Undersecured lenders jealously guard their ability to credit bid in a sale of collateral (i.e. lender offsets the amount that it bids against the debt owed to the lender). This provides protection against a fire sale in which the collateral is sold to a third party for far less than the debt without requiring the lender to pay cash. For bankruptcy sales, Section 363 of the Bankruptcy Code sets forth the rules for sale of property of the bankruptcy estate and specifically authorizes the holder of a secured claim to credit bid (unless the court orders otherwise).
So what’s the issue? Debtors have argued that lenders are not necessarily entitled to credit bid if the sale is conducted as part of a plan of reorganization. In RadLAX the Supreme Court rejected this position and ruled that a lender is entitled to credit bid as provided in Section 363(k) even if the sale is held pursuant to a plan.
The argument is as follows:
- If a class of secured lenders does not vote in favor of a plan that provides for a sale of their collateral without giving them the right to credit bid, a debtor may still attempt to “cramdown” the plan on that class.
- For classes of secured claims, this includes a requirement in Section 1129(b)(2)(A) that the plan provides (i) that the lenders retain liens on the collateral securing their claims and receive cash payments with a present value equal to the value of their interest in the collateral, (ii) for a sale of the collateral, subject to Section 363(k), free and clear of the lenders’ liens, with the liens transferred to proceeds, or (iii) the “realization by such holders of the indubitable equivalent of such claims.”
- A sale can be justified as providing the indubitable equivalent under clause (iii) even though it does not meet the requirements of clause (ii) (because it does include a right to credit bid).
In RadLAX, the debtors proposed to sell substantially all of their assets at an auction to the highest bidder free and clear of the secured lender’s liens, with the proceeds to be used to pay off the claims, as the “indubitable equivalent” of its secured claim. In rejecting this position, the Supreme Court in an opinion written by Justice Scalia characterized it as “hyperliteral and contrary to common sense.”
The Court proceeded to discuss at length a rule of statutory construction that a specific provision prevails over a general provision, asserting that the second alternative (sale with credit bid) is a detailed provision that controls any sales of collateral free and clear of liens, while the third alternative (indubitable equivalent) is a more general provision that must give way to the more specific provision in connection with sales of collateral. The bottom line is that if a debtor wants to sell collateral free and clear of a secured creditor’s lien through a plan of reorganization over the objections of the applicable class of secured lenders, the sale will be subject to the Section 363(k) requirement that the secured creditor be allowed to credit bid.
There is undoubtedly room for further litigation. For example, if a debtor proposes to sell a business as a going concern that includes a manufacturing facility, inventory and other assets, how does it give credit bit rights to a secured creditor that has liens only on the manufacturing facility? However, at a minimum, RadLAX gives a secured lender leverage in negotiating plan provisions that call for sale of its collateral.