It has not taken long for another bankruptcy court to question the propriety of allowing secured creditors to credit bid their loans. You may recall that in the case of Fisker Automotive Holdings, Inc., et al. a Delaware bankruptcy court limited a creditor’s ability to credit bid based on self-serving testimony from a competing bidder that it would not participate in an auction absent the court capping the secured creditor’s credit bid. Although Fisker was a case where bad facts made for bad law for secured creditors, we alerted you that the Fisker decision created a slippery slope and the decision–if followed–could greatly curtail credit bid rights.
In the case of In re Free Lance-Star Publishing Co. in the United States Bankruptcy Court for the Eastern District of Virginia (the “Court”), bad facts once again produced a result that could have far reaching implications for secured creditors. Free Lance- Star, citing Fisker, limited the rights of DSP Acquisition, LLC (“DSP”) to credit bid approximately $39 million of secured debt (purchased at a discount prior to the debtors’ chapter 11 ﬁling) at a Bankruptcy Code section 363 auction for certain of the debtors’ assets. Similar to the facts in Fisker, DSP did not have valid, properly perfected security interests in a portion of the debtors’ assets over which DSP sought to credit bid. In fact, DSP’s loan did not even grant DSP a security interest in those assets. DSP–seemingly aware that it lacked a security interest in some of the debtors’ most valuable assets–unilaterally ﬁled unauthorized liens against those assets prior to and following the bankruptcy case. DSP also misinformed the Court and the debtors concerning those improper lien ﬁlings. In addition, DSP sought to curtail a proper marketing of the debtors’ assets and insisted that any marketing materials clearly and conspicuously provide that the debtors’ assets were subject to a lien in favor of DSP and that DSP had a right to credit bid the full amount of its loan at a sale. The Court concluded that DSP’s behavior indicated that it was aggressively seeking to acquire the debtors’ assets and wanted to chill interest in the assets. On account of these facts, the Court found DSP’s conduct “inequitable.”
Ultimately, the Court capped DSP’s right to credit bid at just under $14 million, an amount that would “prevent DSP from credit bidding its claim against assets that are not within the scope of its collateral pool.”2 As in Fisker, while the Court could have relied simply on collateral imperfection as a basis for limiting DSP’s credit bid rights, it did not. Rather, it took aim at loan-to-own strategies as a basis for limiting credit bidding:
The credit bid mechanism that normally works to protect secured lenders against the undervaluation of collateral sold at a bankruptcy sale does not always function properly when a party has bought the secured debt in a loan-to- own strategy in order to acquire the target company. In such a situation, the secured party may attempt to depress rather than to enhance market value. Credit bidding can be employed to chill bidding prior to or during an auction or to keep prospective bidders from participating in the sales process.
While this ﬁnding should be informed by DSP’s inequitable conduct and overt attempts to chill bidding, it remains unclear when a secured creditor’s actions will give the court sufﬁcient concern to curtail credit bid rights. For example, debtors must publicly disclose the existence of secured debt in court ﬁlings and secured creditors frequently request that a court reserve their rights to credit bid at an asset sale. Will this seemingly innocuous request – when coupled with disclosures regarding the amount of secured debt – result in a court ﬁnding that the secured creditors were attempting to “chill bidding?” In this regard, Free Lance-Star creates its own slippery slope. As previously cautioned, secured creditors looking to credit bid should encourage proper and fulsome marketing of a debtor’s assets and not look to interfere with that process. Secured creditors who (i) publicly focus on preserving their ability to enforce their rights–rather than overtly aggressive enforcement–within a reasonable and well developed sales process and (ii) let third-parties reach a determination as to the value of assets free from unnecessary threats of a credit bid should avoid the fate of DSP.