In In re River Road Hotel Partners LLC, 651 F.3d 642 (7th Cir. 2011), the Seventh Circuit Court of Appeals recently upheld the right of secured parties to credit bid their claims in asset sales conducted pursuant to a chapter 11 plan. This holding is the opposite of the recent holdings by the Third and Fifth Circuit Court of Appeals on the issue. See In re Pacific Lumber Co. 584 F.3d 229 (5th Cir. 2009); In re Philadelphia Newspapers LLC, 599 F.3d 298 (3d Cir. 2010). The matter is now pending by writ of certiori for the Supreme Court’s consideration, and given the divergent views, this issue may be ripe for the establishment of a uniform, nationwide policy.
The River Road case actually involved two unrelated bankruptcies that were consolidated in an appeal. The debtors in River Road built the Intercontinental Chicago O’Hare Hotel between 2007 and 2008, financing the project with approximately $155.5 million in construction loans. Soon after the Hotel opened, the debtors sought additional capital to enable them to finish the construction and pay the general contractors and suppliers. When financing fell through in 2009, the debtors filed for chapter 11 in the Northern District of Illinois.
Separately, the debtors in the Red LAX Gateway Hotels LLC bankruptcy purchased the Radisson Hotel at the Los Angeles International Airport in 2007, with goals of renovating the hotel and building on an adjacent parking structure. The debtors funded their project, in part, with a construction loan of $142 million. During construction, the debtors incurred several millions of dollars in unanticipated costs and subsequently ran out of funds. After failed attempts at obtaining additional financing, the debtors filed for chapter 11 relief in the Northern District of Illinois. The same Judge, Honorable Bruce W. Black, was appointed in both cases.
In June 2010, the debtors in both cases filed their chapter 11 plans providing for the sale of substantially all of their assets free and clear of liens. Both plans proposed sale procedures for conducting public auctions, but neither allowed the lenders to bid their secured claims for the assets, as would normally be allowed under section 363(k) of the Bankruptcy Code. This posed an enormous problem for the lenders, because the stalking horse bidders in each case were offering a fraction of the loaned amounts, and therefore the lenders stood to recover only a small percentage of their secured claims.
One of the lenders objected to the proposed auction procedures, claiming that the plans could not satisfy the cramdown requirements for secured creditors under section 1129(b)(2)(A) of the Code, because the debtors intended to sell assets, free and clear of liens, without giving the lenders the right to credit bid their claims. The debtors responded that their plans were confirmable, over the lenders’ objections, because they provided the lenders with “indubitable equivalent” value as provided in section 1129(b)(2)(A)(iii) of the Code. The debtors’ position in both cases was consistent with the Circuit holdings in the Pacific Lumber and Philadelphia Newspapers cases.
On October 5, 2010, Judge Black entered orders denying the proposed sale procedures in both cases. The orders stated that the debtors’ plans had to follow the specific sale provisions that allowed a chapter 11 plan to cramdown secured creditors. With the permission of Judge Black, the debtors appealed the decision directly to the Seventh Circuit.
Cramdown of Secured Debt:
A chapter 11 plan must be voted on by creditors and approved by one or more classes of impaired creditors in order to be confirmed. Section 1129(b) of the Code, however, allows a chapter 11 plan to be confirmed over the objection of a class of dissenting creditors if it is, among other things, “fair and equitable.” To meet the “fair and equitable” standard with respect to a dissenting class of secured creditors, the plan must provide one of the following three things:
- the creditors retain the liens and receive cash payments equal to the value of their collateral (option 1);
- if the collateral is sold free and clear of liens, subject to the credit bidding rights of secured creditors under section 363(k) of the Code, the creditors’ liens attach to the proceeds of the sale (option 2); or
- the secured creditors must receive the “indubitable equivalent” of their claims (option 3).
The Pacific Lumber and Philadelphia Newspapers cases held that plans selling assets, free and clear of liens, were not required to comply with the option 2 – pertaining specifically to asset sales – in cramdowns of secured creditors. Rather, the Third and Fifth Circuit held that plans could be “fair and equitable” in a sale scenario if the plan provided secured creditors with “indubitable equivalent” of their value, as proposed by option 3 under section 1129(b)(2)(A) of the Code.
Seventh Circuit Opinion:
The Seventh Circuit rejected the approaches taken by the Fifth and Third Circuits, holding that the plans at issue could not be confirmed because they denied the secured lenders’ right to credit-bid their claims. In doing so, the Seventh Circuit relied on two premises: (a) the denial of the right to credit-bid did not provide the lenders with “indubitable equivalent” value and (b) the specific provisions in 1129(b)(2)(A)(ii), pertaining to asset sales, provided the exclusive means to cramdown an asset sale plan over the objections of secured creditors.
The Seventh Circuit first rejected the argument that the public auctions, where the assets were being sold, constituted a free market that would determine the assets current values, thereby providing the lenders with the indubitable equivalent value of their secured claims. The Court found that in many cases, like the case sub judice, there was a “substantial risk” that assets sold in bankruptcy auctions would be undervalued. The Court further found that the Bankruptcy Code, through various other provisions, specifically protected secured creditors from such risk of undervaluation, by giving them a right to credit bid. According to the Court, “indubitable equivalent” value, as prescribed by 1129(b)(2)(A), required similar protections for secured parties.
With respect to the second premise – the more controversial one – the Court determined that section 1129(b)(2)(A) of the Code was ambiguous enough to utilize the cannons of statutory construction. The Court found that section 1129(b)(2)(A) could be interpreted in two ways, where the option 2 – pertaining to asset sales – either had a broader application or a more limited scope. The Court rejected the broader application that allowed confirmation of any form of plan complying with the indubitable equivalent standard under option 3. The Court found that such an interpretation would render options 1 and 2 under 1129(b)(2)(A) meaningless in many circumstances.
Favoring for limited construction of section 1129(b)(2)(A), the Seventh Circuit held that option 2 only applied to cramdown plans selling encumbered assets, free and clear of liens. Option 3, on the other hand, was a catchall that applied in cramdown cases where the debtor proposed to dispose of assets in a manner not covered by options 1 and 2. In River Road, because the plans specifically attempted to sell assets free and clear of liens over the objection of secured creditors, they were not confirmable, as they did no comply with the specific, credit-bidding terms of option 2.
The Pacific Lumber and Philadelphia Newspapers cases served as a warning to secured creditors nationwide that their historical right to credit bid could be compromised by creative lawyers who could persuade not one, but two Circuit courts to construe the Bankruptcy Code out of the box. As a result of these two cases, secured lenders began, almost instantly, to negotiate for additional protections in the collateral and financing orders with chapter 11 debtors.
Nonetheless, there is much hope for secured parties. The Red River case now gives them a powerful tool within one jurisdiction that revives their historical credit-bidding rights. More importantly, the Seventh Circuit opinion creates a rift between several Circuits that may be ripe for resolution by the Supreme Court. If the Supremes grant the certiorari request in Red River, we can expect a nationwide resolution to this very controversial issue soon.