Holders of secured debt now have two cases to make them nervous as to whether they got all they paid for with respect to their right to credit bid at a sale of the collateral in a section 363 sale in bankruptcy. It may appear that both courts chopped back credit bidding rights solely to encourage cash bids. It turns out that verbiage used in the two orders is more alarming than the actual bases for the courts’ orders, which both relied upon problems with the breadth of the security interests and with questionable to inequitable conduct of the credit bidders in connection with the sales process.
While the emerging case law bears watching, it appears that if secured creditors can avoid over-aggressive tactics toward the bankruptcy sale process – if they can be the least bit cool about exercising their credit bidding rights – then their chances of being “Fiskered” are minimized.
Section 363(k) of the Bankruptcy Code provides that in a section 363 sale of property subject to a lien “that secures an allowed claim,” the secured creditor may bid at such sale and, if it purchases such property, the secured creditor may “offset such claim against the purchase price of such property.”[i] This means that the secured lender may credit bid the full debt it bought (such debt is an “allowed claim” if it is valid) in order to purchase the collateral.
But section 363(k) limits credit-bidding rights by permitting them “unless the court for cause orders otherwise.”[ii] What is “cause”? In a prior article published on this site,[iii] Jonathan T. Brand discussed in detail the evidently alarming order entered in the Fisker case.[iv] There the U.S. Bankruptcy Court for the District of Delaware court limited the secured creditor’s credit bid not to the amount of the debt, but to the much smaller amount that the secured creditor had paid for that debt. The court cited an opinion of the Third Circuit (which covers Delaware) in the Philadelphia Newspapers case that stated that, “[a] court may deny a lender the right to credit bid in the interest of any policy advanced by the Code, such as to . . . foster a competitive bidding environment.”[v] The order was alarming because it is easy to imagine how any right to credit bid by an undersecured secured creditor would chill bidding by cash bidders. The scenario is common.
Can courts now find “cause” to order a reduction in credit bid rights solely in order to enhance cash bidding? If so, debt purchasers may not receive the benefit of their bargained-for rights. If so, the value to be paid for such rights by future debt purchasers must sharply decline. If so, originators of secured credit are going to be exposed to greater loss from troubled loans – which implies both more aggressive collection activity by them, and fewer originations. Fisker seemed to be a lightning strike at the economics of secured credit.
The lightning strike seems to have forked. In the Free Lance-Star Publishing case, the U.S. Bankruptcy Court for the Eastern District of Virginia severely limited a secured creditor’s credit bidding rights,[vi] quoting Fisker and Philadelphia Newspapers in succession in favor of the proposition that a court may deny a lender the right to credit bid to foster a competitive bidding environment.[vii]
In his article, Brand gave a fuller account of the Fisker order. While the court declared the “cause” for limiting the credit bidding rights to be that bidding would be “frozen” unless the credit bid were capped,[viii] it also relied upon the facts that the validity of some of the liens had been challenged, and that the secured lender had insisted upon a private sale (not an auction) on 24 business days’ notice (with no justification for the hurry in selling non-operating assets), and even less to the creditors’ committee.[ix] The court set forth all three factors in the order’s conclusion.[x]
It appears that the secured creditor in Fisker was not the least bit cool in hurrying the sale process toward a private sale of non-operating assets while there were serious questions about the extent of its liens. It is difficult to tell from the order the degree to which the order depended solely upon the effect on bidding of the otherwise overwhelming amount the secured creditor could credit bid.
In the Free Lance-Star Publishing order, the court also found that the secured creditor’s lien rights were invalid or shaky with respect to certain assets and, moreover, that the secured creditor both had failed to disclose certain recordations of UCC financing statements immediately before the case began and had made a false declaration in litigation within the case over the liens.[xi] Further, the secured creditor had pressured the Debtor to shorten the marketing period for the sale of its assets “and to put language in the marketing materials conspicuously advertising [the secured creditor’s] credit bid rights.”[xii] The court found that the secured creditor had engaged in inequitable conduct.[xiii] In concluding, the Free Lance-Star Publishing court cited the confluence of the lien problems, the secured creditor’s “over-zealous loan-to-own strategy,” and the effect of the secured creditor’s misconduct on the auction process had “created the perfect storm, requiring curtailment of [the secured creditor’s’ credit bid rights.”[xiv]
In light of Fisker and Free Lance-Star Publishing, then, to be the least bit cool credit bidders should not rush the sale process unless they are both willing and able to testify to very good reasons for doing so. There was no “melting ice cube” in the Fisker case, for example, to justify a rapid private sale. Further, credit bidders should be forthright with the court (as should all parties), unlike the secured creditor in Free Lance-Star Publishing, and should not engage in inequitable conduct to scare off bidders. It also helps to have a well-documented set of senior lien rights, as the credit bidders did not quite have in the two cases.[xv]
[i] 11 U.S.C. § 363(k).
[iii] See Jonathan T. Brand, “The Fisker Case: My Credit Bid is Capped at the Amount I Paid for the Debt?”, Commercial Bankruptcy Investor (February 6, 2014), published at www.commercialbankruptcyinvestor.com.
[iv] In re Fisker Automotive Holdings, Inc., Case No. 13-13087 (Bankr. D.Del. Jan. 17, 2014).
[v] In re Philadelphia Newspapers, 599 F.3d 298, 315-16 n. 14 (3d Cir. 2010).
[vi] From $39 million to about $14 million. 7 15-16.
[vii] In re The Free Lance-Star Publishing Co. of Fredericksburg, VA, Case No. 14-30315 (Bankr. E.D. Va. April 14, 2014), at 10-11.
[viii] In re Fisker Automotive Holdings, Inc., at 9.
[ix] Id. at 10-11.
[x] Id. at 11.
[xi] In re The Free Lance-Star Publishing Co. of Fredericksburg, VA at 12-13 and n. 11.
[xii] Id. at 13.
[xiv] Id. at 15.
[xv] The court in Free Lance-Star Publishing struck its own alarming note, however. The court had characterized the secured creditor’s efforts as “a classic loan-to-own scenario” wherein the secured creditor had “planned from the beginning to effect a quick sale under § 363 of the Bankruptcy Code at which it would be the successful bidder for all the Debtors’ assets utilizing a credit bid.” Id. at 12. The court also stated unremarkably that the credit bid mechanism “does not always function properly when a party has bought the secured debt in a loan-to-own strategy in order to acquire the target company.” Id. at 13. Especially when a credit bidder fails to act the least bit cool, one might be tempted to add. However, the court also declared that the secured creditor’s “motivation to own the Debtor’s business rather than to have the Loan repaid has interfered with the sales process.” Id. (emphass added). Every exercise of a credit bid – a right expressly recognized by section 363(k) – presupposes the “motivation” to own the collateral subject to the bid.
Mr. Cahill is counsel with Lowis & Gellen LLP, in Chicago, Illinois. He guides secured lenders, creditors, debtors, creditors’ committees, potential purchasers and others through bankruptcy cases, out-of-court workouts, assignments for the benefit of creditors, and receiverships. Mr. Cahill has substantial mega-case experience at national law firms representing very large debtors, and has counseled and…
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