Historically, a credit bid in a chapter 11 asset sale pursuant to 11 U.S.C. §363 has frequently been viewed as a "nonsale" event, and the creditors of the debtor-in-possession (DIP) did not feel an obligation to pay an investment banker, business broker, real estate broker or auctioneer (the professional) a commission and/or fee for that result. For one thing, the professional's employment agreement frequently calls for payment "from the sale proceeds," and there are no cash proceeds from which to pay in the event of a credit bid. Additionally, the employment agreement is usually between the DIP and the professional. Unfortunately for the professional, without access to cash sale proceeds, the DIP usually will not have any money with which to pay a commission and/or fee. Furthermore, it may sometimes be difficult to prove a benefit to the estate derived from a credit bid. As a result, a professional can do a lot of work, with no assurance of any compensation, and/or have to rely on the surcharge provisions of 11 U.S.C. §506(c).
In the past, professionals haven't lost much sleep over this conundrum, because they were confident that they would obtain bids that would satisfy the secured creditors, and it was generally understood that a lender might not want to pay a commission simply to "get back" their collateral. Flash forward to today's economic paradigm: With the frequency of large shortfalls between the secured debt and the true market value of the collateral, and the limited number of buyers that have the cash or ready financing to bid in a bankruptcy sale, it is now more likely than ever that secured creditors will successfully (if you can use that word) credit bid on their collateral. As a result, professionals may be reluctant to sign on to work on a success-fee basis in the very cases that most need their help.
Benefits to Secured Creditors
Of course, no one argues that the secured creditor does not benefit from the professional's marketing efforts if a third-party purchaser's offer is accepted and closes, thereby quickly producing cash for the secured creditor without the secured creditor having to take possession of the collateral or outlay cash for a marketing process. Yet it is true that a secured creditor also obtains significant benefits from the professional's marketing activities even when the result of an asset sale is a credit bid. Perhaps the most clear and common benefit is that the secured creditor can avoid the legal and other costs associated with pursuing a motion for relief from the automatic stay in the bankruptcy proceeding, followed by a foreclosure in state court, and the notice and other costs associated with actually gaining possession. Furthermore, the secured creditor is able to quickly establish any deficiency claim it may have without concern that the DIP may challenge the amount of the claim. Within the confines of a chapter 11 case, the secured creditor need only let the DIP run its sale process, and if the secured creditor does not like the result, simply credit bid and acquire clean title to the assets without any further action. In addition, in cases where there are multiple secured creditors with different, perhaps overlapping, sets of collateral, a sale process allows for the creditors to avoid multiple lift-stay motions and separate foreclosures, and if third-party offers are accepted, the potential complexities of each creditor trying to take its collateral without damaging the value of the other creditors' collateral.
Skuna River Lumber LLC
In re Skuna River Lumber LLC, a chapter 11 case in the Northern District of Mississippi, is just such a case. In 2006, Skuna filed its chapter 11 petition and filed motions with the court seeking to employ EPI as its broker and to sell its assets pursuant to 11 U.S.C. §363. At that time, successful credit bids were the exception at bankruptcy auctions, and I suspect that most retention agreements did not even address the possibility of a credit bid and what, if any, compensation would be due the professional. However, in Skuna, the potential fee owed to EPI in the event there was a credit bid by one of Skuna's secured creditors became quite an issue of contention at the hearing to approve EPI's retention agreement with Skuna. Following a hearing and negotiations among EPI, Skuna and the secured creditors, language was included in the order approving the employment of EPI and added to the brokerage agreement between Skuna and EPI to allow for a small flat fee should one of Skuna's secured creditors successfully credit bid. After the auction and sale hearing in which one of Skuna's secured creditors, Borrego Springs Bank (Borrego), purchased all of Skuna's assets by a credit bid, Skuna filed a fee application on behalf of EPI and requested a surcharge pursuant to 11 U.S.C. §506(c). Borrego objected to the fee application and surcharge request. Hon. David W. Houston III, in considering the fee application and surcharge request and Borrego's objection thereto, ruled that Borrego was responsible for paying EPI's fee and out-of-pocket expenses as set forth in the retention agreement. In his opinion, Judge Houston addressed essentially the same benefits outlined above, as well as his concern about what message would be sent to professionals. He feared that professionals would be discouraged from trying to help debtors and creditors if the compensation for their efforts could be negated by a credit bid. See In re Skuna River Lumber LLC, 352 B.R. 788 (Bankr. N.D. Miss. 2006). Borrego appealed Judge Houston's decision, and, in January 2008, Judge Michael Mills of the U.S. District Court for the Northern District of Mississippi, Western Division, affirmed the bankruptcy court's ruling and that Borrego did benefit from EPI's efforts to market Skuna's assets and held that Borrego should pay EPI's fee and expenses. Borrego appealed the district court's decision to the U.S. Court of Appeals for the Fifth Circuit. On Dec. 4, 2008, the Fifth Circuit heard oral argument in Borrego Springs Bank N.A. v. Skuna River Lumber LLC, Case No. 08-60185,regarding Borrego's benefits and obligations related to its credit bid in Skuna River.
Conclusion
Over the last 20 years, we have found successful credit bids to be exceedingly rare, and compensation related to them has not often been a topic of discussion or debate. However, this issue will become particularly relevant in the coming months, as the secured creditor may often be the only bidder and third-party bids may often represent too big a write-down for a creditor to accept-a scenario that is especially likely in the many real estate development cases being filed. There will be many situations where the DIP is not ready to cede control of the sale process, or consent to a lift-stay motion, still holding on to hopes of maintaining the going concern, where the lender is not willing to wait indefinitely to move on its collateral while the DIP may or may not take action to convert the collateral to cash, where very busy professionals are reluctant to get involved in a case that may be deeply underwater, and where a credit bid is somewhat likely. In such cases, the logjam can be broken, and everyone wins, if the lender and professional can agree to a reasonable fee in the event of a credit bid. By doing so, the DIP and the secured creditor, as well as any subordinate creditor classes, get the assurance of a commercially reasonable process and a chance to maximize value, and hopefully preserve the going concern. The secured creditor either gets the cash or "the keys" by a certain date, without having to file a motion for relief from the automatic stay, foreclosure, etc. And the professional gets an engagement that offers a normal fee for a successful third-party sale, while having the assurance of some lesser fee as a consolation prize, without having to litigate the issue, if the credit bid wins the day. While the goal of a sale process should always be a third-party sale at maximum value, based on the Skuna River rulings to date and the efficiencies offered by the §363 sale process, it seems the secured creditor should embrace such a process and negotiate, in advance, a credit bid fee it can live with and that represents an economic savings vis-a-vis a lift-stay and foreclosure.