Even after the U.S. Supreme Court in RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012), pronounced in no uncertain terms that a secured creditor must be given the right to “credit bid” its claim in a bankruptcy sale of its collateral, the controversy over restrictions on credit bidding continues in the courts. A ruling recently handed down by the Fifth Circuit Court of Appeals has added a new wrinkle to the debate. InBaker Hughes Oilfield Operations, Inc. v. Morton (In re R.L. Adkins Corp.), 2015 BL 116996 (5th Cir. Apr. 23, 2015), the Fifth Circuit held that an undersecured creditor which elected to have its claim treated as fully secured under section 1111(b) of the Bankruptcy Code, yet failed to obtain a pre-confirmation ruling on the election or to object to confirmation of a plan providing for the sale of its collateral under section 363(b), was not impermissibly stripped of the right to credit bid its secured claim in connection with the sale.
Credit Bidding Under the Bankruptcy Code
Section 363(k) of the Bankruptcy Code provides that a creditor with a lien on assets to be sold outside the ordinary course of business under section 363(b) may “credit bid” its secured claim at the sale, “unless the court for cause orders otherwise.” A credit bid is an offset of a secured claim against the property’s purchase price. The U.S. Supreme Court explained in RadLAX, 132 S. Ct. at 2070 n.2, that “[t]he ability to credit-bid helps to protect a creditor against the risk that its collateral will be sold at a depressed price” and “[i]t enables the creditor to purchase the collateral for what it considers the fair market price (up to the amount of its security interest) without committing additional cash to protect the loan.”
The Supreme Court ruled in RadLAX that, pursuant to section 1129(b)(2)(A)(ii) of the Bankruptcy Code, although the right to credit bid is not absolute, a nonconsensual, or “cram down,” chapter 11 plan providing for the sale of encumbered property free and clear of a creditor’s lien cannot be confirmed without affording the creditor the right to credit bid for the property.
In the aftermath of RadLAX, the debate shifted largely to the circumstances that constitute “cause” under section 363(k) to prohibit or limit a secured creditor’s right to credit bid its claim. For example, in In re Fisker Automotive Holdings, Inc., 510 B.R. 55 (Bankr. D. Del. 2014), leave to app. denied, 2014 BL 33749 (D. Del. Feb. 7, 2014), cert. denied, 2014 BL 37766 (D. Del. Feb. 12, 2014), the court limited the amount of a credit bid to the discounted purchase price actually paid to purchase the debt because, among other things, the court concluded that an unrestricted credit bid would chill bidding.
In In re The Free Lance-Star Publishing Co., 512 B.R. 798 (Bankr. E.D. Va.),leave to appeal denied sub nom. DSP Acquisition, LLC v. Free Lance-Star Publishing Co., 512 B.R. 808 (E.D. Va. 2014), the court found “cause” under section 363(k) to limit a credit bid by an entity that purchased $39 million in face amount of debt with the intention of acquiring ownership of the debtor’s assets. The court limited the credit bid because: (i) the creditor’s liens on a portion of the assets to be sold had been improperly perfected; (ii) the creditor engaged in inequitable conduct by forcing the debtor into bankruptcy and an expedited section 363 sale process in pursuing an obvious identified “loan to own” strategy; and (iii) the creditor actively frustrated the competitive bidding process and attempted to depress the sale price of the assets.
Finally, the court in In re Charles Street African Methodist Episcopal Church of Boston, 510 B.R. 453 (Bankr. D. Mass. 2014), denied in part a chapter 11 debtor’s motion to limit a credit bid on the basis that the secured creditor’s claims were subject to bona fide dispute. In that case, the debtor had filed counterclaims against the creditor that, by way of setoff, could have reduced the amount of the claims to zero. In finding that “cause” was lacking under section 363(k), the court explained that: (i) despite the debtor’s counterclaims, which did not relate to the validity of the secured creditor’s claims or liens, the claims were “allowed” (a designation that the debtor did not dispute); and (ii) the entire amount of the claims was not likely to be used in a credit bid for the assets.
Protection of Undersecured Creditors
Pursuant to Section 1111(b)
Section 1111(b)(1) of the Bankruptcy Code provides that a secured claim will be treated as a recourse claim even if the creditor does not actually have recourse to the debtor by contract or under applicable state law, unless: (i) the creditor (or the class of which the creditor is a part) makes an election to have its claim treated as fully secured under section 1111(b)(2); or (ii) the creditor does not have recourse and the property securing its lien “is sold under section 363 of [the Bankruptcy Code] or is to be sold under the plan.” Thus, absent a section 1111(b) election or a sale of collateral, an undersecured nonrecourse creditor will have a secured claim to the extent of the value of its collateral and an unsecured claim for any deficiency.
The section 1111(b) election is intended to protect a secured creditor against the possibility that the debtor can realize a windfall if collateral, not being sold by the debtor, is assigned a low value (due to depressed market conditions or valuation error) and the creditor’s secured claim is stripped down to that low value.
However, section 1111(b)(1)(B) provides that the election is not available if, among other things, the creditor has recourse against the debtor and the collateral “is sold under section 363 of [the Bankruptcy Code] or is to be sold under [a chapter 11] plan.” The exception for collateral that is sold is premised upon the idea that protection against low valuation is not necessary when the market determines the value of the collateral. Moreover, creditors do not need the protections of section 1111(b) if the collateral is sold because they have the right under section 363(k) to credit bid at the sale.
In Adkins, the Fifth Circuit considered whether a materialman’s lien creditor that elected to have its claim treated as fully secured under section 1111(b)(2) was impermissibly denied the right to credit bid its claim in connection with the sale of its collateral under a nonconsensual chapter 11 plan.
Baker Hughes Oilfield Operations, Inc. (“Baker Hughes”) and certain other oil and gas service companies filed an involuntary chapter 7 petition against Sweetwater, Texas-based drilling company R.L. Adkins Corp. (“Adkins”) in the Northern District of Texas in July 2011. The case was converted to chapter 11 one month afterward. The court later appointed a chapter 11 trustee to administer Adkins’ estate.
Potential purchaser Scott Oils, Inc. (“Scott”) proposed a chapter 11 plan for Adkins at the end of 2012 under which Adkins, “pursuant to Bankruptcy Code Section 363,” would sell its mineral properties to Scott in a private bulk sale for $3.4 million. The plan recognized that Baker Hughes had a lien on four mineral leases and one well as security for claims aggregating approximately $320,000, but that Baker Hughes’ claims were secured only to the extent of $39,000 because the property was of insufficient value and other creditors had more senior liens on the collateral.
On March 4, 2013, Baker Hughes filed an election with the court under section 1111(b) to have its claims treated as fully secured. Scott filed a response on March 28 in which it stated that section 1111(b)(1)(B)(ii) precludes such an election where the collateral is sold under section 363 or is to be sold under a chapter 11 plan.
The bankruptcy court confirmed the chapter 11 plan on May 13, 2013, after several days of confirmation hearings. Baker Hughes cast a ballot rejecting the plan. However, Baker Hughes did not otherwise participate in any way in the confirmation proceedings, nor did it appeal the confirmation order.
On July 3, 2013, the bankruptcy court issued an order denying Baker Hughes’ election of fully secured status under section 1111(b). In its order invalidating Baker Hughes’ election because the collateral securing its claims was sold “pursuant to § 363 of the Bankruptcy Code,” the court stated:
Baker Hughes . . . construe[s] the Plan’s failure to specifically reference [its] right to make [a] credit bid to somehow validate [its] § 1111(b) election and thus require payment of [its] allowed claim in full. The Court does not so construe the Plan’s effect under the circumstances here. Baker Hughes . . . did make an election; [it] elected not to credit bid. [It] held such right under § 363 of the Bankruptcy Code, not under § 1111(b) of the Bankruptcy Code.
The U.S. District Court for the Northern District of Texas affirmed that ruling, and Baker Hughes appealed to the Fifth Circuit.
The Fifth Circuit’s Ruling
The Fifth Circuit affirmed the rulings below. In the majority opinion, the court rejected Baker Hughes’ argument that either the section 1111(b) election should have been approved or Baker Hughes should have been given the chance to credit bid.
According to the majority, Baker Hughes “never sought a credit bid” and “[a]ny uncertainty Baker Hughes had about the meaning of the Plan, and whether it had been denied the right to credit bid, could have been easily resolved at the hearing on confirmation or by objection or even appeal.” Because the plan provided for the sale under section 363 of property securing Baker Hughes’ claim, the court held that the lower courts had properly denied the section 1111(b) election.
In a concurring opinion, circuit judge Judith H. Jones wrote that “[t]he argument that Baker Hughes waived its § 1111(b) election by failing to pursue it at the confirmation hearing is persuasive.” However, she continued, “[t]he majority unwisely steps beyond this narrow holding . . . when they appear to conclude that the bulk sale of the debtor’s assets, which occurred outside a public auction and included multiple assets burdened by multiple liens, nevertheless protected a secured creditor’s right to credit bid.”
According to Judge Jones, merely because the plan and confirmation order “perfunctorily incant[ed]” section 363 does not mean that the creditor’s right to credit bid was adequately protected. Section 1111(b), she explained, “offers no guidance as to what constitutes a sale ‘under § 363’ or ‘under the plan.’ ” Judge Jones then detailed several hypothetical situations in which a debtor’s assets could be sold in a single blanket sale transaction that could make it difficult for creditors with liens on discrete assets to exercise their credit bidding rights.
Judge Jones delineated three points to “assure proper development of the creditors’ statutory protections”: (i) the court must rule on a timely asserted section 1111(b) election prior to a plan confirmation hearing; (ii) a secured creditor should be allowed to make a section 1111(b) election if the terms of a sale are “found wanting in protection of its credit bid rights”; and (iii) “mindful that RadLAX as well as § 363(k) mandate the availability of credit bidding,” the court should order “transparent, broadly publicized auction[s] of debtors’ assets that test the market for valuations as well as secured creditors’ sincerity about credit bidding.”
Adkins is an unusual case, but it does not appear to represent a significant development in bankruptcy jurisprudence concerning a secured creditor’s right to credit bid its claim in a sale of collateral under section 363 or a chapter 11 plan. The message borne by the ruling is a cautionary missive regarding the consequences of a creditor’s failure to participate in the bankruptcy process. By neglecting to file a specific objection to (or to appeal) confirmation of a plan that provided for the sale of its collateral, the creditor in Adkins was deemed to have waived its right to credit bid. Presumably, Baker Hughes elected not to object on this basis because it had no intention of submitting a credit bid—had it done so, Baker Hughes would have been obligated to pay off more senior liens on the collateral in connection with credit bidding its debt.
The more interesting aspects of Adkins arguably lie in the concurring opinion. Judge Jones made much of the bankruptcy court’s failure to issue a ruling on the validity of Baker Hughes’ section 1111(b) election before confirming Adkins’ chapter 11 plan. However, the court’s failure to make such a straightforward ruling is somewhat surprising. Because the plan proposed for Adkins contemplated the sale of Baker Hughes’ collateral, section 1111(b) expressly barred Baker Hughes from making an election.
Judge Jones criticized the majority for implying that “attaching the statutory labels to a debtor’s proposed collateral sale is enough to deprive a recourse secured creditor like Baker Hughes of the § 1111(b) election.” After positing various scenarios in which a secured creditor’s credit bidding right might be abridged, she wrote that “§ 1111(b) itself offers no guidance as to what constitutes a sale ‘under § 363’ or ‘under the plan.’ ” She concluded that “[a]ll of these [scenarios] could contradict the mutually reinforcing goals of §§ 363(k), 1111(b) and 1129(b)(2)(A) to protect secured creditors from the risk of erroneous judicial property valuations.”
Although this approach might have some logical appeal as a policy matter, it is not required by the express terms of section 1111(b). The election exception set forth in the provision does not mandate that a secured creditor’s right to credit bid be realistic or efficacious under the circumstances. It requires only that the collateral be sold under section 363(b) or a plan.