On June 28, 2011, the United States Court of Appeals for the Seventh Circuit became the latest circuit to weigh in on the hotly contested question of whether a debtor can deny a secured creditor the right to credit bid as part of a Chapter 11 plan providing for the sale of assets encumbered by the secured creditor's liens. In In re River Road Hotel Partners, LLC,1 the Seventh Circuit upheld the right of secured creditors to credit bid, a decision that runs directly contrary to recent opinions in the Third and Fifth Circuits. The River Road decision is a significant victory for secured creditors, one that calls attention to this high-profile circuit split over the right to credit bid in an asset sale under a Chapter 11 plan.
Background
Credit bidding refers to the ability of a secured creditor to
apply up to the full amount owed to that creditor as a bid in
connection with an auction and sale of collateral encumbered by its
liens. Credit bidding provides secured creditors with the option of
taking possession of collateral rather than accepting sale proceeds
from that collateral, a flexibility that may be especially crucial
in the context of a severely distressed market environment, in
which sale prices often fail to reflect the real or expected future
value of collateral.
In a Chapter 11 case, sales of the debtor's property outside of
the ordinary course of business are conducted through either a sale
under section 363 of the Bankruptcy Code, or pursuant to a plan of
reorganization. Under section 363(k), a secured creditor has the
express right to credit bid in connection with a section 363 sale
of the secured creditor's liens.2 However, two
recent opinions in the Third and Fifth Circuits have held that a
secured creditor does not have the right to credit bid in the case
of sales conducted under a Chapter 11 plan. In In re
Philadelphia Newspapers, LLC, (Third Circuit)3 and
In re Pacific Lumber Co. (Fifth Circuit),4 the
Third and Fifth Circuits held that a Chapter 11 debtor may sell its
property free and clear of a secured creditor's liens without
being required to provide the secured creditor with the right to
credit bid.
Section 1129 of the Bankruptcy Code sets forth the requirements for
Chapter 11 plan confirmation. Among these requirements, in the
event that a class of impaired secured creditors votes to reject a
plan,5 a Chapter 11 debtor must satisfy the "fair
and equitable" provisions of section 1129(b)(2)(A) to obtain
plan confirmation. Section 1129(b)(2)(A) sets forth three
alternative methods for meeting the "fair and equitable"
requirement with respect to a secured creditor: (i) a secured
creditor must retain its liens, whether or not its collateral is
sold; (ii) if the secured collateral is sold free and clear of the
secured creditor's liens, the sale must be subject to section
363(k) (which provides the right of the secured creditor to credit
bid); or (iii) the plan provides the secured creditor with the
"indubitable equivalent" of its secured
claim.6
At issue in River Road and in the Third and Fifth Circuit
cases before it, was whether a plan can be confirmed that provides
for the sale of collateral without allowing a secured creditor to
credit bid its claim by relying upon the third prong of the
"fair and equitable" standard, the "indubitable
equivalent" test, even though the text of the second prong
expressly refers to a sale of a secured creditor's collateral
and the third "indubitable equivalent" prong does
not.
In re River Road Hotel Partners, LLC
The debtors in River Road owned and operated the
InterContinental Chicago O'Hare Hotel and affiliated space and
the Radisson Hotel at Los Angeles International Airport. In order
to finance the construction of the hotels, the debtors borrowed a
combined amount of nearly $300 million from lenders. As part of
their Chapter 11 plans, the debtors sought to sell substantially
all of their assets, including the hotel projects, free and clear
of the secured creditors' liens. Amalgamated Bank, in its
capacity as agent, objected to the debtors' bid procedures,
arguing that they impermissibly denied the secured creditors the
right to credit bid. In reply, the debtors relied on the
Philadelphia Newspapers and Pacific Lumber cases,
arguing that the debtors' plans were confirmable because they
satisfied section 1129, including the "fair and
equitable" standard of 1129(b)(2)(A), because the debtors'
plans provided the secured creditors with the "indubitable
equivalent" of their secured claims by virtue of the
allocation of sale proceeds to the secured creditors.
The Bankruptcy Court rejected the debtors' argument, holding
that the debtors could not sell their assets free and clear of the
creditors' liens under the "indubitable equivalent"
prong of section 1129(b)(2)(A). Rather, any plan sale of the
secured creditors' collateral was required to satisfy section
1129(b)(2)(A)(ii), which provides that secured creditors have the
right to credit bid under section 363(k). The debtors appealed the
Bankruptcy Court's decision to the Seventh Circuit.
The Seventh Circuit Opinion
The Seventh Circuit affirmed the Bankruptcy Court's decision
and declined to follow Philadelphia Newspapers and
Pacific Lumber, holding that where a plan called for the
sale of encumbered property free and clear of all liens, and where
the "fair and equitable" standard must be satisfied, the
requirements of subsection (ii) of section 1129(b)(2)(A) must be
met.
Drawing from Circuit Judge Ambro's dissent in Philadelphia
Newspapers, the court found that reliance solely upon
subsection (iii) (the "indubitable equivalent" test) in a
sale context would render subsection (ii) superfluous, and would
therefore violate "a cardinal rule of statutory
construction."7 Thus, the "infinitely more
plausible interpretation of Section 1129(b)(2)(A)" would
interpret each of the subsections as "conclusively
governing" the category of proceedings addressed by that
subsection.8 Under the Seventh Circuit's reading of
the statutory text, subsection (iii) would only apply where a
Chapter 11 plan "proposed disposing of assets in ways that are
not described in [s]ubsections (i) and (ii)."9
Accordingly, where a Chapter 11 plan provided for the sale of
encumbered collateral free and clear of all liens, and where
secured creditors voted to reject the plan, subsection (ii) of the
"fair and equitable" test of section 1129(b)(2)(A) must
apply, and secured creditors must therefore have the right to
credit bid.
The court further supported its decision by emphasizing the dubious
protections provided by the "indubitable equivalent," an
undefined term that if used as the debtors intended, could actually
deny creditors a "crucial check against undervaluation"
in the sale process.10 Such a statutory application
would also run counter to the extensive statutory protections
afforded to secured creditors in other areas of the Bankruptcy
Code.
Implications of River Road
The Seventh Circuit's decision is significant in that it
represents a strong counter to the decisions of the Third and Fifth
Circuits. Furthermore, in the context of restructuring negotiations
outside of the Third and Fifth Circuits, secured creditors can now
make a stronger case for requiring credit bidding rights in a sale
of their collateral under a Chapter 11 plan. Indeed, the emerging
high-profile split in the circuits over this core right of secured
creditors will likely require an ultimate resolution before the
United States Supreme Court.
Footnotes
1 In re River Road Hotel Partners, LLC, Case No.
10-3597 (7th Cir. June 28, 2011). Attorneys from Katten Muchin
Rosenman LLP, Morrison Foerster LLP and Wildman, Harrold, Allen
& Dixon LLP led the effort for the victorious secured creditors
in the case.
2 Section 363(k) provides, "[a]t a sale under subsection (b)
of this section of property that is subject to a lien that secures
an allowed claim, 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." 11 U.S.C.
§363(k).
3 In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d
Cir. 2010). For more information, see the
Katten Client Advisory regarding Philadelphia
Newspapers.
4 Bank of N.Y. Trust Co., N.A. v. Official Unsecured
Creditors' Comm. (In re Pacific Lumber Co.), 584 F.3d 229
(5th Cir. 2009).
5 Generally, a class of secured creditors would vote to reject a
plan that provided for the sale of encumbered property yet denied
the creditors the right to credit bid on that property.
6 11 U.S.C. § 1129(b)(2)(A).
7 In re River Road Hotel Partners, LLC, Case No. 10-3597
at 21 (7th Cir. June 28, 2011).
8 Id. at 23.
9 Id.
10 Id. at 20
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