The U.S. Supreme Court’s recent decision in RadLAX Gateway Hotel, LLC v. Amalgamated Bank ensures that secured creditors in a bankruptcy proceeding will have the opportunity to credit-bid in auctions of collateral securing their claims. The RadLAX decision resolves a split in the circuit courts over whether a debtor’s bankruptcy plan must allow its secured creditors to credit-bid.
A secured creditor’s right to credit-bid is designed to protect certain constitutional property rights and is based on the idea that a secured creditor should receive the benefits of its bargain. Credit-bidding allows a secured creditor to use the value of its claim in an auction of the collateral securing its claim.
For example, suppose a creditor has a $1 million secured claim against a debtor, and the debtor files a bankruptcy petition. If the debtor seeks to sell the collateral at auction, the creditor can bid up to $1 million before being required to make any additional payments to purchase the collateral. If the creditor bids less than $1 million and wins the auction, it receives the property and a deficiency claim in the amount the face value of the secured claim exceeds its bid.
Creditors use credit-bidding to protect the value of their collateral, since an inadequate sale price deprives the creditor of the full benefit of its claim. If the other bids at auction are unsatisfactory and below the value of the creditor’s secured claim, the creditor may credit-bid to drive up the price or purchase the collateral itself. Credit-bidding effectively allows the creditor to set a floor below which a third party may not purchase the collateral and ensures the creditor will either receive a satisfactory price for its claim or take possession of the collateral securing the claim.
In RadLAX, the debtor purchased a hotel and received a secured loan to renovate the hotel and construct a parking garage. The project quickly overran its budget, and the debtor filed for chapter 11 bankruptcy protection.
Chapter 11 of the Bankruptcy Code requires a debtor to submit a reorganization plan to the court, and the debtor’s creditors then vote for or against the plan. In RadLAX, the debtor’s plan proposed an auction sale of its assets free and clear of any liens, which denied creditors the opportunity to credit-bid at the auction. The plan provided that any proceeds received from the sale would be paid to the bank in satisfaction of its claim. The bank objected to the plan, claiming that chapter 11 required the debtor to allow its creditors to credit-bid in the auction of its collateral.
When a creditor objects to a chapter 11 plan, a debtor may force approval of the plan through a process termed “cramdown.” In order to receive confirmation over a creditor’s objection, a plan must be “fair and equitable” to the objecting creditor. A court will deem a plan fair and equitable if it provides for any of three outcomes identified in the Bankruptcy Code: (1) the creditor retains its lien and receives deferred cash payments in satisfaction of its claim; (2) the property is sold free and clear of the lien subject to section 363(k) of the bankruptcy code; or (3) the creditor receives the “indubitable equivalent” of its claim. The RadLAX decision turned on the court’s interpretation of the second and third prongs.
Section 363(k) requires that a creditor be allowed to credit-bid at the sale of collateral. Because the proposed plan did not permit credit-bidding, the bank claimed that the plan failed to achieve the second “fair and equitable” outcome. The debtor argued that the plan satisfied the “indubitable equivalent” standard of the third prong. Previously, the Third and Fifth Circuits accepted similar arguments and permitted cramdown of plans that precluded credit-bidding. Those courts evaluated compliance with the “indubitable equivalent” requirement independently, without considering the effect of the other two “fair and equitable” outcomes. Both courts determined that cash payments from the debtor could provide the “indubitable equivalent” of a secured claim, focusing in part on the “or” separating the three prongs.
The Supreme Court held that the “indubitable equivalent” analysis was unnecessary when a plan seeks to sell property free and clear of creditor liens. The “fair and equitable” requirement identified in the cramdown test provides the terms under which such a plan must operate. Section 363(k) provides a specific framework for selling collateral free and clear of creditor liens. Allowing a debtor to circumvent the procedures set forth in Section 363(k) and receive plan approval under the more general “indubitable equivalent” provision would frustrate congressional intent.
The RadLAX decision represents a victory for creditors seeking to maximize the value of their secured claims. Credit-bidding provides important protections for creditors in an unstable economic environment, and the RadLAX decision ensures that debtors cannot deny secured creditors the opportunity to utilize credit-bidding to protect the value of their claims.
Stephen Switzer is a member of the Tax and Finance Practice Group at Bingham Greenbaum Doll LLPL.