On Monday, March 22, 2010, the United States Court of Appeals for the Third Circuit, in a 2 to 1 decision in the Philadelphia Newspapers, LLC Chapter 11 bankruptcy case, In re Philadelphia Newspapers, LLC, et. al., ruled that the Bankruptcy Code "contains no statutory right to credit bidding" when the auction of the debtor’s assets is conducted under a Chapter 11 plan of reorganization, and the debtor has proposed a plan which does not permit credit bidding.
Philadelphia Newspapers, LLC filed a plan of reorganization in its Chapter 11 bankruptcy case which provided for the sale of its assets at public auction free of liens. Subsequently, the debtor filed a motion for approval of bidding procedures and sought to preclude its lenders from "credit bidding" for the assets, under the theory that the auction sale was to be conducted under Section 1123(a) and (b) of the Bankruptcy Code and not under Section 363 of the Bankruptcy Code. As a result, the debtor proposed that holders of a lien on any asset of the debtor were not permitted to "credit bid" pursuant to Section 363(k) of the Bankruptcy Code. Recall that Section 363(k) of the Bankruptcy Code states that a secured lender has the right to credit bid "unless the court for cause orders otherwise."
The Third Circuit, in reviewing the terms of Section 1129(b)(2)(a) of the Bankruptcy Code, held that a Chapter 11 plan may be confirmed in a "cram down" proceeding as "fair and equitable" if it provides for (i) retention of creditor liens and deferred cash payments, (ii) a free and clear sale of assets subject to credit bidding by lienholders, or (iii) the provision of the "indubitable equivalent" of the secured interest. Since the court found that the plain language of Section 1129(b) was in the disjunctive (using the word "or"), debtors may choose to eliminate credit bidding in auctions to be conducted under a plan, which is contrary to what has been common practice. A fundamental tenet of bankruptcy law is the maximization of recoveries to the debtor’s claimants. A logical corollary of this tenent is that the goal of every bankruptcy sale is to attract the highest price for the debtor’s assets while minimizing the transaction costs associated with the auction. The majority and minority opinions in this case argue whether or not credit bidding aids or impedes obtaining the highest price.
A "cram down" plan of reorganization is a plan confirmation by the Bankruptcy Court under Section 1129(b) of the Bankruptcy Code in the face of a "no" vote by a creditor class - such as a secured lender faced with a plan prohibiting credit bidding.
To put matters in context utilizing the facts of the Philadelphia Newspapers case, the debtor’s plan proposed that assets would be sold at auction, without credit bidding, and that a "stalking horse" bid, which purportedly would produce $37,000,000 in cash for the lenders, would be the opening bid. The secured lenders, if they were permitted to credit bid, would be allowed to bid the full amount of their debt, both secured and unsecured amounts, which reportedly exceeds $300,000,000. The "stalking horse" bid has been reported in the press to be a "friendly" bid and the elimination of credit bidding obviously improved the chances that the "stalking horse" bidder would be successful, unless a secured lender is willing to advance a cash bid. News reports today indicate the lenders are now considering a cash bid.
The Third Circuit was careful to distinguish sales occurring under Section 363 of the Bankruptcy Code and to emphasize that credit bidding is required to be made available under Section 363 of the Bankruptcy Code, under the Court’s previous holdings, including its 2006 decision in Submicron Systems Corporation, et. al. vs. KB Meszzanine Fund II, LP, et. al.
Accordingly, unless the Philadelphia Newspapers decision is overturned on appeal, case law in the Third Circuit (Pennsylvania, New Jersey, Delaware and Virgin Islands) will now afford debtors the option of liquidating by conducting an auction sale under a "cram down" plan of reorganization, thereby avoiding credit bidding under Section 363, greatly disadvantaging secured lenders holding liens on the assets and perhaps foreclosing the possibility that those lenders can realize some appreciation in value. In the Philadelphia Newspapers case, if permitted to credit bid and obtain the assets, the secured lenders might have arranged a subsequent sale at a price greater than $37,000,000.
As a result of the Philadelphia Newspapers case, every would-be-buyer of a bankruptcy debtor’s assets in the Third Circuit, including secured lenders, must come to the auction house with cash. Debtors (or purchasers friendly to a debtor) now may benefit from a statutory tool to circumvent a part of the auction procedure (i.e. credit bidding) that would customarily benefit the debtor’s creditors. Consequently, secured creditors facing the prospect of a Chapter 11 filing by a borrower in the Third Circuit would do well, for the time being, to carefully craft their strategy, given the new debtor option of proposing the sale of all assets under the auspices of a "cram down" plan of reorganization which prevents credit bidding.