I. Introduction
For decades there have been few, if any, significant opinions that considered a secured creditor's right to credit bid its claim in an asset sale under a Chapter 11 plan. The right to credit bid was generally considered a non-controversial topic until September 2009. Remarkably, in the last two years, the Courts of Appeal in each of the Third, Fifth and Seventh Circuits have rendered important and far-reaching decisions addressing a secured creditor's right to credit bid in Chapter 11 plan sales.
The Fifth Circuit in In re Pacific Lumber Co., 584 F.3d 229 (5th Cir. 2009) and the Third Circuit in In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3rd Cir. 2010) each found that secured creditors do not have an absolute right to credit bid their claims in an asset sale conducted under a Chapter 11 plan. Judge Ambro issued a dissenting opinion in Philadelphia Newspapers which was ultimately followed by the Seventh Circuit in In re River Road Hotel Partners, LLC, 651 F.3d 642 (7th Cir. 2011). The Seventh Circuit in River Road, unlike the Third and Fifth Circuits, vindicated a secured creditor's right to credit bid in Chapter 11 plan sales. The conflicting opinions from these three Circuit Courts has lead to the United States Supreme Court's decision to grant a writ for certiorari in order to finally clarify the law in this very important area.
The decisions focus on the language under § 1129(b) of the Bankruptcy Code, known as the "cramdown" provision,1 which permits the confirmation of a Chapter 11 plan over the dissent of an impaired class only if the plan is "fair and equitable" to such class. With respect to secured claims, the statute reads as follows:
(2) For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:
(A) With respect to a class of secured claims, the plan provides—
(i) (I) that the holders of such claims retain the liens securing such claims, whether the property subject to such liens is retained by the debtor or transferred to another entity, to the extent of the allowed amount of such claims;
(II) that each holder of a claim of such class receive on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder's interest in the estate's interest in such property;
(ii) for the sale, subject to section 363(k) of this title, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (iii) of this subparagraph; or
(iii) for the realization by such holders of the indubitable equivalent of such claims.
The Circuit Court decisions analyze the meaning of the word "or" which separates subsections (i), (ii) and (iii). Each of Pacific Lumber and Philadelphia Newspapers determined that the plain meaning of the word "or" leads to the conclusion that a debtor can cramdown the secured creditor class by choosing any one of the three subsections of § 1129(b)(2)(A), even if the plan proposes an asset sale which is specifically addressed in (ii). River Road, on the other hand, agreed with the reasoning of the strong dissenting opinion by Judge Ambro in Philadelphia Newspapers, and decided that the word "or" in 1129(b)(2)(A) was not meant to be read in the fashion suggested by Pacific Lumber and Philadelphia Newspapers because such a reading would conflict with other secured creditor protections in the Code, including a secured creditor's right to credit bid in an asset sale which is specifically set forth in subsection (ii). Thus, River Road states that if a debtor proposes an asset sale free and clear of liens in a Chapter 11 plan, the debtor must proceed under § 1129(b)(2)(A)(ii) as opposed to (i) and (iii). As stated, the split in the Circuits will soon be decided by the United States Supreme Court.
II. Summary of Key Decisions
A brief summary of the key facts and legal analysis underpinning each of the Circuit Court decisions related to credit bidding follows.
a. In re Pacific Lumber Co., 584 F.3d 229 (5th Cir. 2009)
The Debtors comprised of six related entities involved in the sawing, harvesting, and processing of redwood timber filed chapter 11 petitions in the Southern District of Texas. The decision deals with the appeal of a plan involving two of the debtors – Pacific Lumber Company (Palco) and Scotia Pacific LLC (Scopac).
Palco owned and operated a sawmill and power plant in Scotia, California. The assets were estimated to be worth $110 million on the Petition Date. Marathon held a secured claim of $160 million on Palco's assets. Scopac was a special purpose entity owned by Palco. Scopac owned $200,000 acres of prime redwood timberland (the "Timberlands"). Pursuant to an indenture agreement with Bank of New York, the Indenture Trustee for various Noteholders, Scopac owed the Noteholders $740 million, secured by a lien on all of Scopac's assets, including the Timberlands.
There were two competing plans in the bankruptcy case. The Indenture Trustee filed a plan which provided for a sale of all of Scopac's assets. Marathon and MRC, a competitor of Palco, filed a plan proposing the reorganization of the Debtors.
The bankruptcy court determined that the MRC/Marathon plan was confirmable while the Indenture Trustee's plan was not confirmable. The MRC/Marathon plan created 12 classes. Class 6 consisted of the Noteholders' secured claim. Under the plan, Class 6 was to receive the value of their collateral and a lien on proceeds from pending unrelated litigation. Class 9 consisted of Scopac's remaining general unsecured claims, including of the Noteholders' deficiency claim for over $200 million. It was unknown if there would be any recovery to Class 9. Each of Class 6 and Class 9 voted to reject the plan, thus requiring the Debtors to confirm the plan under the cramdown provision of § 1129(b).
A central question for cramdown related to the value of the Timberlands, which after extensive valuation testimony, was valued at no more than $510 million. The bankruptcy court concluded that the valuation amount was the indubitable equivalent of the Noteholders' claim on the Timberlands, under § 1129(b)(2)(A)(iii). The Indenture Trustee, certain Noteholders, and Scopac appealed, and obtained immediate certification to the Fifth Circuit.
The Noteholders, on appeal, argued, among other things, that the plan was not fair and equitable, and thus could not be "crammed" down on them. The Noteholders argued that the plan could not be confirmed because under § 1129(b)(2)(A)(ii), secured creditors had a right to credit bid. The bid procedures deprived the secured creditors of this right.
The Fifth Circuit disagreed with the Noteholders' position stating that because the three subsections of § 1129(b)(2)(A) are joined by the disjunctive "or", there are alternative sections in which to proceed and that one could not treat each subsection as compartmentalized alternatives. Thus, subsection (iii) offered the Noteholders a distinct basis for confirming the plan if it offered the Noteholders the realization of the indubitable equivalent of such claims. The court found that the plan offered cash equal to the value of the Timberlands, and payment to the Noteholders in the amount of $513 million, which exceeded the valuation of $510 million. In the Court's view, this reflected the "indubitable equivalent" of the Noteholders' claims.
b. In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3rd Cir. 2010)
After defaulting on their secured loans of approximately $300 million, Philadelphia Newspapers, LLCand its affiliates filed for chapter 11 relief in the Bankruptcy Court of the Eastern District of Philadelphia. Several months later, the Debtors filed a plan which provided for the sale of substantially all of their assets free and clear of liens to a stalking horse purchaser which was owned, in part, by an insider. The terms of the sale would allow the Debtors' lenders to receive (i) $37 million in cash, (ii) the Debtors' Philadelphia headquarters valued at $29.5 million, subject to a 2 year rent free lease for the purchaser, and (iii) any cash generated from a higher bid at a public auction.
In connection with the proposed sale, the Debtors filed a motion for bidding procedures which sought to preclude the Lenders from "credit bidding" on the assets, thereby requiring all bidders to fund their purchase with cash. The Debtors stated that the right to credit bid did not exist since the sale would be conducted in accordance with a plan. The bankruptcy court rejected the Debtors' position, and entered an order approving bidding procedures which included the Lenders' rights to credit bid. The Debtors appealed and the District Court reversed, finding that the Lenders did not have any legal entitlement to credit bid at an auction sale pursuant to a reorganization plan. The Lenders appealed the District Court's decision to the Third Circuit.
The Lenders offered three primary arguments in support of their right to credit bid.
First, the Lenders contended that the plain language of § 1129(b)(2)(A), when viewed in light of applicable canons of statutory construction, required all sales to occur under subsection (ii). The Lenders argued that the specific term prevails over the general term, and thus since the Debtors proposed an asset sale under the plan, free and clear of their liens, § 1129(b)(2)(A)(ii) addressing asset sales must apply. The Third Circuit dismissed this argument. The Third Circuit indicated that a plain meaning of the word "or" means that the Debtors could proceed under any one of the three subsections of § 1129(b)(2)(A). In reaching this conclusion, the Third Circuit relied, in part, on the Pacific Lumber decision that had reached a similar conclusion.
Second, the Lenders argued that the term "indubitable equivalent" is ambiguously broad, requiring resort to other provisions of the Code that confirm the Lenders' rights to credit bid. The Third Circuit indicated that there is no ambiguity in the term "indubitable equivalent" under subsection (iii) finding that it means "the unquestionable value of a lender's secured interest in the collateral." Id. at 310. To discern that value, a debtor would value the assets at a public auction and then the secured claim could be valued under § 506(a). In other words, the auction results would generate the "indubitable equivalent" of a secured creditor's claim.
Finally, the Lenders argued that denying secured creditors a right to credit bid is inconsistent with other provisions of the Code. The Lenders argued that the Bankruptcy Code guarantees a secured lender many rights, including, among other things, the right to elect to treat their deficiency claims as secured under § 1111(b) or the right to credit bid under § 363(k). The Third Circuit disagreed with the Lenders' argument. First, the Third Circuit notes that § 363(k) is not absolute, and for "good cause" shown, secured creditors can lose the right to credit bid. Next, the Court points out that there are other provisions in the Code which do not allow a secured party to credit bid. For instance, if the debtor proposed a cramdown plan under § 1129(b)(2)(A)(i), there are no credit bidding rights. Thus, the Third Circuit reasoned that it is not true that secured creditors always maintain a right to credit bid in every context.
In conclusion, while the Third Circuit determined that the Debtors, may, as a matter of law, propose a plan involving a sale of assets under 1129(b)(2)(A(iii), the Debtors would still need to prove that the value obtained from the sale was the indubitable equivalent of the Lenders' claim in order to have such plan confirmed.
Judge Ambro issued a dissenting opinion which strongly disagreed with the majority's holding. Judge Ambro did not agree that the plain language of the Code mandated the result achieved in the majority opinion. He contended that § 1129(b)(2)(A) must be read in the context of the entire Bankruptcy Code, which, in a number of provisions, highlighted Congress' intent to protect secured creditors from undervaluation. The majority opinion's reliance on the word "or" to defeat the Lenders' rights went too far and rendered superfluous the specific cramdown subsections contained in (i) and (ii).
c. In re River Road Hotel, 651 F.3d 642 (7th Cir. 2011)
River Road Hotel Partners LLC, Radlax Gateway Hotel, and certain of their affiliates filed for Chapter 11 protection when they began experiencing financial difficulties. Approximately ten months after the Petition Date, the Debtors filed plans in which they sought to sell substantially all of their assets to stalking horse bidders which were partially owned by the debtor's principal. In connection with the sales, the Debtors requested bidding procedures, which, among other things, included a provision which barred the secured lenders from credit bidding on the auction. The Debtors claimed that the plans would be confirmed under § 1129(b)(2)(A)(iii), and thus there was no right to credit bid. The Administrative Agent for the secured lenders objected to the bidding procedures. The Bankruptcy Court's denied the Debtor's bidding procedures, relying on Judge Ambro's dissent in Philadelphia Newspapers. An immediate appeal to the Seventh Circuit was permitted.
The Seventh Circuit stated that the appeal presented "a single, relatively straight forward question": can the debtor sell assets through the plan free and clear of a secured creditor's lien in accordance with § 1129(b)(2)(A)(iii) without also providing a secured creditor with the right to credit? The Seventh Circuit answered this question in the negative disagreeing with the Pacific Lumber and Philadelphia Newspapers decisions, and commenting that the statutory analysis in Judge Ambro's dissenting opinion in Philadelphia Newspapers was "compelling".
The Seventh Circuit concluded that § 1129(b)(2)(A) could be subject to two plausible interpretations: one in which a debtor can proceed under any one of the three subsections of § 1129(b)(2)(B), and the other being that subsection (iii) applies only when subsections (i) and (ii), the more specific provisions, do not apply. Since the statute was unclear and either of the two interpretations was plausible on its face, the Seventh Circuit looked beyond the language of the statute to decide which interpretation made the most sense. The Seventh Circuit explained that subsections (i) and (ii) set forth specific requirements that must be met when a debtor seeks to return possession of an encumbered asset (subsection (i)) or sell an encumbered asset free and clear of liens (subsection (ii)). Subsection (iii), on the other hand, would govern plan confirmation in situations not otherwise covered in subsections (i) and (ii). The Seventh Circuit determined this was the most plausible reading; otherwise, any debtor can proceed with a plan under subsection (iii), making (i) and (ii) superfluous.
Finally, in reaching its conclusion, the Seventh Circuit looked to other specific Bankruptcy Code sections tailored to secured creditors that collectively reveal that Congress provided secured creditors with important rights in a bankruptcy setting. The right to credit bid is a "crucial check against undervaluation" requiring the court's protection. See River Road, 651 F.3d at 651; see also In re Old Prairie Block Owner LLC, 2011 Bankr. Lexis 5133 (Bankr. N.D. Ill. December 22, 2011) (provisionally granting secured creditor's motion to dismiss bankruptcy case where debtor proposed plan which, among other things, denied a secured creditor a right to credit bid contrary to the Seventh Circuit's River Road decision, but providing debtor a short opportunity to amend plan before implementation of motion to dismiss).
After the Seventh Circuit's decision, the bankruptcy court confirmed an alternative plan of reorganization for the River Road Debtors. The Radlax Debtors, on the other hand, filed a petition for a writ of certiorari. In their petition, the Radlax Debtors stated that "th[e] circuit split creates uncertainty regarding a central component of plan sales in bankruptcy and invites forum shopping by potential debtors...[and]... it further upsets the settled expectations of the secured lending industry." The Loan and Syndications Association, a leading financial trade organization filed an amicus brief supporting the Radlax Debtors' petition for review by the Supreme Court, expressing a desire for certainty in the area of credit bidding. In their amicus brief, the LSTA stated, among other things, that "secured creditors' ability to credit bid at auctions of their collateral is central to the detailed scheme of protections that the Bankruptcy Code provides them." On December 12, 2011, the Supreme Court granted the petition for writ of certiorari. See Radlax Gateway Hotel v. Amalgamated Bank, 181 L. Ed. 2d 547 (December 12, 2011). Oral argument has been scheduled for April 23, 2012 with a decision thereafter.
III. Conclusion
A credit bid enables a secured creditor to utilize its secured claim as a means to obtain title to the asset and wait for the value of the property to subsequently increase. A secured creditor views this right as an important and fundamental protection which is now jeopardized in certain instances where a plan of reorganization seeks implementation through a sale process. In a plan structure like the one proposed in Philadelphia Newspapers, the secured creditor may protect itself by paying cash for the asset at the sale—which cash will be immediately returned to the secured creditor as the holder of a lien on the asset. However, given the size and composition of many lending groups, some members of the group may not have the additional liquidity to fund a cash purchase at the auction, thereby subjecting the group to the risk that it might be outbid at the auction at a depressed value. Additionally, in certain exceptional circumstances, a court may not permit the proceeds to be paid over immediately to the secured creditors if there are major lien challenges that have been commenced against the group through pending litigation.
Consequently, secured creditors may attempt to limit the debtor's ability to propose a sale plan without credit bid rights. Secured creditors may refuse to consent to the use of their cash collateral or refuse to provide financing unless such cash collateral/financing orders prohibit the filing of a sale plan without the concomitant right to credit bid. Alternatively, debtors may seek to utilize the Philadelphia Newspapers andPacific Lumber decisions as an opportunity to gain leverage over the lending group or to forum shop. At the very least, all of the Circuit decisions discussed above may create uncertainty and delay in the near future. The uncertainty may remain short-lived however because as stated above, the United States Supreme Court has granted certiorari to decide the conflict between the Third and Fifth Circuits on the one hand, and the Seventh Circuit on the other. The Supreme Court's clarification of the law in this very important area is expected later this year as the Supreme Court is scheduled to hear oral argument in April.
Foonotes:
1.Plans confirmed under section 1129(b) are often referred to as cramdown plans because they have been "crammed down the throats of objecting creditors". Khan v. Nate's Stores No. 2 Inc. v. First Bank, 908 F.2d 1351, 1359 (7th Cir. 1990).
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