Seventh Circuit to Weigh in: A Secured Creditor’s Right to Credit Bid Under §1129(b)(2)(A)

A potential conflict among circuit courts regarding § 1129(b)(2)(A) of the Bankruptcy Code may soon exist. In a recent decision, Hon. Bruce Black in In re River Road Hotel Partners, LLC[1] denied the debtors’ request to sell real property under a plan using bid procedures that denied the secured creditors the right to credit-bid. This ruling is contrary to the position taken by the Third and Fifth Circuits in In re Philadelphia Newspapers LLC [2] and In the Matter of The Pacific Lumber Co., [3] respectively, in which the courts held that under § 1129(b)(2)(A)(iii), secured creditors’ collateral could be sold under reorganization plans without affording the secured creditors the right to credit-bid their debt for their collateral. Judge Black’s decision is on direct appeal to the Seventh Circuit.

Issue Involved with Collateral Sales
Under the Code, if a class of secured creditors rejects a reorganization plan, the debtor can confirm its plan but only if the plan does not “discriminate unfairly” and is “fair and equitable” with respect to that rejecting class. [4] If the rejecting class is one of secured claims, the Code provides what the plan must include to be “fair and equitable.” The plan must (1) allow secured creditors to retain their property liens and receive deferred cash payments totaling the value of the creditor’s interest in the debtor’s interest in the property; [5] (2) provide for a sale of the property subject to § 363(k) free and clear of liens with the liens to attach to the sale proceeds; [6] or (3) provide the secured creditor with “realization of the indubitable equivalent of such claims.” [7] The question that had to be decided in River Road, Philadelphia Newspapers and Pacific Lumber was whether a plan sale that does not allow credit bidding in accordance with § 363(k) as required under § 1129(b)(2)(A)(ii) can still be confirmed under § 1129(b)(2)(A)(iii) with a finding that such secured creditor plan treatment provides an “indubitable equivalent” for that claim.

Philadelphia Newspapers and Pacific Lumber
The Fifth and Third Circuits in Pacific Lumber and Philadelphia Newspapers answered this question in the affirmative. The plans in each case allowed a transfer of the secured creditor’s collateral free of the creditor’s lien without giving the secured creditor a chance to credit bid for its collateral. In Pacific Lumber, the collateral was transferred to a third party under the plan and the secured creditor was paid cash for the court-determined value of the collateral. In Philadelphia Newspapers,the collateral was sold without any competitive bidding. In confirming the plans, the courts relied on the statutory construction of § 129(b)(2)(A). Holding that the constraints of § 1129(b)(2)(A)(ii) were not applicable to § 1129(b)(2)(A)(iii), the Fifth and Third Circuits focused on the disjunctive “or” between the three subsections of § 1129(b)(2)(A)(i)-(iii, which, the court reasoned, merely set forth alternatives. Therefore “indubitable equivalent” is an alternative to the sale with credit bid of § 1129(b)(2)(A)(ii). Further, the use of the word “includes” in the introductory language to these three alternatives—“condition that a plan be fair and equitable includes the following requirements” but is not limiting. Pacific Lumber. [8] As such, the courts believed that permitting a credit bid was not imperative in all cases.

Building on Pacific Lumber, the Third Circuit in Philadelphia Newspapers also cited to the plain language of the statute and did not find the § 1129(b)(2)(A)(iii) term “indubitable equivalent” to be ambiguous. Although broad in scope because that language is an alternative to the prior section that required § 363(k) treatment, the court reasoned that there could be a different treatment that resulted in the same type of secured creditor treatment.

River Road Decision and Dissent in Philadelphia Newspapers
In the River Road case, the debtors also argued that the provisions of § 1129(b)(2)(A) are alternatives to each other, and a sale of property without credit-bidding could satisfy the requirements of § 1129(b)(2)(A)(iii) as an “indubitable equivalent.” The secured creditors in the case, Amalgamated Bank and the FDIC, argued that a sale under a plan was governed exclusively by § 1129(b)(2)(A)(ii) that required the sale to be subject to § 363(k), which provided the right to credit-bid. Judge Black ruled against the debtors, stating that he found “Judge Ambro’s well-reasoned dissent in Philadelphia [N]ewspapers more persuasive.” [9]

Because Judge Black in essence adopted Judge Ambro’s reasoning, it is important to understand Hon. Thomas Ambro’s decision. Judge Ambro provides a plethora of bases for concluding that a sale under a plan in a cramdown situation must comply with the provisions of § 1129(b)(2)(A)(ii). Citing to the same language of § 1129(b)(2) analyzed by the Third and Fifth Circuits, Judge Ambro noted that § 1129(b)(2) gives “requirements” for a plan to be fair and equitable to secured creditors, and that when there is a sale, those “requirements” are governed by the specific language of § 1129(b)(2)(A)(ii), not the general language of § 1129(b)(2)(A)(iii). Further, if § 1129(b)(2)(A)(iii) could be read to also apply to sales of collateral, free of the constraints of § 363(k), then § 1129(b)(2)(A)(ii) becomes a nullity violating a “cardinal principal of statutory interpretation.” [10]

In addition, Judge Ambro (and Judge Black in adopting his reasoning) found that the Third Circuit’s interpretation of §1129(b)(2)(A)(ii)-(iii) created a conflict, preventing reliance on the statute’s “plain language” and requiring analysis of the purpose of credit bidding, § 1111(b) election and other rights afforded secured creditors in the Code. For example, allowing a plan sale without credit-bid rights, which give a creditor the benefit of its collateral by bidding the full amount of its debt, denies the creditor of its right to elect have its claim be a “secured claim to the extent that such claim is allowed.” [11] This election cannot be made if the secured creditor’s collateral is being “sold under Section 363 of this title or is to be sold under the plan.” [12]

Different Views May Have Affected How § 1129(b)(2)(A) Was Read
The different conclusions reached in Philadelphia Newspapers and Pacific Lumber, and the dissent in Philadelphia Newspapers and the court in River Road may be a result of how each court viewed a secured creditor’s rights to its collateral. Under nonbankruptcy law, a secured creditor cannot be denied its collateral without full payment of its debt. In several sections, Judge Ambro’s opinion viewed Code policy as protecting this nonbankruptcy right in bankruptcy. “Part of this protection was the ability of secured creditors to credit-bid at any sale of collateral free of liens.” [13] Judge Ambro also noted that §§ 363(k) and 1111(b) “focused on protecting the secured creditor’s interest in property ordinarily protected under nonbankruptcy law from being undervalued, [this] suggest[s]ing that Congress intended to channel all plan sales…through Section 1129(b)(2)(A)(ii).” [14]

On the other hand, the Fifth Circuit, in allowing a plan sale that did not give the secured creditor a chance to get its own collateral through credit-bid, held that the Code “does not protect a secured creditor’s upside potential.” [15] The Third Circuit also seemed circumspect as to a secured creditor’s right to its collateral absent full payment. The court referred to a secured creditor’s rights under §§ 363(k) and 1111(b) as a preferential treatment to which the secured creditor has no “absolute right.” [16] The court further noted that the Code “provides for a variety of treatments of secured claims…none of which ensure an advantageous return on a secured investment.” [17] It will be interesting to see if the Seventh Circuit’s decision is colored by its view on secured creditor nonbankrutpcy rights and the extent to which those rights may have flowed into the overall scheme of the Code and cramdown plan confirmations.