In RadLAX Gateway Hotel, LLC v. Amalgamated Bank, the United States Supreme Court addressed the issue of “whether a Chapter 11 bankruptcy plan may be confirmed over the objection of a secured creditor pursuant to 11 U.S.C. § 1129(b)(2)(A) if the plan provides for the sale of collateral free and clear of the creditor's lien, but does not permit the creditor to ‘credit-bid’ at the sale.” In a unanimous 8-0 decision, the Supreme Court held that a debtor may not sell its property free and clear of a secured creditor’s lien under § 1129(b)(2)(A) of the Bankruptcy Code without allowing the secured creditor the right to credit bid.
The RadLAX opinion obviated the recent trend in court decisions allowing a debtor to confirm, in certain circumstances, a plan selling its property free and clear of a secured creditor’s lien without allowing the creditor the right to credit bid. Not unexpectedly, much of the literature written to date has focused on RadLAX’s effect on secured creditor rights in chapter 11. It is worth considering, however, what effect—if any—that RadLAX might have on unsecured creditors’ rights. Before exploring this issue, though, a summary of the RadLAX decision is in order.
The RadLAX Case
In RadLAX, the debtors had purchased a hotel and an adjacent lot on which the debtors planned to build a parking structure. The debtors obtained a loan to finance the purchase of the properties, the renovation of the hotel and the construction of the parking structure. To secure the loan, the lender was given a lien on all of the debtors’ assets. After depleting the loan funds, and unable to secure additional financing to finish the project, the debtors filed petitions for relief under Chapter 11 of the Bankruptcy Code. The debtors sought to cram down the secured lender under a plan through which the debtor entities would be dissolved and substantially all of their assets sold at auction. Pursuant to the debtors’ proposed bid and sale procedures, the lender would not be allowed to credit bid the outstanding amount owed it. Rather, the lender would be forced to bid cash if it wanted to purchase the assets subject to its lien.
The United States Bankruptcy Court for the Northern District of Illinois denied the debtors' proposed bid and sale procedures, concluding that such procedures did not comply with § 1129(b)(2)(A)'s requirements for cramdown of a secured creditor. The bankruptcy court certified an appeal directly to the United States Court of Appeals for the Seventh Circuit. The Seventh Circuit affirmed the bankruptcy court’s decision, concluding that § 1129(b)(2)(A) does not permit a debtor to sell an encumbered asset free and clear of a secured creditor’s lien without allowing the creditor the right to credit-bid.
In determining whether a cramdown plan that proposes the sale of a secured creditor’s collateral without allowing the creditor to credit-bid is “fair and equitable”—as required pursuant to § 1129(b)(2)(A)—the Supreme Court focused on the text of the statute, which states as follows:
(2) For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:
(A) With respect to a class of secured claims, the plan provides—
(i) (I) that the holders of such claims retain the liens securing such claims, whether the property subject to such liens is retained by the debtor or transferred to another entity, to the extent of the allowed amount of such claims; and (II) that each holder of a claim of such class receive on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder's interest in the estate's interest in such property;
(ii) for the sale, subject to section 363(k) of this title, 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) of this subparagraph; or
(iii) for the realization by such holders of the indubitable equivalent of such claims.
Distilling the foregoing statutory language, the Supreme Court summarily described each clause of § 1129(b)(2)(A) as follows:
Under clause (i), the secured creditor retains its lien on the property and receives deferred cash payments. Under clause (ii), the property is sold free and clear of the lien, “subject to section 363(k),” and the creditor receives a lien on the proceeds of the sale. Section 363(k), in turn, provides that “unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property”—i.e., the creditor may credit-bid at the sale, up to the amount of its claim. Finally, under clause (iii), the plan provides the secured creditor with the “indubitable equivalent” of its claim.
Notwithstanding the language of clause (ii) dealing with the sale of property, the RadLAX debtors argued that they could sell their property free and clear of the lender’s lien without allowing the lender to credit bid because the debtors would provide the lender with the “indubitable equivalent” of its secured claim by paying the lender with the cash generated through the auction.
In no uncertain terms, the Supreme Court found the debtors’ argument unpersuasive: “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.’” Relying on its prior decisions dealing with statutory interpretation, the Supreme Court concluded that “clause (ii) is a detailed provision that spells out the requirements for selling collateral free of liens, while clause (iii) is a broadly worded provision that says nothing about such a sale. The general/specific canon explains that the ‘general language’ of clause (iii), ‘although broad enough to include it, will not be held to apply to a matter specifically dealt with’ in clause (ii).” As a result, the Supreme Court held that, under the plain language of § 1129(b)(2)(A), the debtors could not sell their property free and clear of the lender’s lien without allowing the lender to credit bid.
What Does RadLAX Mean for Unsecured Creditors?
Because of the clear and unambiguous text of the statute, the Supreme Court declined to consider, among other things, the merits behind allowing secured creditors to credit bid. It stands to reason, however, that, at least in certain circumstances, the Supreme Court’s clarification of a secured creditor’s right to credit bid may provide an overall benefit to the estate and the debtor’s junior priority creditors, including unsecured creditors.
Under normal circumstances, a debtor will arrange a sale using a stalking-horse bidder — a bidder that is pre-approved and that will set the floor for bidding. By allowing a secured creditor to credit bid, it is reasonable to assume that there will be at least one additional bidder vying for the assets to be sold. The more bidders present at an auction, the more likely it is that bidding will be robust, and the more likely it is that the auction will generate more proceeds for the estate and creditors.
It is true that in a case like RadLAX — where the creditor was undersecured and held a blanket lien on all of the debtors’ assets — the ability of the secured creditor to credit bid will likely provide no benefit to junior creditors. In such instances, the secured creditor will likely be entitled to all of the sale proceeds before anything flows down to the junior creditors. But for the same reasons, the unsecured creditors will not be harmed by the secured creditor’s right to credit bid.
In cases where there are other unencumbered estate assets available for distribution to junior creditors (e.g., recoveries on avoidance actions), the prospect of a higher sales price generated through a credit bid could have a positive meaningful impact on junior creditors. For instance, if the secured creditor holds a claim worth $50 million, but the collateral to be sold would generate only a $40 million cash bid at auction, under § 506(a) of the Bankruptcy Code, the secured creditor’s claim would be bifurcated into a $40 million secured claim and a $10 million unsecured claim. As is typically the case, this will likely make the secured creditor the largest unsecured creditor as well, and its $10 million unsecured claim will likely greatly dilute the return otherwise realized by unsecured creditors. If, however, the secured creditor believes the true value of the collateral is $42 million — and if it has the right to credit bid—it may seek to bid such an amount to recoup its collateral. As a result, the secured creditor would then hold only a $8 million unsecured claim. By allowing credit bidding in such an instance, the total unsecured claims are reduced, and the corresponding pro rata distribution to unsecured creditors necessarily increases.
While there are other viewpoints both for and against allowing credit bidding in the context of a plan sale, the fact is that RadLAX eliminates the possibility of the “indubitable equivalent” sale approach adopted by the Third Circuit in Philadelphia Newspapers and the Fifth Circuit in Pacific Lumber. Where a debtor seeks to sell its encumbered property through a Chapter 11 plan free and clear of a secured creditor’s interest, the secured creditor is entitled to credit bid. Though this may frustrate the debtor in certain instances, it does not appear to be a bad thing for unsecured creditors. Only time — and subsequent case law — will tell.