Even after the U.S. Supreme Court in RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012), pronounced in no uncertain terms that a secured creditor must be given the right to "credit bid" its claim in a bankruptcy sale of its collateral, the controversy over restrictions on credit bidding continues in the courts. A ruling recently handed down by the Fifth Circuit Court of Appeals has added a new wrinkle to the debate. In Baker Hughes Oilfield Operations, Inc. v. Morton (In re R.L. Adkins Corp.), 2015 BL 116996 (5th Cir. Apr. 23, 2015), the Fifth Circuit held that an undersecured creditor which elected to have its claim treated as fully secured under section 1111(b) of the Bankruptcy Code, yet failed to obtain a pre-confirmation ruling on the election or to object to confirmation of a plan providing for the sale of its collateral under section 363(b), was not impermissibly stripped of the right to credit bid its secured claim in connection with the sale.
Credit Bidding Under the Bankruptcy Code
Section 363(k) of the Bankruptcy Code provides that a creditor
with a lien on assets to be sold outside the ordinary course of
business under section 363(b) may "credit bid" its
secured claim at the sale, "unless the court for cause orders
otherwise." A credit bid is an offset of a secured claim
against the property's purchase price. The U.S. Supreme Court
explained in RadLAX, 132 S. Ct. at 2070 n.2, that
"[t]he ability to credit-bid helps to protect a creditor
against the risk that its collateral will be sold at a depressed
price" and "[i]t enables the creditor to purchase the
collateral for what it considers the fair market price (up to the
amount of its security interest) without committing additional cash
to protect the loan."
The Supreme Court ruled in RadLAX that, pursuant to
section 1129(b)(2)(A)(ii) of the Bankruptcy Code, although the
right to credit bid is not absolute, a nonconsensual, or "cram
down," chapter 11 plan providing for the sale of encumbered
property free and clear of a creditor's lien cannot be
confirmed without affording the creditor the right to credit bid
for the property.
In the aftermath of RadLAX, the debate shifted largely to
the circumstances that constitute "cause" under section
363(k) to prohibit or limit a secured creditor's right to
credit bid its claim. For example, in In re Fisker Automotive
Holdings, Inc., 510 B.R. 55 (Bankr. D. Del. 2014), leave
to app. denied, 2014 BL 33749 (D. Del. Feb. 7, 2014),
cert. denied, 2014 BL 37766 (D. Del. Feb. 12, 2014), the
court limited the amount of a credit bid to the discounted purchase
price actually paid to purchase the debt because, among other
things, the court concluded that an unrestricted credit bid would
chill bidding.
In In re The Free Lance-Star Publishing Co., 512 B.R. 798
(Bankr. E.D. Va.), leave to appeal denied sub nom. DSP
Acquisition, LLC v. Free Lance-Star Publishing Co., 512 B.R.
808 (E.D. Va. 2014), the court found "cause" under
section 363(k) to limit a credit bid by an entity that purchased
$39 million in face amount of debt with the intention of acquiring
ownership of the debtor's assets. The court limited the credit
bid because: (i) the creditor's liens on a portion of the
assets to be sold had been improperly perfected; (ii) the creditor
engaged in inequitable conduct by forcing the debtor into
bankruptcy and an expedited section 363 sale process in pursuing an
obvious identified "loan to own" strategy; and (iii) the
creditor actively frustrated the competitive bidding process and
attempted to depress the sale price of the assets.
Finally, the court in In re Charles Street African Methodist
Episcopal Church of Boston, 510 B.R. 453 (Bankr. D. Mass.
2014), denied in part a chapter 11 debtor's motion to limit a
credit bid on the basis that the secured creditor's claims were
subject to bona fide dispute. In that case, the debtor had filed
counterclaims against the creditor that, by way of setoff, could
have reduced the amount of the claims to zero. In finding that
"cause" was lacking under section 363(k), the court
explained that: (i) despite the debtor's counterclaims, which
did not relate to the validity of the secured creditor's claims
or liens, the claims were "allowed" (a designation that
the debtor did not dispute); and (ii) the entire amount of the
claims was not likely to be used in a credit bid for the
assets.
Protection of Undersecured Creditors
Pursuant to Section 1111(b)
Section 1111(b)(1) of the Bankruptcy Code provides that a
secured claim will be treated as a recourse claim even if the
creditor does not actually have recourse to the debtor by contract
or under applicable state law, unless: (i) the creditor (or the
class of which the creditor is a part) makes an election to have
its claim treated as fully secured under section 1111(b)(2); or
(ii) the creditor does not have recourse and the property securing
its lien "is sold under section 363 of [the Bankruptcy Code]
or is to be sold under the plan." Thus, absent a section
1111(b) election or a sale of collateral, an undersecured
nonrecourse creditor will have a secured claim to the extent of the
value of its collateral and an unsecured claim for any
deficiency.
The section 1111(b) election is intended to protect a secured
creditor against the possibility that the debtor can realize a
windfall if collateral, not being sold by the debtor, is assigned a
low value (due to depressed market conditions or valuation error)
and the creditor's secured claim is stripped down to that low
value.
However, section 1111(b)(1)(B) provides that the election is not
available if, among other things, the creditor has recourse against
the debtor and the collateral "is sold under section 363 of
[the Bankruptcy Code] or is to be sold under [a chapter 11]
plan." The exception for collateral that is sold is premised
upon the idea that protection against low valuation is not
necessary when the market determines the value of the collateral.
Moreover, creditors do not need the protections of section 1111(b)
if the collateral is sold because they have the right under section
363(k) to credit bid at the sale.
In Adkins, the Fifth Circuit considered whether a
materialman's lien creditor that elected to have its claim
treated as fully secured under section 1111(b)(2) was impermissibly
denied the right to credit bid its claim in connection with the
sale of its collateral under a nonconsensual chapter 11 plan.
Adkins
Baker Hughes Oilfield Operations, Inc. ("Baker
Hughes") and certain other oil and gas service companies filed
an involuntary chapter 7 petition against Sweetwater, Texas-based
drilling company R.L. Adkins Corp. ("Adkins") in the
Northern District of Texas in July 2011. The case was converted to
chapter 11 one month afterward. The court later appointed a chapter
11 trustee to administer Adkins' estate.
Potential purchaser Scott Oils, Inc. ("Scott") proposed a
chapter 11 plan for Adkins at the end of 2012 under which Adkins,
"pursuant to Bankruptcy Code Section 363," would sell its
mineral properties to Scott in a private bulk sale for $3.4
million. The plan recognized that Baker Hughes had a lien on four
mineral leases and one well as security for claims aggregating
approximately $320,000, but that Baker Hughes' claims were
secured only to the extent of $39,000 because the property was of
insufficient value and other creditors had more senior liens on the
collateral.
On March 4, 2013, Baker Hughes filed an election with the court
under section 1111(b) to have its claims treated as fully secured.
Scott filed a response on March 28 in which it stated that section
1111(b)(1)(B)(ii) precludes such an election where the collateral
is sold under section 363 or is to be sold under a chapter 11
plan.
The bankruptcy court confirmed the chapter 11 plan on May 13, 2013,
after several days of confirmation hearings. Baker Hughes cast a
ballot rejecting the plan. However, Baker Hughes did not otherwise
participate in any way in the confirmation proceedings, nor did it
appeal the confirmation order.
On July 3, 2013, the bankruptcy court issued an order denying Baker
Hughes' election of fully secured status under section 1111(b).
In its order invalidating Baker Hughes' election because the
collateral securing its claims was sold "pursuant to §
363 of the Bankruptcy Code," the court stated:
Baker Hughes . . . construe[s] the Plan's failure to specifically reference [its] right[] to make [a] credit bid[] to somehow validate [its] § 1111(b) election[] and thus require payment of [its] allowed claim[] in full. The Court does not so construe the Plan's effect under the circumstances here. Baker Hughes . . . did make an election; [it] elected not to credit bid. [It] held such right under § 363 of the Bankruptcy Code, not under § 1111(b) of the Bankruptcy Code.
The U.S. District Court for the Northern District of Texas
affirmed that ruling, and Baker Hughes appealed to the Fifth
Circuit.
The Fifth Circuit's Ruling
The Fifth Circuit affirmed the rulings below. In the majority
opinion, the court rejected Baker Hughes' argument that either
the section 1111(b) election should have been approved or Baker
Hughes should have been given the chance to credit bid.
According to the majority, Baker Hughes "never sought a credit
bid" and "[a]ny uncertainty Baker Hughes had about the
meaning of the Plan, and whether it had been denied the right to
credit bid, could have been easily resolved at the hearing on
confirmation or by objection or even appeal." Because the plan
provided for the sale under section 363 of property securing Baker
Hughes' claim, the court held that the lower courts had
properly denied the section 1111(b) election.
In a concurring opinion, circuit judge Judith H. Jones wrote that
"[t]he argument that Baker Hughes waived its § 1111(b)
election by failing to pursue it at the confirmation hearing is
persuasive." However, she continued, "[t]he majority
unwisely steps beyond this narrow holding . . . when they appear to
conclude that the bulk sale of the debtor's assets, which
occurred outside a public auction and included multiple assets
burdened by multiple liens, nevertheless protected a secured
creditor's right to credit bid."
According to Judge Jones, merely because the plan and confirmation
order "perfunctorily incant[ed]" section 363 does not
mean that the creditor's right to credit bid was adequately
protected. Section 1111(b), she explained, "offers no guidance
as to what constitutes a sale 'under § 363' or
'under the plan.' " Judge Jones then detailed several
hypothetical situations in which a debtor's assets could be
sold in a single blanket sale transaction that could make it
difficult for creditors with liens on discrete assets to exercise
their credit bidding rights.
Judge Jones delineated three points to "assure proper
development of the creditors' statutory protections": (i)
the court must rule on a timely asserted section 1111(b) election
prior to a plan confirmation hearing; (ii) a secured creditor
should be allowed to make a section 1111(b) election if the terms
of a sale are "found wanting in protection of its credit bid
rights"; and (iii) "mindful that RadLAX as well
as § 363(k) mandate the availability of credit bidding,"
the court should order "transparent, broadly publicized
auction[s] of debtors' assets that test the market for
valuations as well as secured creditors' sincerity about credit
bidding."
Outlook
Adkins is an unusual case, but it does not appear to
represent a significant development in bankruptcy jurisprudence
concerning a secured creditor's right to credit bid its claim
in a sale of collateral under section 363 or a chapter 11 plan. The
message borne by the ruling is a cautionary missive regarding the
consequences of a creditor's failure to participate in the
bankruptcy process. By neglecting to file a specific objection to
(or to appeal) confirmation of a plan that provided for the sale of
its collateral, the creditor in Adkins was deemed to have
waived its right to credit bid. Presumably, Baker Hughes elected
not to object on this basis because it had no intention of
submitting a credit bid—had it done so, Baker Hughes would
have been obligated to pay off more senior liens on the collateral
in connection with credit bidding its debt.
The more interesting aspects of Adkins arguably lie in the
concurring opinion. Judge Jones made much of the bankruptcy
court's failure to issue a ruling on the validity of Baker
Hughes' section 1111(b) election before confirming Adkins'
chapter 11 plan. However, the court's failure to make such a
straightforward ruling is somewhat surprising. Because the plan
proposed for Adkins contemplated the sale of Baker Hughes'
collateral, section 1111(b) expressly barred Baker Hughes from
making an election.
Judge Jones criticized the majority for implying that
"attaching the statutory labels to a debtor's proposed
collateral sale is enough to deprive a recourse secured creditor
like Baker Hughes of the § 1111(b) election." After
positing various scenarios in which a secured creditor's credit
bidding right might be abridged, she wrote that "§
1111(b) itself offers no guidance as to what constitutes a sale
'under § 363' or 'under the plan.' " She
concluded that "[a]ll of these [scenarios] could contradict
the mutually reinforcing goals of §§ 363(k), 1111(b) and
1129(b)(2)(A) to protect secured creditors from the risk of
erroneous judicial property valuations."
Although this approach might have some logical appeal as a policy
matter, it is not required by the express terms of section 1111(b).
The election exception set forth in the provision does not mandate
that a secured creditor's right to credit bid be realistic or
efficacious under the circumstances. It requires only that the
collateral be sold under section 363(b) or a plan.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.