In two recent decisions, the U.S. Court of Appeals for the Fifth Circuit and the U.S. District Court for the Eastern District of Pennsylvania held that a debtor may prohibit secured creditors from credit bidding their debt at a sale of their collateral conducted under a plan of reorganization, provided that the plan of reorganization otherwise meets the "fair and equitable" standard articulated in section 1129(b)(2)(A) of the Bankruptcy Code (governing cramdown) with respect to such secured creditors.
In In re Philadelphia Newspapers, LLC,[1] the U.S. District Court for the Eastern District of Pennsylvania reversed a ruling of the Bankruptcy Court for the Eastern District of Pennsylvania denying approval of bid procedures for an auction sale of substantially all of the debtors' assets pursuant to the debtors' plan of reorganization that required that all bids be made in cash (i.e., no credit bids). The District Court's decision followed a decision by the U.S. Court of Appeals for the Fifth Circuit in In re Pacific Lumber Co.,[2] which confirmed a plan of reorganization that denied a group of secured noteholders their asserted right to credit bid at a private judicial sale of the secured noteholders' collateral.
Background
Credit bidding, which has been used with increasing frequency as a tool for secured creditors to obtain possession of their collateral rather than receive the proceeds of a sale for consideration that they view as inadequate, allows a secured creditor to set off sums owed to such secured creditor as a bid in certain sales of property of a debtor's estate. Sales of property of the estate outside of the ordinary course of the debtor's business may be conducted pursuant to section 363(b) of the Bankruptcy Code or pursuant to a plan of reorganization. While section 363(k) of the Bankruptcy Code expressly authorizes credit bidding in sales conducted pursuant to section 363(b), the Bankruptcy Code does not expressly require that a secured creditor be granted, in all circumstances, the right to credit bid for property of the estate being sold pursuant to a plan.
To be confirmed, a plan of reorganization that has not been accepted by a class of claimants entitled to vote on such plan must demonstrate, among other things, that the plan is "fair and equitable" with respect to any dissenting class. Section 1129(b)(2)(A) of the Bankruptcy Code sets forth three methods by which a plan may be deemed "fair and equitable" with respect to a class of secured claims. First, the holders of secured claims may retain their liens securing their allowed claims and receive a right to deferred payments having a present value equal to the value of their collateral; second, the collateral may be sold free and clear of the liens, with the liens attaching to the proceeds of such sale, so long as the secured creditor is permitted to credit bid (as provided in section 363(k)); and third, the plan may provide for the secured creditors to receive the "indubitable equivalent" of their secured claims (generally meaning substituted value such that the secured creditor receives the benefit of its bargain).
In re Philadelphia Newspapers, LLC
In In re Philadelphia Newspapers, LLC,[3] the debtors sought to require that any qualified bidder in an auction for substantially all of the debtors' assets to be conducted pursuant to a plan of reorganization fund its purchase offer with only cash – thereby seeking to preclude secured creditors from credit bidding for their collateral. The "stalking horse bidder," with whom the debtors had entered into an Asset Purchase Agreement prior to the filing of the plan, was an investor group led by the current management of the debtor. The steering group of the debtors' pre-petition secured lenders (which had long made it known that it intended to place a credit bid) and the agent for the pre-petition secured lenders objected to the requirement precluding credit bidding. Chief Judge Stephen Raslavich of the U.S. Bankruptcy Court for the Eastern District of Pennsylvania rejected the debtors' argument that they could, as a matter of right, deny their secured lenders the opportunity to credit bid, and saw no "cause" to deny the secured lenders the right to credit bid. The Bankruptcy Court agreed with the secured lenders that "the intent of the integrated provisions of the Bankruptcy Code (§§ 363, 111, 1123, and 1129) is 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 to its collateral, either by making an election under § 1111(b) or by credit bidding its debt."[4] The Bankruptcy Court rejected the theory that the disjunctive nature of section 1129(b)(2)(A) of the Bankruptcy Code allowed a debtor to preclude credit bidding so long as the plan was "fair and equitable" under any of the alternative tests.
In a memorandum opinion issued on November 10, 2009, after discussing various canons of statutory interpretation, the U.S. District Court for the Eastern District of Pennsylvania reversed the Bankruptcy Court's decision and held that the debtors could prohibit the use of credit bids at the auction sale of their assets. Applying the "plain meaning" rule of statutory construction and referring to the Fifth Circuit's decision in Pacific Lumber, the District Court explained that, in enacting section 1129(b)(2)(A) of the Bankruptcy Code, Congress appears to have provided chapter 11 debtors with three alternative paths to confirmation, one of which (section 1129(b)(2)(A)(iii)) does not entitle a secured creditor to credit bid for its collateral. The District Court concluded that in seeking to cram down the dissenting secured creditors, the debtors were not limited to utilizing section 1129(b)(2)(A)(ii), the "Sale Prong," which entitles secured creditors to credit bid. The District Court concluded that the Bankruptcy Code permits the sale of a secured creditor's collateral pursuant to a plan of reorganization where the secured creditor will receive the "indubitable equivalent" of its claim. The District Court explained that, under this flexible standard, the debtors were free to craft a sale of their collateral that precluded credit bids, while nonetheless providing the secured creditors with the "indubitable equivalent" of their claims, and reasoned further that a secured creditor precluded from credit bidding (or making a section 1111(b) election) still possesses a deficiency claim in both the secured and unsecured classes.
The steering group of pre-petition secured lenders subsequently filed a motion requesting a stay of the auction pending their appeal to the U.S. Court of Appeals for the Third Circuit. The District Court denied pre-petition secured lenders' written motion, but granted the pre-petition secured lenders' oral motion for a stay of the auction for a period of seven days to maintain the status quo while the U.S. Court of Appeals for the Third Circuit considers expedited arguments.
In re Pacific Lumber Co.
Similarly, in In re Pacific Lumber Co., a group of secured noteholders challenged the confirmation of a plan under section 1129(b)(2)(A)(iii) of the Bankruptcy Code, on the grounds that section 1129(b)(2)(A)(ii) granted the secured noteholders the right to credit bid for the assets to be sold through a private judicial sale under the plan. Like the steering group of pre-petition secured lenders in Philadelphia Newspapers, the secured noteholders sought a stay of the plan's confirmation. No stay was granted, and prior to the issuance of the Circuit Court's opinion, the plan was substantially consummated.
On appeal, the Circuit Court disagreed with the secured noteholders' contentions that section 1129(b)(2)(A)(ii) alone applies in the case of a sale of collateral under a plan, thereby specifically allowing a dissenting secured creditor to credit bid for its collateral. The Circuit Court emphasized that section 1129(b)(2)(A) of the Bankruptcy Code should be read in the disjunctive, thus guaranteeing a secured creditor the right to credit bid only where section 1129(b)(2)(A)(ii) is the only applicable provision of section 1129(b)(2)(A). While the Circuit Court observed that a credit bid option might render section 1129(b)(2)(A)(ii) "imperative" in some cases, the Circuit Court determined that section 1129(b)(2)(A)(iii) "affords a distinct basis for confirming a plan." The Circuit Court explained that "[w]hatever uncertainties exist about indubitable equivalen[cy], paying off secured creditors in cash can hardly be improper if the plan accurately reflected the value of the [n]oteholders' collateral" and that the Bankruptcy Code "does not protect a secured creditor's upside potential; it protects the 'allowed secured claim.'"[5]
Future Implications
While the opinion of the Bankruptcy Court in Philadelphia Newspapers distinguished the circumstances of the steering group of pre-petition secured lenders, which had long made clear its intention to credit bid for the debtors' assets, from the secured noteholders in Pacific Lumber, who only began to raise objections to the sale process following the valuation of their claims, the District Court's opinion in Philadelphia Newspapers seems to do away with any consideration of the factual circumstances and instead simply relies on the precise language of section 1129(b)(2)(A). In an express effort to emphasize the benefits of cooperation between debtors and their secured creditors regarding plans of reorganization, the Circuit Court in Pacific Lumber noted that "the complexity of cramdown often cries out for appellate review, and this 'should encourage the debtor to bargain with creditors to gain acceptance of a plan in the majority of cases.'"[6] The District Court in Philadelphia Newspapers implicitly encourages pre-confirmation bargaining between debtors and their secured creditors by noting that its decision does not purport to "address whether denying the right to credit bid under the circumstances satisfies the fair and equitable or indubitable equivalent standards under section 1129,"[7] thereby leaving open the possibility that, at the confirmation hearing, the pre-petition secured lenders could argue that the plan fails to provide them with the "indubitable equivalent" of their claims.
Therefore, while these cases clearly support the proposition that a debtor is not required to afford secured creditors the right to credit bid at a sale conducted pursuant to a plan of reorganization (and thus represent a clear "win" for debtors trying to sell assets to third parties over the objection of creditors with a lien on such assets), whether debtors will be able to satisfy the "indubitable equivalent" standard in such circumstances remains an open issue. Furthermore, it remains to be seen whether debtors will be more inclined, as a result of these decisions, to effectuate asset sales through the longer and more expensive plan of reorganization route rather than pursuant to section 363(b) of the Bankruptcy Code, even if section 363(b) provides secured creditors with an undeniable right to credit bid (unless the court, for cause, orders otherwise).
1. In re Philadelphia Newspapers, LLC, Case No. 09-mc-178 (ER, J), [Dkt. No. 21] (E.D. Pa. Nov. 10, 2009).
2. Bank of New York Trust Co., NA v. Official Unsecured Creditors' Comm. (In re Pacific Lumber Co.), —F.3d—, Case No. 08-40746 (5th Cir. Sept. 29, 2009).
3. In re Philadelphia Newspapers, LLC, Case No. 09-11204 (SR, CJ), [Dkt. No. 1234] (Bankr. E.D. Pa. Oct. 8, 2009).
4. Id. at 10.
5. Bank of New York Trust Co., NA v. Official Unsecured Creditors' Comm. (In re Pacific Lumber Co.), —F.3d—, Case No. 08-40746 at 28 (5th Cir. Sept. 29, 2009).
6. Id. at 22. (internal citations omitted).
7. In re Philadelphia Newspapers, LLC, Case No. 09-mc-178 at 55 (ER, J), [Dkt. No. 21] (E.D. Pa. Nov. 10, 2009).