On May 29, 2012, the Supreme Court decidedly put to rest an issue that has caused secured lenders angst since 2009 when the Fifth Circuit in the Pacific Lumber case first allowed a debtor to sell assets under a plan of reorganization free and clear of a creditor’s lien without providing that lender the right to credit bid its debt in the sale. Specifically, the Court settled the split among the judicial circuits (the Seventh Circuit on the one hand, and the Third Circuit (home to the Delaware bankruptcy court) and the Fifth Circuit, on the other) by holding that a debtor “may not obtain confirmation of a Chapter 11 cramdown plan that provides for the sale of collateral free and clear of [a secured lender’s] lien, but does not permit the [secured lender] to credit-bid at the sale.” The decision provides needed guidance to secured lenders and practitioners as the previously unsettled state of the law added uncertainty, risk and a higher cost of capital in these credit bid situations.
Generally, a debtor in bankruptcy may sell its assets in two ways: (i) under § 363 of the Bankruptcy Code; or (ii) pursuant to a plan of reorganization under § 1123 of the Bankruptcy Code.
Under § 363, it is not disputed that a secured creditor may credit bid its debt (unless the court in very limited circumstances finds that “cause” exists to deny the secured lender the right to do so).
Alternatively, a debtor can sell its assets pursuant to a plan of reorganization. In certain circumstances, a debtor can “cramdown” a plan of reorganization over the objection of creditors, including a secured creditor. To cramdown a secured creditor, among other things, the reorganization plan must be “fair and equitable” to the secured creditor. The “fair and equitable” standard may be satisfied by showing that the plan provides: (1) that the holders of such claims retain the liens securing such claims and receive deferred cash payments having a present value equal to the value of their collateral; (2) for the sale of the collateral free and clear of liens (with such lien attaching to the sale proceeds of the sale) but subject to the secured creditor’s right to credit bid; or (3) for the realization of the secured creditor’s claim by some means which provides the secured creditor with the “indubitable equivalent” of its claim.
Thus, the plain language of clause (2) above states that a secured creditor shall have the right to credit bid in a sale of its collateral pursuant to a plan of reorganization. Indeed, historically, there has been little dispute that a secured lender had the right to credit bid its debt in such cases. Recently, however, several creative debtors (see e.g., debtors in the Pacific Lumber, Philadelphia Newspapers, and RadLAX cases) have attempted to sell a secured creditor’s collateral pursuant to a plan of reorganization without allowing the creditor to credit bid. Such arrangements have been upheld by two federal circuit courts (the Third and Fifth Circuits), and disallowed by another (the Seventh Circuit).
In the RadLAX case, the debtors proposed selling substantially all of their assets under a plan of reorganization and using the sale proceeds to repay the secured lender. As part of its plan, however, the debtors sought to deny the lender the ability to credit bid its debt. Not surprisingly, the bank objected to such treatment, since the bank would be forced to come out of pocket with cash, which adds both administrative and financing costs to the transaction, instead of using the debt owed to it as currency.
It was fitting that Justice Scalia, one of the Court’s great textualists, delivered the 8-0 opinion for the Court. Calling the debtors’ reading of § 1129 “hyperliteral and contrary to common sense,” Justice Scalia did away with a detailed analysis of the purposes of the Bankruptcy Code, pre-Code practices and the merits of credit-bidding that lower courts focused on, and instead focused on a well established canon of statutory interpretation – the general/specific canon. That principle of statutory interpretation provides that “specific governs the general” and where a general authorization and a more limited, specific authorization exists side-by-side, the terms of the specific authorization must be complied with. Thus, “clause [2] of the fair and equitable standard (above)] is a detailed provision that spells out the requirements for selling collateral free of liens, while clause [3] is a broadly worded provision that says nothing about such a sale. The general/specific canon explains that the ‘general language’ of clause [3], ‘although broad enough to include it, will not be held to apply to a matter specifically dealt with’ in clause [2].”
Justice Scalia, in a nod to the United States Department of Justice, who filed an amicus curiae brief supporting the secured lender’s position, acknowledged in a footnote that the right to credit bid is “particularly important for the Federal Government, which is frequently a secured creditor in bankruptcy and which often lacks appropriations authority to throw good money after bad in a cash-only bankruptcy auction.”
The Supreme Court’s ruling is important for at least two reasons. First, resolution of this issue will streamline the administration of future bankruptcy cases by providing secured lenders the assurance that they can credit bid in both 363 and plan sales under the Bankruptcy Code, which will result in greater efficiency and lower costs of capital.
Second, the Court’s decision upholds the long-standing principle that bankruptcy law has not permitted a secured creditor to lose its lien in bankruptcy without the lender’s consent, payment in full, or surrender of the collateral to the lender.
George is a monthly contributor to the Distressed Debt Investing blog and practices restructuring and bankruptcy law at Ungaretti & Harris LLP. George can be reached at grmesires@uhlaw.com.
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