Distressed assets investors may well breathe a sigh of relief, now that the U.S. Supreme Court has affirmed the right of secured creditors to “credit bid,” in other words to offer back to the debtor what they are owed rather than a cash payment, at an asset auction.
The significance of the right to credit bid is that it protects creditors against the threat that their collateral will be sold at a depressed price. This is a perfectly appropriate safeguard, and key parts of corporate bankruptcy law in the U.S. were clearly drafted with this thought in mind. Unfortunately, careless drafting by Congress and (thirty years later) a hyper-literalist reading by two appellate courts put that safeguard in jeopardy.
The Supreme Court has set this right in RadLAX Gateway v. Amalgamated Bank (2012).
The key statutory language appears in section 1129 of the bankruptcy code, the section that lays out the conditions under which a court is to confirm a reorganization plan for a company in chapter 11. Section 1129(a) gives us the best-case conditions, including 1129(a)(8), which requires that every class of claims must either accept have accepted the plan or be found not to have been impaired by the plan.
But section 1129(b) gives exceptions to that, allowing for a so-called ‘cram-down’ when the conditions of (a)(8) can not be met.
This leads us to section 1129(b)(2)(A) which requires that any cram-down plan must provide for the disposition of those properties in the bankrupt estate that are subject to liens, and which sets out three distinct ways in which this can be accomplished: the retention of liens and deferral of cash payments; a free and clear sale of the secured creditors’ collateral at auction, allowing for credit bidding as under section 363(k); or “the realization by such [lien] holders of the indubitable equivalent of such claims.”
It is this “indubitable equivalent” language in the third prong there that has been causing confusion. What is the equivalent of the protection that credit bidding offers? Does the third prong refer to some unspecified non-auction handling of the liens? Or does continue the discussion of auctions in the second prong, in order to specify that the auction in cram-downs need not allow for credit bidding after all?
Precedents and Grumbling
The Fifth Circuit invoked this language, with emphasis on the use of the disjunctive word “or” between the second and the third prongs, in its Pacific Lumber decision (2009). This decision involved, and upheld, a plan that provided for payment of the secured creditors’ claim based on the judicially assessed value of the collateral, after a several-day-long valuation hearing, in lieu of allowing credit bids.
The Third Circuit followed suit in its Philadelphia Newspapers decision (2010). This decision does not include any finding as to what “indubitable equivalent” requires, since neither the auction nor a plan confirmation hearing had taken place yet when the matter came before the appeals panel. The Third Circuit majority simply said that credit bidding is not mandatory because the “indubitable equivalent” language “unambiguously excludes the right to credit bid,” and allows prepetition lenders to raise objections as to dubiety of equivalence at the confirmation hearing.
This decision also drew attention for Judge Ambro’s sharply written dissent. He said that the language of 1129(b)(2)(A) should not be read in isolation from other provisions of the Code which make it clear that Congress wanted to protect secured creditors from undervaluation.
These decisions created a good deal of grumbling, such as the argument of Jason S. Brookner in the American Bankruptcy Law Journal that these cases threatened “the eradication of a carefully constructed statutory regime through misinterpretation.”
The Seventh Circuit agreed with Ambro and Brookner, finding last year in In re River Road that a secured creditor does have the right to credit bid. The debtor in the Seventh Circuit case appealed, and that is the case that was known before the U.S. Supreme Court as RadLAX v. Amalgamated (2012).
Speaking for all eight participating Justices, (Justice Kennedy sat this one out), Justice Scalia reaffirmed the decision on the Seventh Circuit against the arguments of the Debtor’s lawyers. Those lawyers were, of course, drawing their arguments from the opinions of the Third and Fifth Circuits.
Scalia relies, though, on what he calls the “general/specific canon.” This is the principle of construction that says that statute includes two provisions that justify contrary results; the more specific is to govern over the more general. The need to provide secured creditors with an “indubitable equivalent” of their security is a quite general statement, but the specific statement is that which sets out procedures for an auction. This is done via the second prong, and 363(k) to which it makes reference, and they determine how such auctions must work.
This leaves the third prong just a “residual provision covering dispositions under all other plans – for example, one under which the creditor receives the property itself,” Scalia says.
However he got there, though, Scalia does seem to have come to the right place, the place of which one has to approve on common-sense policy grounds.
Ahhhh … relief.