The U.S. Supreme Court ruled on May 29, 2012, that secured lenders have the right to credit bid their debt instead of having to pay cash in an auction of their collateral as part of a Chapter 11 plan of reorganization. Specifically the Supreme Court held that a debtor in a Chapter 11 bankruptcy case could not confirm a Chapter 11 cram-down plan of reorganization that provides for the sale of collateral free and clear of a secured creditor’s lien but does not permit the secured creditor to credit bid at the sale.
In a unanimous decision,1 the Supreme Court favored the secured lender’s interpretation of the Bankruptcy Code plan provision, basing its decision on statutory construction rather than on the merits of credit bidding. The ability to credit bid enables a creditor to guard against the risk that its collateral will be sold at a depressed price.
Our last year’s bulletin on this topic (December 11, 2011) discussed the split among the federal appeals courts regarding whether secured lenders have the right to credit bid for collateral to be sold under a Chapter 11 plan of reorganization. The U.S. Supreme Court affirmed the decision of the U.S. Court of Appeals for the Seventh Circuit in In re RadLAX,2 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.
Bankruptcy Code Section 363(k) permits parties to offset their secured claim against the purchase price of the encumbered assets. Bankruptcy Code Section 1129(b)(2)(A) allows a debtor to confirm a plan over the secured lender’s objection if, among other things, under clause (ii) it provided for the sale, subject to the credit-bidding right, of any property subject to a lien, with the lien to attach to the proceeds of the sale or, under clause (iii), because it provided secured lenders with the "indubitable equivalent" of their claims. The debtors had claimed that the plan, which did not satisfy clause (ii) by not allowing for a credit bid, could satisfy clause (iii) by providing the lender with the indubitable equivalent in the form of cash generated by the auction.
The Supreme Court held that the debtors’ interpretation under which clause (iii) permits what clause (ii) prohibits (sale without credit bidding) is "hyperliteral and contrary to common sense." Using canons of statutory construction, the Court could not render superfluous a specific provision (sale with credit bidding under clause (ii)) that is swallowed by a general one (indubitable equivalent under clause (iii)).
The Supreme Court did not consider arguments giving weight to the existing lending practices as raised by the Loan Syndications and Trading Association’s amicus brief. And it noted that "the pros and cons of credit-bidding are for the consideration of Congress, not the courts." However, in a footnote, the Supreme Court signaled that it heard the concerns of the Solicitor General, who argued that the U.S. federal government is frequently a secured creditor in bankruptcy that often lacks authority to raise cash in an auction – or as the Supreme Court stated "to throw good money after bad in a cash-only bankruptcy auction."
Even though the decision was based on a literal reading of the Bankruptcy Code, secured creditors can take comfort knowing that an important lender protection remains.
1 Justice Scalia delivered the opinion in which all other justices joined except for Justice Kennedy, who did not take part in the decision of the case.
2 RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. ___ (May 29, 2012).
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