Limiting Credit Bidding for 'Cause' Under Section 363(k)

Recently, the ABI Commission to Study the Reform of Chapter 11 released its 2012-2014 Final Report and Recommendations. There, the Commission acknowledged “the fundamental role of credit bidding under state law and section 363(k)” and that “all credit bidding chills an auction process to some extent.” Final Report at 146-47. The Commissioners stated that they did “not believe that the chilling effect of credit bids alone should suffice as cause under section 363(k).” Id. The Commissioners implicitly rejected the contrary reading of “cause” tendered by the Third Circuit in In re Philadelphia Newspapers, LLC, 599 F.3d 298 (2010) and both cited and seemingly applied, to some degree, in In re Fisker Automotive Holdings, Inc., 510 B.R. 55 (Bankr. D.Del. 2014) and in In re The Free Lance-Star Publishing Co. of Fredericksburg, VA, 512 B.R. 798 (Bankr. E.D. Va. 2014).

Throughout the present discussion, we will refer to the reading of “cause” tendered in Philadelphia Newspapers and rejected by the ABI Commission as the “In and Of Itself” reading, for it would justify a finding of “cause” to limit credit bidding in a bankruptcy sale based on the chilling effect of credit bidding in and of itself.

We agree with the Commission's rejection of the In and Of Itself reading of “cause” in section 363(k). Below, we trace the outlines of arguments that: 1) the In and Of Itself reading of “cause” has no precedent prior to Philadelphia Newspapers and is scarcely supported there; and 2) application of the In and Of Itself reading is not justified on policy grounds, as is proposed by Philadelphia Newspapers.

Section 363(k) and 'Cause'

Section 363(k) of the Bankruptcy Code reads in toto as follows:

At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.

11 U.S.C. ' 363(k).

As discussed in Jonathan Brand and Jonathan Friedland, “You Know About Fisker But Do You Understand Fisker ?” 31 The Bankruptcy Strategist 9 (July, 2014), http://bit.ly/1Lit0e9, there are traditional bases on which courts have limited credit bidding under section 363(k). First, challenges to the validity, priority, and extent of liens on the collateral in question have been brought to bear under section 363(k). The credit-bidding rights provided or recognized in section 363(k) are conditioned: The credit bidder must be the holder of an “allowed claim” with a lien on the property to be sold that secures the allowed claim. That condition might be considered to form the basis upon which a credit bidding right is limited due to defects in the validity, priority, and extent of liens over the collateral in question. Nevertheless, such lien defects or claim allowance issues are often characterized as constituting “cause” to limit credit-bidding rights.

“Cause” in section 363 extends beyond lien defects or claims allowance issues. Most prosaically, credit-bidding rights can be defeated by the creditor's failure to assert them in accordance with procedural orders in the case. For example, in In re Antaeus Technical Services, Inc., 345 B.R. 556 (Bankr. E.D. Va. 2005), the court held that the expiration of certain deadlines per a settlement agreement between debtor and secured creditor resulted in bargained-for abandonment of its rights, including credit-bidding rights, in the principal asset to be sold.

Also, inequitable behavior or misconduct by the secured creditor can constitute “cause” to limit credit bidding rights of the holder of an allowed claim that has none of of the lien defects or allowance issues mentioned above. Penalizing the holder of an allowed claim for its misconduct by limiting credit bidding rights mirrors the application of section 510(c) of the Code, by which a court may “under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim '” Like lien defects and claim allowance issues, as well as procedural defaults, a credit bidder's inequitable conduct can support a court's limitation of credit-bidding rights under section 363(k) ' no part of this statement is controversial.

No Support for the In and Of Itself Reading of 'Cause'

The In and Of Itself reading of “cause” in section 363(k) purports to authorize limiting credit-bidding rights even in the absence of lien defects, claim allowance issues, procedural defaults, and inequitable conduct. The In and Of Itself reading is based solely upon the inevitable effect that exercise of a credit bidding right ' in particular where the secured claim at first glance exceeds the cash value of the collateral ' has on an auction sale of property of the debtor in a bankruptcy case. We cannot distinguish between that effect and the effect caused by a cash bidder clearly able and willing to pay more than any other bidder, but let us leave that to the side.

The Fisker and Free Lance-Star opinions contain language that endorses the In and Of Itself basis for the finding of “cause.” Friedland and Brand argue that both cases can be explained by traditional and uncontroversial analyses described above, i.e., that credit-bidding rights were limited in those cases because of unresolved issues over validity, priority and extent of liens, as well as over inequitable behavior by the secured creditors.

In their references of the In and Of Itself reading of “cause,” the Fisker and Free Lance-Star Publishing courts drew from the fountainhead of text leading up to footnote 14 in the Philadelphia Newspapers majority opinion and from the footnote itself (none of the court's assertions in such text was at issue in Radlax Gateway Hotel, LLC v. Amalgamated Bank, __ U.S. __, 132 S.Ct. 2065, 182 L.Ed.2d 967 (2012), which overruled the major holdings of Philadelphia Newspapers). Both opinions cite the same four cases the Third Circuit cited in that discussion. See Philadelphia Newspapers, 59 F.3d at 315-16 and fn 14; Fisker , 510 B.R. 55 at 59-60; and Free Lance-Star, 512 B.R. 798 at 805.

Those cases are In re Aloha Airlines, No. 08-00337, 2009 WL 1371950 (Bankr. D. Hawaii, May 14, 2009); Greenblatt v. Steinberg, 339 B.R. 458 (N.D.Ill. 2006); In re Anteaus Technical Servs., Inc., 345 B.R. 556 (Bankr. W.D. Va. 2005); and In re Theroux, 169 B.R. 498 (Bankr. D.R.I. 1994). In none of the cases cited by the Third Circuit did the court apply the In and Of Itself reading of “cause” to limit credit bidding. Each featured inequitable behavior or procedural default or lien defects. That should not surprise, for the Philadelphia Newspapers court cited them to support the uncontroversial proposition that “[i]n a variety of cases where a debtor seeks to sell assets pursuant to ' 363(b), courts have denied secured lenders the right to bid their credit,” and not the radical proposition that credit bidding has been denied solely because it might chill bidding.

At footnote 14 in the opinion, the Third Circuit declares in favor of application of the In and Of Itself reading of “cause” and cites its sole authority for the declaration:

The Lenders argue that the “for cause” exemption under '363(k) is limited to situations in which a secured creditor has engaged in inequitable conduct. The argument has no basis in the statute. A court may deny a lender the right to credit bid in the interest of any policy advanced by the Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment. See e.g., 3 Collier on Bankruptcy 363.09[1] (“The Court might [deny credit bidding] if permitting the lienholder to bid would chill the bidding process.”)

59 F.3d at 316, n. 14.

It is dubious for a court to rely exclusively upon a commentator to substantiate a radical change in bankruptcy law, even in dicta . But no such reliance is possible in this instance. The Collier passage on which the court relied cites no authority and in no way supports the proposition for which the Third Circuit cited it. Paragraph [1] of 3 Collier on Bankruptcy 363.09 states, in full:

Subsection (k) provides a right to bid and a right of offset if the creditor purchases property at a sale under subsection (b), but there is no guarantee that the sale will be a public sale. The 1984 legislation added a provision to subsection (k) permitting the holder of an allowed claim to bid at the sale unless the court for cause shown orders otherwise [footnote omitted]. The court might order otherwise if the sale is being negotiated privately and permitting the lienholder to bid would chill the bidding.

3 Collier on Bankruptcy 363.09[1].

The editors of Collier may have had in mind foreclosure sales of personal property under the UCC when they suggested that section 363(k) rights may be asserted in a private sale in a bankruptcy case, for private sales under section 363(b) are extremely rare. After noting that the Code “provides a right” to credit bid and “permit[s]” such a bid unless the court for cause shown orders otherwise, the passage states that the court “ might” so order in a private sale where credit bidding would chill the bidding. In the sentence on which the Third Circuit relied, Collier merely predicted that a court “might” order a limit to credit bidding, and that prediction applied only to the context of private sales, Collier said nothing about courts being empowered to lever any policy of the Code in limiting credit-bidding in private sales, much less in the public auctions by which assets are almost always sold in bankruptcy cases.

In summary, the fountainhead for the In and Of Itself reading of “cause” presented in Fisker and Free Lance-Star Publishing ' a radical break with prior law ' was dicta buried by the Philadelphia Newspapers court in a footnote, supported solely by reference to a treatise, which itself cited nothing as it was talking about something completely different, and which was selectively edited by the court to suit its unrelated purposes.

A Court May Deny a Lender the Right to Credit Bid in the Interest of Any Policy Advanced by the Code

Leaving aside the notional support for the In and Of Itself reading, let us consider whether, as Philadelphia Newspapers would have it, “the interest of any policy of the Code” suffices to authorize a court to limit or deprive an otherwise valid credit bidding right in a bankruptcy sale.

To hazard pronouncing the obvious, we note that bankruptcy courts are not courts of policy. They are bound to apply the statute as written, subject to authoritative canons of interpretation. It follows that Code policies are found only in Code provisions. Courts and advocates can tease a “policy” from any of the hundreds of provisions in the Code to deploy against a contrary teased-out policy. Such advocacy can provide only the lightest support for a radical change in interpretation of the meaning of “cause” in section 363(k).

The Philadelphia Newspapers majority's footnote 14 identified policies (ensuring the success of the reorganization or fostering a competitive bidding environment) but did not identify any provisions that substantiate them or weigh such policies against other policies.

With a moment's consideration, even weary and distracted commentators can summon the priority of payment rules of section 507, the absolute priority rule of section 1129(b), and the secured creditor's election provided under section 1111(b) as substantiating a Code policy in favor of preserving important secured creditor rights. For that matter, such commentators could also cite section 363(k) itself, and its application to plan sales via section 1129(b)(2)(A)(ii) in support of the same policy.

In his Philadelphia Newspapers dissent, Judge Thomas L. Ambro discussed at some length such statutory provisions as constituting “part of a comprehensive arrangement enacted by Congress to avoid the pitfalls of undervaluation, regardless of the mechanism chosen, and thereby ensure that the rights of secured creditors are protected while maximizing the value of collateral to the estate and minimizing deficiency claims against other unencumbered assets.” 599 F.3d at 334 (Ambro, J., dissenting). Judge Ambro's “comprehensive arrangement enacted by Congress” can be deployed against Judge X's “policy of the Code” in any given case.

This is “Let's Call the Whole Thing Off” (George and Ira Gershwin, 1937) territory. The In and Of Itself reading invites resolution of bargained for and reasonable investment-backed expectations based upon nothing firmer than the policy predilections of each judge.

The phrase, “reasonable investment-backed expectations” is intended to evoke Takings jurisprudence. See Palazzolo v. Rhode Island, 533 U.S. 606, 121 S.Ct. 2448, 2457, 150 L.Ed.2d 592 (2001) (citing Penn Central Transportation Company v. City of NY, 438 U.S. 104, 98 S.Ct. 2646, 57 L.Ed.2d 631 (1978)). This is to suggest that application of the In and Of Itself reading of “cause” in section 363(k) of the Code may effect a compensable taking under the Fifth Amendment to the United States Constitution. A topic for another day.

Christopher M. Cahill' of Lowis & Gellen LLP, Chicago, guides stakeholders through bankruptcy cases, out-of-court workouts, and assignments for the benefit of creditors. He can be reached at [email protected]. George W. Kuney is Professor of Law, University of Tennessee College of Law, and Director of the Clayton Center for Entrepreneurial Law. Kuney has practiced bankruptcy and business law for 26 years.

Recently, the ABI Commission to Study the Reform of Chapter 11 released its 2012-2014 Final Report and Recommendations. There, the Commission acknowledged “the fundamental role of credit bidding under state law and section 363(k)” and that “all credit bidding chills an auction process to some extent.” Final Report at 146-47. The Commissioners stated that they did “not believe that the chilling effect of credit bids alone should suffice as cause under section 363(k).” Id. The Commissioners implicitly rejected the contrary reading of “cause” tendered by the Third Circuit in In re Philadelphia Newspapers, LLC, 599 F.3d 298 (2010) and both cited and seemingly applied, to some degree, in In re Fisker Automotive Holdings, Inc., 510 B.R. 55 (Bankr. D.Del. 2014) and in In re The Free Lance-Star Publishing Co. of Fredericksburg, VA, 512 B.R. 798 (Bankr. E.D. Va. 2014).

Throughout the present discussion, we will refer to the reading of “cause” tendered in Philadelphia Newspapers and rejected by the ABI Commission as the “In and Of Itself” reading, for it would justify a finding of “cause” to limit credit bidding in a bankruptcy sale based on the chilling effect of credit bidding in and of itself.

We agree with the Commission's rejection of the In and Of Itself reading of “cause” in section 363(k). Below, we trace the outlines of arguments that: 1) the In and Of Itself reading of “cause” has no precedent prior to Philadelphia Newspapers and is scarcely supported there; and 2) application of the In and Of Itself reading is not justified on policy grounds, as is proposed by Philadelphia Newspapers.

Section 363(k) and 'Cause'

Section 363(k) of the Bankruptcy Code reads in toto as follows:

At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.

11 U.S.C. ' 363(k).

As discussed in Jonathan Brand and Jonathan Friedland, “You Know About Fisker But Do You Understand Fisker ?” 31 The Bankruptcy Strategist 9 (July, 2014), http://bit.ly/1Lit0e9, there are traditional bases on which courts have limited credit bidding under section 363(k). First, challenges to the validity, priority, and extent of liens on the collateral in question have been brought to bear under section 363(k). The credit-bidding rights provided or recognized in section 363(k) are conditioned: The credit bidder must be the holder of an “allowed claim” with a lien on the property to be sold that secures the allowed claim. That condition might be considered to form the basis upon which a credit bidding right is limited due to defects in the validity, priority, and extent of liens over the collateral in question. Nevertheless, such lien defects or claim allowance issues are often characterized as constituting “cause” to limit credit-bidding rights.

“Cause” in section 363 extends beyond lien defects or claims allowance issues. Most prosaically, credit-bidding rights can be defeated by the creditor's failure to assert them in accordance with procedural orders in the case. For example, in In re Antaeus Technical Services, Inc., 345 B.R. 556 (Bankr. E.D. Va. 2005), the court held that the expiration of certain deadlines per a settlement agreement between debtor and secured creditor resulted in bargained-for abandonment of its rights, including credit-bidding rights, in the principal asset to be sold.

Also, inequitable behavior or misconduct by the secured creditor can constitute “cause” to limit credit bidding rights of the holder of an allowed claim that has none of of the lien defects or allowance issues mentioned above. Penalizing the holder of an allowed claim for its misconduct by limiting credit bidding rights mirrors the application of section 510(c) of the Code, by which a court may “under principles of equitable subordination, subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim '” Like lien defects and claim allowance issues, as well as procedural defaults, a credit bidder's inequitable conduct can support a court's limitation of credit-bidding rights under section 363(k) ' no part of this statement is controversial.

No Support for the In and Of Itself Reading of 'Cause'

The In and Of Itself reading of “cause” in section 363(k) purports to authorize limiting credit-bidding rights even in the absence of lien defects, claim allowance issues, procedural defaults, and inequitable conduct. The In and Of Itself reading is based solely upon the inevitable effect that exercise of a credit bidding right ' in particular where the secured claim at first glance exceeds the cash value of the collateral ' has on an auction sale of property of the debtor in a bankruptcy case. We cannot distinguish between that effect and the effect caused by a cash bidder clearly able and willing to pay more than any other bidder, but let us leave that to the side.

The Fisker and Free Lance-Star opinions contain language that endorses the In and Of Itself basis for the finding of “cause.” Friedland and Brand argue that both cases can be explained by traditional and uncontroversial analyses described above, i.e., that credit-bidding rights were limited in those cases because of unresolved issues over validity, priority and extent of liens, as well as over inequitable behavior by the secured creditors.

In their references of the In and Of Itself reading of “cause,” the Fisker and Free Lance-Star Publishing courts drew from the fountainhead of text leading up to footnote 14 in the Philadelphia Newspapers majority opinion and from the footnote itself (none of the court's assertions in such text was at issue in Radlax Gateway Hotel, LLC v. Amalgamated Bank , __ U.S. __, 132 S.Ct. 2065, 182 L.Ed.2d 967 (2012), which overruled the major holdings of Philadelphia Newspapers ). Both opinions cite the same four cases the Third Circuit cited in that discussion. See Philadelphia Newspapers, 59 F.3d at 315-16 and fn 14; Fisker , 510 B.R. 55 at 59-60; and Free Lance-Star, 512 B.R. 798 at 805.

Those cases are In re Aloha Airlines, No. 08-00337, 2009 WL 1371950 (Bankr. D. Hawaii, May 14, 2009); Greenblatt v. Steinberg , 339 B.R. 458 (N.D.Ill. 2006); In re Anteaus Technical Servs., Inc., 345 B.R. 556 (Bankr. W.D. Va. 2005); and In re Theroux, 169 B.R. 498 (Bankr. D.R.I. 1994). In none of the cases cited by the Third Circuit did the court apply the In and Of Itself reading of “cause” to limit credit bidding. Each featured inequitable behavior or procedural default or lien defects. That should not surprise, for the Philadelphia Newspapers court cited them to support the uncontroversial proposition that “[i]n a variety of cases where a debtor seeks to sell assets pursuant to ' 363(b), courts have denied secured lenders the right to bid their credit,” and not the radical proposition that credit bidding has been denied solely because it might chill bidding.

At footnote 14 in the opinion, the Third Circuit declares in favor of application of the In and Of Itself reading of “cause” and cites its sole authority for the declaration:

The Lenders argue that the “for cause” exemption under '363(k) is limited to situations in which a secured creditor has engaged in inequitable conduct. The argument has no basis in the statute. A court may deny a lender the right to credit bid in the interest of any policy advanced by the Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment. See e.g., 3 Collier on Bankruptcy 363.09[1] (“The Court might [deny credit bidding] if permitting the lienholder to bid would chill the bidding process.”)

59 F.3d at 316, n. 14.

It is dubious for a court to rely exclusively upon a commentator to substantiate a radical change in bankruptcy law, even in dicta . But no such reliance is possible in this instance. The Collier passage on which the court relied cites no authority and in no way supports the proposition for which the Third Circuit cited it. Paragraph [1] of 3 Collier on Bankruptcy 363.09 states, in full:

Subsection (k) provides a right to bid and a right of offset if the creditor purchases property at a sale under subsection (b), but there is no guarantee that the sale will be a public sale. The 1984 legislation added a provision to subsection (k) permitting the holder of an allowed claim to bid at the sale unless the court for cause shown orders otherwise [footnote omitted]. The court might order otherwise if the sale is being negotiated privately and permitting the lienholder to bid would chill the bidding.

3 Collier on Bankruptcy 363.09[1].

The editors of Collier may have had in mind foreclosure sales of personal property under the UCC when they suggested that section 363(k) rights may be asserted in a private sale in a bankruptcy case, for private sales under section 363(b) are extremely rare. After noting that the Code “provides a right” to credit bid and “permit[s]” such a bid unless the court for cause shown orders otherwise, the passage states that the court “ might” so order in a private sale where credit bidding would chill the bidding. In the sentence on which the Third Circuit relied, Collier merely predicted that a court “might” order a limit to credit bidding, and that prediction applied only to the context of private sales, Collier said nothing about courts being empowered to lever any policy of the Code in limiting credit-bidding in private sales, much less in the public auctions by which assets are almost always sold in bankruptcy cases.

In summary, the fountainhead for the In and Of Itself reading of “cause” presented in Fisker and Free Lance-Star Publishing ' a radical break with prior law ' was dicta buried by the Philadelphia Newspapers court in a footnote, supported solely by reference to a treatise, which itself cited nothing as it was talking about something completely different, and which was selectively edited by the court to suit its unrelated purposes.

A Court May Deny a Lender the Right to Credit Bid in the Interest of Any Policy Advanced by the Code

Leaving aside the notional support for the In and Of Itself reading, let us consider whether, as Philadelphia Newspapers would have it, “the interest of any policy of the Code” suffices to authorize a court to limit or deprive an otherwise valid credit bidding right in a bankruptcy sale.

To hazard pronouncing the obvious, we note that bankruptcy courts are not courts of policy. They are bound to apply the statute as written, subject to authoritative canons of interpretation. It follows that Code policies are found only in Code provisions. Courts and advocates can tease a “policy” from any of the hundreds of provisions in the Code to deploy against a contrary teased-out policy. Such advocacy can provide only the lightest support for a radical change in interpretation of the meaning of “cause” in section 363(k).

The Philadelphia Newspapers majority's footnote 14 identified policies (ensuring the success of the reorganization or fostering a competitive bidding environment) but did not identify any provisions that substantiate them or weigh such policies against other policies.

With a moment's consideration, even weary and distracted commentators can summon the priority of payment rules of section 507, the absolute priority rule of section 1129(b), and the secured creditor's election provided under section 1111(b) as substantiating a Code policy in favor of preserving important secured creditor rights. For that matter, such commentators could also cite section 363(k) itself, and its application to plan sales via section 1129(b)(2)(A)(ii) in support of the same policy.

In his Philadelphia Newspapers dissent, Judge Thomas L. Ambro discussed at some length such statutory provisions as constituting “part of a comprehensive arrangement enacted by Congress to avoid the pitfalls of undervaluation, regardless of the mechanism chosen, and thereby ensure that the rights of secured creditors are protected while maximizing the value of collateral to the estate and minimizing deficiency claims against other unencumbered assets.” 599 F.3d at 334 (Ambro, J., dissenting). Judge Ambro's “comprehensive arrangement enacted by Congress” can be deployed against Judge X's “policy of the Code” in any given case.

This is “Let's Call the Whole Thing Off” (George and Ira Gershwin, 1937) territory. The In and Of Itself reading invites resolution of bargained for and reasonable investment-backed expectations based upon nothing firmer than the policy predilections of each judge.

The phrase, “reasonable investment-backed expectations” is intended to evoke Takings jurisprudence. See Palazzolo v. Rhode Island , 533 U.S. 606, 121 S.Ct. 2448, 2457, 150 L.Ed.2d 592 (2001) (citing Penn Central Transportation Company v. City of NY , 438 U.S. 104, 98 S.Ct. 2646, 57 L.Ed.2d 631 (1978)). This is to suggest that application of the In and Of Itself reading of “cause” in section 363(k) of the Code may effect a compensable taking under the Fifth Amendment to the United States Constitution. A topic for another day.

Christopher M. Cahill' of Lowis & Gellen LLP, Chicago, guides stakeholders through bankruptcy cases, out-of-court workouts, and assignments for the benefit of creditors. He can be reached at [email protected]. George W. Kuney is Professor of Law, University of Tennessee College of Law, and Director of the Clayton Center for Entrepreneurial Law. Kuney has practiced bankruptcy and business law for 26 years.