Do you think that your lien position is fully secured? Beware! Careful planning is essential. The trend of the judiciary continues to be liberal in circumscribing credit bidding in bankruptcy sales and reorganizations. Likewise, purchasers of debt secured by broad liens may be limited by the bankruptcy court to bidding only the amount paid by the debt purchasers for the secured position and not the amount of the debt purchased. The practical effect can be interference with the secured position of a lender that relied upon a lien position that was negotiated on the front end when the transaction was structured. Another effect of credit bidding uncertainties is increased attorney fees. Similarly, trade creditors continue to benefit at the expense of the secured lenders, though the gnawing of trade creditors from the secured collateral is old news.
Courts Pushing Limits
In the questionably reasoned majority opinion of In re Philadelphia Newspapers,1 the secured lenders were precluded from credit bidding on their collateral in a sale under a plan of reorganization. Interestingly, despite the subsequent U.S. Supreme Court decision in RadLAX Gateway Hotel v. Amalgamated Bank,2 arguably calling rationale of Philadelphia Newspapers and some of its progeny into question,3 judges continue to push the envelope in eliminating or circumscribing credit bidding. Thus, beware.
After the Philadelphia Newspapers case, the U.S. Supreme Court in RadLAX appeared to make clear that debtors may not sell their property free of liens without allowing a lien holder to credit bid. However, the holding in this case in favor of protecting credit bidding rights did not elaborate on the issue of “good cause” to limit credit bidding. Thus, some courts addressing bankruptcy sales continue to be ready, willing and able to find “good cause” to limit the credit bidding rights of lienholders, despite the RadLAX decision. This is not to say all such decisions limiting credit bidding are incorrect, but on occasion the bankruptcy judiciary may lose sight in particular cases of the desirability of simplifying the bankruptcy process, making the process less expensive, sufficiently respecting the secured lien holder’s position and the macroeconomic positives from respecting a lien holder’s position.
A challenge for lienholders in addressing the derogation of lienholder rights in bankruptcy sales starts with the fact that the Bankruptcy Code neither precisely defines credit bidding nor provides much specific guidance as to what constitutes cause to limit credit bidding. In fact, the term “credit bidding” does not appear in the code. However, the Bankruptcy Code does provide that a trustee may sell, other than in the ordinary course of business, property of the estate; and when the property being sold is subject to a lien that secures an allowed claim, unless the court orders otherwise for cause, the holder of such claim — the secured creditor — may bid at such sale, and if the holder of such claim purchases the property at the bankruptcy sale such secured creditor may offset the secured claim against the purchase price of the property.4
Questioning Rationale of Fisker
In the often discussed case of In re Fisker Auto Holdings,5 the secured claimant was only allowed to credit bid the $25 million amount that the secured claimant paid for the $168.5 million principal debt owed by the debtor. The three main reasons for the court’s decision to limit the credit bidding rights appear to be: First, allowing a credit bid higher than $75 million, as proposed by the secured creditor, would freeze out other suitors of the assets; second, the rushed timing and scheduling of the sale by the secured creditor is inconsistent with notions of fairness and bankruptcy process; and third, the extent of the secured creditor’s claim on assets was not clear.
This last point is a reasonable basis to restrict credit bidding because of the illogic of credit bidding based on liens which are indeterminate as to scope or perfection. In other words, how can a secured creditor engage in credit bidding when the extent of its lien rights is unclear as to certain assets? However, limiting credit bidding by a lienholder that purchases debt in good faith in a free market transaction seems somewhat like imposition of personal macroeconomic moral philosophy. Instead, the bankruptcy judiciary should leave it to the marketplace to determine the value of the lien paid for by the secured creditor.
In other words, if A pays B $25 million for a debt of $168 million owed by C to B, then a court should generally be loathe to impede A’s right to credit bid an amount in excess of the purchase price of the lien for C’s property. However, in Fisker the court looked to some amorphous — and technically correct — language about the purposes of the code, as part of the justification to materially limit A’s credit bid rights. In doing so the court was not only unfair to A, depriving A of the benefit of its bargain purchasing the debt owed by C to B, but it also interfered with the free marketplace and the related rational allocation of capital.6
In Fisker, the auction which eventually proceeded produced a large profit for the debt purchaser but at the end of the day such profiteering constitutes financial machinations which do not appear to reflect real economic substance as opposed to a financial play from moving around money. Of course, the Fisker case racked up very large fees, and some of the attorneys took the initiative to seek a fee enhancement, and the judge denied this request.
Wisdom of the Marketplace
Some 2014 and 2015 cases show judicial circumspection in limiting credit bid rights or at least more comforting bases for decisions limiting the secured creditors’ rights. In modifying credit bidding rights in In re RML Development,7 the court acknowledged that “modification or denial of credit bid rights should be the extraordinary exception and not the norm.” In Baker Hughes Oilfield Operations v. Morton,8 the court essentially held that the undersecured creditor waited too long to assert its credit bidding rights when it waited until after confirmation to assert certain of its rights. In denying the debtor’s request to prohibit the secured lender from credit bidding in In re Charles St. African Methodist Episcopal Church,9 the court stated that “the existence of a bona fide dispute as to the secured claim is not necessarily cause.”
As a matter of business sense, all the lawyering in the world cannot substitute for testing monetary value in the marketplace. In addition, for the benefit of the larger economy, certainty about lien rights increases certainty in conducting transactions which in turn increases confidence in making investments as well as the productive allocation of capital. Fundamental fairness would seem to require that a judge be less inclined to substitute her or his evaluation of expert witnesses or the arguments of attorneys about amorphous diffuse Bankruptcy Code goals for the wisdom of the marketplace. Likewise, lenders should be reassured that their rights in collateral will be respected. In other words, credit and capital allocation should not be deterred by lawyers and judges further liberalizing “for cause” determinations which circumscribe credit bidding rights.
The takeaways in protecting lien interests and evaluating credit bid rights are many:
- Are all the assets upon which you may wish to foreclose properly perfected? Make sure the perfection of lien rights is broad and done correctly on the front end of all deals. Remember that under Article 9 of the UCC a lender’s lien rights in many assets are not perfected by filing a financing statement.
- Factor into your transaction the unfair uncertainty of lender lien rights when a bankruptcy occurs.
- For purchasers of debt, consider the possibility that credit bidding the amount of the secured debt purchased, or even the amount of the value of the assets, may not be permitted.
- Consult with bankruptcy counsel sooner rather than later. In the event of a bankruptcy by a borrower, act quickly to evaluate and then assert secured creditor rights. Negotiating the right to credit bid early in the case could serve a secured creditor’s best interests.
- Remember that disputes over credit bidding rights can run up large attorney fees with an uncertain and seemingly unfair outcome. Courts which rely on broad and often amorphous Bankruptcy Code goals to limit the credit bidding rights of secured creditors seem here to stay. Therefore, both on the front end of deals, and on the back end in bankruptcy, beware of the continuing trend toward circumscribing credit bid rights.
- 599 F.3d 298 (3d Cir. 2010)
- 132 S.Ct. 2065 (2012)
- See, e.g., In re NNN Parkway 400 26, LLC, 505 B.R. 277 (Bankr. C.D. Cal. 2014), which specifically calls into question a primary case upon which the majority opinion in In re Phila. Newspapers relies. Similarly, in “Credit Bidding and the Design of Bankruptcy Auctions,” 18 Geo. Mason Law Review. 99, 101 (2010), the authors contend that “Philadelphia Newspapers [was] wrongly decided as a matter of both law and policy.”
- See Bankruptcy Code § 363. The primary rub becomes: what is “cause” to limit the rights of the secured creditor to credit bid?
- 510 B.R. 55 (Bankr. Del. 2014)
- For attorneys, clearly the scope of this article largely excludes issues arising out of the “reinforcing goals of §§ 363(k), 1111(b) and 1129(b)(2)(A) to protect secured creditors from the risks of erroneous judicial property valuations.” Baker Hughes Oilfield Operations, Inc. v. Morton, 784 F. 3d 978, 983 (5th Cir. 2015) (concurrence)
- 525 B.R. 150, 156 (W.D. Tenn. 2014)
- 784 F.3d 978 (5th Cir. 2015)
- 510 B.R. 453, 458 (D. Mass. 2014)