In a recent opinion, the Supreme Court unanimously affirmed a secured lender’s right to credit-bid at a bankruptcy sale of assets encumbered by such lender’s liens. In addition to solidifying the rights and protections afforded to a secured creditor in bankruptcy, the Supreme Court lessened some of the uncertainty associated with the acquisition strategy by which a potential buyer purchases claims secured by the targeted assets of a troubled company and seeks to exercise such secured creditor’s rights as to such assets.
“Credit-bidding” is the practice by which a secured creditor bids for encumbered assets by seeking to offset the debt it is otherwise owed. Thus, the purchase of secured claims at less than face value provides a sophisticated buyer an advantage over other rivals for distressed assets. In particular, every dollar of secured debt purchased by a potential acquirer requires an actual investment of less than a dollar but must be matched at an auction by a competitor bidding a full dollar of value. By credit-bidding its debt, a secured creditor also realizes a timely and certain recovery on its claims and immediately stops the incurrence of additional transaction costs related to the target’s Chapter 11 cases, such as the costs of reviewing and negotiating a plan of reorganization which governs the terms of payment of such secured creditor’s claim.
One significant risk associated with such a method of acquiring distressed assets, however, is that this strategy requires an up-front investment of cash to purchase secured claims without any assurance that the potential buyer will ultimately acquire the targeted assets. The Bankruptcy Code provides some assurance to a purchaser of secured debt by establishing the parameters of “fair and equitable” treatment of a secured creditor’s claims by a debtor. In particular, a debtor can i) allow the creditor to retain its lien on the secured assets and receive deferred cash payments with respect to such assets, ii) sell the property free and clear of such liens, provided that the secured creditor be allowed to credit-bid at the sale and that the creditor’s liens attach to the sale proceeds, or iii) otherwise provide the secured lender the “indubitable equivalent” of its claims.
The question of what is the “indubitable equivalent” of a secured creditor’s claims, and whether a secured creditor can receive the “indubitable equivalent” of its claims if it is not allowed to credit-bid at a bankruptcy auction, has produced inconsistent rulings amongst the courts. In particular, courts have differed on whether a secured creditor can be prohibited from credit-bidding its debt at a bankruptcy auction where the debtor proposes to sell the encumbered assets free and clear of all liens and provide the secured creditor with all of the proceeds resulting from the sale. The U.S. Courts of Appeals for the Fifth Circuit (Scotia Pacific Company, LLC v. Official Unsecured Creditors’ Committee (In re Pacific Lumber)) and the Third Circuit (In re Philadelphia Newspapers, LLC) recently determined that a secured creditor need not be afforded the opportunity to credit bid under such circumstances. In contrast, the Seventh Circuit in RadLAX Gateway Hotel LLC v. Amalgamated Bank held that a debtor cannot sell assets free and clear of liens unless the lien-holder is allowed to credit-bid.
The ability to credit-bid debt at an auction allows a secured creditor to prevent encumbered assets from being sold at a depressed price. Moreover, a credit-bid allows such lender to preserve the value of the encumbered assets without the commitment of additional resources. In essence, credit-bidding allows the secured lender to realize upon the underlying understanding of the initial loan, whereby the lender will either be paid in full or it will possess the collateral securing such loan (unless such creditor willingly agrees to an alternative result). Without the ability to credit-bid, secured creditors (and potential buyers) could be denied the option of acquiring the underlying assets and, thus, could be forced to accept a price which the creditor believes does not adequately represent the assets’ fair market value. In the face of inconsistent Circuit Court rulings, a learned buyer would be understandably reluctant to acquire secured claims (and make the obligatory up-front cash investment) as a method to acquire distressed assets.
On May 29, 2012, the Supreme Court in RadLAX Gateway Hotel LLC v. Amalgamated Bank agreed with the Seventh Circuit as to a lienholder’s right to credit-bid. Applying the rule of statutory construction that specific provisions of a statute supersede more general provisions, the Supreme Court held that the term “indubitable equivalent” can not eliminate the Bankruptcy Code’s more specific requirement that, to provide a secured creditor “fair and equitable” treatment in the context of a sale of encumbered assts, a lienholder must be afforded the right to credit-bid. Indeed, the Supreme Court held that such “indubitable equivalent” language is a residual provision that applies only when encumbered assets are not transferred through a plan under which a creditor’s liens remain attached to the property or may be sold free and clear of such creditor’s liens. Envisioning scenarios where the “indubitable equivalent” standard might apply, the Supreme Court specifically identified plans under which the encumbered assets are returned to the secured creditor. Although the Supreme Court acknowledged that a secured lender could still be denied the right to credit-bid upon the rare demonstration of sufficient cause, the Supreme Court did not pursue such analysis further as no demonstration of cause had been made to the lower courts.
As a result, the Supreme Court has, in the absence of specific cause otherwise, ensured the right of secured creditors to credit-bid at the sale of their encumbered assets. Although a buyer that purchases secured claims as a strategy to better position itself to acquire troubled assets still faces uncertainty and potential pitfalls, such potential buyer is protected from having its liens stripped from the underlying assets for a depressed price in a bankruptcy proceeding without an opportunity to obtain such assets itself. Moreover, such Supreme Court decision also alerts potential buyers that, in the absence of purchasing secured claims itself, acquiring assets in a bankruptcy sale absent the agreement and cooperation of a secured lender could be a difficult and expensive undertaking.
The McDermott Difference
McDermott Will & Emery's Restructuring & Insolvency Group offers a global and fully integrated team of more than 40 lawyers across all Firm departments. For more information on our group or if you have questions about this article, please contact: