The Seventh Circuit recently weighed in on the issue of whether a secured creditor has a right to credit bid at the sale of its collateral in connection with a chapter 11 plan of reorganization. In its decision in In re River Road Hotel Partners, LLC, Case Nos. 10-3597 & 10- 3598 (7th Cir. June 28, 2011), the Seventh Circuit split with decisions of the Third and Fifth Circuit Courts of Appeal holding that secured creditors have no such right to credit bid, raising the prospect that the issue may be ripe for review by the United States Supreme Court.
The River Road Hotel Partners case involved two groups of related debtor entities that operated separate hotels. They each proposed chapter 11 plans that called for the sale of substantially all of their assets at auction sales. Both debtors filed motions seeking approval of bid procedures for the auction sales, including a prohibition on credit bidding. The proposed stalking horse bids for each hotel were substantially less than the amounts of the secured lenders’ claims. In response to the secured lenders’ objection to the proposed bid procedures, Bankruptcy Judge Bruce Black of the Northern District of Illinois ruled that the prohibition on credit bidding prevented the debtors’ proposed plans from being confirmable, for the reasons stated in the dissenting opinion of Judge Thomas Ambro in In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010), and therefore he denied both bid procedures motions.
The issue considered by the Bankruptcy Court was the construction of the portion of the Bankruptcy Code that allows confirmation of a reorganization plan over the objection of one or more classes of secured creditors. Ordinarily, acceptance of a chapter 11 plan by each class of impaired creditors is required for confirmation. However, section 1129(b)(2) provides that a plan may also be confirmed (i.e., “crammed down”) if rejected by one or more dissenting classes of impaired creditors if the plan is “fair and equitable” as to those creditors. Section 1129(b) (2)(A) provides that a plan is considered fair and equitable with respect to secured creditors if it either: (i) permits the dissenting secured creditor to retain its liens; (ii) proposes a sale of the secured lender’s collateral free and clear of all liens with such liens to attach to the proceeds of the sale, subject to the lender’s right to credit bid; or (iii) provides the secured lender with the “indubitable equivalent” of its secured claim, which phrase is not further defined or clarified in the Bankruptcy Code.
Last year, in Philadelphia Newspapers, the Third Circuit addressed whether a similar plan that proposed a sale prohibiting a secured lender from credit bidding would provide that secured lender with the indubitable equivalent of its lien. The Third Circuit followed the Fifth Circuit’s prior decision in In re The Pacific Lumber Co., 584 F.3d 299 (5th Cir. 2009), and found that the indubitable equivalent standard of the “fair and equitable” test unambiguously permitted confirmation of a plan despite a sale that prohibited credit bidding. In reaching this result, the Third Circuit defined indubitable equivalent to mean “the unquestionable value of a secured lender’s secured interest in its collateral”—apparently the fair market value of the collateral. However, it was not possible to consider whether such a sale would actually provide a secured lender with the indubitable equivalent of its lien because the auction sale had not yet taken place. The Third Circuit noted that the determination of indubitable equivalent is based on the total compensation provided to a secured lender under a plan, rather than just the sale price of its collateral. Judge Ambro wrote a lengthy dissent, arguing that the Bankruptcy Code was ambiguous on this issue and concluding that the Bankruptcy Code’s overall scheme and legislative history established that a plan may not use the indubitable equivalent option to prohibit credit bidding.
The Seventh Circuit quickly accepted direct appeals of the issues in both the River Road case and its companion RadLAX case, and issued its opinion about two months after hearing oral argument. Its decision affirmed the Bankruptcy Court’s ruling, relying on much of the reasoning in Judge Ambro’s dissent. The Seventh Circuit found that the three alternative standards for the “fair and equitable” test under section 1129(b) of the Bankruptcy Code were ambiguous, and that the individual “indubitable equivalent” standard of the “fair and equitable” test was also ambiguous. The court then concluded that permitting a sale to proceed under the indubitable equivalent option without credit-bid protection for a secured lender was impermissible, because it rendered the rest of section 1129(b)(2)(A) superfluous and conflicted with the objectives of the Bankruptcy Code, as well as allowing a general Code provision to control over more specific provisions. The Seventh Circuit also held that a sale of collateral could not independently satisfy the indubitable equivalent option without credit bidding. The court noted that the indubitable equivalent of an undersecured claim is the current market value of the collateral and that, under the Bankruptcy Code, current market value is determined either through judicial valuation or free-market valuation. The Seventh Circuit concluded that the debtors could not satisfy the indubitable equivalent option through a free-market valuation without preserving the secured lenders’ credit-bid rights because such rights were otherwise preserved under the Bankruptcy Code, and because such a sale without the opportunity for credit bidding would present a “substantial risk that assets sold in bankruptcy auctions will be undervalued.”
As an epilogue, while the appeal was pending before the Seventh Circuit, the secured lenders proposed their own chapter 11 plan in the River Road cases in which the lenders would receive the debtors’ operating assets. Following some modifications, that plan was confirmed by the Bankruptcy Court on July 7, 2011, a little over a week after the Seventh Circuit issued its decision. However, no such plan was proposed in the companion case, RadLAX, thereby keeping the Seventh Circuit’s decision subject to possible Supreme Court review should those debtors seek certiorari.
Debtors and creditors can be expected to consider these conflicting decisions when evaluating a potential bankruptcy filing. Debtors seeking to sell assets pursuant to a plan of liquidation will certainly be mindful of these opinions in connection with possible venue options. The possibility of being precluded from credit bidding may cause lenders to include the right to credit bid in bankruptcy cases in their loan documents, even though the enforceability of such provisions in bankruptcy is uncertain. Lenders and their counsel will be advised to closely review debtors’ choice of venue as it relates to this issue.