The Bottom Line:

On June 28, 2011, the United States Court of Appeals for the Seventh Circuit affirmed the bankruptcy court’s denial of bid procedures filed in connection with a proposed chapter 11 plan that failed to provide secured creditors with the right to credit bid, finding that the denial was not “fair and equitable” treatment as required under section 1129(b). River Road Hotel Partners LLC v. Amalgamated Bank (In re River Road Hotel Partners, LLC), Nos. 10-3597, 10-3598 (7th Cir. June 28, 2011).  As an initial matter, the Seventh Circuit held that the appeal was not “moot” merely because the time periods in the asset purchase agreement underlying the Chapter 11 plan had expired.  On the substantive issue of credit-bidding, the Seventh Circuit found that the Chapter 11 plan could not be “crammed down” on the secured creditors where the plan provides for a sale of collateral without giving the lenders the right to credit bid their claims under section1129(b)(2)(A)(ii).  The Seventh Circuit declined to follow other circuits that allow for sales without credit-bidding by relying instead upon the “indubitable equivalent” provision of section 1129(b)(2)(A)(iii). 

What Happened:

A chapter 11 plan can only be confirmed where the plan satisfies the requirements set forth under section 1129(a) of the Bankruptcy Code, including the requirement under section 1129(a)(8) that all classes of creditors vote to accept a plan.  Where a class of creditors votes to reject a plan, leaving 1129(a)(8) unsatisfied, section 1129(b) allows the court to “cram down” the plan on the rejecting creditors (i.e., confirm the plan over such creditors’ objection), if the plan is “fair and equitable.”  Relevantly, subsection (b)(2)(A) of 1129 provides that a plan is “fair and equitable” if the plan provides:

(ii) for the sale, subject to section 363(k) of this title, of any property that is subject to the lien 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.

In essence, a plan may be “crammed down” under subsection (ii) only if the plan allows secured creditors to credit bid (pursuant to section 363(k) of the Code), or under subsection (iii) if the plan provides for claimants to receive the “indubitable equivalent” of their claim.  The process of credit-bidding under section 363(k) allows creditors with a secured claim on an asset to submit a bid for that asset that will be credited by the amount of their claim.

Factually, River Road Hotel Partners and River Road Expansion Partners (“River Road”) in addition to RADLAX Gateway Hotel, LLC and RADLAX Gateway Deck (“RadLAX”) (each a “Debtor” and together, the “Debtors”), were in the business of constructing and renovating hotels and event spaces.  In 2007 and 2008, both River Road and RadLAX obtained construction loans to construct and/or to renovate new hotel properties. Both River Road and RadLAX filed for chapter 11 on August 17, 2009.  On June 4, 2010, the Debtors filed their proposed plans of reorganization whereby they sought to sell substantially all of their assets.  Simultaneously, the Debtors filed proposed bid procedures for conducting the sale of those assets by auction, with an initial bid supplied by a stalking horse bidder found prepetition.  The secured lenders objected to the proposed bid procedures because, having voted to reject the proposed plans, the plan could not be confirmed unless it complied with section 1129(b)(2)(A)(ii) and the secured creditors obtained a right to credit bid at the auction.  The Debtors contended that, though their proposed plans did not comply with section 1129(b)(2)(A)(ii), they could still be confirmed under section 1129(b)(2)(A)(iii).  

The bankruptcy court denied the proposed bid procedures and orally ruled that the Debtors’ plans could not be confirmed under subsection (iii).  On direct certification to the Court of Appeals, the Seventh Circuit first addressed contentions by the secured lenders that, because expiration dates in the asset purchase agreements filed by the Debtors had passed while the appeal was pending, the issue was then moot.  Contrary to the secured lenders’ arguments, the Seventh Circuit found that because amended asset purchase agreements were filed with revised expiration dates (none which had occurred at the time of the appeal), and because the Debtors had not abandoned their intentions for an asset sale, the issue was still ripe for appeal.  In addition, the Court found that even if the Debtors’ plans were based on expired asset purchase agreements, this issue would fall within the exception to the mootness doctrine, as it would constitute a case that, due to timing issues, would otherwise evade review.  Because all asset purchase agreements and plans of reorganization necessarily contain dates and deadlines, the Court found that it would “rarely, if ever, be the case that an appellate court would have opportunity to review a bankruptcy court’s confirmation decision prior to the expiration of such deadlines.” Id. at 9.  Thus, the Court found that its review of the bankruptcy court’s decision was proper.

On the substantive issue of whether the Debtors could confirm their chapter 11 plans under subsection (iii) of 1129(b)(2)(A), the Court first looked to the plain language of section 1129(b)(2)(A).  Notwithstanding two recent Circuit Court opinions on the issue — one from the Fifth Circuit in In re Pacific Lumber, Co., 584 F.3d 229 (5th Cir. 2009) which found the sale of encumbered assets to a purchaser for the judicially-determined value of the assets “fair and equitable” under subsection (iii) of 1129(b)(2)(A), and one from the Third Circuit in In re Philadelphia Newspapers, 599 F.3d 298 (3d Cir. 2010), which allowed the sale of encumbered assets without allowing secured creditors to credit bid under a plan, finding that the plan could qualify as “fair and equitable” — the Seventh Circuit chose to support Circuit Judge Ambro’s dissent in In re Philadelphia Newspapers rejecting those conclusions.  First, the Seventh Circuit reasoned that, contrary to the Debtors’ contentions, section 1129(b)(2)(A) does not have one plain meaning.  Even if it were to read subsection (iii) in isolation from the other subsections of section 1129(b)(2)(A), the Seventh Circuit found that such a reading still did not “establish that it can be used to confirm plans that propose auctioning off a debtor’s encumbered assets free and clear of liens without allowing credit bidding.” River Road, slip op. at 20.  The Seventh Circuit reasoned that by failing to provide secured lenders with the ability to credit bid, the Debtors’ proposed auctions lacked a “crucial check on undervaluation” and ran the risk that the secured lenders would not receive the current market value of the assets.

Instead, the Seventh Circuit found that the proper interpretation of section 1129(b)(2)(A) required that, where a plan seeks to sell encumbered assets, secured creditors must obtain the right to credit bid in order for a plan to be crammed down on such creditors.  Rejecting the Debtors’ interpretation of subsection (iii) that any plan that satisfies the “indubitable equivalent” standard may be deemed “fair and equitable,” the Seventh Circuit found that such an interpretation would “render the other subsections superfluous” as it would deem a plan fair and equitable under [s]ubsection (iii) “even if they seek to dispose of encumbered assets in the ways discussed in [s]ubsections (i) and (ii), but fail to meet these [s]ubsections’ requirements.” Id. at 21.  Construing each subsection as “conclusively governing” the category of proceedings it addresses, the Seventh Circuit interpreted section 1129(b)(2)(A) as only allowing plans to qualify as “fair and equitable” under subsection (iii) “if they proposed disposing of assets in ways that are not described in subsections (i) and (ii).” Id. at 23.  Accordingly, the Seventh Circuit found that the Debtors’ proposed bid procedures must be denied and the bankruptcy court decision affirmed.

Why the Case is Interesting:

The Seventh Circuit’s decision in In re River Road Hotel Partners presents a view in opposition with that of the Third and Fifth Circuits – thereby splitting Circuit Courts over the important and strategic issue of whether a contested Chapter 11 plan can deprive a secured creditor of the right to credit-bid for its collateral in an asset sale under the plan.  In the Seventh Circuit, disagreeing secured creditor’s cries of “give me credit” must be provided for in the plan.  It remains to be seen whether other Circuit Courts will choose a side or, ultimately, whether the issue finds its way to the Supreme Court.