News from Philadelphia: Secured Creditors to Be Afforded Right to Credit Bid at Sale of Collateral Conducted under a Plan of Reorganization
by Brian M. Resnick
Davis Polk & Wardwell LLP; New York
Hilary Dengel
Davis Polk & Wardwell LLP; New York
Credit bidding, which has been used with increasing frequency as a tool for secured creditors to obtain possession of their collateral rather than receive the proceeds of a sale for consideration they view as inadequate, allows a secured creditor to set off sums owed to such secured creditor as a bid in certain sales of property of a debtor’s estate. Sales of property of the estate outside of the ordinary course may be conducted pursuant to §363 of the Bankruptcy Code, as well as pursuant to a plan of reorganization. While §363(k) of the Bankruptcy Code expressly authorizes credit bidding in sales conducted pursuant to §363(b),[1] the Bankruptcy Code does not expressly require that a secured creditor be granted, in all circumstances, the right to credit bid for property of the estate being sold pursuant to a plan of reorganization.
In In re Philadelphia Newspapers, LLC,[2] by express language in the bid procedures motion, the debtors sought to require that any qualified bidder, in an auction for substantially all of their assets, fund its purchase offer with only cash—thereby seeking to preclude secured creditors from credit bidding for their collateral. Unsurprisingly, the steering group of the debtors’ prepetition secured lenders and the agent for the prepetition secured lenders (collectively, the “lenders”), objected to the inclusion of this provision precluding credit bidding. Chief Judge Stephen Raslavich of the U.S. Bankruptcy Court for the Eastern District of Pennsylvania rejected the debtors’ argument that they could, as a matter of right, deny the lenders the opportunity to credit bid and saw no “cause” to deny the lenders’ right to credit bid for their collateral.[3]
Background
Philadelphia Newspapers, LLC owns and operates various print and online publications in the Philadelphia area, including the Philadelphia Inquirer, the Philadelphia Daily News, several community newspapers and various online products. At the time of its bankruptcy filing on Feb. 23, 2009, the Philadelphia Inquirer and the Philadelphia Daily News were the two most widely read daily newspapers in the Philadelphia area.
As part of the debtors’ plan of reorganization, they sought to sell substantially all of their assets via a public auction. The debtors entered into an asset-purchase agreement with Philly Papers, LLC, an investor group led by the current management of the debtors and the stalking-horse bidder.[4] While the lenders, described by the debtors as “out-of-town hedge funds,” had long made it known that they intended to place a “credit bid” for the debtors’ assets, the debtors insisted that any qualified bidder fund its purchase offer with cash. The lenders were owed more than $300 million, and the debtors’ plan of reorganization contemplated distributing $66 million to the lenders in full satisfaction of their allowed secured claim.[5]
Denial of the debtors’ Attempt to Preclude Credit Bidding
The debtors argued that the lenders should be precluded from submitting a credit bid at the auction, under the theory that §363(k) of the Bankruptcy Code only expressly authorizes secured creditors to credit bid at a sale pursuant to §363 of the Bankruptcy Code, therefore not requiring that secured creditors be permitted to credit bid at a sale under a plan of reorganization. The debtors maintained that this is particularly true where a debtor seeks cramdown confirmation of a plan of reorganization under §1129(b)(2)(A)(iii) (requiring that the plan proponent demonstrate that the plan provides the secured creditors with the “indubitable equivalent” of their claims).[6] The debtors also argued that allowing the lenders to credit bid would “chill competitive bidding” at the auction, and thus, as a matter of policy, the lenders should be precluded from credit-bidding.[7]
The lenders maintained that the Bankruptcy Code supports the notion that secured creditors should be entitled to credit-bid at a sale of their collateral, regardless of whether the sale is conducted under §363 or a plan of reorganization. Specifically, the lenders noted that while §1111(b) of the Bankruptcy Code allows non-recourse undersecured creditors to elect to waive their deficiency claim and to have their allowed claims treated as fully secured, as undersecured recourse creditors the lenders are statutorily precluded from making this election in connection with the sale of their collateral (whether under §363(b) or a plan of reorganization).[8] The lenders argued “that the intent of the integrated provisions of the Bankruptcy Code (§§363, 1111, 1123 and 1129) is to ensure that where an undersecured creditor’s collateral is proposed to be sold, whether under §363 or under a plan, the secured creditor is entitled in all events to protect its rights in its collateral, either by making an election under §1111(b) or by credit bidding its debt.”[9]
After examining various relevant provisions of the Bankruptcy Code, the court found the provisions to be ambiguous on the issue of credit-bidding at a sale pursuant to a plan of reorganization, but ultimately agreed with the lenders’ position.
In particular, the court disagreed with the debtors’ reading of §1129(b)(2)(A) of the Bankruptcy Code. First, while recognizing that §1129(b)(2)(A) is written in the disjunctive, the court disagreed with the debtors’ assertion that §1129(b)(2)(A)(iii) could “be employed when the exact means by which the plan intends the indubitable equivalent cramdown of a dissenting secured creditor is a cash out of the creditor via an auction sale such as is provided for in detail under [§1129(b)(2)(A)(ii)].”[10] Second, the court rejected the theory that the right to credit-bid found in §1129(b)(2)(A)(ii) applies only to sales under §363(b), observing that it is fair to interpret §1129(b)(2)(A)(ii) as “importing the essence of §363(k)”.[11]
The court considered precedents supporting the debtors’ position, including In re Pacific Lumber Co.,[12] a recent decision from the Fifth Circuit Court of Appeals where the circuit court “rejected the Noteholders’ complaint that confirmation of the subject plan was improper because they had not been afforded the opportunity to make a credit bid for the assets that were sold.”[13] However, the court was able to distinguish such cases from the facts presented. In particular, the court noted that Pacific Lumber involved a private sale, where the value of the collateral being sold “had been judicially determined after an extensive evidentiary hearing” and that the secured creditors in the case had failed to object to the plan of a private sale and the cashing-out of their claims “until it was over and they were dissatisfied with the Bankruptcy Court’s valuation.”[14]
The court further noted that the legislative history regarding §1111(b) supported the position taken by the lenders—“that is, where a reorganization plan proposes sale of a secured party’s collateral and the dissenting class of creditors is precluded from making a
§1111(b) election due to the recourse nature of the debt…[,] [l]egislative history makes clear that where the preferred treatment which follows from the §1111(b) election is unavailable to a secured creditor the creditor’s bid right is preserved.”[15]
Finally, the court noted that the debtors generally failed to rebut the lenders’ allegations that the disallowance of credit bids was “designed to promote the success of the Stalking Horse Bidder and the continuation of current ownership and management.”[16] The court observed that a common criticism of credit-bidding—permitting a secured creditor to “appropriate the going concern value of the business to itself, while sharing no infusion of value through the bid process with other creditors”—was not present in this case because under the plan, “the amounts payable to the debtors’ various creditor constituencies are fixed . . . [and] [a]ny and all funds which might derive from a cash overbid are to go exclusively to the lenders.”[17] The court also rejected the debtors’ argument that the plan precluded credit bids as a way to “test the ability of a bidder ‘to write a check,’” observing that this element is a “‘confirmation issue’ involving feasibility.”[18]
Future Implications
Chief Judge Raslavich’s decision highlights certain practical considerations for secured creditors contemplating a credit bid for their collateral in a sale under a plan of reorganization. The distinctions drawn between the conduct of the lenders in Philadelphia Newspapers, as compared to the secured creditors in Pacific Lumber, illustrate the benefits that may be gained through early involvement and action on the part of secured creditors looking to preserve their rights under §§363(k) and 1129(a)(2)(A) of the Bankruptcy Code, particularly in light of what Chief Judge Raslavich found to be ambiguity in the interplay among §§363, 1111, 1123 and 1129. While the weight of the case law has long favored the position of secured creditors, the Fifth Circuit’s decision in Pacific Lumber highlights the potential consequences of inaction on the part of secured creditors.
1. Section 363(b) of the Bankruptcy Code governs the sale of property of the estate other than in the ordinary course of business. 11 U.S.C. §363(b). Section 363(k) of the Bankruptcy Code provides that “[a]t a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.” 11 U.S.C. §363(k).
2. In re Philadelphia Newspapers, LLC, Case No. 09-11204 (SR, CJ), [Dkt. No. 1234] (Bankr. E.D. Pa. Oct. 8, 2009).
3. See id. at 19, 22.
4. The bid submitted by the stalking-horse bidder was to be marketed and subjected to higher and more attractive bids. Id. at 2.
5. Id. at 4.
6. 11 U.S.C. §1129(b)(2)(A)(iii).
7. In re Philadelphia Newspapers, LLC, Case No. 09-11204 (SR, CJ) [Dkt. No. 1234] at 7 (Bankr. E.D. Pa. Oct. 8, 2009).
8. Id. at 9.
9. Id. at 10.
10. Id. at 10-11 (noting that such reading would be “illogical and at odds with a settled canon of statutory construction which dictates that a generic provision of a statute should not be used to achieve a result not contemplated by a more specific provision”). The court went so far as to call the debtors’ argument on this point “a not so thinly veiled attempt to manipulate the sale process in order to frustrate a credit bid which the debtors anticipate will exceed the bid of the Stalking Horse.” Id. at 11.
11. Id. at 11-12.
12. —F.3d—, No. 08-40746, 2009 WL 3082066 (5th Cir. Sept. 29, 2009).
13. In re Philadelphia Newspapers, LLC, Case No. 09-11204 (SR, CJ) [Dkt. No. 1234] at 17 (Bankr. E.D. Pa. Oct. 8, 2009) (noting that court in Pacific Lumber also “oberve[d] that in some cases provision of a credit bid option to a dissenting secured creditor might be ‘imperative.’”).
14. Id. at17-18(court went on to note that in Pacific Lumber, secured creditors did not propose their own plan of reorganization (as lenders did in present case), among other distinctions).
15. Id. at 14-15.
16. Id. at 21.
17. Id.
18. Id. at 22 (noting that this issue “applies equally as much to a cash bidder versus a credit bidder”). The court noted that its conclusions negated the need for the court to consider the lenders’ arguments about the potential effect that the court’s approval of the Bid Procedures Motion (including the cash bid requirement) might have on the secured lending industry or that precluding the lenders from credit bidding would ultimately result in an unconstitutional taking of the lenders’ property. Id.