Last year, a divided panel of the Third Circuit Court of Appeals held that the plain language of § 1129(b)(2)(A) of the Bankruptcy Code allows a debtor to propose the sale of a secured creditor’s collateral free and clear of liens without providing a right to credit-bid, so long as the creditor receives the indubitable equivalent of its claim.[1] This summer, a unanimous panel of the Seventh Circuit decided just the opposite; that a debtor cannot sell a secured creditor’s collateral free and clear of liens under a plan without affording them the right to credit-bid.[2] The decisions have obvious and immediate importance for secured creditors, particularly in the loan-to-own context. However, a topic that has been less widely discussed is how, if at all, the decisions may affect unsecured creditors.
In Philadelphia Newspapers, the plight of the unsecured creditors was relegated to a footnote in the majority opinion, which considered that "[o]nly the plan treatment of secured lenders is the subject of this appeal, though unsecured lenders assert that they have an interest in the treatment of secured lenders under the Plan because the Lenders have agreed to waive deficiency claims if they are permitted to credit bid."[3] In the River Road decision, unsecured creditors did not even get a mention. So was this an oversight, or do the holdings really affect unsecured creditors in any meaningful way?
One of the more interesting discussions in each of the cases addresses whether a secured lender can ever realize the "indubitable equivalent" of its collateral if it is not permitted to credit-bid, the logic being that things are worth whatever people are willing to pay and a successful credit-bid, in effect, defines the value of the collateral.[4] According to Judge Ambro, a secured lender will not credit-bid more than its collateral is worth and, conversely, will only credit-bid if it believes its collateral is being sold for less than market value.[5]Thus, Judge Ambro was of the opinion that credit-bidding "helps to minimize the deficiency claims that can be asserted against the rest of the bankruptcy estate and other unencumbered assets, maximizing recovery for all creditors."[6]
Similarly, the River Road Court considered that "[b]y granting secured parties [the] ability [to credit-bid], the Code provides lenders with means to protect themselves from the risk that the winning auction bid will not capture the asset's actual value…. This protection is important since there are number of factors that create a substantial risk that assets sold in bankruptcy auctions will be undervalued."[7] According to the Court, those factors include: (1) the timing of bankruptcy auctions and corresponding limitations on the ability to market estate assets; (2) the risk of self-dealing on the part of management; (3) the limited availability of credit in the current economic climate; and (4) the fact that bidders will usually reduce their bid in an amount commensurate with their transaction costs, thereby decreasing the likelihood an asset’s sale price will reflect its actual value.[8]
However, even assuming credit-bidding serves to maximize the value of estate assets – and Judge Ambro's dissent in Philadelphia Newspapers is convincing in this regard – this does not address the question of whether unsecured creditors benefit as a result. As an abstract proposition, unsecured creditors always have an interest in the maximization of the value of estate assets. However, the treatment of unsecured creditors under a chapter 11 plan is often unrelated to whether a credit-bid generates more value for the estate than the next highest cash bid as unsecured creditors will often seek to leverage their support for allowing (or opposing) a credit bid in exchange for assurances as to the treatment of unsecured creditors in the plan.
For example, Philadelphia Newspapers is noteworthy for the fact that the creditors' committee filed an appellate brief in support of the lenders’ right to credit-bid.[9] The interest of the Philadelphia Newspapers Committee (PNC) in the secured lenders' credit-bid rights was explained as follows: "the Debtors' Plan provides a de minimis distribution to unsecured creditors, whereas a credit bid from the Prepetition Lenders is likely to result in a far better result for unsecured creditors…. The Prepetition Lenders … have the ability to make a bid that provides for an increased equity distribution to unsecured creditors, provide minority shareholder protections and waive the Prepetition Lenders' rights to receive a substantial part of the [general unsecured creditor] pool that otherwise would go to them on account of their deficiency claims. The Prepetition Lenders have agreed to these very substantial benefits for unsecured creditors if they are able to acquire the companies via a credit bid."[10]
However, under different circumstances, unsecured creditors might just as easily be found arguing that credit-bidding undervalues estate assets and hurts their recovery. Indeed, in distinguishing Pacific Lumber[11]– on which the Philadelphia Newspapers majority ultimately relied – the PNC argued that Pacific Lumber "illustrates that bad facts often make bad law. The Pacific Lumber court was faced with two competing plans – one a heavy-handed attempt by one group of secured creditors to favor themselves to the detriment of all other constituents via a plan that was clearly neither confirmable nor supported by any other constituent, and the other a plan that provided for substantial distributions for all creditors and was widely supported."[12]
Conclusion
In the final analysis, it is self-evident that a secured lender cannot fail to benefit from having the option to credit-bid when its collateral is being sold free of liens under a plan. However, returning to the question posed at the outset, do unsecured creditors benefit merely by being exposed to the possibility that a secured lender is free to exercise such an option? It is submitted that the answer, at least outside the Seventh Circuit, is that this will depend on the structure of the credit bid and what value unsecured creditors can extract for supporting or opposing the credit bid from other constituencies.
1. In re Phila. Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010).
2. River Rd. Hotel Partners LLC v. Amalgamated Bank, __ B.R. __, 2011 U.S. App. LEXIS 13131 (7th Cir. 2011).
3. In re Phila. Newspapers LLC, supra at 302.
4. In re Phila. Newspapers LLC, supra at 320-321 (Ambro J., dissenting) (citing In re SubMicron Sys. Corp., 432 F.3d 448, 460 (3d Cir. 2006)).
5. Id at 321.
6. Id. at 333.
7. River Rd. Hotel Partners LLC v. Amalgamated Bank, supra at *23 (7th Cir. 2011).
8. Id. at 24-25, fn. 6.
9. See 3d Cir.; Case No.: 09-4349
10. (Comm. App. Br. pp. 22-23).
11. 584 F.3d 229 (5th Cir. 2009)
12 (PNC App. Br. at pp. 45-46, citing Pacific Lumber, supra at 250-252).