Editor's Note - The Unsecured Trade Creditor's Committee recently hosted a committee call dealing with these same cases. To listen to the recording of this call, click here.
A secured creditor’s right to credit-bid its claim when its collateral is sold under chapter 11 is a fundamental right recognized by the Bankruptcy Code. However, the right to credit-bid is not absolute and may be limited “for cause.” Until recently, courts have found cause to deny credit-bidding solely when there is a pending objection to the validity of a secured creditor’s lien or the amount of its claim or when a rapid sale of the assets is necessary to preserve value.
But in a January 2014 decision by the U.S. Bankruptcy Court for the District of Delaware, In re Fisker Automotive Holdings Inc., and in a more recent decision by the U.S. Bankruptcy Court for the Eastern District of Virginia, In re The Free Lance-Star Publishing Co. of Fredericksburg VA, et al., bankruptcy courts have seemingly broadened what constitutes cause in order to limit the amount a secured creditor may credit bid at auction.[1] While it remains to be seen whether these decisions are anomalies or signs of a trend, they undoubtedly have the attention of creditors’ committees and other parties in interest – which are hoping for a new weapon to add to their arsenal to attack the increasingly common use of loan-to-own strategies – as well as distressed-debt acquirers contemplating the efficacy of such strategies.
The Right to Credit-Bid
Pursuant to § 363(k) of the Bankruptcy Code, a secured creditor may bid the amount of its outstanding secured claim at the sale of its collateral.[2] If the secured creditor is the winning bidder, no money is exchanged and the purchase price is offset against the secured claim. Credit-bidding grants an important right to a secured creditor by ensuring that its collateral is not sold for a depressed value. If a secured creditor believes that its collateral is being sold below market value, it has the option of taking the collateral in exchange for some or all of its claims.
Potential acquirers of a company often purchase secured claims in the secondary market, usually at a substantial discount, and bid those claims up to face value in a bankruptcy auction. Although credit-bidding can be useful in a distressed-acquisition strategy, one of its risks has always been that a bankruptcy court will deny or limit credit bidding “for cause” under § 363(k) of the Bankruptcy Code.
Fisker Automotive
On Nov. 22, 2013, Fisker Automotive Holdings Inc. and its affiliated entities (collectively, the “Fisker Debtors”) filed for bankruptcy protection. The Fisker Debtors filed a first-day motion seeking approval of a private sale of substantially all of their assets to their senior secured lender, Hybrid Tech Holdings LLC, in consideration for a $75 million credit-bid. Prior to the petition date, Hybrid purchased $168.5 million in secured debt from the U.S. Department of Energy for $25 million. The Fisker Debtors asserted that neither a private sale nor the cost and delay associated with an auction were likely to result in increased value for the estates and thus were not advisable under the circumstances. Accordingly, the Fisker Debtors sought approval of the sale only 24 business days after the bankruptcy filing.
The Fisker Debtors’ unsecured creditors’ committee objected to the sale and filed a separate motion requesting a competitive auction in order to permit Wanxiang America Corp. to submit a competing bid. The committee separately disputed Hybrid’s right to credit-bid, arguing that (1) a material portion of the assets were not subject to properly perfected liens or were subject to a bona fide dispute that could not be quickly resolved, or alternatively, (2) “cause” existed to disqualify the credit-bid (or, at a minimum, to cap the credit-bid at $25 million, the amount Hybrid paid for the debt) in order to facilitate an open and competitive cash auction and/ or because the assets being sold included encumbered, unencumbered and disputed assets.
While the court began its decision by acknowledging that it was “beyond peradventure that a secured creditor is entitled to credit bid its allowed claim” under § 363(k), the court pointed out that § 363(k) explicitly provides that credit-bidding may be limited “for cause.” The court then rejected the lender’s assertion that “cause” required some showing of inequitable conduct on the part of the lender. Rather, the court found that a bankruptcy court may deny a credit-bid “in the interest of any policy advanced by the Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment.”
The court found that no bidding would occur if Hybrid’s credit-bid was not capped based on unrebutted evidence to that effect. The court viewed this as significant, considering that the other potential bidder, Wanxiang, had a “vested interest” in purchasing the Fisker Debtor’s assets given that it had recently paid $300 million to acquire assets that included the primary component for the Fisker Debtors’ electric cars. The court also noted that neither the Fisker Debtors nor Hybrid offered a satisfactory reason for the expedited timeline for the sale. Indeed, the court found that “Hybrid’s rush to purchase … is inconsistent with the notions of fairness in the bankruptcy process” and that Hybrid should not be permitted to “short-circuit the bankruptcy process.”
The court’s decision also noted that the amount of Hybrid’s secured claim was uncertain. The court rejected Hybrid’s argument that it was entitled to credit-bid its entire claim under the Third Circuit’s decision in In re Submicron Systems Corp.[3] According to the court, Submicron was inapposite because it involved an allowed secured claim, “albeit the secured collateral was deficient as to the entirety of the claim.” With respect to Hybrid, the court noted, “we do not yet know how much of Hybrid’s claim is secured” in light of questions raised by the committee as to the perfection and validity of Hybrid’s lien. Based on the foregoing, the court held that Hybrid’s credit-bid would be capped at $25 million.[4]
Free Lance-Star
The Free Lance-Star Publishing Company of Fredericksburg, VA and William Douglas Properties, LLC (collectively, the “Free Lance Debtors”) were a family-owned publishing, newspaper, radio and communications company. The Free Lance Debtors were party to a $50 million pre-petition loan facility from Branch Banking and Trust (BB&T). The loans under the facility were secured by certain assets of the Free Lance Debtors, but not by the Free Lance Debtors’ “tower assets,” which were associated with the Free Lance Debtors’ radio broadcasting operations.
Prior to the petition date of the bankruptcy case, BB&T sold its secured loan to Sandton Capital Partners, which sought to push the Free Lance Debtors into chapter 11 and acquire the Free Lance Debtors’ assets through a related entity, DSP Acquisition LLC (DSP). DSP took certain pre-petition actions that put the scope of DSP’s security interest at issue when DSP sought to credit-bid its purported secured claims at a bankruptcy auction for the Free Lance Debtors’ assets. Specifically, even though DSP knew that it did not have liens on the debtors’ “tower assets,” it nonetheless recorded financing statements in various jurisdictions on those assets without giving any notice to the Free Lance-Star Debtors.
Shortly after the petition date, DSP filed a complaint seeking a declaration that it had valid and perfected liens on substantially all of Free Lance-Star Debtors’ assets and that it had the right to credit-bid its claim at the sale. DSP also filed a motion seeking summary judgment on all counts set forth in its complaint. The Free Lance-Star Debtors filed a cross-motion for summary judgment, arguing that cause existed to limit DSP’s credit-bid amount.
At a combined evidentiary hearing on the motions, the court found (similar to the findings in In re Fisker) that (1) DSP did not have valid, properly perfected liens on certain contested property, (2) DSP could not credit-bid a claim against assets on which it lacked a valid lien, and (3) DSP had engaged in inequitable conduct that required the court to limit its credit-bid right to foster a competitive bidding process. The court also found that DSP had engaged in inequitable conduct by influencing the asset-sale process through (1) exerting pressure on the Free Lance-Star Debtors for a speedy bankruptcy filing, (2) insisting that the Free Lance-Star Debtors shorten the marketing period for the sale and (3) insisting that the Free Lance-Star Debtors conspicuously advertise DSP’s credit-bidding right in the sale marketing materials. Based on these findings, the court held that “[t]he confluence of (i) DSP’s less than fully-secured lien status; (ii) DSP's overly zealous loan-to-own strategy; and (iii) the negative impact DSP’s misconduct has had on the auction process has created the perfect storm, requiring curtailment of DSP's credit bid rights.”
Without any evidence being offered by DSP, the court requested that the Free Lance Debtors’ expert witness provide testimony on the best procedure for fashioning a competitive auction sale and credit-bid price. The Free Lance Debtors’ expert eliminated the unencumbered assets (as determined by the court) and applied a market analysis to develop an appropriate cap for the credit-bid. The court accepted this approach and limited DSP’s credit-bid of approximately $38 million to $13.9 million.[5]
Anomalies, or Signs of a Trend?
Although the Supreme Court recently affirmed the right of secured creditors to credit-bid in the RadLAX decision, the Fisker Automotive and Free Lance-Star cases offer a stark reminder that credit-bidding could be limited by a bankruptcy court “for cause” based on policy considerations, such as to ensure the success of the reorganization or to foster a competitive bidding environment based on the facts and circumstances of the case.[6] The application of the Fisker Automotive and Free Lance-Star cases to other cases going forward is unclear, particularly in situations involving publicly traded debt or bonds. But the decisions have undoubtedly caught the attention of distressed-debt traders, secured creditors and parties in interest seeking to employ, or contest, acquisition strategies through the purchase of distressed debt.
[1] In re Fisker Auto. Holdings Inc., 2014 Bankr. LEXIS 230, Case No. 13-13087-KG (Bankr. D. Del. Jan. 17, 2014), and In re Free Lance-Star Publ’g Co., 2014 Bankr. LEXIS 1611, *7-14, Case No. 14-30315-KRH (Bankr. E.D. Va. Apr. 14, 2014).
[2] See 11 U.S.C. § 363(k) (“At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed claim, unless the court for cause orders otherwise, the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.”).
[3] 432 F.3d 448 (3d Cir. 2006).
[4] Following the decision, Hybrid filed an emergency motion for leave to appeal the ruling and an emergency motion for direct appeal to the Third Circuit. The U.S. District Court for the District of Delaware denied Hybrid’s motions on Feb. 7, 2014, and February 12, 2014, respectively.
[5] Following the decision, DSP filed, among other things, an emergency motion for certification and leave to appeal, requesting that the district court consider the bankruptcy court’s ruling before the proposed auction date: May 15, 2014. On May 7, 2014, the U.S. District Court for the Eastern District of Virginia denied DSP’s motion, relying heavily on the U.S. District Court for the District of Delaware’s refusal to consider Hybrid Tech Holdings’s appeal of the Fisker credit-bidding decision.
[6] RadLAX Gateway Hotel LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012).