Once might be considered an aberration. Is twice the new normal?

We wrote last month about the Delaware Bankruptcy Court’s surprising opinion in In re Fisker Automotive Holdings, Inc., broadening the definition of “for cause” under Bankruptcy Code § 363(k) to enable the court to limit a discounted secured debt purchaser’s credit bid rights based on the goal of fostering a competitive bidding environment at a § 363 sale. Now, in a Memorandum Opinion issued on April 14, 2014 in the In re Free Lance-Star Publishing Co. Chapter 11 case, the Bankruptcy Court for the Eastern District of Virginia has likewise limited a discounted secured debt purchaser’s credit bid rights, at least in significant part, on the same expanded “for cause” grounds.

In In re Free Lance-Star Publishing, the secured creditor bought approximately $38 million of ostensibly secured debt at a discount before the Chapter 11 filing, and after the filing moved for a § 363 sale with the intention of credit bidding the full $38 million of debt at the sale. Responding to debtor and creditors’ committee objections to the credit bid, the bankruptcy court ruled that the creditor’s credit bid would be limited to $13.9 million based upon three grounds: First, the court concluded that the creditor’s liens did not extend to some of the debtor’s assets (but without specifically assigning a dollar value to the assets that were, or were not, covered by the liens); Second, the court concluded that the creditor made “efforts to frustrate the competitive bidding process” and therefore engaged in “inequitable conduct”; and Third, limiting the amount of the creditor’s credit bid was necessary “in order to foster a fair and robust sale.” The line blurring between grounds two and three can be interpreted to signal the Virginia bankruptcy court’s apparent agreement with the Delaware bankruptcy court’s expansion of “for cause” under Bankruptcy Code § 363(k) to include sale competitive bidding considerations, either alone or in conjunction with traditional “for cause” findings, as a legitimate basis for limiting the amount a secured creditor may credit bid.

Perhaps the most troubling, from a distressed secured debt purchaser’s point of view, is the Virginia bankruptcy court’s implicit suggestion that a “loan-to-own” strategy[1]by itself depresses enthusiasm for sale in the marketplace and causes otherwise interested bidders not to participate. If that is accepted as conventional wisdom by bankruptcy courts generally, the loan-to-own playbook will need to evolve.