United States: In Re Philadelphia Newspapers: Potential Ramifications For Secured Lenders In Debt Restructurings

The Eastern District of Pennsylvania held that secured creditors do not have a right to credit bid their claim when the sale of a debtor's assets is conducted under a plan of reorganization.

On November 10, 2009, the U.S. District Court for the Eastern District of Pennsylvania in In re Philadelphia Newspapers, LLC, reversed a decision on appeal from the U.S. Bankruptcy Court for the Eastern District of Pennsylvania and held that a secured creditor did not have a right to credit bid its claim at a sale of a debtor's assets when such sale was conducted pursuant to a plan of reorganization. The district court's decision exposes a potential discrepancy in chapter 11 of the U.S. Bankruptcy Code, and, if affirmed by the U.S. Court of Appeals for the Third Circuit, may greatly affect the way debtors and lenders alike approach debt restructurings. As of the date hereof, the Third Circuit has issued a stay of the bankruptcy court's sale through December 15, 2009, which is the date the Third Circuit expects to hear oral argument on the appeal of the District Court's opinion.


Philadelphia Newspapers, LLC, and its related debtor-entities (the Debtors) filed for relief under chapter 11 of the Bankruptcy Code on February 22, 2009. The Debtors owed approximately $300 million to a group of senior lenders (the Lenders), which debt was secured by substantially all of the Debtors' assets. At the time of the Debtors' chapter 11 filing, the Lenders' collateral was valued by the Debtors at approximately $66 million. On August 20, 2009, the Debtors filed their disclosure statement and plan of reorganization (the Plan) which, among other things, bifurcated the Lenders' claim into a secured claim equal to the fair market value of the collateral and an unsecured deficiency claim equal to the difference between the fair market value of the collateral and the face amount of the debt, and proposed to sell substantially all of the Debtors' assets through a public auction. The Debtors intended to use the "cram down" provisions of section 1129(b) of the Bankruptcy Code to confirm the Plan over the objections of the Lenders. The Debtors argued that the Plan was confirmable because it proposed to provide the Lenders with the "indubitable equivalent" value of their secured claim by paying the Lenders cash in the amount of $36 million and transferring real property to the Lenders, the value of which was estimated at approximately $30 million.

In connection with the sale of all of their assets, the Debtors entered into an asset purchase agreement with Philly Papers, LLC, (the Stalking Horse Bidder) to purchase the Debtors' assets. According to the Plan, the Debtors' assets would be marketed, and the purchase price offered by the Stalking Horse Bidder would be subject to higher and better offers in accordance with certain bidding procedures (the Bidding Procedures). A key provision of the proposed Bidding Procedures prohibited the Lenders from credit bidding their debt as part of a bid for the Debtors' assets. The Lenders objected to the Bidding Procedures on the grounds that the restriction on their right to credit bid was not supported by the Bankruptcy Code.

The Bankruptcy Court's Ruling

At issue before the bankruptcy court was the Debtors' proposed Bidding Procedures, which prohibited the credit bidding of the Lender's claims, as is usually permitted under section 363(k) of the Bankruptcy Code, because the sale under the plan was not being conducted pursuant to section 363, but rather through sections 1123 and 1129, which do not contain an equivalent express right for a secured creditor to credit bid the face amount of its debt. The Debtors argued that sections 1123 and 1129 of the Bankruptcy Code, when read together, do not require that a secured creditor be allowed to credit bid its claim at an asset sale when such secured creditor will receive the "indubitable equivalent" value of its claim under section 1129 of the Bankruptcy Code. The intended result of the Debtors' proposed sale process was based on the Debtors' belief that a sale without a credit bid component would spur a more competitive bidding process. However, the impact of the Bidding Procedures was to reduce the Lenders' secured claim from the face amount of the debt to the current fair market value of the collateral securing such claim and to treat the remainder as an unsecured deficiency claim. As discussed above, the value of the collateral was roughly 22 percent of the face value of the debt.

The bankruptcy court disagreed with the Debtors' analysis and declined to approve the Bidding Procedures. The court reasoned that the Lenders, as undersecured creditors, were entitled to protect their investment by either credit bidding on the assets the full amount of their claim or making their "election" under section 1111(b) of the Bankruptcy Code, which allows an undersecured creditor to elect to have its entire claim treated as a secured claim if the loan the secured lender extended is a non-recourse loan. However, because the Lenders held recourse loans, they did not qualify for the section 1111(b) election. The bankruptcy court thus emphasized that secured creditors must be able to exercise one of the two protections mentioned above, as provided under the Bankruptcy Code. As a result, the bankruptcy court refused to approve the Bidding Procedures because they did not allow for the Lenders to credit bid their debt in the sale under the Plan.

The District Court's Ruling

The district court reversed the bankruptcy court's ruling and held that, when an asset sale is conducted under a plan of reorganization pursuant to sections 1123 and 1129 (and not pursuant to section 363) and the secured creditor is to be paid the "indubitable equivalent" value of its claim, a debtor can deny the secured creditor the right to credit bid the amount of its debt to purchase the debtor's assets. The district court reasoned that, unlike section 363, sections 1123 and 1129 do not afford secured lenders the express right to credit bid, and the plain meaning of section 1129 indicates that a secured creditor should not be entitled to credit bid when it receives the "indubitable equivalent" value of its claim. The district court noted, however, that it was not making a determination that the Lenders were in fact receiving the "indubitable equivalent" value of their claim under the Plan, but merely that the Lenders' ability to credit bid could be limited.

The district court's ruling was appealed by the Lenders to the Third Circuit, which has granted a stay of the order approving the Bidding Procedures until it can hold a hearing on the merits, which is scheduled on December 15, 2009.


If the district court's ruling is affirmed on appeal by the Third Circuit, this decision will have a significant impact on the way borrowers and lenders negotiate out-of-court workouts and restructurings and the way debtors structure their chapter 11 cases. Based upon the district court's opinion, a debtor can now structure an asset sale to prohibit its secured creditor from credit bidding on the debtor's assets if the sale is conducted pursuant to a plan of reorganization and the debtor intends to provide the secured creditor the "indubitable equivalent" value of its secured claim. While it is too early to tell what the true impact of this decision will be, it appears that a strategic door has opened for borrowers that are in distress—a door that lenders will likely seek to shut and lock.

Nava Hazan and Jared Zajac were also principal authors of this On the Subject.

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.

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