One way to purchase assets (including the assets of a business as a going concern) is to prevail at a foreclosure sale or a § 363 bankruptcy auction with a credit bid. The first step is to acquire the senior secured debt on the assets at a steep discount. The next step is to outbid cash bidders with a credit bid up to the face value of the debt. Last year, the US Supreme Court gave credit bidders greater confidence in § 363 bankruptcy auctions by clarifying the right to credit bid. Recently, though, a Delaware bankruptcy shook credit bidder confidence by preventing a holder of debt from credit bidding more than it paid for the debt. Such a ruling gives potential purchasers of debt (as well as lenders) a reason to pause.
Although the right to credit bid in a §363 sale not involving a chapter 11 plan has long been unquestioned, there was a split among courts as to whether a secured creditor can credit bid its secured claim in a chapter 11 plan sale context. The Supreme Court settled the question in Radlax Gateway Hotel, LLC v. Amalgamated Bank, 132 S.Ct. 2065 (2012). In Radlax, the Supreme affirmed the Seventh Circuit’s affirmation of the bankruptcy court’s decision denying confirmation of the debtors’ chapter 11 plan because the plan sought to sell encumbered assets free and clear of liens without allowing the secured lender to credit bid its debt in the sale.
Radlax unquestionably strengthened the position of secured creditors and buyers of distressed debt. True, the notion that a court can limit the right of a secured creditor (including one who becomes a secured creditor by virtue of buying the original secured creditor’s claim) to bid “for cause,” but those limitations traditionally consist of preventing a creditor from credit bidding at all (where, for example, there is a real dispute about the validity of the claim) or requiring the creditor to escrow whatever amount of the creditor’s claim is disputed (when there is a real dispute about the amount of the claim).
A decision rendered by Bankruptcy Judge Gross in Delaware, on January 17th, In re Fisker Automotive Holdings, Inc., Case No. 13-13087 (Bankr. D. Del. Jan. 17, 2014) [Docket Nos. 483 and 484] however, raises an issue that most bankruptcy participants have long assumed is no issue at all: is a credit bid limited to the amount the holder of the claim paid for it? In other words, by example, if a buyer of distressed debt (think: HIG Capital, Sun Capital Partners, Summit Investment Management or Versa Capital Management) pays $25 million for a $50 million claim, can that buyer bid $50 million at a §363 sale or is it limited to a $25 million bid? The answer, before January 17th, that most bankruptcy lawyers would give was that the buyer can bid up to $50 million. Judge Gross says otherwise – though his decision has already been appealed.
Regardless of the outcome on appeal, it should serve as a reminder that: (a) credit bidding is not an absolute right; and (b) strategic actions may be taken to avoid a finding that ‘cause’ exists to deny or limit credit bidding.
Fisker Automotive Holdings, Inc. and its affiliate, Fisker Automotive, Inc. (collectively, “Fisker” or “Debtors”) were designers and manufacturers of plug-in hybrid electric vehicles. In 2010, the United States Department of Energy (“DOE”) provided Fisker a $168.5 million senior secured loan. After Fisker suffered financial distress, the DOE terminated the Fisker’s lending facility. In 2013, the DOE held a public auction and sold the loan to Hybrid Tech Holdings, LLC (“Hybrid”) for $25 million, or fifteen percent of the face value of the loan. After purchasing the DOE loan, Hybrid agreed to purchase substantially all of Fisker’s assets by submitting a $75 million credit bid. The parties agreed that the proposed sale should be effectuated through a private sale transaction conducted in a chapter 11 case.
On November 22, 2013, the Debtors’ case began. In the first day filings, the Debtors filed a motion seeking to approve the private sale to Hybrid on an expedited basis (24 business days after the bankruptcy filing). After the Official Committee of Unsecured Creditors (“Committee”) was appointed, it objected to the proposed private sale and filed a separate motion seeking a competitive auction in order to allow a competing bidder, Wanxiang America Corporation (“Wanxiang”), to participate and submit a competing bid. Wanxiang had recently purchased the primary component of Fisker electric vehicles through an auction in a separate bankruptcy proceeding. In turn, Hybrid filed a limited objection to the Committee’s motion.
At the sale hearing, the Debtors and Committee narrowed the issues for the court by stipulating:
(i) if Hybrid’s ability to credit bid was capped at $25 million (the amount for which it purchased the secured debt from the DOE), a strong likelihood existed that an auction would create a material benefit for the estate;
(ii) if Hybrid’s credit bid was not capped, no auction would occur;
(iii) limiting Hybrid’s ability to credit bid would facilitate competitive bidding; and
(iv) certain assets of the Debtors were subject to Hybrid’s security interest, other assets of the Debtors were not subject to Hybrid’s security interests, and a dispute existed as to whether Hybrid had a properly perfected security interest in other assets of the Debtors.
The court was quick to note a secured creditor’s right to credit bid pursuant to Bankruptcy Code §363(k), “unless the court for cause orders otherwise . . . .”. The court then cited the Third Circuit’s In re Philadelphia Newspapers, 599 F. 3d 298, 315-16 (3d Cir. 2010) to provide precedent for limiting or denying a secured party’s right to credit bid.
The cases cited in the excerpt of the Philadelphia Newspapers opinion provide that there is not an absolute right for a secured credit to credit bid in all situations. “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.” Id. at FN14 (citing 3 Collier on Bankruptcy 363.09(“the Court might [deny credit bidding] if permitting the lienholder to bid would chill the bidding process.”)).
Interestingly, the cases cited in the Fisker opinion are distinguishable from the facts of the Fisker case. Also, none of the cases cited in the Fisker opinion, through quoting the Philadelphia Newspapers case, cap the amount that a secured party could credit bid. Rather, the cases cited deny a secured party’s right to credit bid under the specific facts of each case (malfeasance by secured party, failing to observe certain procedures set by the court, and presenting a credit bid significantly below the fair market value of the assets). In this regard, the act of allowing Hybrid to credit bid, but limiting the amount of the credit bid seems controversial. The Court did not provide a reason for capping Hybrid’s bid at the price it paid for the DOE loan.
The court found cause to limit the amount of Hybrid’s credit bid, in part, because Wanxiang stated that it would not participate in any auction where Hybrid was allowed to credit bid the face amount of its debt. Also, quoting footnote 14 of Philadelphia Newspapers, the court limited Hybrid’s credit bid in order to allow a competitive bidding process to move forward. “Thus, the ‘for cause’ basis upon which the Court is limiting Hybrid’s credit bid is that bidding will not only be chilled without the cap; bidding will be frozen.”
The court also took issue with the expedited nature of Fisker’s sale motion and that Hybrid’s claim was unsettled. The expedited nature of the sale motion seemed misplaced since Fisker was not operating at the time of the bankruptcy filing. The court asserted “Hybrid’s rush to purchase . . . is inconsistent with the notions of fairness in the bankruptcy process. The Fisker failure has damaged too many people, companies and tax papers to permit Hybrid to short-circuit the bankruptcy process.” The dispute over the extent of Hybrid’s security interest also gave the Court an additional basis to limit Hybrid’s credit bid. The court noted that where the validity of a creditor’s lien has not been determined, the creditor cannot bid its lien.
Even if overturned, Fisker should serve as a reminder to purchasers of distressed debt that credit bidding is not a right absolute. It may be the rule, but there are exceptions which may cause a court to limit or deny credit bidding in its entirety. In light of this opinion, what can a distressed debt purchaser try to do to avoid the pitfalls Hybrid experienced in Fisker?
Jonathan T. Brand is a managing attorney at Lakelaw in Chicago, Illinois. Jonathan provides expert advice and counsel in the areas of bankruptcy, chapter 11 reorganizations, commercial litigation, and related transactional matters, and regularly represents debtors, trustees, and creditors in a variety of complex insolvency matters. He also assists clients with out-of-court workouts, assignments for…
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90 Second Lesson: Credit Bidding in Plan Sales
Cram Downs and Artificial Impairments – Can a Debtor Rewrite its Own Credit Terms in a Bankruptcy?
RECOMMENDED READING: How Fisker and Free Lance Star-Publishing Did Not Alter Credit-Bidding
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