May a Chapter 11 plan permit a debtor to auction property free and clear of a creditor’s lien while preventing that creditor from credit-bidding the amount of its debt? A question that split the U.S. Circuit Courts was settled when earlier this week the Supreme Court came out 8-0 on the side of the secured creditors in a decision of paramount interest to lenders with bankrupt borrowers (Justice Kennedy took no part in the decision).
The concise, 12-page opinion penned by Justice Scalia in RadLAX Gateway Hotel v. Amalgamated Bank concludes that the debtor’s proposed auction procedures – which prevented the secured creditors from being able to credit-bid – could not satisfy the Code’s requirement that a cramdown be “fair and equitable” to non-consenting secured creditors. Earlier cases from the 3rd, 5th and 7th Circuits had created a split that called into question what had been, for many, an accepted tenant of the 363 sale – that a secured creditor could protect itself from the potential of a depressed auction price by credit bidding and obtaining the auctioned asset for its own account.
As background, in order for a cramdown plan to be confirmed over the objection of a class of secured creditors, the plan must be deemed to be “fair and equitable” – a determination requiring that one of three tests be met. One test (relating to 363 sales (1129(b)(2)(A)(ii)) specifically requires that the secured creditor be permitted to credit bid. However, an alternate test (1129(b)(2)(A)(iii)) requires only that the secured creditor be provided with the “indubitable equivalent” of its claim. The 3rd and 5th Circuits interpreted these criteria as wholly independent of each other and therefore determined that a lien-free sale of assets by a debtor that would provide a secured creditor with the “indubitable equivalent” of its claim would be permitted under (iii) - notwithstanding the fact that the creditor was precluded from credit-bidding (in apparent violation of (ii)).
The 7th Circuit took a differing view in RadLAX when considering a plan similar in many respects to those confirmed by the 3rd and 5th. In RadLAX, the Appeals Court prevented the confirmation of a plan that proposed auctioning the property (presumably to a stalking horse bidder for an amount reported to be approximately $50 million) and using the sale proceeds to repay secured creditors because those secured creditors were prohibited from credit-bidding. In affirming the lower court’s decision, Scalia commented that a statutory interpretation that would allow the “indubitable equivalent” test to permit what the “363-sale test” would proscribe “to be hyperliteral and contrary to common sense”. (His words not mine.)
With June’s annual flood of decisions from the Supremes nigh, this decision stands as an important one for real estate lenders – granting lenders a critical strategic advantage over what shape a Chapter 11 plan might take.
By: Matthew Clark and Eric Kotloff with Kaitlin McGrath