Credit bidding upheld by the Supreme Court

November 15, 2012 (Press-News.org) This summer, the United States Supreme Court ruled upon a number of controversial issues, including immigration and health care reform. It also ruled on the divisive, yet increasingly common issue of credit bidding, and its ruling may have changed the way Chapter 11 bankruptcies work. This article will highlight the case of RadLAX Gateway Hotel v. Amalgamated Bank and the court's reasoning behind its decision.

What is credit bidding?

Credit bidding is based largely in part on Section 363 of the Bankruptcy Code and is seen as one of the most important rights secured creditors have in bankruptcy. It essentially allows them to assert their rights to use their debt to acquire or drive the price of the sale of their collateral. When the collateral securing a lien to be discharged is to be sold at a bankruptcy auction, a secured creditor may bid the amount of its debt as a credit bid. In other words, the secured creditor does not have to submit its bid in cash while other bidders must do so.

How does it work within corporate bankruptcies?

In Chapter 11 bankruptcies, a debtor may sell a particular property and use the proceeds to pay the respective creditor. The right to credit bid helps secured creditors when the value of their collateral is worth less than the amount they are owed. For example, if a building now worth $1.25 million serving as collateral for a $1.75 million loan were to be sold at an auction, the debtor would find it difficult to sell the property over the objection of the secured lender because it would be allowed to bid the full amount of its $1.75 million claim without offering any cash. Other bidders would presumably not bid in excess of the market value and must pay cash. The lender's credit bid protects the creditor's interest in the collateral by ensuring that it can only be outbid by cash bids (thereby ensuring that the creditor gets paid). This is especially important when debtors seek to auction property free and clear of a creditor's interest through a "cramdown" plan under Section 1129(b)(2)(A) of the Bankruptcy Code.

The 'RadLAX' case and its reorganization plan

In RadLAX, the debtor obtained a commercial loan to renovate a hotel near Los Angeles International Airport. RadLAX became insolvent before the renovation project was completed, and after a number of failed attempts to sell the property, it filed for bankruptcy protection under Chapter 11. RadLAX attempted to confirm a cramdown bankruptcy plan that proposed selling its assets through an auc-tion (including its interests in the hotel) and using the proceeds to repay the primary creditor, Amalgamated Bank.

Under RadLAX's proposal, Amalgamated would not be permitted to credit bid. Instead, the plan proposed to provide Amalgamated with the "indubitable equivalent" of its claim as allowed under the Bankruptcy Code.

The bankruptcy court denied RadLAX's request, finding that the auction procedures did not comply with Section 1129(b)(2)(A)'s requirements for cramdown plans. The 7th U.S. Circuit Court of Appeals affirmed the ruling, holding that Section 1129(b)(2)(A) does not permit debtors to sell an encumbered asset free and clear of a lien without permitting the lienholder to credit-bid.

RadLAX considers a common scenario that arises when a debtor desires to sell an asset that has been pledged as collateral. The secured creditor asserted that it should be allowed to foreclose on the collateral if the debt is unpaid. RadLAX contended that the sale of the collateral should be authorized, and the secured creditor should be required to bid the most on the collateral if the secured creditor wishes to procure it. The Supreme Court held that the secured creditor should not be required to put new cash toward the purchase of an asset where unpaid debt to the secured creditor already exists.

The Supreme Court's reasoning

The Supreme Court granted certiorari in order to resolve a dispute on this critical issue (The 3rd U.S. Circuit Court of Appeals in In Re Philadelphia Newspapers, LLC confirmed a plan, which disallowed credit bidding). The Court affirmed the 7th Circuit's decision, holding that clause (iii) is merely a broadly worded option for confirmation plans that does not expressly forbid credit bidding allowed in clause (ii). It reasoned that the clauses under Section 1129(b)(2)(A) created a tiered system of exceptions for cramdown plans where clause (i) would be the rule when the creditor retains a lien to the property, clause (ii) applies when the debtor seeks to sell the property free and clear of the lien, and clause (iii) encompasses all other plans. The Court noted that RadLAX did not identify any unique circumstances where clause (iii) would apply to its plan. Since it sought to sell its interests without Amalgamated retaining its interest in the loan, the Court believed that RadLAX's plan fell squarely within the provinces of clause (ii). With this, credit bidding would be allowed as part of the auction sale.

How the decision may affect future Chapter 11 plans

RadLAX could have been the end of credit bidding, affording debtors great control and influence in the reorganization process. Instead, the Supreme Court's decision reinforces the practice and protects creditors' interests in distressed property.

If you have questions about credit bidding in Chapter 11 cramdown plans, an experienced bankruptcy attorney can advise you.

Article provided by Weintraub & Selth, A Professional Corporation
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