On January 17, 2014, Chief Judge Kevin Gross of the Bankruptcy Court for the District of Delaware issued a decision limiting the right of a holder of a secured claim to credit bid at a bankruptcy sale. In re Fisker Auto. Holdings, Inc., Case No. 13-13087-KG, 2014 WL 210593 (Bankr. D. Del. Jan. 17, 2014). Fisker raises significant issues for lenders who are interested in selling their secured debt and for parties who buy secured debt with the goal of using the debt to acquire the borrower’s assets through a credit bid. This decision also provides solid guidance to all restructuring professionals and their clients regarding pitfalls to be avoided when attempting to rush a sale process through Bankruptcy Court. Just two days ago, on appeal, the United States District Court for the District of Delaware issued a memorandum that implicitly, if not explicitly, endorsed the credit bid decision of the Bankruptcy Court.
Facts and the Bankruptcy Court’s Analysis
The Debtors, whose hybrid electric vehicle business had encountered substantial difficulties, filed for chapter 11 to effectuate an expedited, private sale of substantially all of their assets to Hybrid Tech Holdings, LLC (“Hybrid”). Hybrid was an affiliate of one of the Debtors’ shareholders and had purchased the Debtors’ senior secured debt of $168.5 million for $25 million (i.e., 15 cents on the dollar) shortly before the bankruptcy filings from the United States Department of Energy (“DOE”). The Bankruptcy Court specifically noted as key facts that Hybrid’s claim was “partially secured, partially unsecured and of uncertain status for the remainder.” Id. at 10. The Debtors had other creditors who asserted aggregate claims in excess of $34.7 million.
After Hybrid bought the DOE debt, the Debtors and Hybrid entered into an agreement pursuant to which Hybrid would acquire substantially all of the Debtors’ assets at a private sale for various consideration, including a credit bid in the amount of $75 million. Id. at 4. (The other consideration included, among other things, the waiver of $4 million in claims under a debtor-in-possession financing and a small cash payment.) The Debtors and Hybrid came before the Bankruptcy Court presenting their transaction as an emergency.
The Debtors filed for chapter 11 protection and filed a motion to approve the Hybrid sale on November 22, 2013. The Debtors asked for and received an expedited hearing on the sale motion and plan confirmation on January 3, 2014, allowing a little more than a month for this entire process, during a time of year that included the Thanksgiving, Christmas and New Year holidays. (The Committee was not appointed until December 5, 2013.) The Debtors and Hybrid failed to provide the Bankruptcy Court with a satisfactory explanation of why the sale of the Debtors (which were no longer operating) needed to occur in such a rushed fashion and, according to the Bankruptcy Court, ignored the Bankruptcy Court’s expressions of concern regarding the timing of this process.
The Committee objected to the sale motion, specifically objecting to Hybrid’s right to credit bid its entire debt, and filed its own sale motion presenting Wanxiang America Corporation (“Wanxiang”) as a buyer who was willing to participate in an auction for the Debtors’ assets. Prior to the Bankruptcy Court’s hearing on the Debtors’ sale motion, the Debtors and the Committee stipulated that (a) elimination of Hybrid’s credit bid right (or capping such right at a maximum credit bid of $25 million) would likely result in an auction creating value in excess of Hybrid’s existing bid; (b) absent such capping, there likely would not be an auction, as neither Wanxiang nor anyone else would likely submit a bid for an amount greater than Hybrid’s debt; (c) capping Hybrid’s right to credit bid would foster a competitive environment; and (d) the assets proposed to be sold included assets not subject to properly perfected liens in favor of Hybrid and assets as to which there was a material dispute as to whether Hybrid had a properly perfected lien. Id. at 2-3.
The Bankruptcy Court began its analysis by acknowledging that a secured creditor has the right to credit bid its secured claim. The sole issue, in the Bankruptcy Court’s view, was not whether Hybrid could credit bid but what the amount of such credit bid could be, since section 363(k) of the Bankruptcy Code empowers the Bankruptcy Court to limit the credit bid right “for cause.” Id. at 3-4. The Bankruptcy Court concluded that, because an unfettered right to credit bid would eliminate the possibility of an auction, cause existed to cap Hybrid’s credit bid right. The Bankruptcy Court emphasized that Wanxiang was “a highly attractive and capable participant” and had purchased related assets for nearly $300 million at a recent bankruptcy auction. The Bankruptcy Court concluded that, because Hybrid’s unfettered right to credit bid would eliminate any auction, “cause” existed to limit the maximum amount of any credit bid by Hybrid to $25 million. Id. at 4-5.
As further support for its ruling, the Bankruptcy Court emphasized that the failure of the Debtors and Hybrid to respond to the Bankruptcy Court’s admonition regarding the timing of this entire sale process was troublesome. “Hybrid’s rush to purchase and to persist in such effort [despite the Bankruptcy Court’s concerns] is inconsistent with the notions of fairness in the bankruptcy process.” Id. at 4. The Bankruptcy Court also pointed out that Hybrid’s “drop dead” date was pure fabrication designed to place maximum pressure on creditors and the Bankruptcy Court. Id. at 5.
Finally, Hybrid took an immediate appeal of the Bankruptcy Court’s ruling to the District Court. On February 12, 2014, the District Court joined in the critique of the Fisker process, issuing a memorandum siding with the Bankruptcy Court. In re Fisker Auto. Holdings, Inc., Case No. 14-CV-99 (GMS) (D. Del. Feb. 12, 2014). Hybrid appealed to the District Court and presented what the District Court described as a “barrage of ‘emergency’ motions of dubious merit and even more doubtful urgency.” Id. at 1 n.1. Among them, Hybrid asked the District Court to certify Hybrid’s appeal of the Bankruptcy Court’s order for a direct appeal to the Third Circuit Court of Appeals, which would have had the effect of bypassing the District Court. In denying that request, District Court Chief Judge Gregory Sleet agreed with the Bankruptcy Court’s ruling and went so far as to bar Hybrid from filing any more motions regarding the Bankruptcy Court’s order on appeal. Id. While the District Court memorandum is not a decision on the merits of the appeal, it does support the conclusion that the District Court was not initially impressed with the merits of Hybrid’s appeal.
Practical Implications Of The Fisker Decision
The headline takeaway from Fisker is that the Bankruptcy Court capped the amount of the secured creditor’s credit bid to the amount paid for the claim to foster a competitive sales process. It is impossible to ignore the fact that this decision constitutes the erosion of a secured creditor’s right to credit bid the full amount of its debt. The “cause” exception to the credit bid right under section 363(k) of the Bankruptcy Code arguably is broad enough to swallow and eliminate the right itself, inasmuch as any substantial secured claim in which the underlying value of the collateral is less than the amount of the claim is likely to be in the same veto position as Hybrid’s claim. Viewed in that light, “cause” arguably will almost always be present, absent a scenario in which the value of the creditor’s collateral exceeds the amount of such claim.
The Bankruptcy Court’s decision to cap the credit bid at the amount paid is also troubling. Even assuming the need to foster a competitive sales process constitutes “cause,” the amount paid for the claim is a somewhat arbitrary number to select as a limit on the credit bid right. The alleged chilling effect is a function of the amount of the entire claim rather than the amount paid for the claim. Tying the maximum credit bid to the claim purchase amount may also lead to the anomalous situation where, on otherwise identical facts and circumstances, a lender who initially lends the money and asserts a credit bid right would have an unrestricted credit bid right, whereas a third-party purchaser is limited to the amount paid for such claim.
There were also other, less controversial ways to reach the same result achieved by the Bankruptcy Court. The Committee had raised substantial issues regarding the senior secured debt and whether the Hybrid credit bid covered assets that were not subject to an unavoidable lien. Bona fide issues regarding the amount and perfection of a secured claim, rather than a perceived need to foster a competitive auction, may appear to be reasonable bases upon which to rule “cause” exists to limit or at least condition the credit bid right. (For example, it is common for Bankruptcy Courts to require a lender with a claim and/or lien seriously in doubt to post a letter of credit to backstop its credit bid right.) Moreover, Hybrid was arguably an insider and limiting the amount of the senior secured claim to the amount Hybrid paid for such claim due to the insider issue would have been consistent with cases limiting claims purchased by insiders or fiduciaries to the amount paid for such claims.
To the extent that the holder of the secured claim has the ability to pay cash (which will ultimately be returned to the secured creditor under a chapter 11 plan or otherwise), the diminution or elimination of the right to credit bid is likely to be of less significance. Holders of secured claims that do not, however, have the ability to “round trip” cash, such as governmental entities or securitization trusts, are more likely to face adverse consequences should the Bankruptcy Court’s rationale be adopted elsewhere. The bottom line, however, is that the Fisker decision leaves the door open for further deterioration of the credit bid rights of purchasers of secured debt. Buyers and sellers of secured debt should take note of this development.
The second important lesson of Fisker is that marshalling evidence and paying attention to the concerns of the Bankruptcy Court are critical to anyone who wants to successfully advance the interests of their clients in Bankruptcy Court. All bankruptcy practitioners know that “cause” is a highly flexible, factually-intensive legal standard. In Fisker, the Bankruptcy Court was clearly troubled by the process and timing employed by the Debtors and Hybrid, and those concerns became part of the record upon which “cause” was found to exist by the Bankruptcy Court. Those who proceed into Bankruptcy Court would be well-advised to be mindful of what does and what does not constitute an emergency when racing into Bankruptcy Court for relief, especially when what is being sought is dispositive relief like the sale of substantially all of a debtor’s assets. If the actual “need for speed” is viewed by a Bankruptcy Court as nothing more than a desire to steamroll a process, then the Fisker decision serves as an excellent reminder of how that approach may backfire and result in failure.