Tuesday, June 5, 2012

Supreme Court Upholds Right to Credit Bid in Cramdowns

In what Justice Scalia termed “an easy case,” the United States Supreme Court has ruled 8-0 that a debtor cannot strip a secured creditor’s right to credit bid under 11 U.S.C. § 1129(b)(2)(A)(ii).  RadLAX Gateway Hotel, LLC, et al. v. Amalgamated Bank, NO. 11-166. The Court granted certiorari in this case to resolve a split in the circuits between the Seventh Circuit, on one hand, and the Third and Fifth Circuits, on the other, as to the ability of a debtor to prevent a secured creditor from credit bidding at a sale pursuant to a plan of reorganization. 

Under clause (i) of 11 U.S.C. § 1129(b)(2)(A), the secured lender retains its lien on its collateral and receives deferred cash payments.  Clause (ii) provides for the sale of the collateral free and clear of a security interest so long as the secured creditor can credit bid at the sale.  Clause (iii), on the other hand, provides for confirmation so long as the secured creditor receives the “indubitable equivalent.”

The Seventh Circuit had held that a debtor could not use clause (iii) to avoid the credit bidding requirements found in clause (ii).  In RadLAX, the debtor sought to confirm its plan through a sale to an insider group for an amount substantially below the secured lender’s debt.  RadLAX Gateway Hotel, LLC, et al. v. Amalgamated Bank, 651 F.3d 642 (7th Cir. 2011).  To achieve its cramdown, the debtor refused to allow the secured lender to credit bid its debt and proposed that the cash proceeds from the sale would constitute the “indubitable equivalent” and,  therefore, would satisfy 11 U.S.C. § 1129(b)(2)(A).  The bankruptcy court denied confirmation and the Seventh Circuit affirmed the denial.

The Third and Fifth Circuits on the other hand had previously held a debtor may strip a secured creditor of its ability to credit bid at a sale by using clause (iii) and providing the creditor with the indubitable equivalent.  In the Third Circuit case, In re Philadelphia Newspapers, 599 F.3d 298 (3rd Cir. 2010), the debtors sought to sell the assets of the company to a group consisting of insiders. The secured lenders were to receive cash, the company headquarters, and any cash above the insiders’ bid.  The plan did not allow the secured lenders to credit bid and forced any bid to be made with cash.  The Third Circuit held that by providing the secured creditor with the indubitable equivalent under clause (iii) the debtor satisfied 11 U.S.C § 1129(b)(2)(A) and, therefore, the plan could be confirmed.

The Fifth Circuit case, In re Pacific Lumber Co., 584 F.3d 229 (5th Cir. 2009), shared similar themes to Philadelphia Newspapers. There a competitor of the debtor and one of debtor’s secured lenders filed a competing plan that allowed the competitor and the secured lender to take over the debtor by purchasing its assets in exchange for cash and the conversion of debt.  However, the plan did not allow other secured creditors to credit bid on the assets.  The court in Pacific Lumber approved the sale and held the other secured creditors could not demonstrate that clause (ii) exclusively applied to the transaction.  Accordingly, the court held that clause (iii) could be used to cramdown the other lenders.

Against this backdrop, the Supreme Court affirmed the Seventh Circuit’s decision in RadLAX, effectively overturning Philadelphia Newspapers and Pacific Lumber. Justice Scalia authored the unanimous opinion and, in typical Justice Scalia fashion, was rather blunt in dismissing the debtor’s arguments.  The Court flatly rejected all of the debtor’s arguments regarding the interpretation of 11 U.S.C. § 1129(b)(2)(A) and when credit bidding must be allowed.  The Court stated the debtor’s interpretation of 11 U.S.C. § 1129(b)(2)(A) was hyperliteral and contrary to common sense.

 The Court seized on what it termed the specific/general canon of statutory interpretation and held that where, as here, a specific provision of a statute is precisely applicable, a general provision cannot prevent the application of the specific provision.  According to the Court, the debtor was attempting to do precisely what clause (ii) prevented – a sale without the right to credit bid.  Therefore, the debtor could not use the more general provisions of clause (iii) to get around the specific requirements set forth by Congress.

The Court’s opinion provides clarity to an issue that, as noted above, had divided the Circuits.  The opinion, however, does not appear to be a major upheaval but rather seems to confirm what most lenders and debtors had come to expect regarding credit bidding and the cramdown process.  While it will clearly impact debtors in the Third and Fifth Circuits, the rest of the country will likely see this more as clarifying issues than raising new ones.

Fennemore Craig, P.C.

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