On March 22, 2010, the United States Court of Appeals for the Third Circuit issued a decision in the bankruptcy case for Philadelphia Newspapers, LLC and its affiliates (collectively, the “Debtors”). The Third Circuit affirmed the district court’s opinion approving proposed bidding procedures for an auction sale under the Debtors’ plan of reorganization which prohibited secured lenders from “credit bidding” their debt in lieu of cash. This decision has significant implications for issuers of secured credit.
The Debtors filed voluntary petitions for chapter 11 relief in 2009. On August 20, 2009, the Debtors filed a joint plan of reorganization. The plan provided for the sale of substantially all of the Debtors’ assets at a public auction. The assets were to be sold free of secured lenders’ liens and the proceeds of the sale were to be distributed to the Debtors’ secured lenders on account of their secured claims.
On August 28, 2009, the Debtors filed a motion for approval of the bidding procedures for the proposed auction. The bidding procedures required all qualified bidders to fund their offers with cash. The practical effect of this restriction was to deny secured lenders the opportunity to “credit bid” their debt and offset the amount they are owed against the purchase price of the assets. The Debtors’ secured lenders objected.
The dispute between the Debtors and their secured lenders centered on section 1129(b) of the Bankruptcy Code. Section 1129(b)(1) provides that a bankruptcy court can confirm a plan of reorganization over the objections of secured creditors who vote to reject the plan, but only if the plan is “fair and equitable” to the creditors. Under section 1129(b)(2), a plan must satisfy certain minimum requirements to be considered “fair and equitable.” One way to meet those requirements is to organize a sale of the secured creditors’ collateral free of liens and grant the secured creditors an opportunity to credit bid (the “First Option”). A second, alternative way to fulfill the requirements is to provide the secured creditors with the “indubitable equivalent” of their secured claims (the “Second Option”).
The secured lenders argued that because the Debtors’ plan provided for a sale of their collateral free of liens—ostensibly pursuing the First Option—the plan could not be considered “fair and equitable” unless the secured lenders received an opportunity to credit bid at the auction. The Third Circuit disagreed. Focusing on the “plain meaning” of section 1129(b)(2), the Third Circuit held that the Debtors’ plan could still qualify as “fair and equitable” under the Second Option if the proposed auction generated the “indubitable equivalent” of the secured lenders’ claims. Given that the auction had not yet taken place, the Third Circuit concluded that it was not in a position to say, as a matter of law, that the Debtors’ plan would not be “fair and equitable.”
For secured creditors, the right to credit bid at a sale of their collateral constitutes an important protection against the risk that the collateral will be undervalued. Although arguably narrow in scope, the Third Circuit’s decision calls this protection into question. Indeed, in a related decision in the bankruptcy case for Pacific Lumber Company and its affiliates, the United States Court of Appeals for the Fifth Circuit recently held that a plan which provided for the sale of the debtors’ assets without allowing secured creditors to credit bid ultimately was “fair and equitable.”