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The recently decided case of RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. ____ (2012), puts to rest a conflict among the Third, Fifth, and Seventh Circuits as to the right of secured creditors to credit bid at a proposed sale of their collateral under a plan of reorganization that the secured creditor opposes. The practice of credit bidding is codified in the Bankruptcy Code at 11 U.S.C. §363(k) and is the right of a secured creditor to bid the amount of its secured debt at a debtor’s sale of the creditor’s collateral in bankruptcy. If the secured creditor is the winning bidder, for an amount that does not exceed its secured debt, it will not have to put up cash to take possession of the collateral. This reduces the creditor’s secured claim by the amount bid, but also gives the secured creditor the right to prevent the sale of its collateral for a lower value. The secured creditor must therefore make a judgment as to the real value of its collateral when bidding. If the secured creditor does not bid, or bids and loses, it will get the cash paid by the winning bidder, up to the amount of its secured claim. The collateral will then pass to the winning bidder, free and clear of the secured creditor’s lien.

Credit bidding can play a critical role in the confirmation of a Chapter 11 reorganization plan, as well as in sales of assets. Most secured creditors assumed that their right to credit bid was preserved in a plan of reorganization that proposed to sell the secured creditor’s collateral as part of the plan. Under 11 U.S.C. §1129(b)(1), a plan cannot be confirmed over the negative vote of a class of secured creditors (a so-called “cram down”) unless the bankruptcy court determines that the plan’s treatment of the secured creditors is “fair and equitable.” 11 U.S.C. §1129(b)(2)(A) provides three disjunctive standards to be used in determining whether a plan is fair and equitable as to a dissenting class of secured creditors. The plan must provide that: (i) the creditor retains its lien in the property and receives cash payments over time; (ii) the debtor sells the creditor’s collateral, allows the creditor to credit bid at the sale per 11 U.S.C. §363(k), and attaches the creditor’s lien to any proceeds of sale; or (iii) the creditor receives the “indubitable equivalent” of its claim. RadLAX only deals with the issue of whether the “indubitable equivalent” standard in subsection (iii) overrides the application of the right to credit bid under subsection (ii).

Secured creditors assumed that their right to credit bid at a debtor’s sale of their collateral under a reorganization plan was preserved until the decisions in In re Pacific Lumber Co., 584 F.3d 229 (5th Cir. 2009) and In re Philadelphia Newspapers, 599 F.3d 298 (3d Cir. 2010). The Fifth and Third Circuits upheld lower court decisions permitting a debtor to bypass 11 U.S.C. §1129(b)(2)(A)(ii)’s credit bidding requirement and “cram down” a plan that proposed to sell the secured creditor’s collateral but did not allow the secured creditor to credit bid. The courts determined that if the secured creditor was to receive all of the sale proceeds under the plan, then the secured creditor would receive the “indubitable equivalent” of its claim. This opened a loophole through which debtors could sell collateral subject to a secured creditor’s lien without the secured creditor’s participation. Secured creditors were rightly concerned that, if upheld, these decisions would allow debtors to use the “cram down” provisions of 11 U.S.C. §1129(b)(2)(A)(iii) to avoid a credit bidding situation otherwise required under 11 U.S.C. §363(k) and 11 U.S.C. §1129(b)(2)(A)(ii).

The Seventh Circuit held, in the companion case to RadLAX, that 11 U.S.C. §1129(b)(2)(A) did not allow confirmation of a plan over a secured creditor’s negative vote if the plan excluded the secured creditor from credit bidding at the sale of its collateral. See River Road Hotel Partners, LLC. v. Amalgamated Bank, 651 F.3d 642 (2011)¹. This raised a conflict with the Third and Fifth Circuits, and the Supreme Court took the case.

The Supreme Court, in a unanimous 8-0 decision (one justice did not participate), held that a debtor seeking to confirm a plan of reorganization over the objection of a secured creditor cannot use 11 U.S.C. §1129(b)(2)(A)(iii) to circumvent the express requirements of 11 U.S.C. §§1129(b)(2)(A)(i)-(ii). The Court did not reach most of the policy arguments raised by the debtor and the secured creditor; however, in a telling footnote, Justice Scalia, writing for the unanimous court, gave his view on the merits of credit bidding and how it protects the federal government:

The ability to credit-bid helps to protect a creditor against the risk that its collateral will be sold at a depressed price. It 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. That right is particularly important for the Federal Government, which is frequently a secured creditor in bankruptcy and which often lacks appropriations authority to throw good money after bad in a cash-only bankruptcy auction.

RadLAX, 566 U.S. ___ (slip op., at 4 n.2).

The Court, in its finding in RadLAX, invoked the well-established “general/specific” canon of statutory construction; that is, when two subsections of a statute address a situation, the more specific one should govern. Here, subsections (ii) and (iii) of 11 U.S.C. §1129(b)(2)(A) both addressed the debtors’ inclusion of a sale of collateral as part of their proposed “cram down” plan at different levels of generality. However, subsection (ii) was the more specific one. The Court held that if the debtors could evade the requirements of 11 U.S.C. §1129(b)(2)(A)(ii) and force the sale upon their secured creditor exclusively through subsection (iii)’s broader language, subsection (ii) would be rendered meaningless. This would frustrate Congressional intent to “target specific problems with specific solutions.” RadLAX, 566 U.S. ___ (slip op., at 5) (quoting Varity Corp. v. Howe, 516 U.S. 489, 519 (1996) (Thomas, J, dissenting).

The Court’s relatively “easy” decision should put to rest this issue in future disputes over a secured creditor’s right to credit bid when a debtor proposes to “cram down” a reorganization plan that includes the sale of the secured creditor’s collateral. Debtors will now be forced to either negotiate with a secured creditor to obtain their approval of the plan, or allow the secured creditor to credit bid in any sale proposed by the plan.

¹ River Road was settled and the plan confirmed before the issue reached the Supreme Court, which left RadLAX as the only case to decide.

This advisory was prepared by the Commercial Finance and Workout, Restructuring and Bankruptcy practice groups at Nutter McClennen & Fish LLP. For more information, please contact your Nutter attorney at 617.439.2000.

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.