The U.S. Supreme Court takes on a limited number of cases per year, and those relating directly to the credit profession and bankruptcy activity make up only a minute portion of those annually slated. This year, a key case regarding protocol in a bankruptcy asset auction conducted as part of a plan of reorganization, RadLAX Gateway Hotel LLC v. Amalgamated Bank, found its way onto the schedule for April 23 arguments with a decision to follow by the summer. At stake is whether secured creditors have an absolute right to bid the value of debt owed to them by a debtor selling assets at auction, when the sale is part of a plan of reorganization, a process called credit bidding, as the U.S. Court of Appeals for the Seventh Circuit ruled. However, that view is at odds with contrary decisions by the U.S. Courts of Appeal for the Third and Fifth Circuits, which preceded it. Those held that the right to credit bid may not be available to secured creditors under certain circumstances if the assets are sold as part of a plan of reorganization.
"In the bankruptcy world, this case is very important because the Supreme Court takes so few bankruptcy cases in a year," said Eric Brunstad, law professor at Yale University and partner at Dechert LLR "What it writes about bankruptcy law and how it works is very important because it impacts how things are administered generally, particularly in a Chapter 11 case. A case like this is very important. Having the case in question clear up a gray area makes it that much more critical. It's always good to know what the rules of the game are. If we get clarity on the rules, it helps the bankruptcy process work more efficiently."
It's not surprising the high court's justices have to officiate contrary opinions out of the Seventh, Third and Fifth circuits--NACM's go-to legal experts don't even necessarily agree on the topic. One camp believes that credit bidding within an auction process helps facilitate other bidding, thus driving up the price and providing for a bigger pot for creditors-unsecured and secured alike--to draw from at plan confirmation time. Wanda Borges, Esq. of Borges and Associates LLP has recounted instances where, without a credit bid, the assets would have sold for a fraction of what became the final price, leaving unsecured suppliers and vendors literally with nothing. However, there's the flip side that believes if too much is owed to a secured creator, it essentially freezes out outside bidders and those with lower standing. Bruce Nathan, Esq. of Lowenstein Sandier PC holds that not forcing secured creditors to put up cash in such scenarios can discourage competitive bids and prevent a "robust" auction process.
RadLAX Gateway Hotel LLC v. Amalgamated Bank
In RadLax, the Seventh Circuit allowed a secured creditor the right to bid its claim, in other words, the amount of debt owed, in lieu of a cash bid as part of a plan confirmation process. The practice of credit bidding has been in play for quite some time in the bankruptcy process, generally, and was rarely challenged when made as part of the plan process. On the surface, the decision may not have generated much debate or discussion. However, because RadLAX followed two other cases that denied secured creditors the right to credit bid on assets sold as part of the plan process, the high court found it necessary to clear up the conflict.
The Third Circuit decision in Delaware came in the bankruptcy case of Philadelphia Newspapers LLC. In that case, a three-judge panel denied a creditor group's attempt to credit bid in the sale of the company as part of the plan process. The debtor was the operator of the Philadelphia Inquirer and Philadelphia Daily News, and owed the bidders a significant amount of money. The Third Circuit's ruling resulted in a new auction. However, the circuit ruled the tactic would not be allowed and forced a auction. The group in question eventually did gain control of the assets, but only after it pledged its own cash during the new auction set by the judge. Similarly, credit bidding rights were denied to secured creditors in a sale pursuant to a plan process in the Fifth Circuit's Pacific Lumber decision.
In some ways, RadLAX has similarities to 1999's Bank off America v. 203 North LaSalle Street. Brunstad, who wrote an amicus brief in the Supreme Court RadLAX case in support of the notion that secured creditors have the absolute right to credit bid, referenced LaSalle in said brief. In LaSalle, the debtor owned more than a dozen floors of an office building in Chicago that was encumbered by a mortgage lien held by the bank. The plan of reorganization would have allowed existing shareholders to keep their shares and continue to own the floors of the building, while the secured creditor would not be paid in full. In short, the holders of the equity were getting a good deal--"too good of a deal" in the court's estimation, said Brunstad--at the expense of the bank. However, the absolute priority rule says those equity holders should receive nothing until the secured creditors are paid first. Hence, the Supreme Court held there needed to be some kind of market test, to ensure the most money can be raised to either recapitalize the struggling debtor's business or generally better benefit the creditors.
"In my view, the Radlax case is the same concept,' said Brunstad. "Debtors want to sell the asset. Insiders of the debtor get to have benefits--the right to purchase an interest in the purchaser and continue to manage the asset. Is that too good a deal? How we know is to have a market test. So the market test [in a credit bidding scenario] would be that the transaction is up for a higher bid, but the secured can come in with a credit bid. The idea is to actually participate in the bidding so the bid is higher. That's a protection to make sure the proposed transaction is not too good a deal for the old equity holders. It's called the fair and equitable concept of bankruptcy law"
Brunstad said he found the decision in Philadelphia Newspapers very surprising, though he admits a biased view on what is or isn't fair about credit bidding in that instance because he was working for one of the stakeholders involved. He wasn't alone in his holding though, as surprise was the dominant reaction upon the circuit court ruling in 2011. However, scrutiny reveals there was reason to believe the ever-assumed right of credit bidding could be challenged in certain situations.
"Sometimes in the development of the law, there are seemingly-bizarre decisions which, after reflection and after the appeals process is through, don't seem so strange after all,' said Bob Bernstein, Esq. of Bernstein Law Firm PC. "Putting a secured creditor bidder on a level playing field with other bidders, by making them bid with cash, is not a strange concept at all. It happens frequently in state court foreclosure cases"
Impact and Arguments
Brunstad believes that, should the court overturn the Seventh Circuit decision allowing credit bidding, the result would be at odds with the bankruptcy system. Debtors, in his estimation, could and would start to file bankruptcy simply as a means to avoid the absolute priority rule.
"That would create an anomaly, and anomalies in the marketplace are problematic," he said. "Anomalies lead to gray areas and [thus] higher pricing."
Nathan, though he personally believes credit bidding often freezes out unsecured creditors unfairly or creates forgone auction conclusions, sides with the Seventh Circuit view because overturning it denies creditors what he believes are critical rights they have under the Bankruptcy Code.
"I don't like credit bidding in many instances, but just because I'm against it doesn't mean a statute shouldn't be upheld" Nathan said.
Still, such an outcome is far from a slam dunk, despite the reality that there is more support for the side of the secured creditors in the pending appeal. According to Lynnette Warman, Esq., partner in the Dallas office of Hunton & Williams LLP, the lack of support for the debtor's side of the argument in this appeal is not entirely surprising. "Debtors counsel is always underrepresented in cases like these because there are no organized groups of companies out there that see themselves as potential debtors who need to file briefs and participate," she said. "On the other hand, banks and creditors do foresee having to face similar issues with debtors in the future. They have a vested interest in what Congress is doing to protect their rights, and in how those statutes are interpreted by the courts. For example, NACM is very active bankruptcy issues because it knows their members will be affected year after year."
Should the justices side with the Third and Fifth Circuits, unsecured creditors may benefit in some cases, like when the property or asset in question is over-secured, Warman noted. That said, a finding against the Seventh Circuit may affect the decision-making process and risk assessment on the part of credit grantors, running the risk of pushing the cost of credit upward or limiting its availability.
Getting attorneys, even the most knowledgeable in the game, to play along and predict exactly which way the Supreme Court will lean on RadLAX is no easy task.
"It's always dangerous predicting what the Supreme Court is going to do" Brunstad said, declining a request to predict the high court outcome. "You always think in your mind where things will go. Every lawyer that practices in the Supreme Court tries to figure that out to formulate the different kind of arguments they're going to make."
Similarly declining were Borges and Nathan. Nathan, however, did provide some scenarios. To wit, Nathan said a close, strict reading of laws and statutes, as drafted, would likely yield a finding similar to those of the Third and Fifth Circuits--a "more expansive, analytical view" should affirm that of the Seventh.
Warman, however, did step out on a limb with a prediction, albeit tepidly, that the court may find on behalf of the debtors.
"The Supreme Court tends to look first at the plain meaning of the statutes in question," she noted, which, if strictly applied in this case, could result in rejecting the Seventh Circuit's analysis. "The court has not always been consistent in its decisions with its respect to the Bankruptcy Code. That said, if the Supreme Court is looking for an opportunity to make a statement or if they get deep into the facts of this case, who knows what they could decide."
Warman predicted it all boils down to which justice(s) becomes most interested in the case and who writes on it. Therein, it is critical how the writer weighs the debtor's position-that sales under Section 363 of the Bankruptcy Code, which require a credit bid except for limited circumstances, are different than sales under Section 1129 and related statutes, which do not appear to specifically require giving secured creditors an absolute right to credit bid in the plan process. This opposed the lender's assertion that the right to credit bid is a property right, which Congress originally intended to preserve for secured creditors when drafting the U.S. Bankruptcy Code, and which countless courts have upheld for decades.
Bernstein argued that the decision does not necessarily have to be black and white on credit bidding:
"If I had to wager on the outcome, I would bet on the court agreeing that the bankruptcy court can craft the terms of sale, but in a way that eliminates credit bidding in proper situations. I don't think the court will outline all of those possibilities, but I would give a small advantage to the court agreeing that there are rights to credit bid, [but there are] limits to the rights."
Either way, a final ruling over what are contrarian decisions from three widely well-regarded appellate courts should go a long way to providing clarity on the situation, regardless of which parties are pleased or agitated by it.
Brian Shappell, CBA, NACM staff writer, can be reached at firstname.lastname@example.org.…