On June 28, 2011, the Court of Appeals for the Seventh Circuit rejected the views of the Third Circuit and the Fifth Circuit and held that a reorganization plan which proposes the sale of encumbered assets free and clear of liens must honor the secured creditor’s right to credit bid its claim in order to be confirmed under the “fair and equitable” standard of the Bankruptcy Code. In the combined appeals of In re River Road Hotel Partners, LLC, et al. and In re Radlax Gateway Hotel, LLC, et al. (“River Road”)¹ the Court rejected the debtors’ attempts to cram down plans that denied credit bidding on two alternative grounds. First, the Seventh Circuit disagreed with the views of the Third² and Fifth Circuits³ that debtors could use the “indubitable equivalence” standard of the third subsection of the secured creditor cram down provision (section 1129(b)(2)(A)(iii)) to circumvent the express grant of credit bidding rights in the second subsection (section 1129(b)(2)(A)(ii)). In an alternative holding, the Seventh Circuit focused on the indubitable equivalence standard and held that a sale without credit bidding would not satisfy that standard because of the protection credit bidding provides against the risk that the collateral might be undervalued at the sale.⁴

The Third and Fifth Circuits had focused on section 1129(b)(2)(A)’s use of the word “or” to connect the three alternative methods of satisfying the “fair and equitable” secured creditor cram down requirement. Since “or” is not exclusive, those courts reasoned that the three alternatives were not mutually exclusive and that a debtor could use the section 1129(b)(2)(A)(iii) indubitable equivalence option even where the plan provided for a free and clear sale that fell within the ambit of the section 1129(b)(2)(A)(ii) alternative.

The Seventh Circuit in River Road takes a completely different approach to statutory interpretation. Rather than focus on a single word in isolation, the Court reasons that the statute must be construed as a whole to determine its meaning. Since the denial of credit bidding rights would render subsections (i) and (ii) largely superfluous and since the denial of credit bidding is inconsistent with the general treatment of secured creditors in other sections of the Bankruptcy Code, the Seventh Circuit holds that the three alternatives set forth in section 1129(b)(2)(A) are mutually exclusive and that the third option’s indubitable equivalence standard could not be used where the plan proposed a free and clear sale that was covered expressly by the second option.⁵ The Court states, “We cannot conceive of a reason why Congress would state that a plan must meet certain requirements [to satisfy sections 1129(b)(2)(A)(i) and (ii)] if it provides for the sale of assets in particular ways and then immediately abandon these requirements in a subsequent subsection [1129(b)(2)(A)(iii)]” by providing a generalized alternative that renders the prior sections surplusage.⁶

Case Background

Before the Seventh Circuit in River Road were the consolidated appeals by debtors who owned the InterContinental Chicago O’Hare Hotel and adjacent land and the Radisson Hotel at Los Angeles International Airport and adjacent land (the “Debtors”). The Debtors filed separate voluntary petitions for relief under chapter 11 of Title 11 of the United States Code, §§ 101, et seq. (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Northern District of Illinois (the “Bankruptcy Court”). Approximately nine months into their cases, the Debtors submitted reorganization plans to the bankruptcy court for confirmation. Both plans sought to sell substantially all of the Debtors’ assets, with proceeds to be distributed among the Debtors’ creditors in accordance with the priorities established in the Bankruptcy Code. The Debtors also filed motions seeking court approval of sale procedures, with the proposed procedures providing for an auction with a stalking horse bidder lined up in the postpetition, pre-plan period.⁷ The bid procedures motions included a request to preclude the Debtors’ respective secured creditors from credit bidding. Certain of the Debtors’ creditors objected to the bid procedures motions. The Bankruptcy Court denied the bid procedures motions. Finding the dissent in In re Philadelphia Newspapers, LLC⁸persuasive, the Court ruled that, as a matter of law, the Debtors could not use section 1129(b)(2)(A)(iii) to preclude secured creditors from credit bidding at the plan sales. The Philadelphia Newspapers dissent had argued that each subsection of section 1129(b)(2)(A) applies to an entirely different situation: subsection (i) to retention of assets and transfers of assets where the liens remained; subsection (ii) to sales free and clear of liens; and the “catch all” subsection (iii) to other situations not covered by subsections (i) and (ii). Thus, the dissent explained that the use of “or” in 1129(b)(2)(A) could not be interpreted and applied to read clause (ii) out of the statute where the secured creditor’s collateral was being sold free of the lien.

Following the Bankruptcy Court’s decision, the Debtors appealed directly to the Seventh Circuit.

Philadelphia Newspapers and Pacific Lumber

Cramdown is a statutory mechanism by which a reorganization plan can be confirmed over the objection of a dissenting class of creditor claims. Section 1129(b)(1) of the Bankruptcy Code requires a Bankruptcy Court to assess whether the proposed treatment of the dissenting class or classes is “fair and equitable.” Pursuant to section 1129(b)(2)(A) of the Bankruptcy Code, a plan that proposes to cram down a class of secured claims can meet this requirement if it: (i) provides for retention by the debtor of the property subject to the secured creditor’s lien or the transfer of the asset to another entity, in each case with the liens intact and deferred cash payments equal to the present value of the lender’s secured interest in the collateral; (ii) provides for a sale of any property that is subject to liens free and clear of those liens, subject to the secured creditor’s credit bidding rights under section 363(k)⁹, with the liens attached to the proceeds of the sale and the treatment of the liens on the proceeds pursuant to subpart (i) or (iii) of 1129(b)(2)(A); or (iii) provides for the realization by a secured lender of the “indubitable equivalent” of its claim. The decisions in Philadelphia Newspapers and Pacific Lumber focused on the plain meaning of “or” as used in section 1129(b)(2)(A) finding that a cram down plan that met the 1129(b)(2)(A)(iii) standard did not have to provide the secured creditor with a right to credit bid.

The Seventh Circuit’s Analysis

The Seventh Circuit’s decision creates a conflict with the Third Circuit’s decision in Philadelphia Newspapers and the Fifth Circuit’s decision in Pacific Lumber.

Unlike the decisions in Pacific Lumber and Philadelphia Newspapers, where the Courts found a single “plain meaning” based on the use of the disjunctive “or” in section 1129(b)(2)(A), the Seventh Circuit determined that “[n]othing in the text of Section 1129(b)(2)(A) directly indicates whether Subsection (iii) can be used to confirm any type of plan or if it can only be used to confirm plans that propose disposing of assets in ways that can be distinguished from those covered by Subsections (i) and (ii).”¹⁰ For this reason, the Seventh Circuit found that the statute had two different plausible meanings, “one that reads Subsection (iii) as having global applicability and one that reads it as having a much more limited scope.”¹¹ As a result, the Court decided that it had to resort to other statutory construction principles, as appropriate.¹² Construing the statute as a whole, the Seventh Circuit explained that it would be unacceptable for a debtor to use section 1129(b)(2)(A)(iii) in cases where the plan proposed to deal with encumbered assets in the ways provided for in subsections (i) or (ii) and where the plan did not meet the requirements of those subsections. To do so, “would render the other subsections of the statute superfluous.”¹³ In addition, the Seventh Circuit argued that the Bankruptcy Code generally provides protection against undervaluation when auctioning assets pursuant to sections 363(k) and 1129(a)(2)(B)(ii) and for asset retention in the section 1111(b) election.¹⁴ The Debtors’ interpretation “would not provide secured creditors with the types of protections that they are generally accorded elsewhere in the Code.”¹⁵ Thus, the Court reasoned that it is “more plausible” to interpret section 1129(b)(2)(A)(iii) to apply only to plans that deal with encumbered assets in ways not covered by subsections (i) and (ii).

As further support for its affirmance of the Bankruptcy Court, the Seventh Circuit analyzed the “indubitable equivalent” standard that is set forth in subsection 1129(b)(2)(A)(iii). The Seventh Circuit determined that even if section 1129(b)(2)(A)(iii) applied in this context, indubitable equivalence requires that a secured creditor who is undersecured receive the “current market value” of its collateral. Note that this view of what is required protects only the economic value of the secured claim and not other bargained for rights of the creditor. The Court reasoned that a plan auction sale presents a risk that the asset will be undervalued (e.g., by the speed and timing of an auction and the inability to provide sufficient notice to interested parties). Thus, according to the Seventh Circuit, the auction sale and the creditor’s right to the proceeds of the sale do not satisfy the indubitable equivalence standard unless there is protection against undervaluation. Credit bidding protects the secured creditor against that risk because “by granting secured creditors the right to credit bid, the Code promises lenders that their liens will not be extinguished for less than face value without their consent.”¹⁶ Thus, the plain language of section 1129(b)(2)(A)(iii) does not permit confirmation of a plan that dispenses with credit bidding.

Implications of the River Road Decision

The Seventh Circuit’s decision has created a circuit split on the issue with the Third and Fifth Circuits. This split increases the likelihood that the United States Supreme Court will accept this issue and resolve the conflict. At the same time, the Seventh Circuit’s adoption of the dissent’s view in Philadelphia Newspapers may change the momentum as courts around the country grapple with the credit bidding issue.

The debate whether a secured creditor can be denied the right to credit bid centers on a fundamental clash of perspectives and policies: (i) the secured creditor’s property rights; and (ii) the debtor’s Congressional granted right to attempt to reorganize. For the secured creditor, the right to credit bid is its protection from a judicial undervaluation of its collateral, or an auction that is flawed, or skewed in favor of insiders. Where the secured creditor is denied the right to credit bid on the basis of the section 1129(b)(2)(A)(iii) indubitable equivalence standard, what is the indubitable equivalence for being denied the right to credit bid? In addition, if the secured creditor is denied the right to credit bid, then it may have to submit a cash bid in order to protect itself against a perceived undervalue sale. In many cases, the secured creditor will lack the ability to make a cash bid as a practical matter. For example, where the secured creditor is not a single creditor but a lending syndicate, it may not be possible to organize a cash bid.¹⁷

From the debtor’s perspective, granting a secured creditor the right to credit bid could chill bidding and undermine the debtor’s reorganization effort. Denial of the credit bidding right may give the debtor greater control over the sale process and the course of the restructuring.

The Seventh Circuit’s decision is unlikely to be the last word on the secured creditor’s right to credit bid where its collateral is sold under a plan of reorganization. Practice has already witnessed secured creditors seeking to validate and protect a right to credit bid in cash collateral and debtor in possession financing orders. In addition, since the contours of “indubitable equivalence” are fact specific, even in those courts that permit use of subsection 1129(b)(2)(A)(iii) the debtor may not be able to confirm a plan that denies credit bidding rights, especially if those courts adopt the Seventh Circuit’s view of what that standard requires.

¹Case Nos. 10-3597 & 10-3598 (7th Cir. June 28, 2011).
²In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010).
³In re Pacific Lumber, Co., 584 F.3d 229 (5th Cir. 2009). However, in a footnote, the Seventh Circuit distinguished the decision in Pacific Lumber noting that: “Given that the Debtors’ assets in this case have not gone through the judicial valuation process and the Debtors’ reorganization plans involve using an auction to determine the assets’ current value, it is clear that Philadelphia Newspapers is more relevant precedent than Pacific Lumber.” River Road, at 15, n. 4.
⁴Curiously, this holding is supported by reference to anecdotal commentary, id. at 19-20, n. 6, and not evidence in the record.
⁵One could take issue with this reasoning since section 1129(b)(2)(A)(ii) itself references section 1129(b)(2)(A)(i) and 1129(b)(2)(A)(iii).
⁶River Road, at 22-23. Apparently, the Seventh Circuit did not consider a reading of section 1129(b)(2)(A)(i) and (ii) as a specific subset (a safe harbor if you will) of the more general “indubitable equivalent” standard of section 1129(b)(2)(A)(iii). The Bankruptcy Code is not a stranger to using broad standards with specific non-limiting examples of the concept. See, e.g., 11 U.S.C. § 361 (setting forth non-limiting examples of “adequate protection”).
⁷In the River Road case, while the debtor owed at least $140,000,000 on its loans, the stalking horse offer was for $42,000,000. With respect to the RadLAX case, the debtors owed at least $120,000,000 and the stalking horse offer was only $47,500,000.
⁸599 F.3d 298.
⁹A secured creditor’s right to credit bid pursuant to section 363(k) can be denied for cause. 11 U.S.C. § 363(k).
¹⁰River Road, at 16.
¹¹Id.
¹²Id. at 16-17.
¹³Id. at 22.
¹⁴In so doing, the Seventh Circuit did not give weight to the fact that the right to credit bid could be denied for cause.
¹⁵Id. at 24.
¹⁶Id. at 18.
¹⁷This practical difficulty is mitigated, however, by the right of a collateral agent for the lender syndicate to bind all of the lenders. See In re Chrysler LLC, 576 F.3d 108, 119 (2d Cir. 2009), vacated on other grounds, In re Chrysler, LLC, 592 F.3d 370 (2d Cir. 2010) (stating that the collateral agent controls credit bidding and consent to 363 sales, even over the objection of a dissenting minority lender); In re Metaldyne Corp., 409 B.R. 671 (Bankr. S.D.N.Y. 2009).