A recent opinion out of the United States Bankruptcy Court for the Eastern District of Virginia (Richmond Division) serves as a reminder to secured creditors to steer clear of conduct that a bankruptcy court may deem inequitable and provide the court with cause to limit the secured creditor’s credit bid rights.  In In re The Free Lance-Star Publishing Co. of Fredericksburg Va., et al.,the bankruptcy court determined that the secured creditor engaged in inequitable conduct by acting in a manner intended to depress the value of the debtors’ assets.  As a result, the bankruptcy court held that the secured creditor would only be permitted to credit bid a small portion of the value of its secured claim.

Credit Bidding Under the Bankruptcy Code

As a general rule, secured creditors are entitled under the bankruptcy code to credit bid the full amount of their secured claim at the auction of a debtor’s assets.  Credit bid rights provide secured creditors with an important safeguard against the potential undervaluation of their secured claim without requiring the secured creditor utilize cash to protect its position.  The right to credit bid, however, is not absolute and may be limited by the bankruptcy court upon a finding of “inequitable conduct.”

Attempts to Devalue Estate Assets Prior to a Bankruptcy Court Auction May Constitute Inequitable Conduct That Serves to Limit Credit Bid Rights

In The Free Lance-Star, the debtors are a newspaper publisher that also owns and operates radio stations in Fredericksburg, Virginia and an entity that owns a portion of the land upon which the operating entity operates.  Among the debtors’ assets were radio towers used for the debtors’ broadcast operations.  Several years prior to filing chapter 11, the debtors secured a loan from BB&T in the amount of $50.8 million to expand their newspaper printing operations.  The loan was secured by substantially all of the debtors’ assets with the exception of the debtors’ radio towers.  After the debtors fell out of compliance with certain of the BB&T loan covenants, BB&T sold the loan to a third party, Sandton Capital Partners (“SCP”).

Shortly after acquiring the loan, SCP informed the debtors that it wanted them to file chapter 11 and sell their assets to DSP Acquisition, LLC (“DSP”), an affiliate of SCP.  As part of its restructuring plan, DSP requested that the debtors place liens upon all of the radio tower assets, which request the debtors rejected.  Unbeknownst to the debtors, and after the debtors refused to grant DSP a security interest in the radio tower assets, DSP unilaterally filed UCC Fixture Financing Statements against the radio tower assets.         

During the pre-bankruptcy negotiations with the debtors, DSP also insisted that the debtors open a post-petition credit facility with DSP that would grant DSP post-petition liens on the radio tower assets, which the debtors, again, refused.  Finally, DSP attempted to require the debtors include conspicuous language highlighting DSP’s credit bid rights in all materials advertising the bankruptcy court auction. 

Ultimately, the debtors filed chapter 11 without any agreement with DSP.  Along with their bankruptcy petitions, the debtors also filed motions to sell business assets and radio tower assets.  Prior to the auction for the debtors’ assets, the bankruptcy court had a three day evidentiary hearing to determine whether DSP could credit bid its claim and to determine the validity, extent and priority of DSP’s liens.  At the conclusion of the hearing, the bankruptcy court ruled that DSP did not maintain valid, properly perfected liens on the radio tower assets and that DSP would not be permitted to credit bid a claim against assets on which it lacked a valid lien or security interest.  The bankruptcy court also found that DSP had engaged in inequitable conduct that warranted the limitation of DSP’s credit bid rights so as to facilitate a competitive auction.  Specifically, the bankruptcy court found the following constituted inequitable conduct: (i) DSP’s unilateral decision to file financing statements against the debtors’ assets, despite knowing that it lacked valid liens on such assets, (ii) DSP’s failure to voluntarily disclose to the court the existence of such filings at the evidentiary hearing, and (iii) the overt pressure DSP placed upon the debtors to include conspicuous language in advertising materials highlighting DSP’s credit bid rights.  As of result of such inequitable conduct, the bankruptcy court significantly curtailed the amount by which DSP could credit bid on the debtors’ non-radio tower assets.

Conclusion

Although the right of secured creditors to credit bid is supported by well-reasoned public policy and the bankruptcy code, the right is not unlimited.  Debtors and creditors committees may seek to challenge credit bid rights where valuable estate assets are to be sold.  As such, secured creditors should be sure that their pre- and post-petition actions are reasonable and cannot be construed to be inequitable.