Ruling Protects Secured Creditors' Rights
When a Chapter 11 debtor proposes to sell secured assets prior to confirmation of a plan, it may not do so without providing its secured creditor with the right to "credit-bid" for the assets. 11 U.S.C. §363(k). "Credit-bid" in this context means bidding for the assets by a credit of up to the full amount of the secured creditor's claim, even when the value of its collateral is worth less, and notwithstanding the general rule in bankruptcy that an allowed secured claim is limited to that value.
The rationale for providing a secured creditor with the right to credit-bid is to enable it to protect against "the risk that its collateral will be sold at a depressed price." Radlax Gateway Hotel LLC v. Amalgamated Bank, 132 S. Ct. 2065, 2070 n. 2 (May 29, 2012). In other words, if the secured creditor believes its collateralized assets are being sold for too low a price, it can credit-bid for them and retain what it believes is their higher intrinsic value.
What remained unclear until recently, however, was whether the right to credit-bid can be denied to a secured creditor, over its objection, when its collateral is sold as part of a plan of reorganization. Compare In re Philadelphia Newspapers LLC, 599 F. 3d 298 (3d. Cir. 2010) (no credit-bid necessary); In re Pacific Lumber Co., 584 F. 3d. 229 (5th Cir. 2009) (same) with In re Radlax Gateway Hotel LLC, 651 F. 3d. 642 (7th Cir. 2011) (right to credit-bid cannot be denied under sale plan), aff'd 132 S. Ct. 2065 (May 29, 2012).
At issue in those cases was the proper construction of the so-called "cram-down" provisions of the Bankruptcy Code. "Cram-down" is the colloquial term for a bankruptcy court's approval of a plan which impairs the contractual or other rights of a class of creditors and is rejected by that class. The alternative ways in which a class of creditors may be "crammed down" are set forth in Bankruptcy Code §1129(b) under the broad standard of "fair and equitable" treatment to the dissenting class.
The theory espoused for withholding the right to credit-bid in the plan context was based on the last of three statutory alternatives for the cram-down of a secured creditor under a Chapter 11 plan, which says that a plan may be confirmed over objection if it provides the secured creditor with the "indubitable equivalent" of its secured claim. 11 U.S.C. §1129(b)(2)(A)(iii).
The thinking, as expressed in Philadelphia Newspaper, was that if the plan provided the secured creditor with the right to receive the proceeds of an auction sale, but not the right to credit-bid for the assets, that treatment would constitute the "indubitable equivalent" of its secured claim. Although the immediately preceding sub-section of the cram-down provisions, 11 U.S.C. §1129(b)(2)(A)(ii), directly addresses the sale of assets under a plan, providing that a secured creditor can be crammed down by an asset sale if it is given the right to credit bid under §363(k), courts relying on the "indubitable equivalent" theory reasoned that because the three cram-down alternatives are phrased in the disjunctive, they represent independent options for cram-down.
'Fair And Equitable'
In Radlax Gateway Hotel LLC v. Amalgamated Bank, 132 S.Ct. 2065 (May 29, 2012), the U.S. Supreme Court resolved the issue by holding that if a plan of reorganization provides for a sale of a secured creditor's collateral, it must afford an objecting secured creditor with the right to credit-bid for the assets in order to be "fair and equitable" and therefore confirmable.
Declining to address the various policy arguments that were made for and against credit-bidding, the Court relied on the "well established canon of statutory interpretation … that the specific governs the general." Thus, according to the Court, the "indubitable equivalent" standard, although broad enough to embrace an asset sale plan, could not trump the specific statutory section which provides that cram-down can be achieved by the sale of secured assets, subject to the secured creditor's right to credit-bid under §363(k).
The Supreme Court's ruling in Radlax harmonizes the law on the treatment of undersecured creditors in Chapter 11 in both sale and non-sale plans. In a plan that does not provide for a sale of assets, a secured creditor whose collateral is worth less than its debt cannot be forced to accept a cash payout of its allowed secured claim, which is set based on the value of its collateral, because of what is known as the "1111(b) election."
The 1111(b) election allows an undersecured creditor to treat the full amount of its claim as secured, even though its collateral is worth less, but it is not available for pre-confirmation sales or sales under a plan. 11 U.S.C. §1111(b)(1)(A)(ii). In a non-sale context, therefore, the 1111(b) election prevents a debtor from "cashing out" a secured creditor in an amount that is determined by the bankruptcy court to be the fair market value of its collateral.
Now, after Radlax, for asset sales under a plan the collateral of a secured creditor cannot be sold at a "market" price, leaving it to collect the net proceeds from the sale, without also giving it the option to purchase the assets by credit-bidding up to the full amount of its claim. This option serves a function similar to that served by the 1111(b) election, that is, protecting a secured creditor from being cashed out for the market value of its collateral. Insofar as secured creditors are concerned, the cram-down provisions of the Bankruptcy Code, however unappealing the thought of their use may be, are now in proper alignment.
Irve J. Goldman is a partner in the Bankruptcy and Creditors' Rights practice at Pullman & Comley LLC and has been certified by the American Board of Certification as a business bankruptcy specialist since 1993.