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Chilled bidding

Limiting Credit Bidding in Section 363 Bankruptcy Sales Post-In Re Aéropostale, Inc.

Chilled Credit Bidding and the Section 363 Sale

Section 363(k) of the Bankruptcy Code (the “Code”) allows a secured creditor to bid at a section 363 sale and use the amount of their claim to offset the purchase price at the sale, called “credit bidding.” A court may limit this right “for cause.” The “for cause” standard is not defined in the Code, and disagreement exists as to what constitutes “for cause.” Traditional bases for limiting credit bidding include challenges related to the lien itself, failure to correctly assert the right to credit bid by the creditor, and inequitable behavior or misconduct by the secured creditor.

Further, some courts hold the view that exercise of the credit bidding right “in and of itself” chills the auction process and therefore may constitute “cause” under section 363(k). This view, sometimes called the “In and of Itself” view, is supported to varying degrees by decisions such as In re Fisker, 510 B.R. 55 (Bankr. D. Del. 2014); In re Free Lance-Star, 512 B.R. 798 (Bankr. E.D. Va. 2014); and In re Phila. Newspapers, LLC, 599 F.3d 298, 329 (3d Cir. 2010).

In re Aéropostale, Inc. Opened the Door to Limiting Credit Bidding “For Cause”

In the case of In re Aéropostale,Inc. Judge Sean Lane of the Southern District of New York upheld the secured creditor’s right to credit bid and rejected the argument that chilled bidding, by itself, constitutes “cause” to limit credit bidding under section 363(k). Judge Lane found that while chilled bidding is often a factor in findings of “cause” to limit credit bidding, other “traditional” factors must be present, such as:

  • Inequitable conduct in the sales process
  • Challenges to the lien
  • A procedurally incorrect assertion of the right to credit bid

However, Judge Lane seemed to leave the door open to finding “cause” in cases more similar to Fisker where, among other things, there would have been no bidding if the secured creditor was allowed to credit bid.

The Legal Standard for Credit Bidding

Credit bidding protects secured creditors from the undervaluation of their collateral at an asset sale by allowing the secured creditor to bid for its collateral using the debt owed to offset the purchase price. However, the right to credit bid is not absolute. Section 363(k) of the Bankruptcy Code allows a secured party with an allowable claim to credit bid “unless the court for cause orders otherwise . . . .” The Bankruptcy Code does not define “cause,” and courts “determine whether cause exists on a case-by-case basis.” Acting “for cause” is an exercise of the court’s equitable powers, and “can only be exercised within the confines of the Bankruptcy Code.” “[M]odification or denial of credit bid rights should be the extraordinary exception and not the norm.”

Traditional Bases For Limiting Credit Bidding

Traditional bases for limiting credit bidding under section 363(k) include challenges to the lien itself, procedurally incorrect assertions of the right to credit bid, and inequitable behavior or misconduct by the secured creditor.

Challenges to the lien itself include challenges to the validity, priority, and extent of the liens on the collateral in question. The right to credit bid under section 363(k) is conditioned upon the credit bidder holding an “allowed claim” with a lien on the property to be sold that secures the allowed claim. Therefore, if there are defects in the lien or the allowability of the claim, then there is “cause” to limit the credit bidding. Where the validity of the secured creditor’s lien is not affirmatively established, courts will deny the right to credit bid. For example, in Fisker, “absence of evidence on the perfection of the liens” constituted “cause” under section 363(k).

Credit bidding may also be limited where “the party seeking to credit bid fails to comply with procedural requirements established by the court for the sale of collateral.” For example, in Greenblatt v. Steinberg, the district court upheld the bankruptcy court’s decision to deny a secured creditor’s right to credit bid because the secured creditors failed to follow the requirements of the sales procedures order requiring them to challenge the nature, extent, or validity of another creditor’s lien on the property.

Courts may also find “cause” to limit credit bidding under section 363(k) where the secured creditor engages in inequitable behavior or misconduct, even where no defects in the lien or allowance of the claim are present. Findings of section 363(k) “cause” for inequitable conduct often involves behavior that “also directly affects the estate or the bidding process.” For example, in In re Aloha Airlines, credit bidding was denied because of a secured creditor’s undisclosed sponsorship of a third party’s acquisition of the debtor’s assets through the bid in question. The behavior on the part of the party seeking to credit bid in In re Aloha Airlines was particularly bad, including misuse of confidential information, sworn misstatements to cover the truth of the party’s dishonesty, and destroyed records. However, “cause” to deny credit bidding may be found for less extreme behavior such as “collusion, undisclosed agreements, or any other actions designed to chill the bidding or unfairly distort the sales process.”

When Does the “In and of Itself” Reading of Cause Limit Credit Bidding?

The “in and of itself” reading of “cause” in section 363(k) is defined by Cahill and Kuney as “purport[ing] to authorize limiting credit bidding even in the absence of lien defects, claim allowance issues, procedural defaults, and inequitable conduct,” based solely on the “inevitable effect” of exercising a credit bidding right—chilled bidding at a section 363 sale of assets.

The “in and of itself” reading of “cause” comes from dicta in In re Philadelphia Newspapers, LLC, specifically footnote 14. In In re Philadelphia Newspapers, LLC, the Third Circuit addressed the question of “whether § 1129(b)(2)(A) of the Bankruptcy Code requires that any debtor who proposes, as part of its plan of reorganization, a sale of assets free of liens must allow creditors whose loans are secured by those assets to bid their credit at the auction.”

Philadelphia Newspapers, LLC (the “Debtor”) was a print and online news publishing company that had recently been acquired with the help of a $295 million loan from a consortium of lenders (the “Lenders”). The Lenders obtained a first priority lien in all of the Debtor’s real and personal property worth approximately $318 million. After going through financial troubles, the Debtor filed a voluntary petition under chapter 11, and filed a plan of reorganization that provided for a public auction of substantially all of its assets, free of liens. The Debtor filed a motion for approval of bid procedures under which the Lenders were precluded from credit bidding because the sale was being conducted under section 1123(a) and (b) of the Bankruptcy Code, and not section 363.

The bankruptcy court refused to bar the lenders from credit bidding, reasoning that “while the Plan proceeded under the ‘indubitable equivalent’ prong of § 1129(b)(2)(A)(iii), it was structured as a § 1129(b)(2)(A)(ii) plan sale in every respect other than credit bidding.” Therefore, the bankruptcy court reasoned, any sale of the Debtors’ assets required that a secured lender be able to credit bid.

The district court reversed the bankruptcy court on appeal, holding that the Code “provides no legal entitlement for secured lenders to credit bid at an auction sale pursuant to a reorganization plan.” Relying on the plain language of section 1129(b)(2)(A), the district court held that this section provides three distinct routes to plan confirmation, and because the right to credit bid was not incorporated into the “indubitable equivalent” route, Congress therefore did not intend to require credit bidding with that route..

On appeal to the Third Circuit, the Lenders argued, among other things, that the Bankruptcy Code guaranteed a secured lender’s rights either to treat their deficiency claims as secured under section 1111(b) or to make a credit bid under section 363(k). Because they were precluded from making a section 1111(b) election, the Lenders argued that they must be afforded the right to make a credit bid. Further, the Lenders argued that the “for cause” exemption under section 363(k) is limited to situations where a secured creditor has engaged in inequitable conduct.

Disagreeing with the Lenders, the court stated, “A court may deny a lender the right to credit bid in the interest of any policy advanced by the Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment.” Further, the court cited 3 Collier on Bankruptcy 363.09[1] which says, “The Court might [deny credit bidding] if permitting the lienholder to bid would chill the bidding process.”

While the “in and of itself” reading was buried in dicta and a footnote, the Third Circuit’s favorable treatment of the reading was cited and relied on to varying degrees in cases limiting credit bidding, including In re Fisker Auto. Holdings, Inc., and In re Free Lance-Star. In In re Fisker, the court cited Philadelphia Newspapers in its decision to limit credit bidding in part because evidence suggested that if credit bidding was not limited, there would be no bidding at all—not just chilled bidding. The court in In re Free Lance-Star cited the same language from Philadelphia Newspapers, but did not seem to rely too much on it because it also found that the secured creditor in that case did not have a lien over many of the assets in which it asserted an interest.

That the courts in Fisker and Free Lance-Star cited language favoring an “in and of itself” reading of “cause” is less momentous than it could be because in both cases the court relied heavily on more traditional grounds for limiting credit bidding. Other allegations of wrongdoing and bid chilling were the primary basis for limiting the credit bidding and thus, as Brand and Friedland argue, those cases do not establish a new basis for “cause” under section 363(k).

The language from Philadelphia Newspapers continues to inspire discussion, as shown by the attention of the American Bankruptcy Institute Commission to Study the Reform of Chapter 11 (the “Commission”). While the Commission’s 2012-2014 Final Report and Recommendations recognized that “all credit bidding chills an auction process to some extent,” the Commission stated that they “did not believe that the chilling effect of credit bids alone should suffice as cause under section 363(k).” Further, the view continues to crop up in parties’ arguments, as shown by In re Aéropostale, Inc.

The Aéropostale Decision: Limitations on Credit Bidding Were Unnecessary

In In re Aéropostale, the Debtors filed a motion to, among other things, disqualify a group of creditors (the “Term Lenders”) from credit bidding in a sale of the Debtor’s assets under section 363(k). The Debtors argued that the Term Lenders should be disqualified from credit bidding based on inequitable conduct and the fact that credit bidding would chill bidding at the auction.

The Debtors’ alleged that the Term Lenders acted inequitably in three ways: (1) by breaching a sourcing agreement by “retroactively” imposing new payment terms for orders made but not yet delivered; (2) by engaging in a “secret plan” to buy the company at a discount; and (3) by improperly trading stock while in possession of material nonpublic information. In a lengthy and detailed analysis, the court declined to find that the Term Lenders acted inequitably in any of these ways and refused to limit credit bidding on that basis.

The court cited case law and the facts before it in rejecting the Debtors’ further argument that credit bidding should be barred because of the risk that it will chill auction bidding.

The court recognized that courts will refer to concerns about the chilling of bidding as a factor while noting that such opinions “almost invariably also feature some other factor that supports a limitation on the creditor.” Citing to footnote 14 of Philadelphia Newspapers, the court seemed to partially dismiss the “in and of itself” reading of “cause” in that decision by saying that it must be understood in light of RadLax Gateway Hotel, LLC v. Amalgamated Bank, in which the Supreme Court held that a debtor may not confirm a chapter 11 cramdown plan that provides for the sale of the collateral free and clear of the lien but does not permit the secured creditor to credit bid at the sale.

Further, the court observed that it was unaware of any cases in which chilled credit bidding alone constituted sufficient “cause” to limit credit bidding. The court then construed Fisker and Free Lance-Star as mentioning chilled bidding while basing their rulings primarily on the more traditional grounds of inequitable behavior and challenges to the validity of liens. Lastly, the court cited the quoted language above from the American Bankruptcy Institute Commission to Study the Reform of Chapter 11 Final Report.

The facts of In re Aéropostale, Inc. showed that there was significant interest in the Debtors’ assets both as a going concern and on a liquidation-sale basis.[40] Thus the court could find that, even setting aside the lack of inequitable conduct, the case before it was distinguishable from Fisker, where there would have been no bidding if the court did not limit the credit bid.[41]

Take-Aways: Chilled Bidding Isn’t “Cause” to Limit Credit Bidding

The court in In re Aéropostale, Inc. all but explicitly rejected the “in and of itself” reading of “cause” in section 363(k). Parties seeking to limit credit bidding should be aware that the argument that chilled bidding constitutes cause to limit credit bidding will not get them far before Judge Lane. Even in his court, however, the door seems open to assertion of “cause” based upon “frozen” rather than merely “chilled” bidding, such as was the case inFisker. Traditional bases under section 363(k) most reliably support arguments for limiting credit bidding. If the bidding is not “frozen” and none of the traditional bases exist, credit bidding will almost surely not be limited.

[Editor’s Note: The author would like to thank Professor George Kuney for his help and advice. To learn more about this and related topics, you may want to attend the following webinars:The Nuts & Bolts of a 363 Motion andOpportunity Amidst Crisis: Saving Companies & Their Owners From Financial Ruin. This is an updated version of an article originally published on November 7, 2016.]

©All Rights Reserved. July, 2020. DailyDAC, LLC

About Luke Smith

Luke Smith graduated from the University of Tennessee College of Law with a concentration in Business Transactions and now works for Kirkland & Ellis. Smith is the Editor-in-Chief of Transactions: The Tennessee Journal of Business Law, and recently co-authored an article titled "Perfect Civil Enforcement? Litigation Financing in the Wake of Gawker Media v. Bollea." Academically, Smith…

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Luke Smith