Credit-bidding allows lenders to use their debt to acquire assets of bankrupt companies. In a credit bid, the lender offsets its bid against the balance it is owed.
After three Circuit Courts of Appeals ruled differently on whether lenders must be allowed to credit-bid their debts in bankruptcy auctions, the U.S. Supreme Court has agreed to decide the matter once and for all. The high court will hear oral arguments on April 23 and make a decision by June, sources say.
The issue first came up in Pacific Lumber Co.'s bankruptcy case. On Sept. 29, 2009, the 5th Circuit Court of Appeals, which covers Louisiana, Mississippi and Texas, ruled against the lenders' ability to credit-bid. The 3rd Circuit Court of Appeals, which covers Pennsylvania, Delaware and New Jersey, ruled the same way on March 22, 2010, barring Philadelphia Newspapers LLC's lenders from credit-bidding their debt.
"That threw a monkey wrench into the system," says Gerald Bender of O'Melveny & Myers LLP, who represented the official committee of unsecured creditors in the Philadelphia Newspapers bankruptcy. Bender says the right to credit-bid has generally been assumed to be sanctioned by the Bankruptcy Code.
"That ruling caused bankruptcy lawyers across the country to scratch their heads," agrees Ben Logan, also of O'Melveny & Myers, who worked with Bender on the case.
David M. Neff of Perkins Coie LLP, who will be arguing against credit-bidding before the Supreme Court, disagrees.
"The plain language [of the Bankruptcy Code] does not require credit bidding," he says.
The Supreme Court on Dec. 12 agreed to consider the issue, after Neff on Aug. 5 filed a writ of certiorari appealing a ruling that contrasted with the earlier decisions. The 7th Circuit Court of Appeals, which covers Illinois, Indiana and Wisconsin, on June 28, 2011, sanctioned lenders' right to credit-bid in the case of RadLAX Gateway Hotel LLC and affiliate River Road Hotel Partners LLC.
Neff is debtor counsel.
Lawrence McMichael of Dilworth Paxson LLP, who sat on the same side of the aisle for Philadelphia Newspapers, rails against credit-bidding, asserting it "perverts the basic economics of an auction. In an auction, shouldn't bids be in the same currency?"
Neff says that lenders can abuse the right to credit-bid and bid in excess of the value of assets. In that case, potential bidders that would offer cash would be deterred from participating in an auction that they were unlikely to win.
Judge Stephen Raslavich of the U.S. Bankruptcy Court for the Eastern District of Pennsylvania in Philadelphia shot down that argument during the Philadelphia Newspapers case, saying that lenders are unlikely to bid more than they think the assets are worth, even if they are owed more.
Neff disagrees, arguing that lenders will submit artificially high credit bids to obtain assets. Debtors, therefore, may have difficulties confirming a plan, which must address other creditors as well. Sales, Neff says, are meant to generate money for the bankrupt estate to pay all creditors, not just the secured lender.
Conversely, lenders fear artificially low auction prices. Especially when the debtor's principals have a stake in the sale outcome or the stalking horse is an insider of the debtor.
"Credit-bidding prevents sales that are not adequately marketed," Logan says.
McMichael agrees that low prices are a legitimate concern, but he argues lenders should bring up those concerns on a case-by-case basis.
"We're not arguing that credit-bidding should never be allowed," he says, "just that an auction can be held without credit bids."
For example, RadLAX and River Road had wanted to auction off their assets with two separate buyers, both partially owned by insiders of the debtors. RadLAX had secured a $47.5 million stalking-horse bid for its Radisson Hotel at Los Angeles Airport from LAX Century & Sepulveda Hotel LLC, and River Road received a $42 million stalking-horse bid from O'Hare River & Technology Hotel LLC for the InterContinental Hotel Chicago O'Hare. Both of the stalking-horse bidders were 95% owned by Och-Ziff Real Estate Acquisitions LP and 5% owned by Harp Group Inc. and Blue Vista Capital Partners. Harp Group owned both RadLAX and River Road.
Lenders Amalgamated Bank and San Diego National Bank, owed $161 million by River Road and $130 million by RadLAX, wanted to participate in an open auction, but the bidding procedures had banned credit-bidding.
Judge Bruce W. Black of the U.S. Bankruptcy Court for the Northern District of Illinois in Chicago denied the debtors' bidding procedures on Aug. 30, 2010, and the 7th Circuit affirmed the ruling.
In the Philadelphia Newspapers auction, which similarly prevented credit bidding but was approved by the district and circuit courts, the lender group got around the credit bid ban and ended up winning the auction with a $105 million cash bid. Of course, some of that bid circled back to repay the lenders.
McMichael notes that other lenders wanting to obtain assets could go the same route. He attributes the competitive auction in the case to the disallowance of credit bids.
Lenders, however, have a hard time fronting cash in auctions, according to Logan. Lenders may fail to raise the funds and may have trouble getting their credit committees to approve them putting more cash into a company that already owes them substantial debts.
In deciding the issue, the Supreme Court may have to address the concepts of "statutory interpretation" and "plain meaning," which determine how legislation is implemented. Plain meaning interprets legislation based on literal definitions of words, while statutory interpretation accounts for the intention of the legislation.
The Supreme Court's decision will have wide implications for the bankruptcy process. Already secured creditors are trying to protect their right to credit-bid by asking the bankruptcy court to include provisions in earlier documents such as orders approving debtor-in-possession loans or the use of cash collateral, Logan says.
The bottom line, McMichael says, is the Bankruptcy Code was drafted to give debtors some flexibility when it comes to repaying their debts.
The Supreme Court will have to decide just how much flexibility they should be afforded.
Ken deRegt will retire as head of fixed income at Morgan Stanley and be replaced by Michael Heaney and Robert Rooney. For other updates launch today's Movers & shakers slideshow.
Jamie Dimon has earned his shareholders' confidence and loyalty. Now, what else can he do? More video