)(2)(A) if the plan provides for the sale of collateral free and clear of the creditor's lien, but does not permit the creditor to credit bid at the sale. The Court then answered that question in the negative.

The Court found the Debtors' reading of ' 1129(b)(2)(A), under which clause (iii) allows precisely what clause (ii) forbids, to be “hyperliteral and contrary to common sense.” Relying on the canon of statutory interpretation that the specific governs the general, the Court reasoned that if it accepted the Debtors' argument, the specific provision of clause (ii) would be completely negated by the more general clause (iii). This, in turn, would violate the “cardinal rule that, if possible, effect shall be given to every clause and part of a statute.”

The Court explained that the general language of clause (iii), although broad enough literally speaking to include clause (ii), would not be held to apply to a matter already specifically dealt with in clause (ii). Under well-established canons of statutory interpretation, when the conduct at issue falls under both a general provision and a specific provision, the specific provision presumptively governs, making this case an “easy” one. The Debtors' plan providing for the sale of secured property free and clear of the secured creditor's lien could not be confirmed without affording the secured creditor the right to credit bid for the property under section 1129(b)(2)(A)(ii).

Implications for Chapter 11 Debtors and Secured Creditors

Credit bidding has long been available as an important creditor protection in the context of a Chapter 11 debtor's disposition of collateral. As explained in RadLAX, the ability to credit bid protects a secured creditor against the risk that its collateral will be sold at a depressed price, by enabling the creditor to purchase the collateral for what it considers to be the fair market value of the property.

The recent decisions from the Third and Fifth Circuits created considerable doubt about the availability of credit bidding in the Chapter 11 plan context. But with the Supreme Court's unambiguous rejection of the use of Bankruptcy Code ' 1129(b)(2)(A)(iii) to strip a secured creditor of the right to credit bid, secured creditors have scored a significant win.

Alan Lepene and Andrew L. Turscak, Jr., are partners and James Henderson is an associate in the Business Restructuring, Creditors' Rights & Bankruptcy Group at Thompson Hine LLP in Cleveland. They can be reached at [email protected], [email protected], and [email protected], respectively.