Can Noteholders Credit Bid?

With the greatest financial crisis in a century roaring full steam ahead with no end in sight, bankruptcy filings are up as well as §363 sales. Sales pursuant to §363 of the Bankruptcy Code have become more common than traditional plans of reorganization in bankruptcy cases. As a consequence, senior secured lenders have enforced their right to credit bid in such §363 sales. The majority of the case law involves the rights of secured lenders and a secured lender’s ability to credit bid. However, a recent decision in the U.S. Bankruptcy Court for the District of Delaware, In re Electroglas Inc.,[1] discussed the issue of whether noteholders may credit bid. Judge Walsh held that noteholders may not credit bid, either directly or indirectly, their portion of the notes or all of their notes.[2] The court examined the provisions of the indenture to reach its decision.

First, the court examined the language of the indenture. Pursuant to Section 7.4 of the indenture, no noteholder could take action that did not treat all noteholders equally and accrue a common benefit to all the noteholders.[3] Section 7.4 of the indenture stated: “[I]t being understood and intended, and being expressly covenanted by the taker and holder of every Note with every other taker and holder and the Trustee, that no one or more holders of Notes shall have any rights in any manner whatever by virtue of or by availing of any provision of this Indenture to affect, disturb or prejudice the rights of any other holders of Notes, or to obtain or seek to obtain priority over or preference to any other such holder, or to enforce any right under this Indenture, except in the manner herein provided and for the equal, ratable and common benefit of all holders of Notes….”[4] This section of the indenture, according to the court, made it impossible for the noteholders to credit-bid only their portion of their notes.[5] If the noteholders did credit-bid their notes, then they would be in violation of the Indenture’s requirement that the noteholders act for the benefit of all noteholders.[6] The court found support for the collective benefit theme in other portions of the indenture that stated that the agent was required to hold the collateral and take all actions for the benefit of all the noteholders.

Moreover, Section 7.4 of the indenture provided that the noteholders did not have “any right by virtue of or by availing of any provision of this indenture to institute any suit, action or proceeding in equity or at law upon or under or with respect to this Indenture” unless they made a written request of the trustee to take certain action and then the trustee did not take the requested action within 60 days after such request was made.[7] Again, the noteholders could not step into the trustee’s shoes and take action that did not benefit all the noteholders.

Second, the court held that the indenture forbade the noteholders from forcing the trustee to take certain actions.[8] Specifically, Section 7.7 of the indenture stated: “the holders of a majority in aggregate principle amount of the Notes…shall have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Trustee.”[9] Rather, the majority of the noteholders could only prescribe procedure to the trustee. As a result, if the noteholders could not force the trustee to credit-bid, then they could not credit-bid on their own initiative.[10]

In addition, the indenture prescribed the trustee’s action in the event of a default. Specifically, Section 7.5 of the indenture stated: “[T]he Trustee may in its discretion proceed to protect and enforce the rights vested in it by this Indenture by such appropriate judicial proceedings as the Trustee shall deem most effectual to protect and enforce such rights, either by suit in equity or by action at law or by proceeding in bankruptcy or otherwise, whether for the specific enforcement of any covenant or agreement contained in this Indenture or in aid of the exercise of any power granted by this Indenture, or to enforce any other legal or equitable right vested in the Trustee by this Indenture or by law.”[11] The court read this section of the indenture as specifically granting the trustee, not the noteholders themselves, the power to take all actions that it deemed appropriate.[12] This provision did not give the noteholders authority to take any action apart from the trustee’s actions.[13] Therefore, according to the court, without clear language in the indenture permitting the noteholders to act separately from the trustee, the noteholders could not act separately from the trustee.[14] Based on the foregoing, the court found that no provision of the indenture permitted the noteholders to credit either a portion of their notes or all of their notes.[15]

Third, the indenture did not allow the noteholders to require the trustee to credit-bid the notes.[16] However, the noteholders could make a request that the trustee credit-bid the notes, but it remained in the trustee’s discretion to take substantive action, including credit-bidding.[17] The court explained that if the trustee did not take a specific action proposed by the group of noteholders, such as credit-bidding, the noteholders could have a cause of action against the trustee for acting improperly, but the noteholders could not “go over the head of the Trustee and take an action they think appropriate simply because the Trustee” declined to take such action.[18]

Although the court held that the noteholders could not credit-bid all or a portion of their notes, it did hold that the trustee could credit-bid the notes if it chose to do so because (1) Section 7.2 of the indenture provided that the trustee was “entitled to institute any actions or proceedings a law or in equity for the collection of sum due and paid” and (2) Section 7.5 of the indenture granted the trustee the “broadest powers to take action in the event of a default, which would include credit bidding.”[19]

The Electroglas decision illustrates that although individual noteholders could not credit-bid based on the specific language of the indenture; the trustee was free to credit-bid if it chose to do so. The decision also illustrates that individual noteholder power to credit-bid should be contemplated in the initial drafting of the indenture should the noteholders wish to credit-bid at any subsequent sale of the assets.