In a major victory for secured creditors, the United States Bankruptcy Court for the Western District of Tennessee has held that a sale of secured property must afford a secured creditor the right to credit bid for its collateral under section 363(k) of title 11 of the United States Code (Bankruptcy Code), except in extraordinary circumstances upon a showing of “cause.” The court held that even where secured party credit bidding might impact the competitive bidding process – including potentially “chilling” third party bids – this alone does not constitute sufficient cause to deny a creditor the ability to credit bid. In so holding, the court sharply departed from recent rulings of two other bankruptcy courts – which relied on the “for cause” exception in section 363(k) to limit credit bidding – and it reaffirmed one of the most important protections secured creditors have to protect the value of their collateral.
Credit Bidding in Bankruptcy
Credit bidding is a practice by which a secured creditor may bid for a debtor’s assets that constitute the creditor’s collateral by using the debt it is owed to offset the purchase price. Credit bidding is specifically authorized by section 363(k) of the Bankruptcy Code, which provides that in a section 363 sale of property subject to a secured claim, the secured creditor may bid on the property by offsetting its claim against the purchase price of the property being sold, unless the court orders otherwise “for cause.”1 The right to credit bid under section 363(k) is also incorporated into Bankruptcy Code requirements for confirmation of a plan of reorganization that provides for the sale of property subject to liens.2
Thus, a creditor with an allowed claim secured by a lien on property that is to be sold pursuant to a section 363 sale, or a sale under a plan of reorganization, may use some or all of the amount of its allowed claim to bid. Under common credit bidding practice, a secured creditor will be required to put up new capital only if its bid exceeds the amount of its allowed claim. The only exception would be if the court were to find that cause existed to deny credit bidding, which, in the past, rarely occurred. Until recently, a secured creditor’s right to credit bid was widely regarded as relatively non-controversial.
The Pre-RadLAX Case Law Split Over Credit Bidding
The general consensus was shaken after both the Third and Fifth Circuit Courts of Appeal held that a chapter 11 plan eliminating the credit bid rights of a secured creditor could be confirmed over the objection of the creditor.3 A circuit split subsequently emerged when the Seventh Circuit denied confirmation of a plan that proposed to preclude the secured creditor from credit bidding.4
In RadLAX, the Supreme Court resolved the split by unanimously siding with the Seventh Circuit.5 Relying on well-established canons of statutory interpretation, the Court, in an “easy case,” held that a debtor’s plan providing for a sale of secured property free and clear of the creditor’s lien could not be confirmed without affording the secured creditor the right to credit bid for the property.
Credit Bidding Post-RadLAX
A Narrow Approach: Fisker and Free Lance-Star Publishing
After RadLAX, many commentators believed the right of a secured creditor to credit bid had been conclusively resolved. However, over the ensuing months, two bankruptcy courts limited this right.6 The first of these decisions arose from the Fisker Automotive Holdings bankruptcy case in the Delaware bankruptcy court. As one of the bases for its ultimate decision, the court determined that permitting the secured creditor to credit bid would “chill” the bidding process.7 For this reason, the court found that cause existed to severely limit the secured creditor’s ability to credit bid. A few months later, in the Free Lance-Star Publishing case, the bankruptcy court for the Eastern District of Virginia similarly limited the ability of a secured creditor to credit bid.8 The court, citing Fisker, also employed the for cause exception to limit the right of the secured creditor to credit bid, based upon, among other things, the need to promote a “robust and competitive” bidding climate.9
An Expansive Approach: RML Development
In recent weeks, the bankruptcy court for the Western District of Tennessee departed from Fisker and Free Lance-Star Publishing.10 While acknowledging the right to credit bid is not absolute, the court rejected the proposition that potential chilling of third party bids – without more – constitutes sufficient cause to modify or deny a secured creditor’s rights. Instead, the court held the right to credit bid should be abrogated only in cases where there are “competing claims, collusion, or other fraudulent or bad faith acts.”11 The court further explained that denial of credit bid rights should be the “extraordinary exception” and not the rule.12 Thus, according to the court, a creditor holding an uncontested secured claim should ordinarily be allowed to credit bid for its collateral regardless of the impact on other bidding.
The Future of Credit Bidding
After RadLAX, many viewed the right to credit bid to have been resolved and affirmed. However, subsequent decisions from bankruptcy courts in Delaware and the Eastern District of Virginia created significant concern that the “for cause” exception in section 363(k) might be used to functionally abrogate this important creditor protection. The rejection of this broad reading of the for cause exception in RML Development represents a big win for secured creditors, providing strong precedent for them to vigorously oppose attempts to limit their right to credit bid.