Historically, a credit bid in a chapter 11 sale has frequently been viewed as a "non-sale" event, and the parties did not feel an obligation to pay an investment banker, business broker, real estate broker or auctioneer (the professional) a commission for the result. 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. The employment agreement is usually between the debtor-in-possession (DIP) and the professional, but unfortunately for the professional, without access to cash sale proceeds, the DIP usually will not have any money with which to pay a commission. Furthermore, it is difficult to prove 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. 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 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, albeit less obvious, that a secured creditor also obtains significant benefits from the professional's marketing activities even when the result 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. 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
Skuna River Lumber LLC, which is pending in the Northern District of Mississippi, is just such a case. On Dec. 4, 2008, the Fifth Circuit Court of Appeals heard oral arguments in Borrego Springs Bank NA v. Skuna River Lumber LLC regarding a secured creditor's (Borrego's) benefits and obligations related to its credit bid in Skuna River. In 2006, when the 11 U.S.C. §363 sale process was underway, successful credit bids were the exception at 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. Yet the potential fee for a credit bid became quite an issue of contention at the hearing to approve the broker's retention agreement, and language was added to the broker's agreement to allow for a small flat fee should that come to pass. With a creditor sending signals that it intends to credit bid, why would any professional want to get engaged without some protection in the event of that outcome? In September 2006, Hon. David W. Houston III, after approving a credit bid in the case, ruled that the secured creditor (Borrego) had to pay a commission and expenses, as spelled out in the professional's retention agreement. In his opinion, Judge Houston addressed essentially the same benefits outlined above, along with 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. Borrego appealed the decision, and in January 2008, Hon. Michael Mills of the District Court for the Northern District of Mississippi, Western Division, affirmed that the secured creditor did benefit from the professional's marketing efforts and resulting credit bidding, and that the broker's fees and expenses should be paid by that creditor. It will be interesting to see what comes out of the ongoing appeal in the Fifth Circuit in which Craig Geno and Melanie Vardaman of Harris Jernigan and Geno PLLC continue to make the case on behalf of the debtor and its professional.
Conclusion
Over the past 20 years, we have found successful credit bids to be exceedingly rare, and compensation related to them has never been a high-priority item. However, this issue will become particularly relevant in the coming months, as the secured creditor may often be the only bidder and the market value bids may often represent too big a writedown for a creditor to accept-a scenario that is especially likely in the many real estate development cases being filed. There will be several situations where the DIP is not ready to cede control of the sale process, or consent to a lift-stay motion, still holding onto hopes of maintaining the going-concern; where the lender is not wiling 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 broker 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 to preserve the going-concern. The secured creditor either gets its 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 that 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.