The U.S. Supreme Court has ruled that a secured creditor cannot be denied its right to “credit bid”—i.e., to offset the amount of its debt against the purchase price of assets, rather than bidding in cash—in sales of collateral undertaken in connection with plans of reorganization under Chapter 11 of the Bankruptcy Code. In so ruling, the Court resolved a widely publicized split of authority among the Circuit Courts of Appeal, and rejected the Third Circuit’s ruling in the Philadelphia Newspapers case.1
Credit bidding protects a secured creditor from the risk of undervaluation of its collateral by allowing the secured creditor to bid in its debt rather than paying the full purchase price in cash. Absent unusual circumstances, the Bankruptcy Code expressly guarantees the right of a secured creditor to credit bid in sales under Section 363. At issue in RadLAX Gateway Hotel, LLC v. Amalgamated Bank, however, was whether secured creditors similarly enjoy that right in asset sales under plans of reorganization. The Supreme Court answered that question, unequivocally, in the affirmative.
In 2007, the debtors in RadLAX purchased the Radisson Hotel at Los Angeles International Airport, together with an adjacent lot on which the debtors planned to build a parking structure. To finance the project, the debtors obtained a $142 million loan. The lenders obtained a blanket lien on all assets to secure the loan. By August 2009, the project soured, and, with $120 million of the secured debt outstanding, the debtors filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code.
In 2010, the debtors filed a plan of reorganization under which they proposed to sell substantially all of their assets via auction, with an initial stalking horse bid of $47.5 million—an amount significantly less than the $120 million secured claim against the assets. The proposed sale procedures did not allow the secured lender to credit bid. Upholding the secured creditors’ objection, the bankruptcy court denied the proposed sale procedures. The Seventh Circuit took an immediate appeal and affirmed the decision of the bankruptcy court. The debtors then appealed to the Supreme Court.
The Supreme Court’s Decision
The Supreme Court affirmed the Seventh Circuit, unanimously concluding that debtors may not sell their property free of liens under plans of reorganization without allowing secured creditors to credit bid.2 The dispute in RadLAX arose under the “cramdown” provisions of Section 1129(b) of the Bankruptcy Code. In order to confirm a plan of reorganization over the objections of a dissenting impaired class of creditors, the plan proponent must demonstrate, among other things, that the plan is “fair and equitable” to the dissenting class. To determine whether a plan meets this standard, Section 1129(b)(2)(A) provides three alternative standards by which a plan may be deemed fair and equitable with respect to a dissenting class of secured creditors:
(i) The secured creditor retains the liens securing its claims, whether or not the debtor retains the property, and receives deferred cash payments with a present value equal to the value of the collateral;
(ii) If the plan proposes the sale of collateral to a buyer free and clear of liens, then the sale is subject to Section 363(k) (i.e., absent unusual circumstances, the secured creditor must be allowed to credit bid) and the secured creditor receives a lien on the sale proceeds; or
(iii) The secured creditor receives the “indubitable equivalent” of its secured claim.
The debtors argued that, notwithstanding the more specific provision of clause (ii), which specifically contemplates the sale of collateral free and clear of liens, the broadly-worded clause (iii) permits the sale of assets under a plan of reorganization without providing the secured creditors the ability to credit bid. In other words, the cash generated at auction could serve as the “indubitable equivalent” of the secured claim.
The Supreme Court disagreed, finding this an “easy case” with no statutory ambiguity.3 The Court observed that clause (ii) specifically contemplates the sale of assets free and clear of liens. Applying an “old and familiar rule” of statutory construction, the Court reasoned that “the specific governs the general,” and that “the ‘general language’ of clause (iii), ‘although broad enough to include [sales contemplated by clause (ii)], will not be held to apply to a matter specifically dealt with’ in clause (ii).” A plan of reorganization that proposes the sale of collateral free and clear of liens, therefore, must comply with clause (ii) and must allow credit bidding.
The RadLAX opinion is a significant victory for secured creditors. Secured creditors bargain for the right to be repaid in full, and, if not, to foreclose upon or sell their collateral. The Bankruptcy Code, however, forestalls creditor remedies and allows a debtor to sell assets free and clear of liens at auction. If the secured creditor views the auction sale price as being too low, the secured creditor can protect itself by credit bidding its debt and, if it proves to be the highest bidder, obtain ownership of the collateral through that bid. In being able to so participate in the sale process through such credit bidding, the secured creditor will have protected itself against the risk of the undervaluation of its collateral and will have put itself in a better position to realize the fair market value of its collateral. The Supreme Court’s decision thus reinforces the expectations of secured creditors in the context of asset sales in bankruptcy, whether under Section 363 of the Code or under plans of reorganization.
For more information about the RadLAX decision, or any other matter raised in this Legal Update, please contact Brian Trust at +1 212 506 2570, Howard S. Beltzer at +1 212 506 2684, or Thomas S. Kiriakos at +1 312 701 7275.
1 See our Legal Updates, “Seventh Circuit Upholds Secured Lender’s Right to Credit Bid in Asset Sales Under a Chapter 11 Plan” and “In re Philadelphia Newspapers, LLC – Uprooting Three Decades of Secured Creditor’s Expectations?” as well as the recent Mayer Brown Supreme Court Decision Alert, “Bankruptcy – Right to Credit Bid in Chapter 11.”
2 Justice Kennedy took no part in the decision.
3 RadLAX Gateway Hotel, LLC v. Amalgamated Bank, No. 11-166, slip. op. at 10 (U.S. May 29, 2012).