The Irrelevance of Philadelphia Newspapers

In In re Philadelphia Newspapers LLC, [1] the Third Circuit held that a secured creditor does not have a statutory right to credit-bid its claim at an asset sale under a proposed plan of reorganization. Many commentators considered the decision significant because, although most asset sales during a bankruptcy case occur under § 363(k)—with its inherent right of credit-bidding by secured lenders—debtors can alternatively sell their assets as part of a reorganization plan under § 1129(b)(2)(A). The Third Circuit held that a debtor can sell substantially all of its assets free and clear of liens under subsection (iii) of § 1129(b)(2)(A)—the indubitable equivalence prong—and not subsection (ii), which expressly incorporates § 363(k) and a presumptive right to credit bid.

The dissenting opinion in Philadelphia Newspapers, followed by certain commentators, asserts that the decision misapplies settled case law and misconstrues the text of the Bankruptcy Code. Furthermore, in recent months, the legal reasoning of the Philadelphia Newspapers decision has been criticized by at least one other court. [2] This article eschews the doctrinal and interpretative issues raised by the Philadelphia Newspapers decision and its progeny and instead analyzes whether Philadelphia Newspapers will have a major impact on bankruptcy practice. This article argues that it likely will not.

First, the factual circumstances in Philadelphia Newspapers were unusual because outside investors continued to support the debtor, thereby enabling the debtor to largely forego debtor-in-possession financing from its pre-petition lenders and ignore its lenders’ demands. Second, although asset sales are common during bankruptcy, they typically occur under § 363, before a plan of reorganization is proposed, not as part of a plan of reorganization. Third, even if the Third Circuit had upheld a right to credit-bid during plan sales, § 363(k) allows bankruptcy judges to limit or prohibit credit-bidding “for cause.” Finally, secured lenders can potentially argue that a plan of reorganization that prevents credit-bidding runs afoul of the Code’s confirmation and cramdown requirements.

Background
Selling Assets during Bankruptcy
Debtors in bankruptcy are often unable to reorganize and instead must sell off substantially all of their assets to provide a recovery to creditors. Assets are typically sold pursuant to § 363 of the Code, which permits a trustee or debtor-in-possession to “use, sell, or lease, other than in the ordinary course of business, property of the estate….” [3]
Section 363 sales are common in the bankruptcy process for several reasons. First, § 363 sales occur outside of the plan-confirmation process and thus need not satisfy the strictures of the plan-confirmation process under §§ 1123 and 1129 of the Code. Second, § 363 permits debtors to sell their assets “free and clear” of liens, which is attractive for buyers who “do not want to risk having to redeem preexisting liens if the debtor fails to pay off the secured creditors in full.” [4] Finally, and perhaps most importantly, § 363 expressly permits a secured creditor to “credit bid” the value of its claim at a sale. [5] In other words, in order to purchase its collateral, a secured lender only needs to come up with the cash for the difference between the face value of the outstanding debt and the price of the asset. If the underlying asset is worth less than the value of the secured lender’s claim, then the lender can acquire the asset without putting up any additional cash. [6]

The ability to credit-bid is important to a secured lender because it enables a lender to acquire assets of the debtor without having to spend additional capital or turning to the capital markets, thereby reducing the transaction costs for a secured creditor. As one recent article on the topic observes, “credit bidding…avoids [a] senseless shuffling of funds from the [b]ank to the creditor to the debtor to the creditor to the [b]ank.” [7] The ability to eschew the need for additional capital is particularly important when capital markets are tight, such as in the months following the collapse of Lehman Brothers in 2008. During that period, many lenders and investors who held secured debt often used their claims to credit-bid for their collateral when capital was lacking and few other potential purchasers of a debtor’s assets existed.

Section 363, however, is not the exclusive mechanism for selling assets in bankruptcy. Debtors can alternatively sell assets as part of a plan of reorganization, over the secured creditor’s objection, if the plain is “fair and equitable” under § 1129. That “cramdown” section provides that a plan will be fair and equitable to a secured lender if (i) the lender retains liens on its collateral; (ii) the collateral is sold “free and clear” of the liens under § 363(k), which permits credit-bidding, or (iii) the lender is provided with the “indubitable equivalent” of its claim. [8] The plan process—especially cramdown—may be costly and time-consuming, but there are benefits to conducting a sale as part of a plan, including tax benefits. [9]

The Philadelphia Newspapers Decision
It was long assumed that a right to credit-bid existed in plan sales under § 1129(b)(2)(A). [10]In Philadelphia Newspapers, [11] however, the Third Circuit held otherwise, following in the footsteps of the Fifth Circuit.[12]

Philadelphia Newspapers, LLC (the “debtors”) was owned by a group of financial and media interests led by PMH Holdings, LLC, which obtained The Philadelphia Inquirer, The Philadelphia Daily News and philly.com, a news and entertainment website that catered to residents of the greater Philadelphia metro area, for $515 million. [13] A group of lenders provided $295 million in financing pursuant to a credit agreement that granted the lenders a first-priority lien on substantially all of the debtors’ real and personal property.

Within two years, the debtors were in default on their loans and filed to reorganize under chapter 11. When the debtors filed their joint plan of reorganization, the lenders were owed approximately $318 million. Under their plan, the debtors proposed to sell their assets “free and clear” of the lenders’ liens to Philly Newspapers, LLC, the stalking-horse bidder, for $37 million. The debtors also proposed to transfer their headquarters, located in downtown Philadelphia and valued at $29 million, to the lenders, provided that the lenders granted Philly Newspapers a rent-free lease for two years.

The proposed sale was notable for two reasons. First, the debtors were largely beholden to insiders of Philadelphia Newspapers, one of the debtors. Bruce Toll, the chairman of PMH Holders—the holding company of Philadelphia Newspapers—was a major stakeholder in Philly Newspapers, LLC. The pension fund of a politically connected union was also a key shareholder of the debtors.

Second, the proposed plan was notable because the debtors barred the lenders from credit-bidding. The bankruptcy court refused to prohibit credit-bidding, [14] but the district court reversed, [15] reasoning that secured lenders are protected under § 1129(b)(2)(A) by (i) keeping their liens intact, (ii) conducting a sale under § 363(k) or (iii) providing the secured lenders with the “indubitable equivalent” of their claims. The district court held that there was no requirement to permit credit-bidding because § 1129(b) was phrased in the disjunctive, and a sale need only provide lenders with the indubitable equivalent of their claims under subsection (iii), which could include a sale that did not conform to the strictures of § 363(k) and under subsection (ii) of § 1129(b)(2)(A). [16]

The lenders appealed to the Third Circuit, which affirmed the decision of the lower court. [17] The lenders principally argued that although § 1129(b)(2)(A) was written in the disjunctive, it should properly be read to require all “free and clear” asset sales to fall under subsection (ii), such that sales must thus comply with § 363(k), which permits credit-bidding. The majority rejected this argument, however, over a strong dissent from Judge Ambro, [18] who was a well-regarded bankruptcy attorney before he took the bench. Relying on a standard of statutory interpretation from a Supreme Court case arising under the Employee Retirement Income Security Act of 1974 (ERISA), [19] the court rejected the proposition that free-and-clear asset sales must proceed under subsection (ii). The court reasoned that “[a]lthough subsection (ii) specifically refers to a ‘sale’ and incorporates a credit bid right under section 363(k), we have no statutory basis to conclude that it is the only provision under which a debtor may propose to sell its assets free and clear of liens.” [20] In other words, the word “sale” in subsection (ii) “does lead inexorably to the conclusion that Congress meant for subsection (ii) to be the exclusive means through which such collateral is transferred.” [21]

The court also rejected the argument that the lenders would be denied the indubitable equivalent of their claims unless they were permitted to credit-bid under § 1129(b)(2)(A). The lenders argued that the term “indubitable equivalent” was ambiguous because it was broad in scope and that the court should turn to other canons of construction in order to determine whether there was, in fact, a right to credit-bid, notwithstanding the language of subsection (iii). The court rejected the lenders’ argument and held that subsection (iii) is not ambiguous, precluding the need to apply other canons of construction. The court held that a term in a statute is not ambiguous merely because it is broad in scope. [22]

The Initial Response to Philadelphia Newspapers
Some commentators argued in the wake of the Third Circuit’s opinion that Philadelphia Newspapers is a dark omen for secured lenders. In one response, several bankruptcy practitioners argue that Philadelphia Newspapers “will have serious repercussions in the lending community” because the decision “shifts the balance of power in the debtor-lender relationship and alters the dynamic ordinarily at play in corporate reorganizations…[by] produc[ing] greater uncertainty for lenders, which in turn could make the cost of corporate reorganizations that much greater.” [23] 

Ralph Brubaker, a business law professor and a former bankruptcy practitioner, writing before the Third Circuit released its opinion in Philadelphia Newspapers, criticized the opinion of the district court, which was later upheld by the Third Circuit. [24] Prof. Brubaker disapproved of the district court’s reliance upon the “plain-meaning canard” when interpreting § 1129(b)(2)(A), which resulted in the “surprise ‘discovery’ of [an] unprecedented cramdown power, over 30 years after the enactment of section 1129(b)….” [25] 

Finally, two other commentators criticized Philadelphia Newspapers on policy and legal grounds. As a policy matter, they argued that “credit bidding is likely to produce an auction with more bidders and lower transaction costs, which means higher expected returns to creditors.”[26] As such, they contended that it is an abuse of discretion for a bankruptcy judge to approve a plan without permitting credit-bidding.[27]

Analysis
Much of the criticism of Philadelphia Newspapers is misplaced, as a practical matter, because the decision will likely have a limited impact on bankruptcy practice. The debtor in Philadelphia Newspapers was unique because it had an uncommon ability to ignore its pre-petition lenders. The holding in Philadelphia Newspapers will likely have a limited impact on asset sales in bankruptcy because most asset sales occur during the case under § 363, which permits credit-bidding. Moreover, even if the Third Circuit held that there is a statutory right to credit-bid under § 1129, courts can still bar credit-bidding for cause. Finally, secured lenders can argue that a plan that prohibits credit-bidding runs afoul of the Code’s confirmation and cramdown requirements.

The Scarcity of Double-Down Debtors and Contractual Remedies
The debtor in Philadelphia Newspaper was unique because it did not need to rely on debtor-in-possession (DIP) financing provided by its pre-petition lenders. After filing for bankruptcy, the debtors retained the support of the group of investors—wealthy families in the Philadelphia area committed to keeping the papers in local hands—that purchased the Inquirer, the Daily News and philly.com in a massive leveraged buyout in 2006 for more than $500 million. This support took two forms. First, during the restructuring process, the investors sponsored a “keep it local” campaign that encouraged Philadelphians to support keeping ownership of the papers in the Philadelphia area. [28]

Second, and more importantly, the investors essentially “doubled down” on their original investment and continued to pour cash into the debtors’ operations. With cash coming in, the debtors did not need to rely on DIP financing from their pre-petition lenders. Without the need to cater to the interests of their secured lenders, the debtors had a free hand to play hardball over—among other things—credit-bidding.

The fact that the debtors did not need to rely on their lenders for DIP financing distinguishes Philadelphia Newspapers from many other chapter 11 cases. For example, a 2003 study found that nearly 60 percent of publicly traded firms that file for chapter 11 received post-petition DIP financing from their pre-petition secured lenders, [29] representing a nine-fold increase from the 1980s. [30] A different analysis found that upwards of 90 percent of DIP lenders impose operational restrictions on debtors’ activities. [31] Because debtors usually rely on their lenders for DIP financing, they have little choice but to heed their demands. In the typical case, if a secured lender is intent on acquiring its collateral by credit-bidding its claim, a debtor has little choice but to acquiesce: It can choose to defy the lender, but doing so will most certainly cause the lender to cut off access to the cash collateral, which will cause the firm to sink immediately. In other words, there will likely not be many cases like Philadelphia Newspapers in the foreseeable future because few debtors can survive post-petition without DIP financing, provided most often by their pre-petition secured lenders. Moreover, a secured lender that is concerned about its ability to compel a debtor to acquiesce to credit-bidding can simply contract around § 1129(b)(2)(A) by making the right to credit-bid in a plan sale a condition of permitting the debtor to use the lender’s cash collateral or of any DIP loan.

The Continuing Appeal of § 363 Sales
Many asset sales occur under § 363 before a plan is proposed, not under the cramdown requirements of § 1129(b). The Third Circuit’s decision does not affect the ability of secured creditors to credit-bid in pre-plan sales of assets under § 363. 
            
No study has yet systematically analyzed the extent to which debtors prefer to sell assets under § 363 rather than as part of a plan of reorganization or liquidation. A variety of empirical and qualitative analyses, however, suggest that assets are rarely sold off as part of a plan of reorganization and that they are regularly sold off before a plan is proposed. Although chapter 11 filings continue to rise, fewer firms actually reorganize under the Bankruptcy Code. [32] Moreover, asset sales are increasingly being conducted under § 363. During the 1980s, three corporations were sold off entirely during bankruptcy under § 363 sales. [33] In 2000, eight companies were sold off in toto under § 363 sales during bankruptcy. [34] In 2001, 12 businesses did the same, [35]and in 2003, 16 businesses followed suit. [36]
            
These trends suggest that companies are filing for chapter 11 and then using other Code protections—such as the automatic stay and the § 363 process—to sort out their finances. This is significant because although asset sales generally occur under § 363, it is unlikely that the Philadelphia Newspapers decision will curtail the ability of secured creditors to credit-bid.

A potential counterargument is that it is irrelevant that most asset sales are conducted under § 363 because until Philadelphia Newspapers was decided, it was assumed that credit-bidding was allowed under both §§ 363 and 1129. Now that it is clear that credit-bidding is expressly allowed under § 363, but not under § 1129(b)(2)(A), this dynamic could change. 

There are two reasons to suspect that § 363 will nonetheless retain its appeal. First, sales under § 363(k) enable the debtors to bypass some requirements entailed in the plan-confirmation process. Second, secured lenders concerned about their ability to credit-bid can preserve the ability to credit-bid as a condition of either extending credit and permitting the debtor access to cash collateral. In addition, provided that pre-petition secured lenders continue to provide the bulk of DIP financing post-petition, the ability to contract will be a particularly strong guarantee that secured lenders will be able to credit-bid.

The Option to Prohibit Credit-Bidding “For Cause”
A contrary result in Philadelphia Newspapers would not necessarily have enabled the debtors to credit-bid. Section 363(k) permits the bankruptcy court, at its discretion, to limit or prohibit credit-bidding “for cause.” [37]Courts and commentators have identified three factors that favor limiting or prohibiting credit-bidding in some asset sales, regardless of whether they occur under § 363(k) or a plan. First, bankruptcy courts have limited credit-bidding by secured lenders in order to protect the rights of other secured lenders. [38] Second, courts have prohibited credit-bidding when the bankruptcy process is being abused. [39] Finally, commentators have suggested that courts should limit credit-bidding by “loan-to-own” DIP financing lenders, as loan-to-own bidders do not share the interests of “ordinary” lenders because loan-to-own lenders want to acquire the debtor’s assets on the cheap, rather than to maximize the bids offered in order to ensure that they are repaid on their initial loans. [40]

Although it is doubtful that any of these factors should have led the bankruptcy court to curtail credit-bidding in Philadelphia Newspapers, the fact remains that even if asecured lender has a right to credit-bid, the bankruptcy court can nonetheless limit or prohibit credit-bidding based on any of these factors. [41]

Other Protections Included in the Bankruptcy Code
A final reason that further diminishes the importance of the Philadelphia Newspapers decision is that a plan to sell assets under a plan of reorganization may only be crammed down over a dissenting class of secured creditors if it meets the other requirements of confirmation and the cramdown rules, a point alluded to briefly by Judge Ambro in his dissent. [42] Secured lenders can potentially argue that a plan that bars credit-bidding runs afoul of the confirmation requirements if, for example, such a plain is not proposed in good faith as required by § 1129(a)(3)[43] because it is merely “a thinly veiled way for insiders to retain control of an insolvent company minus the debt burden the insiders incurred in the first place,” [44] a scenario alluded to by Judge Ambro. Alternatively, a secured lender can argue that a plan that bars credit-bidding cannot be crammed down under § 1129(b) because it is not, as Judge Ambro suggested, “fair and equitable.” [45] In short, secured lenders who are denied the ability to credit-bid can potentially argue that such a plan runs afoul of the Code’s general confirmation requirements, as well as the cramdown provisions.

Conclusion
The Philadelphia Newspapers decision has generated a large share of criticism from scholars and bankruptcy practitioners. Although the Third Circuit, according to the dissent and others, may very well have been wrong as a matter of law, there is little to suggest that the decision will have a major impact on how asset sales occur in bankruptcy cases. Perhaps Philadelphia Newspapers will spur Congress to modify § 1129(b)(2)(A). However, even absent such a legislative change, there is little reason to think that in an era when pre-plan sales are on the rise, that the Philadelphia Newspapers decision will impact a secured lender’s ability to credit-bid.