The United States Court of Appeals for the Third Circuit has ruled that a Chapter 11 debtor may forbid secured creditors from entering credit bids at a sale under a plan of reorganization, upending what many had viewed as settled doctrine to the contrary. In re: Philadelphia Newspapers, LLC, et al., No.09-4266 (3rd Cir. March 22, 2010)(available at the Third Circuit website, www.ca3.uscourts.gov, under Recent Precedential Opinions).
The Chapter 11 case of the publishers of The Philadelphia Inquirer, Daily News, and philly.com (the "Debtors"), pending since February 2009 in the United States Bankruptcy Court in Philadelphia, has been quite contentious. More than $300 million in senior secured debt held by a syndicate of lenders (the "Secured Creditors") has been in default since 2007. In August 2009, the Debtors proposed a joint plan of reorganization (the "Plan") providing for the sale at auction of substantially all of the Debtors' assets free and clear of all liens to a "stalking horse" bidder funded by entities connected with case insiders and others. The auction procedures sought by the Debtors prohibited the Secured Creditors from credit bidding (that is, bidding their claim amount rather than cash) at the sale. The Bankruptcy Court refused to allow this, but on appeal the District Court reversed, allowing the prohibition on credit bidding to stand. On further appeal, a divided Third Circuit panel of three judges affirmed the District Court.
The Third Circuit Majority Holding
The core issue of the case involves the secured creditor "cramdown" provisions of Section 1129(b)(2)(A) of the Bankruptcy Code, which sets forth the methods that a debtor can use to confirm a plan despite the plan's rejection by secured creditors. One method, in which the lender retains its liens on the assets regardless of any transfer of ownership (and where the fight is usually over the interest rate and length of term of the debt), was not involved here. The other two methods were the focus of the dispute, and the issue was whether the prong of the subsection allowing a secured creditor to receive the "indubitable equivalent" of its claim could stand on its own and allow the Debtors to prohibit credit bidding in a sale free and clear of liens. The Secured Creditors argued that it could not and that a third "cramdown" method, a sale free and clear of liens in which credit bidding is expressly recognized, was the only means the Debtors could use. The Third Circuit majority rejected this argument, finding that since the statutory text joined the methods with an "or," each of them was a nonexclusive means to confirm a plan.
The majority also held that "indubitable equivalent" is not an ambiguous phrase and did not need to be read in the context of other Bankruptcy Code provisions. The majority further emphasized that the case on appeal pertained only to the approval of the bidding procedures proposed in the Plan, holding only that an auction sale under a plan that prohibited credit bidding but still could be shown to produce the indubitable equivalent could theoretically still be considered proper for purposes of plan confirmation.
In a lengthy (and, to many bankruptcy practitioners, highly persuasive) dissent, Circuit Judge Thomas Ambro contended that the "indubitable equivalent" prong of the statute was ambiguous and did not work to make a plan with a sale free and clear of liens, and no credit bidding, confirmable. In his view, the specific terms of the sale free and clear provision, especially when considered in the context of statutory canons of construction and other provisions of the Bankruptcy Code, applied here, and credit bidding should have been allowed.
The Debtors' victory in this case was short-lived. Just over a month later, the auction sale took place and a group of some, but not all, of the Secured Creditors submitted a winning all-cash bid for the Debtors' assets, outbidding the "stalking horse" group and a third group. Assuming confirmation of the Secured Creditors' plan, which should take place in June, the Debtors' present management will be gone.
Whatever its shortcomings, the majority opinion in Philadelphia Newspapers is a precedential decision that binds all bankruptcy courts in Pennsylvania, New Jersey, and Delaware. Review of this issue by the United States Supreme Court is not likely until another circuit court of appeals rules the other way, creating a conflict among the circuits. A Supreme Court decision on this point could be years away.
Writing Around the Result
For many lenders, the central issue now is whether they can "write around" the Philadelphia Newspapers result by putting provisions in their loan documents that keep credit bidding rights inviolate. There is no clear answer to this. To begin with, the credit bidding right in free and clear sales under Section 363(k) of the Bankruptcy Code is not absolute, as both the majority and the dissent in Philadelphia Newspapers recognized. Instead, the statute provides that credit bidding is allowed "unless the court for cause orders otherwise," and there is a hint (but not a holding) in the majority opinion that the burden of establishing "cause" may not be as formidable as many have thought.
Nevertheless, lenders should consider including credit bidding protections in their loan documents early and often. An established course of dealing between a lender and borrower on this point may prove helpful to a lender seeking to enforce it in a bankruptcy proceeding, but there can be no assurance that it will be dispositive. And although the prospects for enforcement of such a provision in a post-petition financing contract are somewhat better, lenders should not assume that a provision that was "not the deal" in the past will pass muster with an energetic committee of unsecured creditors, or for that matter the bankruptcy court.
McCarter & English lawyers have decades of experience in representing secured and unsecured creditors, trustees, purchasers of assets in bankruptcy sales, and others whose claims and interests are affected by the bankruptcy laws, rules, and processes. If you or your businesses are facing bankruptcy issues, please call us. More information about our bankruptcy and restructuring practice is available at www.mccarter.com.
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