In re RML Dev., Inc., 528 B.R. 150 (Bankr. W.D. Tenn. 2014) –

A mortgagee sought to modify a sale order to (1) modify the bid procedures and (2) confirm that it had a right to credit bid.

The debtor obtained a court order approving a Section 363 sale of two residential apartment complexes.  The order provided that the sale should be conducted “consistent with the ordinary sale of real property” – meaning the owner markets the property, receives an offer, accepts the best offer creating a purchase contract, and executes necessary documents to close the sale.

This was somewhat unusual since typically a court will want to see an offer tested in the market to maximize value unless the debtor can show some good reason why this is not necessary or appropriate.  The mortgagee – with the support of another creditor that claimed security in the property and a chapter 7 trustee for one of the debtor’s shareholders – asked the court to modify the bid procedures to provide for a public auction.

The mortgagee also sought court confirmation that it was entitled to do a credit bid – meaning that its debt could be offset against its bid price.  The court noted that the Bankruptcy Code does not use the term “credit bid.”  However, it acknowledged that a secured creditor’s right to bid and then offset the bid against the value of its loan at closing is a good description of the rights set forth in Section 363(k).

Wading into the nuances of Section 363(k), the court noted that the offset right is limited to property that is subject to a lien that secures “an allowed claim.”  Generally a filed proof of claim is “deemed allowed” unless a party objects.  In this case the mortgagee filed a proof of claim, but there was an objection. So the proof of claim was not deemed allowed.

Although the claim was not deemed allowed, the court concluded it could estimate the claim for purposes of the sale.  The debtor had objected to calculation of interest and reconciliation of payments and fees, as opposed to the entire claim.  The court’s interpretation was that the debtor would admit the claim was at least ~$2.35M (out of a claim totaling ~$2.54M).  Consequently, the court decided to “estimate” the claim at ~$2.35M and allow the mortgagee to make a credit bid up to that amount.

Section 363(k) also provides that there is a setoff right “unless the court for cause orders otherwise.”  The court reviewed several recent cases (including In re Fisker Automotive Holdings, Inc., 510 B.R. 55 (Bankr. D. Del. 2014)) holding that a secured creditor does not have an absolute right to credit bid.  While agreeing with this general statement, from the court’s perspective, “cause” did not give the court the right to act arbitrarily or to be “freewheeling,” but instead looked to the court’s equity powers to balance the interests of the parties for maximization of the estate and equitable distribution to creditors.

In addition to the debtor’s objection, there were a couple of other parties that claimed interests in the property and contended that those interests were senior to the mortgagee’s liens.  The court understood that the parties were in the process of settling those claims.  However, if the parties did not reach agreement before the sale occurred, the court would require the mortgagee to post a letter of credit, surety bond or other similar security in the amount of the proposed bid (or distribution of sale proceeds) until the disputes were resolved.

Implicit in the court’s findings is that “credit bid” is shorthand for collapsing the two-step process of paying the purchase price and applying the proceeds.  If there are senior claims, the payment would first be applied to the senior claims and not to the lender’s claim.  Consequently the lender would not be able to setoff its bid against its loan since that is not how the bid proceeds would be applied.

So, although there is a tendency to use a shorthand description of credit bid to mean simply that the purchase price can be set off against the secured debt, that presupposes that there are no intervening claims that would be entitled to receive the proceeds first.  While noting other cases holding that a secured lender does not have an absolute right to credit bid, the court commented in a footnote that:

[T]his court is not prepared to go as far as some of these courts and hold that the mere “chilling” of third-party bids is sufficient cause to justify modifying or denying a secured creditor’s rights.  The modification or denial of credit bid rights for cause under §363(k) should be an extraordinary exception that is used only upon equitable considerations (e.g., competing claims, collusion, or other fraudulent or bad faith acts).  This court is convinced that, where a creditor holds an uncontested secured claim, it should ordinarily be permitted to bid at a §363 sale of its collateral regardless of its intrinsic impact on other bidding.

Given this explanation, the court’s decision is really only saying that it is appropriate to tailor the right to credit bid so that a secured creditor can proceed even though its claim has not been allowed, but with assurance that matters can be unwound if it turns out that the bid price is not supported by the final allowed claim.  In this case that meant (1) not permitting the lender to credit bid the disputed portion of its claim, and (2) requiring it to post security if it was not able to resolve the dispute about the alleged senior priority of other claims.