=20

Secured Credit Committee

ABI Committee News

Volume 6, Number=20 2/November 2009

In This Issue:

News=20 from Philadelphia: Secured Creditors to Be Afforded Right to Credit = Bid at=20 Sale of Collateral Conducted under a Plan of Reorganization=20
Beware=20 of Borrowers with Underground Storage Tanks=20
Letter=20 from SCC Committee Co-Chairs

Co= mmittee=20 Officers=20
Upcoming = Events=20
Contribute to the = Newsletter=20
ABI World=20
Ne= wsletter=20 Archives

News from Philadelphia: Secured Creditors to Be = Afforded Right=20 to Credit Bid at Sale of Collateral Conducted under a Plan of = Reorganization

Davis Polk & Wardwell LLP; New York

Credit bidding, which has been used with increasing frequency as a = tool for=20 secured creditors to obtain possession of their collateral rather than = receive=20 the proceeds of a sale for consideration they view as inadequate, allows = a=20 secured creditor to set off sums owed to such secured creditor as a bid = in=20 certain sales of property of a debtor=92s estate. Sales of property of = the estate=20 outside of the ordinary course may be conducted pursuant to =A7363 of = the=20 Bankruptcy Code, as well as pursuant to a plan of reorganization. While = =A7363(k)=20 of the Bankruptcy Code expressly authorizes credit bidding in sales = conducted=20 pursuant to =A7363(b),[1] the Bankruptcy Code does not expressly require = that a=20 secured creditor be granted, in all circumstances, the right to credit = bid for=20 property of the estate being sold pursuant to a plan of = reorganization.

In In re Philadelphia Newspapers, LLC,[2] by express language in the bid procedures = motion, the=20 debtors sought to require that any qualified bidder, in an auction for=20 substantially all of their assets, fund its purchase offer with only=20 cash=97thereby seeking to preclude secured creditors from credit bidding = for their=20 collateral. Unsurprisingly, the steering group of the debtors=92 = prepetition=20 secured lenders and the agent for the prepetition secured lenders = (collectively,=20 the =93lenders=94), objected to the inclusion of this provision = precluding credit=20 bidding. Chief Judge Stephen Raslavich of the U.S. = Bankruptcy=20 Court for the Eastern District of Pennsylvania rejected the debtors=92 = argument=20 that they could, as a matter of right, deny the lenders the opportunity = to=20 credit bid and saw no =93cause=94 to deny the lenders=92 right to credit = bid for their=20 collateral.[3]

Background

Philadelphia Newspapers, LLC owns and operates various print and = online=20 publications in the Philadelphia area, including the Philadelphia=20 Inquirer, the Philadelphia Daily News, several community=20 newspapers and various online products. At the time of its bankruptcy = filing on=20 Feb. 23, 2009, the Philadelphia Inquirer and the = Philadelphia Daily=20 News were the two most widely read daily newspapers in the = Philadelphia=20 area.

As part of the debtors=92 plan of reorganization, they sought to sell = substantially all of their assets via a public auction. The debtors = entered into=20 an asset-purchase agreement with Philly Papers, LLC, an investor group = led by=20 the current management of the debtors and the stalking-horse bidder.[4] While the lenders, described by the debtors as=20 =93out-of-town hedge funds,=94 had long made it known that they intended = to place a=20 =93credit bid=94 for the debtors=92 assets, the debtors insisted that = any qualified=20 bidder fund its purchase offer with cash. The lenders were owed more = than $300=20 million, and the debtors=92 plan of reorganization contemplated = distributing $66=20 million to the lenders in full satisfaction of their allowed secured = claim.[5]

Denial of the debtors=92 Attempt to Preclude Credit=20 Bidding

The debtors argued that the lenders should be precluded from = submitting a=20 credit bid at the auction, under the theory that =A7363(k) of the = Bankruptcy Code=20 only expressly authorizes secured creditors to credit bid at a sale = pursuant to=20 =A7363 of the Bankruptcy Code, therefore not requiring that secured = creditors be=20 permitted to credit bid at a sale under a plan of reorganization. The = debtors=20 maintained that this is particularly true where a debtor seeks cramdown=20 confirmation of a plan of reorganization under =A71129(b)(2)(A)(iii) = (requiring=20 that the plan proponent demonstrate that the plan provides the secured = creditors=20 with the =93indubitable equivalent=94 of their claims).[6] The debtors also argued that allowing the = lenders to=20 credit bid would =93chill competitive bidding=94 at the auction, and = thus, as a=20 matter of policy, the lenders should be precluded from credit-bidding.[7]

The lenders maintained that the Bankruptcy Code supports the notion = that=20 secured creditors should be entitled to credit-bid at a sale of their=20 collateral, regardless of whether the sale is conducted under =A7363 or = a plan of=20 reorganization. Specifically, the lenders noted that while =A71111(b) of = the=20 Bankruptcy Code allows non-recourse undersecured creditors to elect to = waive=20 their deficiency claim and to have their allowed claims treated as fully = secured, as undersecured recourse creditors the lenders are statutorily=20 precluded from making this election in connection with the sale of their = collateral (whether under =A7363(b) or a plan of reorganization).[8] The lenders argued =93that the intent of = the=20 integrated provisions of the Bankruptcy Code (=A7=A7363, 1111, 1123 and = 1129) is to=20 ensure that where an undersecured creditor=92s collateral is proposed to = be sold,=20 whether under =A7363 or under a plan, the secured creditor is entitled = in all=20 events to protect its rights in its collateral, either by making an = election=20 under =A71111(b) or by credit bidding its debt.=94[9]

After examining various relevant provisions of the Bankruptcy Code, = the court=20 found the provisions to be ambiguous on the issue of credit-bidding at a = sale=20 pursuant to a plan of reorganization, but ultimately agreed with the = lenders=92=20 position.

In particular, the court disagreed with the debtors=92 reading of=20 =A71129(b)(2)(A) of the Bankruptcy Code. First, while recognizing that=20 =A71129(b)(2)(A) is written in the disjunctive, the court disagreed with = the=20 debtors=92 assertion that =A71129(b)(2)(A)(iii) could =93be employed = when the=20 exact means by which the plan intends the indubitable = equivalent=20 cramdown of a dissenting secured creditor is a cash out of the creditor = via an=20 auction sale such as is provided for in detail under = [=A71129(b)(2)(A)(ii)].=94[10] Second, the court rejected the theory that the = right to=20 credit-bid found in =A71129(b)(2)(A)(ii) applies only to sales under = =A7363(b),=20 observing that it is fair to interpret =A71129(b)(2)(A)(ii) as = =93importing the=20 essence of =A7363(k)=94.[11]

The court considered precedents supporting the debtors=92 position, = including=20 In re Pacific Lumber Co.,[12] a recent decision from the Fifth Circuit Court = of=20 Appeals where the circuit court =93rejected the Noteholders=92 complaint = that=20 confirmation of the subject plan was improper because they had not been = afforded=20 the opportunity to make a credit bid for the assets that were sold.=94[13] However, the court was able to distinguish = such cases=20 from the facts presented. In particular, the court noted that = Pacific=20 Lumber involved a private sale, where the value of the collateral = being=20 sold =93had been judicially determined after an extensive evidentiary = hearing=94 and=20 that the secured creditors in the case had failed to object to the plan = of a=20 private sale and the cashing-out of their claims =93until it was over = and they=20 were dissatisfied with the Bankruptcy Court=92s valuation.=94[14]

The court further noted that the legislative history regarding = =A71111(b)=20 supported the position taken by the lenders=97=93that is, where a = reorganization=20 plan proposes sale of a secured party=92s collateral and the dissenting = class of=20 creditors is precluded from making a
=A71111(b) election due to the = recourse=20 nature of the debt=85[,] [l]egislative history makes clear that where = the=20 preferred treatment which follows from the =A71111(b) election is = unavailable to a=20 secured creditor the creditor=92s bid right is preserved.=94[15]

Finally, the court noted that the debtors generally failed to rebut = the=20 lenders=92 allegations that the disallowance of credit bids was = =93designed to=20 promote the success of the Stalking Horse Bidder and the continuation of = current=20 ownership and management.=94[16] The court observed that a common criticism of=20 credit-bidding=97permitting a secured creditor to =93appropriate the = going concern=20 value of the business to itself, while sharing no infusion of value = through the=20 bid process with other creditors=94=97was not present in this case = because under the=20 plan, =93the amounts payable to the debtors=92 various creditor = constituencies are=20 fixed . . . [and] [a]ny and all funds which might derive from a cash = overbid are=20 to go exclusively to the lenders.=94[17] The court also rejected the debtors=92 = argument that the=20 plan precluded credit bids as a way to =93test the ability of a bidder = =91to write a=20 check,=92=94 observing that this element is a =93=91confirmation = issue=92 involving=20 feasibility.=94[18]

Future Implications

Chief Judge Raslavich=92s decision highlights certain practical = considerations=20 for secured creditors contemplating a credit bid for their collateral in = a sale=20 under a plan of reorganization. The distinctions drawn between the = conduct of=20 the lenders in Philadelphia Newspapers, as compared to the = secured=20 creditors in Pacific Lumber, illustrate the benefits that may = be gained=20 through early involvement and action on the part of secured creditors = looking to=20 preserve their rights under =A7=A7363(k) and 1129(a)(2)(A) of the = Bankruptcy Code,=20 particularly in light of what Chief Judge Raslavich found to be = ambiguity in the=20 interplay among =A7=A7363, 1111, 1123 and 1129. While the weight of the = case law has=20 long favored the position of secured creditors, the Fifth Circuit=92s = decision in=20 Pacific Lumber highlights the potential consequences of = inaction on the=20 part of secured creditors.

1. Section 363(b) of the Bankruptcy Code governs the = sale of=20 property of the estate other than in the ordinary course of business. 11 = U.S.C.=20 =A7363(b). Section 363(k) of the Bankruptcy Code provides that =93[a]t a = sale under=20 subsection (b) of this section of property that is subject to a lien = that=20 secures an allowed claim, unless the court for cause orders otherwise = the holder=20 of such claim may bid at such sale, and, if the holder of such claim = purchases=20 such property, such holder may offset such claim against the purchase = price of=20 such property.=94 11 U.S.C. =A7363(k).

2. In re Philadelphia Newspapers, LLC, Case = No. 09-11204=20 (SR, CJ), [Dkt. No. 1234] (Bankr. E.D. Pa. Oct. 8, 2009).

3. See id. at 19, 22.

4. The bid submitted by the stalking-horse bidder was = to be=20 marketed and subjected to higher and more attractive bids. Id. = at=20 2.

5. Id. at 4.

6. 11 U.S.C. =A71129(b)(2)(A)(iii).

7. In re Philadelphia Newspapers, LLC, Case = No. 09-11204=20 (SR, CJ) [Dkt. No. 1234] at 7 (Bankr. E.D. Pa. Oct. 8, 2009).

8. Id. at 9.

9. Id. at 10.

10. Id. at 10-11 (noting that such reading = would be=20 =93illogical and at odds with a settled canon of statutory construction = which=20 dictates that a generic provision of a statute should not be used to = achieve a=20 result not contemplated by a more specific provision=94). The court went = so far as=20 to call the debtors=92 argument on this point =93a not so thinly veiled = attempt to=20 manipulate the sale process in order to frustrate a credit bid which the = debtors=20 anticipate will exceed the bid of the Stalking Horse.=94 Id. at = 11.

11. Id. at 11-12.

12. =97F.3d=97, No. 08-40746, 2009 WL 3082066 (5th = Cir. Sept. 29,=20 2009).

13. In re Philadelphia Newspapers, LLC, Case = No.=20 09-11204 (SR, CJ) [Dkt. No. 1234] at 17 (Bankr. E.D. Pa. Oct. 8, 2009) = (noting=20 that court in Pacific Lumber also =93oberve[d] that in some = cases=20 provision of a credit bid option to a dissenting secured creditor might = be=20 =91imperative.=92=94).

14. Id. at17-18(court went on to note that in = Pacific Lumber, secured creditors did not propose their own = plan of=20 reorganization (as lenders did in present case), among other=20 distinctions).

15. Id. at 14-15.

16. Id. at 21.

17. Id.

18. Id. at 22 (noting that this issue = =93applies equally=20 as much to a cash bidder versus a credit bidder=94). The court noted = that its=20 conclusions negated the need for the court to consider the lenders=92 = arguments=20 about the potential effect that the court=92s approval of the Bid = Procedures=20 Motion (including the cash bid requirement) might have on the secured = lending=20 industry or that precluding the lenders from credit bidding would = ultimately=20 result in an unconstitutional taking of the lenders=92 property.=20 Id.

Secured Credit Committee

ABI Committee News

Volume 6, Number=20 2/November 2009

In This Issue:

News from Philadelphia: Secured Creditors to Be = Afforded Right=20 to Credit Bid at Sale of Collateral Conducted under a Plan of = Reorganization

by Brian=20 M. Resnick

Davis Polk & Wardwell LLP; New York

Hilary = Dengel

Davis Polk & Wardwell LLP; New York