On October 5, 2010, Judge Bruce Black of the United States Bankruptcy Court for the Northern District of Illinois (the “Bankruptcy Court”) issued a ruling in the River Road Hotel Partner LLC, et. al. (the “Debtors”) bankruptcy cases denying the Debtors’ bid procedures motion incident to plan confirmation. The bid procedures motion, among other things, sought the denial of secured creditor’s right to credit bid. Judge Black ultimately ruled that the Debtors may not use section 1129(b)(2)(A)(iii) to deny secured creditor’s right to credit bid, and the Debtors failed to show sufficient cause to deny credit bidding under sections 1129(b)(2)(A)(ii) and 363(k).

Prior to filing their bid procedures motion, the Debtors, owners of the InterContinental Hotel Chicago O’Hare1, negotiated the primary economic terms of an asset purchase agreement to sell substantially all of their assets to O’Hare River & Technology Hotel LLC (the “Stalking Horse Purchaser”) for $42 million in cash. The asset purchase agreement was filed contemporaneously with the bid procedures motion. The Debtors stated in their bid procedures motion that the Stalking Horse Purchaser’s bid would be subject to a continued marketing effort and higher or better offers. The Debtors intended to execute the sale of substantially all of their assets in connection with a Chapter 11 plan (the “Plan Sale”) free and clear of liens, pursuant to sections 1123 and 1129 of the Bankruptcy Code, specifically, section 1129 (b)(2)(A)(iii) or in the alternative 1129(b)(2)(A)(ii) and 363(k).

The Debtors’ proposed bid procedures stated that “no holder of a lien on any assets of the Debtors shall be permitted to credit bid pursuant to section 363(k) of the Bankruptcy Code.”

The Bankruptcy Code provides two methods by which a debtor may sell substantially all of its assets. The first is a sale conducted pursuant to Bankruptcy Code section 363 and the second is pursuant to a plan under Bankruptcy Code section 1123(b).

The Debtors stated in their bid procedures motion that “based upon the plain language of the Bankruptcy Code and established case law, the Debtors’ secured creditors should be precluded from submitting credit bids for the purchase of the Debtors’ Assets.”

In the Debtors’ attempt to deny secured creditors the right to credit bid, the Debtors relied heavily on the Third Circuit’s decision in Philadelphia Newspapers2. In Philadelphia Newspapers, the court concluded that subsection (iii) of Bankruptcy Code section 1129(b)(2)(A), which contains no statutory right to credit bid (unlike subsection (ii) of Bankruptcy Code section 1129(b)(2)(A) which specifically references section 363(k) and the right to credit bid), unambiguously permits a debtor to proceed with any plan that provides secured lenders with the “indubitable equivalent” of their security interest in the asset. The Philadelphia Newspapers decision contained a strong dissent written by Judge Thomas Ambro of the Third Circuit.

Certain prepetition River Road lenders objected to the Debtors’ bid procedures motion on the grounds that, in denying the opportunity to credit bid, the Debtors failed to provide the indubitable equivalent of the prepetition lender’s claims under section 1129(b)(2)(A)(iii). The prepetition lenders further argued that approval of the Debtors’ bid procedures motion would allow for the gross undervaluation of the Debtors’ assets, benefiting no one but the Stalking Horse Purchaser and the insiders of the Debtors that would remain in managerial control.

The prepetition lenders also emphasized the ambiguity of section 1129(b)(2)(A) and the interpretation given by the Third Circuit, in contrast with the treatment of secured creditors in other parts of the Bankruptcy Code. The prepetition lenders supported the dissenting opinion of Judge Ambro in Philadelphia Newspapers. In consideration of the disjunctive phrasing of section 1129(b)(2)(A)’s subparagraphs, Judge Ambro (and the prepetition lenders) argued that “[t]o use clause (iii) to accomplish a sale free of liens, but without following the specific procedures prescribed by clause (ii), undoubtedly places the two clauses in conflict. It seems Pickwickian to believe that Congress would expend the ink and energy detailing procedures in clause (ii) that specifically deal with plan sales of property free of liens, only to leave general language in clause (iii) that could sidestep entirely those procedures.”3

The prepetition lenders also argued that the gross undervaluing of the Debtors’ assets gives credence to the concerns expressed by Judge Ambro in his Philadelphia Newspapers dissent. Judge Ambro opined that denial of secured creditor’s right to credit bid would encourage undervaluing of assets and allow stalking horse purchasers to buy assets for less than actual value. Judge Ambro also observed that denying secured lenders their “presumptive right to credit bid” would remove the “procedural safeguard against undervaluation contemplated by the Code’s drafters …[t]he only party that stands to benefit from any undervaluation is the purchaser of the assets…”4

Judge Black agreed with the prepetition lenders and Judge Ambro. In his decision, Judge Black stated that he found Judge Ambro’s “well-reasoned” dissent in Philadelphia Newspapers more persuasive.

In the alternative, the Debtors sought to deny the secured creditor’s right to credit bid under Bankruptcy Code sections 1129(b)(2)(A)(ii) and 363(k). Under section 363(k), a secured creditor may credit bid up to the full amount of its claim unless “the court for cause orders otherwise” (emphasis added). The Debtors argued that cause exists to deny the secured creditors their right to credit bid because (i) there were disputes between secured creditors with respect to lien priorities that had yet to be resolved, (ii) the secured lenders caused the Debtors to file for Chapter 11 protection by improperly refusing to provide funding under their prepetition contracts, (iii) certain secured creditors will be compensated by the Federal Deposit Insurance Corporation for losses sustained with respect to the sale, and (iv) allowing secured lenders to credit bid will chill bidding.

Judge Black disagreed with the Debtors, stating that none of the circumstances espoused by the Debtors constituted cause to prevent secured creditors from credit bidding. Judge Black reasoned that (i) the Debtors did not assert, nor present evidence5 showing that the secured lenders breached their prepetition contracts or acted with any intent to harm the Debtors, and, even if the Debtors had, such acts did not constitute cause to deny the right to credit bid, (ii) the Debtors did not provide any specific evidence to support the assertion that credit bidding would chill bidding and (iii) the court may place certain conditions on a secured creditor’s right to credit bid without denying this right altogether in an effort to alleviate the problems associated with disputes over lien priorities of certain secured creditors.

Conclusion: The 1129(b)(iii) issue on asset sales related to a plan of reorganization continues to develop in bankruptcy courts in the different circuits. There is a substantial evidentiary burden that needs to be satisfied to justify sufficient “cause” to deny a secured creditor’s right to credit bid under Section 363(k).