The Logic and Limits of Credit Bidding by Secured Creditors Under the Bankruptcy Code

Abstract

Outside of bankruptcy, the right of a secured creditor to “credit bid” allows the secured creditor to compete with cash bids in foreclosure to assure that the secured creditor’s collateral is not sold for less than the secured creditor thinks it is worth. In reorganization cases under chapter 11 of the Bankruptcy Code, credit bidding performs a similar function: It insulates the secured creditor from being cashed out at a time of depressed asset values and protects the secured creditor from the risk of suffering a “bankruptcy discount,” which some assert can occur in connection with chapter 11 sales. While some have argued that credit bidding “chills” bidding by third parties by permitting the secured creditor to “overbid” with currency that may be of little or no value, this criticism seems misplaced. If the value of the collateral is less than the amount of the secured creditor’s claim, the secured creditor would not credit bid if it expected third parties to offer a fair price in the absence of a competing bid from the secured creditor and the secured creditor would be the one who would suffer if appropriately priced bids were deterred.

A circuit split – one of the most significant for secured creditors in recent years – has developed over whether the absolute priority rule as applied under the Bankruptcy Code requires that dissenting secured creditors be afforded the right to credit bid at a sale of their collateral pursuant to a chapter 11 plan of reorganization. The Third and Fifth Circuits, in the cases of In re Philadelphia Newspapers, LLC and In re Pacific Lumber Co., respectively, have taken the view that secured creditors may be precluded from credit bidding at a sale pursuant to a plan. The Seventh Circuit, in In re River Road Hotel Partners, LLC, recently took the opposite view. On December 12, 2011, the United States Supreme Court granted certiorari to resolve this issue.

This article first explores secured creditors’ rights to credit bid under state law, as well as pre-Code law supporting the right in bankruptcy of a secured creditor to credit bid. Next, the article considers case law addressing credit bidding under the Bankruptcy Code, including the rarely disturbed right to credit bid at sales conducted outside a reorganization plan pursuant to section 363 of the Bankruptcy Code and the interplay between sections 1111(b) and 1129(b)(2)(A) of the Bankruptcy Code in connection with sales of collateral under a plan. Finally, the conflicting circuit court opinions are reviewed in detail, and the proper interpretation of the absolute priority rule (the so-called “fair and equitable” test) in the context of a sale of collateral under a plan is considered.

Keywords: credit bidding, Bankruptcy Code, Chapter 11