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Supreme Court Reverses Third Circuit's Decision on Credit Bidding

Chapter 11 filers must carefully consider the rights of secured creditors in Chapter 11 bankruptcy proceedings, a recent Supreme Court decision confirms.

2012-10-20
October 20, 2012 (Press-News.org) The Supreme Court of the United States has reversed a ruling of the Third Circuit Court of Appeals on a Chapter 11 bankruptcy issue known as credit bidding. The Supreme Court unanimously ruled that Chapter 11 reorganization plans cannot sell the property of a secured creditor without giving that creditor the opportunity to credit bid on it.

Two Important Terms: Credit Bidding and Cramdown

In order to understand the Supreme Court's recent decision, it is necessary to understand two key Chapter 11 bankruptcy terms: credit bidding and cramdown. In the Chapter 11 bankruptcy process, filers develop a reorganization plan that may include auctioning property to pay off their debts. This property may include collateral used by creditors to secure a loan. For example, a small office building may be used as collateral on the mortgage of that building.

At the auction, secured creditors usually have the option of credit bidding on the collateral property. This means they can offer to forgive part of the debt the filer owes instead of a cash bid on the property. For example, the creditor who owns the mortgage on the small office building may offer the filer forgiveness of half of the loan as a bid on the property, while third parties may offer cash bids.

A cramdown is another common Chapter 11 term. Since Chapter 11 does not liquidate assets but allows filers to come up with a reorganization plan, often creditors must reach a compromise with the filer on the amount of debt owed. A cramdown allows the filer to get their reorganization plan approved despite creditors' grievances. In other words, the reorganization plan is "crammed down" the throats of creditors. Cramdowns allow bankruptcy courts to modify loan terms to make them equitable for all parties.

The Supreme Court's Unanimous Decision Reinforces a Creditor's Right to Credit Bidding

In the Supreme Court's unanimous opinion, Justice Antonin Scalia explained that there are three ways courts can determine whether or not a reorganization plan is fair for objecting secured creditors. First, a secured creditor can keep the lien and the filer can make deferred payments. Or, the property can be sold clear of the lien and the creditor is paid with the proceeds of the sale. Lastly, the reorganization plan may pay the secured creditor the "indubitable equivalent" of the loan amount.

In the case before the Supreme Court, the bankruptcy filer, RadLAX, proposed a Chapter 11 reorganization plan after it ran out of money in a hotel redevelopment project near the Los Angeles Airport. In the plan, RadLAX required that their secured creditor bid on its collateral property in cash rather than with credit. Knowing that this would prompt objections from the creditor, the filer tried to cramdown the plan, claiming that the cash bidding provided an "indubitable equivalent" of the property's worth.

The Third Circuit Court of Appeals upheld this interpretation of bankruptcy rules, but the Supreme Court reversed the Circuit Court's opinion, calling the interpretation "hyperliteral and contrary to common sense". In its opinion, the Supreme Court explained that the filer's interpretation ignores section 363k of the bankruptcy code, which allows secured creditors to use loan forgiveness to bid on its collateral properties rather than cash.

The Supreme Court's decision will require Chapter 11 bankruptcy filers to carefully consider the protections secured creditors enjoy in the bankruptcy code. However, it does not affirm that bankruptcy filers cannot cramdown reorganization plans that meet the requirements of bankruptcy rules but are still objectionable to secured creditors. If you are considering Chapter 11 bankruptcy but have concerns about the objections of your secured creditors, please contact an experienced bankruptcy attorney.

Article provided by Scura, Mealey, Wigfield & Heyer, LLP
Visit us at www.scuramealey.com


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[Press-News.org] Supreme Court Reverses Third Circuit's Decision on Credit Bidding
Chapter 11 filers must carefully consider the rights of secured creditors in Chapter 11 bankruptcy proceedings, a recent Supreme Court decision confirms.