Credit Bids a No-Brainer, High Court Says
June 1, 2012
It was an open-and-shut case.
That was the Supreme Court’s assessment in a closely-watched decision that affirmed the right of secured lenders to use their debt as currency in bankruptcy auctions.
The eight justices ruling sided with lender Amalgamated Bank, which protested efforts by the owners of a Los Angeles airport hotel to engineer a cash-only auction, barring the bank from bidding the $120 million it was owned. Instead, the debtor wanted to sell the hotel and an adjacent parking garage to a stalking horse bidder for just $55 million.
[The Court of Appeals for the Seventh Circuit agreed with Amalgamated, but that was at odds with determinations in similar cases in the Third and Fifth Circuits; the Supreme Court resolved this split.]
The case, RadLAX Gateway Hotel, LLC and RadLAX Gateway Deck, LLC v. Amalgamated Bank, has far-reaching importance for any party affected by a Chapter 11 plan in a business bankruptcy case, including the federal government.
While banks and other secured lenders have a longstanding expectation that they'll either be repaid or permitted to take their collateral by means of a credit bid, or, in other words, pay for the collateral with their lien, the justices didn’t devote much space to the merits of this practice.
“The pros and cons of credit bidding are for the consideration of Congress, not the courts,” the justices wrote in their opinion, which was delivered by Justice Antonin Scalia.
Instead, the opinion focused on the language that governs bankruptcy sales and creditor-payment plans. The justices found the hotel owner’s reading of the Bankruptcy Code “hyperliteral and contrary to common sense.”
“The Bankruptcy Code standardizes an expansive (and sometimes unruly) area of law, and it is our obligation to interpret the Code clearly and predictably using well established principals of statutory construction,” the justices wrote. “Under that approach, this is an easy case.”
“This is about as clear a decision as you can get,” said Elliot Ganz, general counsel at the Loan Syndication and Trading Association, which filed an amicus brief with the Supreme Court.
Ganz said that if a secured lender were unable to use its credit as currency, "a debtor could sell the collateral to an insider at a fraction of its actual value, resulting in substantial losses for the lenders."
"It’s gratifying to see that the Supreme Court, in a unanimous decision, resolved the issue of whether secured lenders must be permitted to credit bid in favor of the Bankruptcy Code generally, and an interpretation of the Bankruptcy Code that comports with the understanding of most practitioners and scholars on this issue," said Madlyn Gleich Primoff, a partner in the bankruptcy and restructuring practice at Kaye Scholer.
Primoff said that more than just the right to credit bid was at stake. Had the decision gone the other way, she said, "it could potentially have been open season for aggressive or clever borrowers and debtors to see what else they could get away with."
But by focusing narrowly on the language of the Bankruptcy Code, the Surpreme Court left unclear a few issues some practitioners would like to have seen resolved.
“The words 'indubitable equivalence,' were used nearly 100 years ago in a decision by Justice Learned hand, and the words somehow found their way into the Bankruptcy Code, although the Bankruptcy Code doesn’t define what they mean,” Primoff said. “Some people were hoping the Court would clarify their meaning in its decision."
Another "striking" thing the decision leaves unclear, according to Primoff, is an exception to a secured lenders' right to credit bid that was not addressed by the RadLAX case. "The statute says if there’s going to be a sale under a plan, it has to comply with [Section] 363k, which gives secured lenders the right to credit bid, unless the court orders 'for cause’ otherwise,” she said.
In footnote 3, the Court refers to this exception, and notes that the Bankruptcy Court below found no cause to deny credit bidding. "This leaves open a crack, and a debtor (or borrower) could ask that the secured lender be denied the right to credit bid ‘for cause.’"
That’s not to say that such a ruling would be easy to obtain. "In a typical situation, there needs to be some material showing, like bad faith, or manipulation of the process" before a court would consider denying a credit bid,” Primoff said.