A recent decision in the bankruptcy case of Fisker Automotive Holdings, Inc., et al. has called into question a long-held belief that secured creditors hold dear: that debt purchased at a discount can nonetheless be credit bid at its full face amount at a collateral sale. While it remains to be seen how other courts will interpret Fisker, this decision has the potential to restrict participation in Bankruptcy Code section 363 sales and dampen liquidity in the robust secondary markets.
Secured creditors lend money based upon (i) a borrower’s promise to repay and (ii) the ability to exercise rights and remedies against speciﬁc collateral upon a borrower’s default. One of those rights and remedies is to “credit bid” at a foreclosure or Bankruptcy Code section 363 sale. Credit bidding allows a secured creditor to pay for the collateral by extinguishing (or offsetting) an amount of indebtedness equal to the amount bid for the assets by the secured creditor. In general, a secured creditor may credit bid the full face amount of its debt at a collateral sale.
Consider the following scenario:
- An opportunity presents itself to buy the ﬁrst lien debt of a troubled company at a signiﬁcant discount.
- A distressed debt fund buys $200 million of debt for $25 million.
- The borrower and the distressed fund agree that the borrower will ﬁle for bankruptcy protection and seek authorization to conduct a Bankruptcy Code section 363 sale of all of its assets.
- The fund agrees to become the stalking horse purchaser for the debtor’s assets.
- Because each of the company and the ﬁrst lien debt was extensively marketed before the bankruptcy ﬁling, the fund and the debtor agree to conduct a private section 363 sale of the debtor’s assets.
- The fund proposes to close the sale within 30 business days of the bankruptcy case to limit bankruptcy expenses and operating losses.
- The fund proposes to buy the borrower’s assets in exchange for a $75 million credit bid.
- A creditors’ committee objects to the sale and proposes a more traditional public 363 sale and auction process. The committee raises the issue of capping the fund’s ability to credit bid the full face amount of its debt and argues that the fund’s right to credit bid should be capped “for cause”1 because: (i) another bidder informed the committee that it will refrain from bidding unless the court caps the fund’s right to credit bid and (ii) the fund’s lien on a substantial and material portion of the collateral is not properly perfected on account of an error by the original lender.
- The court sides with the committee and restricts the fund’s credit bid rights to $25 million – using the $25 million price paid the debt as a proxy for the actual value of the fund’s allowed secured claim.
- Ultimately, the collateral is sold at public auction to the competing bidder.
Based on a similar set of facts, in the bankruptcy case of Fisker Automotive Holdings, Inc., et. al., Case No. 13- 13087(KG), a Delaware Bankruptcy Court found that there was “cause” under section 363(k) to limit a secured lender’s right to credit bid at an amount equal to the price it paid to acquire the debt in the secondary market.2 The United States District Court for the District of Delaware denied the lender’s appeal of that ruling.3
The Bankruptcy Court found that sufﬁcient “cause” existed to limit this essential secured creditor remedy of credit bidding merely on account of (i) a statement by a competing bidder that it would not bid unless the secured creditor’s right to credit bid was capped, (ii) a stipulation submitted by the debtor and the creditors’ committee speculating that limiting the secured creditor’s right to credit bid would likely foster a competitive bidding environment, and (iii) a stipulation by the debtor and the creditors’ committee arguing that the lender did not have a properly perfected lien over a material portion of the debtor’s assets. Importantly, even if the lender had a properly perfected lien, the court could have, and seemingly would have, reached the same conclusion. Id. at 9.
Underlying the Bankruptcy Court’s decision was its belief that the secured lender was attempting to “freeze out other suitors for the assets.” The Bankruptcy Court made this ﬁnding after the secured lender and the debtor failed to provide the Bankruptcy Court with a reasonable explanation as to why the sale of a non- operating business required such speed despite “repeated admonition that the timing” of the sale troubled the court.
On the surface, the Fisker decision is most threatening to distressed investors on account of the Bankruptcy Court’s use of the price paid for the debt as a proxy for the debt’s “allowed value” and the amount which the lender could credit bid its debt. This holding is at odds with the general maxim that secured creditors can bid the full face amount of their debt without regard to the price paid for the debt or the collateral’s actual value. For loan market participants, efforts by creditors’ committees to limit credit bid rights are not, however, new. In fact, bankruptcy courts have relied on section 363(k) to limit credit bid rights where parties have demonstrated legitimate concerns that (i) a secured lender did not properly perfect its lien or (ii) credit bidding would forestall a competitive auction process. What is most worrisome about Fisker is that the Bankruptcy Court found “cause” existed primarily based on a competing bidder’s statement that it would withhold its bid absent a signiﬁcant cap on the lender’s credit bid. If a self-interested statement by a competing bidder can establish cause under section 363(k) both creditors’ committees (by providing them with greater leverage over the sale process and negotiations concerning unsecured creditor recoveries) and strategic purchasers of collateral (that are paying cash and want to limit the amount of a potentially competing credit bid) are likely to become embolden to challenge secured creditor’s credit bid rights.
Although it is unclear if other courts will view Fisker as persuasive, Fisker underscores the importance of (i) proposing a sale process that a court will ﬁnd is likely to permit a fair and competitive bidding process notwithstanding the prospect of a credit bid and (ii) conducting a careful review of collateral to ensure that liens are properly perfected prior to undertaking a debt purchase.