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As this economic downturn continues, so does a clear trend of bankruptcy law decisions unfavorable to secured creditors.  In case after case—including the Chrysler and General Growth Properties cases¹—the courts are trampling previously assumed, inviolate rights of secured creditors. That trend continued this week with the Third Circuit Court of Appeals' decision in In re Philadelphia Newspapers, LLC et al², which held that a secured creditor can be denied a credit bid in a sale of its collateral made under a bankruptcy plan. This ruling may make the bankruptcy process longer and more costly for secured creditors. 

Background

A debtor filed a reorganization plan that included an auction sale of its assets.  The  assets were encumbered by a security interest in favor of a creditor group. The auction procedures required that all bids be made in cash; credit bids were prohibited.  The debtor also embarked on a campaign of trying to favor a bid by a "local" group that included substantial current management involvement.

The Bankruptcy Court refused to approve auction procedures that did not include a credit bid right for the secured creditor group. It did, however, adjourn the proposed auction sale to permit the debtor to appeal to the District Court.

Reversing the Bankruptcy Court's decision, the District Court ruled that a debtor can sell its assets free and clear of a secured creditor's liens without affording a secured creditor the right to credit bid its debt at the sale.

The Third Circuit's Decision

The Third Circuit upheld the District Court ruling, noting that when a bankruptcy court is asked to confirm a reorganization plan over the secured creditor's objection, Section 1129(b)(2)(A) of the Bankruptcy Code provides the secured creditor with three alternative minimum sets of protections: 

• The retention of liens on the collateral, and payment of the collateral's present value, over a time period approved by the Bankruptcy Court (the "Lien Retention Prong");
  
  
• The sale of the assets free and clear of liens, subject to a secured creditor's credit bid right (the "Sale Prong"); or
  
  
• The provision for the secured creditor to realize the "indubitable equivalent" of the value of its claim (the "Indubitable Equivalence Prong"). 
  

The Third Circuit ruled (as the Fifth Circuit did in a case in the fall of 2009 titled In re Pacific Lumber, 584 F.3D 229 (5th Cir. 2009)³) that, so long as a plan proponent meets the requirements of the Indubitable Equivalence Prong, a sale of assets free and clear of liens need not occur exclusively under the Sale Prong (where the secured creditor's credit bid right is expressly preserved). 

The Third Circuit's ruling was not unanimous. The dissent argued that the Sale Prong requires a credit bid right, asserting that to allow a sale free and clear of liens without a credit bid right under the Indubitable Equivalence Prong undermines the specificity of the Sale Prong. But the majority held that, as long as the cash payment to the secured creditor is the realization of the indubitable equivalent of its secured claim, compliance with the Sale Prong is not needed, as the Indubitable Equivalence Prong is an equally available alternative for the plan proponent.

The Silver Lining

The court did provide some glimmers of hope for secured creditors.  First, it stated that its ruling addressed only the question of whether a debtor can sell assets, free and clear of liens, under a plan without providing a credit bid to the secured creditor. However, the court also stated that the Bankruptcy Court had not answered the question of whether—under the debtor's plan in Philadelphia Newspapers—the secured creditors' proposed treatment constituted the indubitable equivalent value of the secured creditors' secured claim. 

Second, the court noted that other grounds, available under Section 1129, for opposing plan confirmation remained open to the secured creditors.  However, the court did not state whether the requirement, that a plan be "fair and equitable" to a class of creditors that does not accept the plan, requires anything more the Indubitable Equivalence Prong.  Going forward, it remains to be seen whether a secured creditor will be able to successfully oppose—on the grounds that it is still not fair and equitable—the confirmation of a plan that satisfies the Indubitable Equivalence Prong. 

For more information on these issues or other lending & restructuring matters, please contact:

Gary Eisenberg at (973) 274-2055 or geisenberg@herrick.com

Copyright © 2010 Herrick, Feinstein LLP. Lending and Restructuring Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.

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¹ Click here to read an article on these cases in Commercial Lending Review by Herrick partner Stephen Selbst.
² --- F.3d ----, 2010 WL 1006647 (3rd Cir. 2010)
³ Click here to read our October 2009 Lending and Restructuring Alert, by Herrick partner Paul Rubin, which analyzes this case.