Secured creditors took solace from the Supreme Court’s 2012 ruling in RadLAX that affirmed the right of a secured lender to credit bid in bankruptcy
cases.¹ That relief proved short-lived when the Bankruptcy Court for the District of Delaware barred credit bidding in Fisker Automotive Holdings reviving the “for cause” limitation to preserve the integrity of the bankruptcy auction process.² After Fisker was decided,
debtors sought to rely on its rationale, leading to renewed litigation in the bankruptcy courts over when credit bidding would be barred or limited.

Under the Bankruptcy Code, a secured creditor is entitled to be paid the value of its collateral before any junior class receives any distribution. To protect that right, the Bankruptcy Code contains two key provisions: section 1111(b) and section 363(k). Section 1111(b) protects a secured lender from being cashed out for less than the face value of its debt in which the debtor retains the collateral. If a section 1111(b) election is made, the creditor receives payments equal to the face amount of its claim, whose present value must equal the value of the collateral. Where the debtor sells the collateral, section 363(k) provides the lender the right to credit bid.

Credit bidding has become critically important in recent years because the typical Chapter 11 case involves a sale of the debtor’s assets. Distressed investors, who have become major players in Chapter 11 by buying defaulted debt, sometimes pursue a strategy in which they acquire the “fulcrum” security and then pressure for a prompt bankruptcy asset sale. If the borrower resists, the distressed investor threatens foreclosure. That combination of leverage and/or threats may result in claims of inequitable conduct, raising the issue of whether the borrower’s right to credit bid should be limited for cause.

Controversy in Credit Bidding

Until the U.S. Court of Appeals for the 5th Circuit decided the Pacific Lumber case in 2009, credit bidding was not controversial.³ In Pacific Lumber, the court approved a plan of reorganization in which secured bondholders were cashed out without the right to credit bid in a case in which the debtor sold its assets. The debtor relied on a provision of the Bankruptcy Code that says secured lender claims may be satisfied if they receive the “indubitable equivalent” of the value of their collateral. The court ruled that when creditors received that “indubitable equivalent,” credit bidding was not available. Shortly thereafter, the U.S. Court of Appeals for the 3rd Circuit confirmed a similar plan in Philadelphia Newspapers.⁴ But in RadLax, the U.S. Court of Appeals for the 7th Circuit held that no plan that called for a sale of the debtor’s assets could be confirmed without the right to credit bid.⁵

The Supreme Court agreed to resolve the circuit split on the issue of whether a debtor may sell assets under a plan without allowing credit bidding. On May 29, 2012, a unanimous court held that credit bidding was required when the debtor seeks to sell assets under a reorganization plan. But the court did not address the dicta in Philadelphia Newspapers that recognized the ability of a court to limit credit bidding for cause.

Fisker and Its Progeny

RADLax appeared to resolve credit bidding, but Fisker Automotive Holdings reignited the controversy. Fisker involved a startup that built electric automobiles. Among its lenders was the Department of Energy (DOE), which lent the company $168.5 million. Hybrid Tech Holdings, a rival developer, purchased the DOE claim for $25 million and agreed to purchase Fisker’s assets. Fisker filed for Chapter 11 on November 22, 2013, and sought to close its sale to Hybrid on January 3, 2014. The creditors committee objected, arguing that Hybrid’s credit bid would chill the bidding. The creditors committee had located an alternative bidder and argued that if Hybrid could not credit bid, the alternative bidder would make a cash bid above $25 million. Fisker stipulated that if Hybrid could credit bid in full, no other party would bid. The bankruptcy court limited Hybrid’s right to credit bid to $25 million for “cause.” The court was clearly troubled that Fisker and Hybrid had insisted upon an unfair and hurried auction process and concluded that failing to cap Hybrid’s credit bid would freeze bidding.

Free-Lance Star Publishing Company

After Fisker was decided, debtors tried to use its “for cause” rationale as a basis for limiting credit bidding. In June 2013, DSP, a distressed investment fund, purchased a bank’s secured loan to Free Lance-Star (FLS), a newspaper and radio company in Virginia. But the bank’s liens did not cover some of FLS’s assets, including its radio towers and FCC license. DSP wanted FLS to sell its assets to DSP in a fast bankruptcy sale. FLS initially agreed to work with DSP, but negotiations broke down. In the interim, DSP filed liens against the previously unencumbered assets without notifying FLS. On January 23, 2014, FLS filed for Chapter 11 and sought to sell its assets. Initially, the court allowed DSP to credit bid, but DSP sought a declaration that it had liens on all of FLS’s assets, including the newly disclosed liens on the radio towers and FCC license. FLS objected to DSP’s credit bid, arguing that its conduct was inequitable. The court barred DSP’s credit bid. It found that DSP did not have valid liens on the contested assets and thus could not credit bid on those assets, and that DSP had engaged in inequitable conduct, consisting of pressuring FLS for a speedy bankruptcy filing and chilling the bidding.⁶

RML Development

RML Development (RML) owned apartment complexes in Tennessee. After it filed for Chapter 11 in 2014, it sought to sell the complexes. Its secured lender SilverPoint wanted to credit bid its $2.54 million claim. RML disputed the amount, arguing that SilverPoint was owed $2.35 million and thus should not be able to credit bid. The court approved SilverPoint’s credit for the undisputed $2.35 million claim, and otherwise declined to limit its credit bid, ruling that: “The bankruptcy court should only modify or deny a §363(k) credit bid when equitable concerns give it cause … [s]uch a modification or denial of credit bid rights should be the extraordinary exception and not the norm.”⁷

Charles Street AME Church

Charles Street African Methodist Episcopal Church of Boston owned two parcels of real property, both subject to bank mortgages. In its Chapter 11 case, Charles Street sought to sell the properties and to bar the bank from credit bidding. Charles Street asserted counterclaims that, if successful, would have eliminated the bank’s claim. Charles Street argued the bank’s claim was subject to a bona fide dispute, and that the dispute was cause to deny credit bidding. The court rejected the argument, ruling: “Charles Street does not dispute the validity of the underlying loan agreements, the validity, perfection or priority of [the bank’s] mortgages, the amounts claimed to be due or anything intrinsic to either of [the bank’s] claims.”⁸

RadioShack

The RadioShack case presented a challenge to credit bidding by a competing lender, which hoped that by disqualifying the senior lender, it would strengthen its own bid. When RadioShack filed for Chapter 11 in February 2015, its senior lender was Standard General, a hedge fund that bought RadioShack’s senior bank debt. It also had a term loan from Salus Capital Partners. After RadioShack filed for Chapter 11, Standard General made a combination cash and credit bid for its assets, a $117 million credit bid and cash. Salus tried to bar Standard General from credit bidding, arguing that Standard General could not credit bid more than $111 million. Salus did not allege any misconduct by Standard General, and it was clear that Salus’s purpose was to obtain a competitive advantage by blocking Standard General. When Standard General reduced its credit bid to $112 million, it won the auction.

Lessons From The Post-Fisker Cases

Although RadLAX confirmed that secured creditors may credit bid, Fisker revived the “for cause” limitation, and when cause exists, credit bidding can be limited or barred. Lessons from the post-Fisker cases include: creditors that engage in misconduct may be barred from credit bidding, courts will not tolerate chilling the auction process, having a counter-bidder strengthens the case for limiting credit bidding and mere boilerplate allegations of cause are insufficient. Credit bidding remains the default rule; challenges that lack substance will not be upheld.

Footnotes

1. RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. __ (2012); 132 S. Ct. 2065.
2. In re Fisker Automotive Holdings, Inc., 510 B.R. 55 (Bankr. D. Del. 2014).
3. Bank of N.Y. Trust Co. v. Official Unsecured Creditors’ Comm. (In re Pacific Lumber Co.), 584
   F.3d 229 (5th Cir. 2009).
4. In re Phila. Newspapers, LLC, 599 F.3d 298 (3rd Cir. 2010).
5. River Rd. Hotel Partners, LLC v. Amalgamated Bank, 654 F.3d 642 (7th Cir. 2011).
6. In re Free Lance – Star Pub. Co., 512 B.R. 798 (Banker E.D.Va. 2014).
7. In re RML Development, dba Pinetree Place Apartments dba Raintree Apartments, No. 13-29244 (Bankr. W.D. Tenn. July 10, 2014).
8. In re Charles St. African Methodist Episcopal Church, 510 B.R. 453 (Bankr. D.Mass. 2014).