In a short opinion for what it considered an “easy case,” the Supreme Court decided 8-01 in RadLAX Gateway Hotel, LLC v. Amalgamated Bank2 on May 29, 2012 that if a plan of reorganization proposes a sale of property, secured lenders with liens on that property must be allowed to credit bid, i.e., “pay” using the amount of their allowed secured claim. This is a definite victory for secured lenders who, generally, will now not have to advance additional capital in order to protect their collateral.
The Legal Background
As is common, a debtor can propose to sell property outside of a plan of reorganization. In that case, Bankruptcy Code §363(k)3 provides that a creditor with a lien on that property can credit bid its secured claim “unless the court orders otherwise for cause.” Courts have ordered “otherwise for cause” only when there have been serious issues concerning the validity of the secured claim.
A debtor (or a creditor after the exclusivity period) can instead propose to sell property pursuant to a Chapter 11 plan. If the secured creditor does not consent to its treatment under the plan and is impaired by the plan, the debtor can sell the creditor’s collateral free and clear under a “cramdown” plan if the plan is “fair and equitable” with regard to its treatment of that creditor’s claim.4 Section 1129(b)(2)(A) provides, as to holders of secured claims, that the plan must provide: (i) that the secured creditor retains its lien and receives a deferred payment stream not less than the value of the allowed claim; (ii) “for the sale, subject to section 363(k) . . ., of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (III) . . .” (emphasis added); or (iii) “for the realization by such holders of the indubitable equivalent of such claims.”5
The Supreme Court agreed to hear the case by granting certiorari because of a conflict between the Circuit Courts of Appeal as to whether, in the case of a sale through a plan of reorganization as opposed to through a §363 sale, the plan proponent can give a secured creditor either prong (ii) (subject to its right to credit bid, a lien on sale proceeds) or prong (iii) (the indubitable equivalent of its claim). In 2009 and 2010, the Fifth and Third Circuits had interpreted prongs (ii) and (iii) as disjunctive (i.e., either-or) alternatives.6 Under their reasoning a secured creditor did not have an absolute right to credit bid in a sale effectuated through a cramdown plan.
In contrast, the Seventh Circuit had held in the RadLAX case7 that only prong (ii) is available when a plan proponent seeks to sell property in a cramdown context. The Seventh Circuit held that §363(k) and §1129 (b)(2)(A) worked together to ensure that the secured creditor’s lien would not be extinguished for less than the value of its collateral:
By granting secured parties [the ability to credit bid], the Code provides lenders with means to protect themselves from the risk that the winning auction bid will not capture the asset’s actual value. If a secured lender feels that the bids that have been submitted in an auction do not accurately reflect the true value of the asset and that a sale at the highest bid price would leave them undercompensated, then they may use their credit to trump the existing bids and take possession of the asset. In essence, by granting secured creditors the right to credit bid, the Code promises lenders that their liens will not be extinguished for less than face value without their consent.8
The Supreme Court affirmed the Seventh Circuit’s decision, and held that only prong (ii) is available in the context of a cramdown sale of a secured creditor’s collateral. It reasoned as follows:
We find the debtors’ reading of § 1129(b)(2)(A)-- under which clause (iii) permits precisely what clause (ii) proscribes—to be hyperliteral and contrary to common sense. A well established canon of statutory interpretation succinctly captures the problem: “[I]t is a commonplace of statutory construction that the specific governs the general.”9
The Supreme Court did note that “the general/specific canon is not an absolute rule, but is merely a strong indication of statutory meaning that can be overcome by textual indications that point in the other direction. The debtors point to no such indication here.”10
The RadLAX decision has been widely reported, but its implications have not.
Practically, debtors will search for creative ways to get around RadLAX. Calling the transaction proposed in the plan something other than a “sale” is unlikely to succeed, as the bankruptcy court will look through the formalisms to the actual substance of the transaction. One avenue debtors might seek is to propose a long term lease.
In addition, debtors will begin to argue that the secured lender should be denied the right to credit bid under §363(k) “for cause.” Such an argument might prevail where the secured creditor is or was an insider, and where there was some questionable self-dealing; of course, this is most likely to be proposed if the plan proponent is someone other than the debtor.
What if the secured creditor’s lien extends to multiple parcels either through cross-collateralization or otherwise? It might simply not be feasible to allow a credit bid in such a situation, and that might constitute cause under §363(k).
The Supreme Court’s reasoning in RadLAX that the specific governs the general has other implications for bankruptcy jurisprudence. Will that reasoning be applied to other Code sections? For example §361 provides that adequate protection required under §§362, 363, or 36411 may be: (1) appropriate cash payments to the extent of a decrease in the value of the petitioning party’s interest in property; (2) additional or replacement liens to the extent of a decrease in the value of the petitioning party’s interest in property; or (3) “such other relief . . .as will result in the realization by such entity of the indubitable equivalent of such entity’s interest in such property.” Can a debtor decline to make cash payments or grant liens, and instead choose to grant the entity the indubitable equivalent? Will the court refuse to approve such adequate protection accepting the theory, as advanced by the Supreme Court in RadLAX, that the specific governs the general? Is this a context in which “textual indications” overcome the general/specific canon?
Strategies for Undersecured Lenders
A remedy that an undersecured creditor frequently uses when its borrower has filed for bankruptcy, is a motion for relief from the automatic stay predicated under Bankruptcy Code §362(d)(2), claiming that the debtor has no equity in the property and that the property is not necessary to an effective reorganization.
RadLAX has major implications for the second prong of §362(d)(2) “not necessary to an effective reorganization,” at least when it is apparent that the reorganization will take place through a sale. As the Supreme Court explained in its significant Timbers12 decision:
Once the movant under §362(d)(2) establishes that he is an undersecured creditor, it is the burden of the debtor to establish that the collateral at issue is “necessary to an effective reorganization”. . . What this requires is not merely a showing that if there is conceivably to be an effective reorganization, this property will be needed for it; but that the property is essential for an effective reorganization that is in prospect. This means . . . that there must be “a reasonable possibility of a successful reorganization within a reasonable time.”13
Given RadLAX’s holding that a secured creditor can credit bid, who will overbid and pay more than the value of the property, other than perhaps insiders who have personal reasons for wanting to own the property? Outside bidders will have to put up cash in competition with the undersecured creditor’s credit bid, and in addition, will be concerned that the undersecured creditor has the best information about the property and might bid more than its debt. An undersecured creditor can and will make these arguments to convince the court that there is no effective reorganization in prospect. To this, the Supreme Court said: “[T]he pros and cons of credit-bidding are for the consideration of Congress, not the courts.”14
Even if relief from the automatic stay is denied until the debtor has an opportunity to explore its options, the undersecured creditor is likely to emerge from its motion for relief from stay with something constituting “adequate protection” of its interest in its collateral. If an undersecured creditor produces evidence that its collateral is decreasing in value, either because it is cash collateral or for other reasons, it should receive under §361 adequate protection of either cash (not usually available in a Chapter 11 case) or an additional or a replacement lien. Will the Supreme Court’s reasoning in RadLAX be applied to §361 to hold that the debtor cannot provide the indubitable equivalent, whatever that may be?
There is an additional reason that an undersecured creditor should move for relief from stay as soon as it has an appraisal to put into evidence with its motion: courts are divided as to whether the value to be protected is measured as of the filing of the petition, or as of the date on which the creditor requested adequate protection.15
Secured creditors have won a victory in the RadLAX decision. It has yet to be seen in what creative ways debtors will try to structure a sale as “not a sale,” and how quickly undersecured creditors can obtain relief from stay once it is clear that the debtor’s only feasible option is a sale.
As published in the April 2013 issue of The Secured Lender.