From time immemorial, banks and other secured lenders have relied on their ability to "credit bid" for their collateral as a key source of protection and negotiating leverage against debtors and competing bankruptcy acquirors. Credit bidding secured debt rather than paying cash for collateral has been an effective counterweight against a debtor’s protections of the automatic stay and its exclusive right to control the plan formulation process and bankruptcy sales under Section 363 of the Bankruptcy Code.
This delicate balance is being weighed by the U.S. Supreme Court, which has agreed to resolve a split between the federal appeals courts as to whether secured lenders have the right to credit bid for collateral to be sold under a Chapter 11 plan of reorganization. This decision will affect all secured debtholders and could raise the cost of financing for companies.
The case to be heard next spring by the U.S. Supreme Court is an appeal of the decision of the U.S. Court of Appeals for the Seventh Circuit upholding the denial of the debtors' attempts to prevent the secured creditors from credit bidding in an auction for the sale of substantially all of the assets (comprising primarily an airport hotel) in the context of a cram down plan of reorganization. Specifically, the Seventh Circuit ruled that a proposed plan of reorganization contemplating the sale of a debtor's assets free and clear of a dissenting secured lender’s liens cannot be confirmed under Bankruptcy Code Section 1129(b)(2)(A) unless the plan offers the secured lender the opportunity to credit bid in connection with the sale of the assets.
The Seventh Circuit's ruling in In re River Road in favor of the secured lenders is in sharp contrast to last year's Third Circuit Philadelphia Newspapers decision and an earlier decision issued by the Fifth Circuit in In re Pacific Lumber, Co. In Philadelphia Newspapers, the Third Circuit held that a debtor could sell assets free and clear of liens under a proposed plan of reorganization without affording dissenting secured lenders the opportunity to credit bid.
The Seventh Circuit looked at whether, under applicable subsections of Section 1129(b)(2)(A), the plan was fair and equitable to the debtor’s secured lenders either because it provided for the sale, subject to Bankruptcy Code Section 363(k), of any property subjection to a lien, with the lien to attach to the proceeds of the sale or, more generally, because it provided secured lenders with the "indubitable equivalent" of their claims. Bankruptcy Code Section 363(k) permits parties to offset their secured claim against the purchase price of the encumbered assets. The Seventh Circuit noted the growing practice of debtors to sell assets under a plan without abiding by the credit bid protections of Bankruptcy Code Section 363(k) and then to seek cram down of the secured lenders so long as the plan merely provides secured lenders with the indubitable equivalent of their claim.
The Loan Syndications and Trading Association filed a brief in the River Road case, noting that the absence of a lender's ability to credit bid would cause the price of lending to increase because lenders would need to find alternative protective remedies.
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