Recently, the Supreme Court of the United States held that a debtor cannot confirm a Chapter 11 “cramdown” plan that provides for the sale of collateral free and clear of a secured creditor’s lien when it denies the secured creditor’s right to credit bid at the auction.  This should be welcome news to members of the secured lending community because guaranteeing the right of secured creditors to credit bid will reduce the risk of making such loans.

On May 30, 2012, the Supreme Court of the United States issued a landmark decision protecting a secured creditor’s right to credit bid when a debtor tries to sell its property free and clear of its liens.  The opinion was written by Justice Scalia and joined by all other justices (except Justice Kennedy, who took no part in the decision), and held that a debtor cannot confirm a Chapter 11 “cramdown” plan that provides for the sale of collateral free and clear of a secured creditor’s lien when it denies the secured creditor’s right to credit bid at the auction. 

By way of background, in 2007, RadLAX Gateway Hotel LLC and RadLAX Gateway Deck LLC (the Debtors) purchased the Radisson Hotel in the Los Angeles International Airport and a parcel of real estate adjacent thereto on which they intended to build a parking structure.  To finance the acquisition and related renovation and construction costs, the Debtors obtained a $142 million loan from Longview Ultra Construction Loan Investment Fund, for which Amalgamated Bank (the Lender) serves as trustee, and granted the Lender a blanket lien on all of the Debtors’ assets.  However, adverse economic events ultimately resulted in the Debtors seeking relief under Chapter 11 of the Bankruptcy Code.

Thereafter, the Debtors sought to confirm a plan of reorganization, over the Lender’s objection, pursuant to section 1129(b)(2)(A) of the Bankruptcy Code.  The plan proposed to sell substantially all of the Debtors’ assets at auction and repay the Lender by using the proceeds of the sale.  Notably, the Debtors’ proposed bidding procedures, which would govern the auction, denied the Lender the right to “credit bid” (i.e., the right to bid for the collateral securing its loan using the debt it is owed to offset the purchase price).

Section 1129(b)(2)(A) of the Bankruptcy Code has three subsections under which a Chapter 11 plan can be “crammed down” over the objection of a class of secured creditors.  Specifically, a plan can only be confirmed if: (1) a secured creditor retains its lien on the collateral and receives deferred cash payments equaling at least the allowed amount of its claim; (2) the collateral is sold free and clear of the creditor’s lien, but the creditor is allowed to credit bid at the auction to sell the collateral and receives a lien on the proceeds of the sale; or (3) the secured creditor receives the “indubitable equivalent” of the value of its claim.  

In their motion seeking the approval of the proposed bidding procedures, the Debtors argued the use of the word “or” connecting the three subsections of section 1129(b)(2)(A) of the Bankruptcy Code permitted them to deny the Lender its right to credit bid as long as the Lender was provided the “indubitable equivalent” of the value of its secured claim.  In other words, the Debtors argued the disjunctive language in the statute unambiguously indicated each of its three subsections provided independent means (which a debtor had discretion to choose from) for a Chapter 11 plan to be confirmed. 

Although this interpretation of the Bankruptcy Code was controversial, two recent Circuit Court opinions supported the Debtors’ interpretation (see Scotia Pacific Company, LLC v. Official Unsecured Creditors’ Committee (In re Pacific Lumber), 584 F.3d 229 (5th Cir. 2009); In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010).  However, the Bankruptcy Court for the Northern District of Illinois and the U.S. Court of Appeals for the Seventh Circuit rejected the reasoning of these opinions and concluded that a debtor cannot sell an encumbered asset free and clear of a lien, pursuant to a Chapter 11 plan, without allowing the lien-holder to credit bid. 

In a watershed opinion, the Supreme Court agreed with the Seventh Circuit and Illinois bankruptcy court.  Applying the rule of statutory construction that specific provisions of a statute govern the general, the Supreme Court found section 1129(b)(2)(A) of the Bankruptcy Code unambiguously dictated that clause (1) applies to plans that allow secured creditors to retain their liens, clause (2) applies to plans under which the property is sold free and clear of the creditor’s lien and clause (3) is a residual provision applying to all situations not covered by clauses (1) or (2).   

In response to the contention that the use of the word “or” in section 1129(b)(2)(A) of the Bankruptcy Code indicated that each of its three subsections provided independent means to confirm a “cramdown” plan, the Supreme Court stated such a reading is “hyperliteral and contrary to common sense.”  Moreover, in response to the argument that the Supreme Court’s interpretation rewrote the statute by replacing the word “or” with “and,” the court replied “[t]he question here is not whether debtors must comply with more than one clause, but rather which one of the three they must satisfy.” 

In conclusion, when a debtor seeks to sell a secured creditor’s collateral free of liens in the context of a plan of reorganization, the secured creditor may be entitled to credit bid unless there is “cause” to deny this right.  This should be welcome news to members of the secured lending community because guaranteeing the right of secured creditors to credit bid will reduce the risk of making such loans.