A defaulted borrower in a down economic cycle may find that its senior lender or lending group is happy, or at least willing, to “amend and extend” in the face of a covenant default, particularly if the borrower is able to continue making debt service payments. During the last bankruptcy boomlet of 2008-09, however, many borrowers found themselves faced with lending groups led by aggressive, non-traditional lenders that used the occurrence of an event of default as an opportunity to force an acquisition of their borrower’s business.

The borrowers and their equity holders, in turn, viewed the economic downturn as anomalous and temporary, and refused to give up their companies without a fight. This tension helped lead to an uptick in Chapter 11 filings during that time, as borrowers used the protections of the U.S. Bankruptcy Code to try to stave off what they viewed as opportunistic, hostile takeover attempts by their lenders.

The Chapter 11 case of In re Philadelphia Newspapers, LLC, et al. (Philly Newspapers) was one such situation. The debtors in Philly Newspapers were the owners and publishers of the Philadelphia Inquirer and related publications. The debtors commenced their Chapter 11 proceedings in February 2009 with over $300 million in senior secured debt, plus another $85 million in unsecured mezzanine debt. The debtors’ enterprise value at the time of filing had fallen to less than half of the principal balance of the senior secured debt, and their earnings continued to fall during the Chapter 11 case due to macroeconomic factors facing the print media industry at that time.

The senior lender group was a mix of bank lenders, traditional non-bank lenders and hedge funds. The funds held more than half the debt and thus controlled the lender group during the case. Their goal was to acquire the company. The debtors’ management wanted the ownership of their local newspapers to remain with an interested group of local Philadelphians, some of whom were existing debtor equity holders. From the outset of the case, filed without debtor-in-possession (DIP) financing or even advance notice to the lenders, it was a constant showdown between the senior lender group and old equity. The mezzanine debt controlled the official unsecured creditors’ committee, which generally sided with the senior lenders.

The debtors determined that the sale of the business was the best alternative for maximizing the value of the debtors’ estates. A sale of the debtors’ assets under §363(b) of the Bankruptcy Code, however, was problematic, as §363(k) provides that holders of allowed claims secured by valid liens may bid their debt at any such sale unless the bankruptcy court for cause orders otherwise. The Philly Newspapers debtors had over $300 million of validly secured debt, the holders of which were substantially undersecured.

The debtors believed that a §363(b) sale, with credit bid rights, would have the effect of chilling bidding by other interested parties. It was highly unlikely that any competing bid could compete with the debt currency held by the debtors’ secured lenders. The debtors therefore decided to proceed with a sale under §1123(a)(5)(D) of the Bankruptcy Code,[1] pursuant to a Chapter 11 plan, as opposed to §363. To do so, they had to argue that the credit bid rights set forth in §363(k) may be denied to secured creditors in an asset sale pursuant to a Chapter 11 plan of reorganization, and that such a plan would be “fair and equitable” to adverse secured creditors under §1129(b)(2)(A) of the Bankruptcy Code.[2]

The debtors asserted that, although a sale plan that involved the sale of their assets would have to allow for secured creditor credit bidding to be crammed down on their lenders under §1129(b)(2)(A)(ii), as that section expressly indicates that secured creditors must be given §363(k) rights, such a plan could meet the requirements of §1129(b)(2)(A) so long as it allows the secured creditors to realize the indubitable equivalent of their claims. In other words, the “sale prong” of §1129(b)(2)(A)(ii) is not the exclusive means of satisfying the fair and equitable requirements of secured party cram down, as the “indubitable equivalent” prong of subsection (iii) is a catch-all that can be met in a plan sale context.

The debtors proceeded to seek approval of plan sale bid procedures that 1.) designated a newly formed entity (owned in part by the debtors’ current equityholders) as the stalking-horse bidder, and 2.) provided that “no holder of a lien on any assets of the debtors shall be permitted to credit bid pursuant to §363(k) of the Bankruptcy Code.” Concurrently, they filed their Chapter 11 plan and disclosure statement.

The U.S. Bankruptcy Court for the Eastern District of Pennsylvania rejected the debtors’ argument and denied their motion to approve bid procedures.[3] Bankruptcy Judge Stephen Raslavich held that, under canons of statutory interpretation, “a generic provision of a statute should not be used to achieve a result not contemplated by a more specific provision.”[4] As the debtors could not confirm a cram down plan that included the sale of the debtors’ assets without allowing secured parties to credit bid under §1129(b)(2)(A)(ii), which specifically contemplates a sale of a debtor’s assets, they cannot do so under the more generic provisions of §1129(b)(2)(A)(iii). Otherwise, the court reasoned, the specific sale provisions of subsection (ii) are rendered superfluous.[5]

Two appeals later,[6] in a much-publicized 2-1 decision, the U.S. Court of Appeals for the Third Circuit disagreed.[7] The majority held that when a debtor proposes a Chapter 11 plan that provides for the sale of the debtors’ assets free and clear of a secured creditor’s liens may deny the secured creditor the right to credit bid at such sale and still satisfy the fair and equitable requirements of §1129(b)(2)(A), so long as the plan satisfies the “indubitable equivalent” treatment requirement of subsection (iii).

The Third Circuit held that the language of §1129(b)(2)(A) clearly and unambiguously provides that the three tests for secured party cram down are stated in the disjunctive, are mutually exclusive, and are thus each available to any plan regardless of the means of implementation, including an asset sale. And since the “indubitable equivalent” prong of §1129(b)(2)(A) does not expressly provide for secured party credit bids rights, a sale that otherwise meets the requirements of subsection (iii) need not allow for credit bidding to be fair and equitable to a secured creditor. Importantly, however, the Third Circuit noted that the debtors still bore the burden of demonstrating that their plan provided their secured lenders with the indubitable equivalent of their secured claims.

In theory, the Third Circuit ruling was a material victory for the debtors. Any assumption that the secured lenders could bid a cash amount that would simply “round trip” back to themselves in satisfaction of their own debt at closing would have been misplaced. The Philly Newspapers lending group consisted of over 50 lender entities, certain of which desired to own the company and certain of which would have accepted that outcome, but when faced with the prospect of a cash payment in lieu of new equity in the reorganized debtors would have been happy to accept their fellow lenders’ cash and exit the credit. The group could therefore easily split into bidding lenders and “cash out” lenders, with much of the bidding lenders’ cash payment going to non-bidding lenders instead of back to themselves. Thus, the Third Circuit’s ruling presented a meaningful obstacle to the lenders in the group that sought to own the business.

The debtors, in turn, faced daunting challenges of their own in attempting to keep the business out of their lenders’ hands. They still had to meet all confirmation requirements of §1129 of the Bankruptcy Code. Significantly, they still bore the burden of showing that their plan met the requirements of §1129(b)(2)(A)(iii) even though it denied credit bid rights to secured lenders that at least arguably were willing to bid over $300 million of real debt currency to acquire their collateral (a question the Third Circuit had expressly declined to answer). They faced an adverse unsecured creditor committee, which called into question their ability to obtain the acceptance of their plan by an impaired class of non-insider creditors as required by §1129(a)(10).

Finally, their stalking-horse bidder had to put up significant new capital in making a cash offer that could defeat a motivated group of lenders that still had a meaningful head start, even if their bid did not include 100% participation from the group. In the end, a subgroup of the secured lenders submitted the winning bid at the plan auction, with the remainder of the lenders opting to cash out. The plan that the debtors consummated in September 2010 transferred all of their equity to the bidding lenders. The debtors, in effect, won the battle and lost the war. Nonetheless, and even though the challenges faced by the Philly News debtors would likely be faced by most debtors seeking to deny credit bidding rights under the Third Circuit’s ruling, the decision was widely viewed as a setback to the rights of secured creditors in Chapter 11 cases, and a new weapon in a Chapter 11 debtor’s arsenal.

This summer, the U.S. Court of Appeals for the Seventh Circuit leveled the playing field and provided a circuit split[8] on the issue of credit bidding in plan sales. In the case of In re River Road Hotel Partners, LLC et al., ___ F.3d. ___, 2011 WL 2547615 (7th Cir. June 28, 2011) (River Road), the Seventh Circuit, in a direct appeal from the U.S. Bankruptcy Court for the Northern District of Illinois, rejected the Third Circuit’s ruling and held that the second prong of §1129(b)(2)(A) is the exclusive means of establishing fair and equitable treatment of a rejecting class of secured claims where the plan’s means of implementation is a sale of the debtor’s assets, and, therefore, the holders of such claims must be afforded the right to credit bid or the plan is not fair and equitable.

Whereas the Third Circuit had ruled that the “indubitable equivalent” prong has general application and is available regardless of whether the means of the plan’s implementation is specifically contemplated in subsection (i) or (ii), the Seventh Circuit held the opposite, that the “indubitable equivalent” prong is only available if the means of implementation is not the preservation of the secured party’s liens under subsection (i) or the sale of the collateral under subsection (ii).

The Seventh Circuit observed that a secured creditor’s right to credit bid is a “crucial check against undervaluation” in the context of a plan auction sale, and thus, without providing a secured creditor with the right to credit bid, a plan sale cannot demonstrably provide the secured creditor with the indubitable equivalent of the value of its collateral.[9] The Seventh Circuit also echoed Judge Raslavich, stating that allowing subsection (iii) global applicability to all Chapter 11 plans would render subsections (i) and (ii) superfluous, in violation of canons of statutory interpretation.[10]

The issue may now be headed for a final answer. On August 5, 2011, certain of the debtors in the River Road case filed a Petition for Writ of Certiorari with the U.S. Supreme Court, seeking the answer to the question of, “[w]hether a debtor may pursue a Chapter 11 plan that proposes to sell assets free of liens without allowing the secured creditor to credit bid, but instead providing it with the indubitable equivalent of its claim under §1129(b)(2)(A)(iii) of the Bankruptcy Code.”[11] The River Road debtors describe the issue as “the most hotly debated issue in bankruptcy law today.”[12] If the Supreme Court accepts the case, parties on both sides of the issue will receive welcome clarity, and regardless of the outcome will be able to avoid significant cost and delay in litigating the issue in circuits where the issue has not yet been settled.

Paul Possinger is a partner in the Bankruptcy & Restructuring Group of the law firm of Proskauer Rose LLP, and is located in the Chicago office. Possinger focuses his practice on corporate reorganization, creditors’ rights and bankruptcy matters, and primarily represents financially troubled entities and senior, second lien and mezzanine lenders, in and out of bankruptcy, in debt restructuring and reorganization, workouts, asset and going-concern sales, and litigation.

The author wishes to thank to Jim Peko, principal in the Corporate Advisory & Restructuring Services group of Grant Thornton LLP, for his assistance with this article.

The River Road debtors describe the issue as “the most hotly debated issue in bankruptcy law today.” If the Supreme Court accepts the case, parties on both sides of the issue will receive welcome clarity…


[1] Section 1123(a)(5)(D) provides in relevant part that “a plan shall … provide for adequate means of implementation, such as … sale of all or any part of the property of the estate, either subject to or free from any lien…”

2 Section 1129(b)(2)(A) of the Bankruptcy Code provides that:

(2)     For the purposes 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; and (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 §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.

11 USC §1129(b)(2)(A) (emphasis added).

3In re Philadelphia Newspapers, LLC, No. 09-11204, slip op. (Bankr. E.D. Pa. Oct. 8, 2009).

4 Id. at p. 11.

5 Judge Raslavich offered other justifications for his ruling, including a finding that the language of §1129(b)(2)(A) is inherently ambiguous, thus requiring a review of legislative history, treatises and other sections of the Bankruptcy Code (including §363(k) and §1111(b)) that he found indicated Congressional intent to safeguard the rights of secured creditors to either preserve their claims and liens or credit bid their debt. See generally id. at pp. 12-19.

6 The debtors first appealed to the U.S. District Court for the Eastern District of Pennsylvania, which reversed Judge Raslavich’s decision. See In re Philadelphia Newspapers, LLC, No. 09-mc-178, slip op. (E.D. Pa. Nov. 10, 2009). The debtors’ lenders then appealed the district court’s ruling to the Third Circuit.

7 In re Philadelphia Newspapers, LLC, et al., 599 F.3d 298 (3d. Cir. 2010).

8 Prior to the Third Circuit’s ruling in Philly News, the U.S. Court of Appeals for the Fifth Circuit reached the same conclusion as the Third Circuit, that §1129(b)(2)(A)(iii) may apply to Chapter 11 plans implemented through a sale of property of the estate. In re Pacific Lumber Co., 548 F.3d 229 (5th Cir. 2009). Thus, the Seventh Circuit’s ruling in River Road is the first rejection of this interpretation at the circuit level.

9 In re River Road Hotel Partners, LLC et al., 2011 WL 2547615, *7.

10 Id., *8-9.

11 Radlax Gateway Hotel, LLC v. Amalgamated Bank, 2011 WL 3511028 (2011).

12 Id. at *3.