Recently, a chink to the armor of distressed debt purchasers resonated throughout the secondary market with the decision of the Delaware Bankruptcy Court in In re Fisker Automotive Holdings, in which the bankruptcy court limited the right to credit bid of the holder of secured debt purchased at a discount to the amount paid by the holder for the claim. In that case, the purchaser of a $168.5 million secured claim was only permitted to credit bid $25 million — the amount it paid for the claim.

As the court in Fisker observed, “It is beyond peradventure that a secured creditor is entitled to credit bid its allowed claim.” However, the court also concluded that “the right to credit bid is not absolute” by virtue of the text of Section 363(k) which permits a court “for cause” to impair a secured lender’s right to credit bid. In particular, the court concluded that while the secured lender will be entitled to credit bid, “[t]he only question is: in what amount.”

There was ample reason for the Fisker court to be concerned about the amount of the secured lender’s credit bid, given the stipulation between the debtor and the creditors committee in which they agreed, among other things, that if the secured creditor was not permitted to bid at all or its bid was limited to $25 million, there was “a strong likelihood that there would be an auction that has a material chance of creating value” above the secured lender’s bid; if the credit bid was not capped there would be “no realistic possibility of an auction;” that the highest and best value for the estate would be achieved only in the sale of all of Fisker’s assets as entirety; and, that material assets were either not encumbered by the secured creditor’s liens or such liens were in dispute. Indeed, for those reasons the court concluded there was sufficient cause under Section 363(k) to limit the amount of the secured lender’s credit bid.

Fisker Decision Compounds Complexity of Credit-Bidding Process

While commentators and practitioners may argue that the Fisker decision is not especially surprising in the circumstances of the case or inconsistent with the bankruptcy code or bankruptcy principles, it is nonetheless a case of first impression and assuredly, adds another layer of complexity to creditor dynamics in Chapter 11.

The decision in Fisker undoubtedly serves to increase the disenchantment of discounted debt purchasers with section 363 sales. Many have already become jaded by the imposition of complex bidding procedures and longer sales periods, as the bankruptcy courts endeavor to ensure the process is inclusive, competitive and transparent. Fisker adds yet another element of risk, even when the holder of the secured claim has reached détente with a debtor about a credit bid sale. Opportunistic buyers of debt can no longer assure themselves that a bankruptcy court will enforce such agreements if the court concludes it will interfere with a robust sale process that it is generally agreed may realize a better result. Indeed, Fisker clearly puts the debtor’s fiduciary duties to the estate ahead of any such agreement with a secured creditor and permits the debtor to undermine an agreed upon credit bid sale if an auction process may realize more.