In 2009, the owners and management of The Philadelphia Inquirer, one of the nation's largest daily circulation newspapers, proposed a bankruptcy plan that attacked secured creditors' rights to bid their loans. When the District Court and the Third Circuit both approved the tactic, the plan gained national attention. Blocking the right of the newspaper's secured creditors from "credit bidding" their secured loans gave management, which had agreements with key unions, an advantage in the "auction" for the newspaper the plan proposed because the syndicated lender group was having trouble raising new cash. As with most syndicated lender groups, many of the lenders were not financial institutions with ready access to cash, but rather special purpose entities which were created only to participate in the original loan.
For the next three years, plans that kept secured lenders from credit bidding became popular and a major subject of commentary. When the Seventh Circuit Court of Appeals refused to allow such a plan, creating a split among circuits, the Supreme Court decided to rule on the issue.
With its recent decision in RadLAX Gateway Hotel, LLC v. Amalgamated Bank, the Supreme Court has abruptly ended the tactic. The Court agreed with the Seventh Circuit and unanimously held that a cramdown Chapter 11 plan will not be confirmed when it provides for the sale of collateral free and clear of a creditor's liens without permitting credit bidding at the sale. The Court's opinion and reasoning in RadLAX will have wide-ranging implications for Chapter 11 commercial debtors and secured creditors.
THE ISSUES IN PHILADELPHIA NEWSPAPERS AND RADLAX
In 2007, RadLAX purchased several commercial properties to renovate and build out, using $300 million in secured loans from two investment funds. After the 2008 real estate/market collapse, RadLAX filed for Chapter 11 protection, still owing the investment funds at least $120 million.
Using "the tactic" discussed above, RadLAX proposed a plan to auction its property while prohibiting the secured lenders from credit bidding. The lenders objected, contending that the plan could not be confirmed unless the lenders were permitted to credit bid. Section 1129(b) allows plans to be confirmed over the objection of a class of creditors holding impaired claims, popularly known as "cramdown" plans. To confirm such plans, section 1129(b)(1) requires they be "fair and equitable" to objecting creditors. Under sub-clause (b)(2)(A), a cramdown plan is "fair and equitable" to secured creditors if: (i) the secured creditor retains its lien on the collateral and receives deferred cash payments; (ii) the property is sold free and clear of liens, subject to credit bidding by the secured lender, with the creditor receiving a lien on the proceeds; or (iii) the plan provides the creditor with the "indubitable equivalent" of its claim. Sub-clause (b)(2)(A)(ii), applicable in the majority of cramdown plans, permits a secured creditor to credit bid under section 363(k), enabling it to offset its claim against the sale price.
RadLAX argued the lenders would receive the "indubitable equivalent" of their claim, even if they could not credit bid. This was the precise argument made by management of The Philadelphia Inquirer.
Both the Bankruptcy Court and the Seventh Circuit refused to allow the plan. The Seventh Circuit held that the phrase "indubitable equivalent" did not authorize confirmation of a plan barring credit bidding. The Seventh Circuit's ruling differed from those by the Third Circuit in In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010) and the Fifth Circuit in Scotia Pacific Co., LLC v. Official Unsecured Creditors' Comm. (In re Pacific Lumber Co.), 584 F.3d 229 (5th Cir. 2009), both of which interpreted the "indubitable equivalent" standard as permitting asset sales free and clear of liens that bar credit bidding.
THE SUPREME COURT'S DECISION
Justice Scalia's opinion for the unanimous court hewed close to the text of the statute. The Court criticized the Debtors' reading of section 1129(b)(2)(A) as "hyperliteral and contrary to common sense." The Court believed the debtors were essentially trying to accomplish under sub-clause (iii) of section 1129(b)(2)(A) that which was prohibited by sub-clause (ii) -- namely, selling the lenders' collateral free and clear of any liens without allowing them to credit bid at the sale. In reaching its conclusion, the Court relied on "[a] well established canon of statutory interpretation": the specific governs the general. The Court explained that the general/specific canon is commonly applied with statutes containing a specific prohibition or permission that contradicts a general prohibition or permission. To eliminate such contradiction, "the specific provision is construed as an exception to the general one."
But at bottom the Court signaled that it did not wish to see a secured creditor's rights dispensed with so easily, noting "[t]he ability to credit-bid helps to protect a creditor against the risk that its collateral will be sold at a depressed price."
RadLAX will have deep and wide-reaching significance. It provides substantial protection to a secured creditor's right to credit bid on its collateral. While the Court acknowledged an exception to credit-bidding found in section 363(k), there is little case law on that code provision, and any effort to deny a secured creditor its ability to credit bid will have to be viewed in light of the Court's pro-secured lender stance. While the Third Circuit recognized that a court may deny a creditor its right to credit bid in the interest of any policy advanced by the Code, to ensure a successful reorganization, or to foster a competitive bidding environment, the refusal of that Court and the Supreme Court to allow that to happen should not provide optimism for those attempting "the tactic."
As recognized in the briefing in the RadLAX case, U.S. businesses are financed by trillions of dollars of secured debt. Plan sales are a dominant feature of modern Chapter 11 reorganizations, and more than half of Chapter 11 debtors seek to sell their assets. Syndicated lending groups particularly stand to gain from RadLAX, which should discourage insiders from creating artificial "lowball" bids at an auction.
On the other hand, secured lenders generally receive a greater return on their collateral when sold at auction as part of a going concern, as opposed to what they would gain from simply liquidating the assets. RadLAX should not stop management from saving the company with a successful bid. All that it will require is finding a management team with access to enough money to pay the proper, auction-determined price. The RadLAX decision will therefore be important to all participants in the distressed merger and acquisitions markets, which are increasingly a prime source of capital speculation.