On March 22, 2010, the United States Circuit Court of Appeals for the Third Circuit filed it opinion in In Re: Philadelphia Newspapers, LLC, et al. Case No. 09-44266. In that case, a Debtor who owned and operated newspapers and other assets specifically sought to have an auction of its assets and prevent secured creditors from credit bidding at the sale.
One of the tools commonly used by Debtors in Chapter 11 proceedings is a sale of their assets free and clear of liens and encumbrances. This generally allows the Debtor to auction its properties so that the assets can be repurposed, even if the Debtor’s liabilities exceed the value of its enterprise. The Section of the Bankruptcy Code allowing for such a sale is 11 U.S.C. § 363. Consequently, such sales are commonly known as “363 Sales”.
Congress, however, recognizing the potential for abuse in such sales specifically provided within Section 363 that creditors maintain the right to “credit bid” their debt to prevent collusive sales against the creditor’s interest. This right is embodied in § 363(k). Another effect of provisions of § 363(k) is that if it looks like the auction is going for too low of a price, and the secured creditor believes that it could sell the property later for more money, the secured creditor could come in, use its credit bid rights and prevent the artificially low sale.
In order to get around this rule, the Debtor in the Philadelphia Newspapers case decided to sell their assets pursuant to their Plan of Reorganization instead of via a § 363 Sale. They argued that because the auction through their Plan, they did not need to give the secured creditors their § 363(k) rights.
The Bankruptcy Court disagreed with the Debtor’s argument and gave the creditors the right to credit bid. However, the District Court and now U.S. Court of Appeals for the Third Circuit sided with the Debtor. The Third Circuit in reaching its decision relied upon U.S.C. § 1123(a)(5)(D) which allows the Debtor to sell property of the estate free and clear of liens and encumbrances in their Plan.
While this language does sound promising for the Debtor, it does not exist in a vacuum. This is because that a Plan that proposes such a sale may not be confirmed unless it also complies with the Plan Confirmation Rules contained in 11 U.S.C. § 1129. 11 U.S.C. § 1129(b)(2)(A) provides that the Plan may only be confirmed if, 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 the holders of the indubitable equivalent of such claims.
As such, it would seem that, according to the clear language of §1129(b)(2)(A)(ii) , any sale of the Debtor’s property in the Plan must, pursuant to the Plan, must preserve the Lender’s Credit Bid rights under § 363(k).
The Third Circuit, however, concentrated on the disjunctive word “or” at the end of (ii) which allows for the creditor to instead receive the “indubitable equivalent” of its claims. The Third Circuit decided that the Debtor could use this Subsection to provide that a Debtor could hold an auction and allow that auction serve to set the price for the creditor’s assets.
This would seem to allow precisely the type of collusive behavior that 11 U.S.C. § 363(k) was designed to prohibit. This could be devastating to the secured lender in a situation where an auction, for whatever reason, seems to be bringing significantly less than the true value of the property. Under the Third Circuit’s Rule, the creditor could be forced, unless it puts in additional new cash as its bid, to stand aside and watch while its collateral is liquidated for what the creditor believes is substantially less than its true value. Its lien would be gone and it would be left with only the insufficient proceeds.
As of this writing, requests for an en banc rehearing and appeal to the Supreme Court are still open to the creditors in the In Re: Philadelphia Newspapers. Further, while this decision is not yet precedential in the Seventh Circuit and does seem contrary to Congressional intent, it is of concern enough that secured lenders should take note of it in both structuring commercial credits from the outset and considering how they wish to proceed during the pendency of Chapter 11 cases.
Hopefully, this decision will be reversed by later appeal and/or not followed by other Circuits. Because the Third Circuit includes Delaware, the home of a significantly high percentage of Chapter 11 cases, until such a reversal, if any, this precedent will have significant ramifications.
Author: Andrew C. Ozete (bio)
Phone: 812.452.3582
email: aozete@bamberger.com
Tags: 363 Sales, Andrew C. Ozete, credit bidding, secured creditor