Credit-Bidding and the Costs of Sale in Chapter 11: Requiring Payment of a Buyer’s Premium from Lenders Who Credit-Bid Under § 363(k)

In enacting the Bankruptcy Code in 1978, Congress recognized, as public policy, a need to ensure that professional services provided to a trustee or debtor in possession were provided by skilled, competent professionals. This policy is codified in the Bankruptcy Code’s sections relating to the employment and compensation of estate professionals (§§ 327, 328 and 330), which overruled the judicially fashioned doctrine of “economy of the estate” applicable under the Bankruptcy Act. These sections were crafted to ensure adequate, predictable compensation for estate professionals. [1] Section 328’s provisions providing for pre-approval of professional fee arrangements, in particular, represent a significant departure from prior practice under the Bankruptcy Act, under which professionals were entitled to reasonable compensation determined strictly on a quantum meruit basis. [2]

Despite these provisions, estate professionals are well aware that the risk of nonpayment remains. Such risk is particularly present when an estate’s ability to pay professionals conflicts with the rights afforded to secured lenders under the Bankruptcy Code. [3] That conflict, and the related risk of nonpayment, assumes particular importance when a trustee or debtor in possession employs an auctioneer or broker to sell encumbered estate assets pursuant to an agreement providing for the payment of a percentage-based commission or buyers’ premium, and secured lenders opt to exercise credit-bid rights pursuant to § 363(k) of the Bankruptcy Code.

Under § 363(k), when an estate sells encumbered assets outside of the ordinary course of business, a secured lender is entitled to “bid” for the assets and, if the secured lender is the winning bidder and purchases the assets, may “offset” its secured claim against the purchase price of the assets. [4] As the U.S. Supreme Court has explained:

The ability to credit-bid helps to protect a creditor against the risk that its collateral will be sold at a depressed price. It enables the creditor to purchase the collateral for what it considers the fair market price (up to the amount of its security interest) without committing additional cash to protect the loan. [5]

But if a secured creditor is not required to “commit additional cash,” how is an estate to compensate a court-approved auctioneer or broker following such a sale?

As recently held by Bankruptcy Judge Eduardo Rodriguez of the Southern District of Texas in In re Dalton Crane LLC, the answer lies in the application of Bankruptcy Code § 506(c) and in the equitable requirement that all bidders in a bankruptcy court-supervised sale be afforded equal treatment. [6]

In re Dalton Crane

In Dalton Crane, the debtor engaged Tiger Capital Group, LLC and Great American Global Partners, Inc. as auctioneers to sell all of the debtor’s assets pursuant to a bifurcated sales process. First, the debtor was to market its assets for a turnkey sale, but if that failed, the assets were to be sold at a public auction. [7] When the debtor was unable to attract a qualifying turnkey offer or obtain secured lender consent for a turnkey sale below the applicable turnkey minimum, the debtor provided notice that the first phase had concluded unsuccessfully and sought court approval of modified auction procedures.

The proposed auction procedures included, among other modifications, a reduction of the buyer’s premium to be charged by the auctioneer at auction. Rather than a 15% buyer’s premium as previously approved, the proposed auction procedures provided that a 7% buyer’s premium would be charged to a purchaser of an asset paying in cash and further reduced the buyer’s premium to 3% for any secured creditor purchasing an asset through a credit-bid. [8] Despite these concessions, multiple secured creditors objected to the proposed auction procedures, arguing that the general rule barring the payment of estate expenses from secured lenders’ collateral and the principles of § 506(c) precluded any requirement that a secured lender be required to pay a buyer’s premium when exercising credit-bid rights under § 363(k). [9]

The court easily rejected the secured lenders’ contentions, noting first that “[n]othing in [§] 506(c) or the Fifth Circuit [case law] prevents a court from permitting a surcharge against the collateral of a successful credit bidder,” as long as the requisite showing under § 506(c) is made. [10]

For example, the court noted that in In re Skuna River Lumber, both the bankruptcy court and the district court permitted surcharge of a secured lender’s collateral to pay the fees of a financial adviser in connection with the conduct of an auction of the debtor’s assets, even though the secured lender’s credit-bid was the prevailing bid. [11] Notably, the lower courts in Skuna River not only found that the financial adviser’s services benefited the secured lender, but further noted:

[T]o disallow reimbursement of expenses and compensation to [the financial adviser] would significantly discourage [similar] professionals … from attempting to assist debtors and trustees in efforts to market assets if a credit bid could negate the prospects of being compensated. [12]

More importantly, as the Dalton Crane court noted, while the Fifth Circuit ultimately overturned the Skuna River decisions on jurisdictional grounds, its decision in doing so suggests that a surcharge may be permitted as long as the bankruptcy court still has jurisdiction over the secured lender’s collateral. [13]

The Dalton Crane court further noted that other courts have permitted surcharges on credit bids as well, citing In re A-1 Plank & Scaffold Manufacturing [14] and In re NJ Affordable Homes Corporation. [15] Like the Skuna River lower courts, the A-1 Plank court specifically noted that “[i]f credit-bidding by the senior lender defeated any compensation to the estate’s realtor, there would rarely be an incentive for any realtor to participate in a bankruptcy sale that involved real estate encumbered by a lien.”

Of further note, the Dalton Crane court also implicitly rejected the arguments of certain lenders that the court’s prior order authorizing the auctioneer to charge a buyer’s premium to all “purchasers” of estate assets during phase two did not apply to secured lenders’ credit-bids. [16] Although the Dalton Crane court did not formally address such arguments, the court did note that “a credit bid has the same effect as a cash bid.” [17] As such, the Dalton court required that any buyer’s premium charged must be consistent for all successful bids, whether cash or credit. [18]

Conclusion

The Dalton Crane opinion, along with the precedents cited therein, comport with the general policy codified in §§ 327, 328 and 330 of providing certainty of payment to estate professionals. While a secured lender’s right to credit-bid should ordinarily be protected, that right is not absolute and cannot immunize the lender from bearing the reasonable costs of preserving and disposing of its collateral when such actions result in no recovery to the estate beyond satisfaction of the lenders’ claims. Moreover, secured lenders should not be able to sit by idly while a duly employed estate professional incurs fees and expenses marketing the lender’s collateral for sale, then swoop in at the last minute to claim the benefit of such efforts without compensation to the professional.

At a minimum, such lenders receive the benefit of testing the market through the estate’s efforts, in addition to the benefits of having their collateral marketed for sale. Requiring such lenders to pay buyer’s premiums or surcharging collateral, even when those lenders purchase assets through the exercise of § 363(k) credit-bid rights, in order to cover the costs of sale is not only the fair and equitable result, but is the result that most promotes the effective, efficient administration of estates under the Bankruptcy Code.