Bankruptcy Law Insights : Kelley Drye & Warren LLP Bankruptcy and Restructuring Practice Group

The U.S. Supreme Court will rule this term in RadLAX Gateway Hotel Inc. v. Amalgamated Bank on whether the Bankruptcy Code permits a debtor in a chapter 11 case to sell encumbered assets without providing the secured lender an opportunity to credit bid its debt. Determination of this question will require the Court essentially to choose between two opposing approaches to statutory interpretation, and decide whether the so-called “plain meaning” of a highly formalistic reading of the Bankruptcy Code should trump decades of established commercial practice.   

A circuit split arose earlier this year, when the Seventh Circuit in River Road Hotel Partners, a companion case to RadLAX Gateway Hotel, declined to follow the Third Circuit’s 2010 decision in Philadelphia Newspapers, and instead expressly adopted the position set forth in the dissenting opinion from that case of Judge Tom Ambro. As previously described on this site, the debtor in River Road sought to rely on Philadelphia Newspapers in putting forward a plan of reorganization that proposed an auction of the secured lenders’ collateral, but would have expressly denied the lenders the right to credit bid their debt.  Section 1129(b)(2)(A) of the Bankruptcy Code describes three different means by which a plan of reorganization can be found to be “fair and equitable” and thus capable of being confirmed without the consent of a secured lender class (i.e., “crammed down”):

(i) lender retention of liens securing the obligations and receipt of the present value of its secured claim,

(ii) sale of collateral free and clear of liens but subject to credit bidding, or

(iii) the realization by the creditor of the “indubitable equivalent” of its secured claim.

Notwithstanding the express reference in subsection (ii) of Section 1129(b)(2)(A) to the right to credit bid in connection with a sale “free and clear” of liens, the Third Circuit in Philadelphia Newspapers held that a sale “free and clear” could also take place without allowing the lenders to credit bid under subsection (iii), the “indubitable equivalent” prong.  The Third Circuit concluded that the “plain meaning” of the use of the disjunctive “or” in the statute shows that subsection (ii) is not the “exclusive means” by which a secured lender’s collateral may be sold “free and clear” under a plan of reorganization and that, so long as the debtor or other plan proponent could show that the “indubitable equivalent” prong were being satisfied, the opportunity to credit bid need not be provided. 

Judge Ambro, a longtime bankruptcy practitioner before being named to the bench, castigated the majority’s refusal to look beyond what it viewed as the sole plausible reading of Section 1129(b)(2)(A).  In Judge Ambro’s view, the result flew in the face of both the established principle that property rights in bankruptcy look to applicable non-bankruptcy law, and the expectation that the Bankruptcy Code expressly protects such non-bankruptcy rights -- particularly the right of a secured creditor to look to its collateral in the event of non-payment. As he wrote, “In effect, a single ‘or’ becomes the bell, book and candle that excommunicates Congressional intent from the Bankruptcy Code . . . [and] upset[s] three decades of secured creditors’ expectations[.]”

The bankruptcy judge in River Road expressly rejected the reasoning of the Philadelphia Newspapers majority. The Seventh Circuit unanimously agreed, stating that “like the bankruptcy court, we find the statutory analysis articulated by Judge Ambro in his Philadelphia Newspapers dissent to be compelling.” 

The RadLAX Gateway Hotel debtor sought a writ of certiorari from the Supreme Court. They were joined by the Loan Syndication and Trading Association (“LSTA”), a loan market participants’ industry group that has been strongly supportive of lenders’ credit bidding rights. The LSTA announced that it “decided to support the appeal to the Supreme Court because, although [RadLAX Gateway Hotel] is a favorable ruling, the benefit to the market of certainty on credit bidding is an opportunity that cannot be missed.” 

The Supreme Court has not been consistent in its approach to Bankruptcy Code interpretation. While it has strictly applied the “plain meaning” approach in several recent bankruptcy cases, at other times it has been willing to look to underlying Congressional purpose. The latter approach here will unquestionably result in an affirmation of the Seventh Circuit. The former will leave the LSTA regretting that it got what it asked for.

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Critics of last year’s decision on credit bidding by the Third Circuit Court of Appeals in the Philadelphia Newspapers chapter 11 case welcomed the Seventh Circuit’s recent unanimous opinion in River Road Hotel Partners LLC. The Seventh Circuit expressly adopted the Judge Tom Ambro’s cogent analysis in his Philadelphia Newspapers dissent.   

In River Road, the debtors sought to rely on Philadelphia Newspapers in putting forward a plan of reorganization that proposed an auction of the secured lenders’ collateral, but would have expressly denied the lenders the right to credit bid their debt. The rationale in both cases rested on a formalistic reading of Section 1129(b)(2)(A) of the Bankruptcy Code. That section describes three different means by which a plan of reorganization can be found to be “fair and equitable” and thus capable of being confirmed without the consent of a secured lender class (i.e., “crammed down”):

   (i) lender retention of liens securing the obligations and receipt of the present value of its secured claim,

   (ii) sale of collateral free and clear of liens but subject to credit bidding, or

   (iii) the realization by the creditor of the “indubitable equivalent” of its secured claim.

Notwithstanding the express reference in subsection (ii) of Section 1129(b)(2)(A) to the right to credit bid in connection with a sale “free and clear” of liens, the Third Circuit in Philadelphia Newspapers held that a sale “free and clear” could also take place without allowing the lenders to credit bid under subsection (iii), the “indubitable equivalent” prong. The River Road debtors asked the bankruptcy court to follow the Third Circuit’s conclusion that the “plain meaning” of the use of the disjunctive “or” in the statute shows that subsection (ii) is not the “exclusive means” by which a secured lender’s collateral may be sold “free and clear” under a plan of reorganization and that, so long as the debtor or other plan proponent could show that the “indubitable equivalent” prong were being satisfied, the opportunity to credit bid need not be provided.

The bankruptcy judge, Judge Bruce Black of the Northern District of Illinois, declined the invitation. Judge Black expressly rejected the reasoning of the Philadelphia Newspapers majority, stating that he found the dissent from Judge Ambro, “well-reasoned [and] more persuasive.” At the River Road debtors’ request, Judge Black certified an appeal directly to the Seventh Circuit. The court affirmed Judge Black’s decision, stating that “like the bankruptcy court, we find the statutory analysis articulated by Judge Ambro in his Philadelphia Newspapers dissent to be compelling.”

The Seventh Circuit decision first takes aim at the contention that there exists a single “plain meaning” interpretation of Section 1129(b)(2)(A) that directs the result. 

Nothing in the text of Section 1129(b)(2)(A) directly indicates whether Subsection (iii) can be used to confirm any type of plan or if it can only be used to confirm plans that propose disposing of assets in ways that can be distinguished from those covered by Subsections (i) and (ii). Hence, there are two plausible interpretations of the statute: one that reads Subsection (iii) as having global applicability and one that reads it as having a more limited scope.

The Seventh Circuit then considered whether Congress, having specified in Section 1129(b)(2)(A)(ii) the means by which a debtor could confirm a plan when proposing to sell a secured lender’s assets free and clear, i.e., by expressly protecting the lender’s right to credit bid, would then negate such protection in the immediately following subsection by permitting the debtor to conduct a “free and clear” sale without allowing for credit bidding. “The infinitely more plausible interpretation,” the court held, would only permit “free and clear” collateral sales as specified in subsection (ii). “Under such a reading, plans could only qualify as ‘fair and equitable’ under Subsection (iii) if they proposed disposing of assets in [a] way that [is] not described in [Subsection (ii)].”  

The Seventh Circuit’s vigorous seconding of Judge Ambro’s approach shows plainly why judges take the time to publish dissenting opinions. Judge Ambro, writing from a practitioner’s pragmatic viewpoint, clearly found it hard to accept the Philadelphia Newspapers majority’s refusal to look beyond what it viewed as the sole plausible reading of Section 1129(b)(2)(A) and consider any sense of Congressional purpose or the underlying principles of the Bankruptcy Code as evidenced by complementary Code sections. As he wrote, “In effect, a single ‘or’ becomes the bell, book and candle that excommunicates Congressional intent from the Bankruptcy Code . . . [and] upset[s] three decades of secured creditors’ expectations[.]” The Seventh Circuit’s decision in River Road vindicates Judge Ambro’s arguments.

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The U.S. Court of Appeals for the Seventh Circuit has taken under advisement the latest case involving the now contentious issue of credit bidding. 

Judge Bruce Black of the United States Bankruptcy Court for the Northern District of Illinois last year refused to permit the debtors in In re River Road Hotel Partners LLC, et al. (“River Road”) to circumvent a secured lender’s right to credit bid in connection with a sale of assets subject to the lender’s lien. The debtors in River Road were relying on the Third Circuit Court of Appeals’ controversial decision in Philadelphia Newspapers, which upheld a debtor's efforts to prevent its secured lenders from credit bidding in connection with an auction held under a plan of reorganization. 

The majority opinion in Philadelphia Newspapers determined that, notwithstanding the express reference in subsection (ii) of Section 1129(b)(2)(A) to the right to credit bid in connection with a sale “free and clear” of liens pursuant to a plan of reorganization, a sale “free and clear” could also take place pursuant to a plan, without allowing the lenders to credit bid, under Section 1129(b)(2)(A)(iii), the “indubitable equivalent” provision. Third Circuit Judge Thomas Ambro, a bankruptcy practitioner of many years, penned a lengthy dissent, noting that the result flew in the face of the established principle that property rights in bankruptcy look to applicable non-bankruptcy law, and the long standing expectation that the Bankruptcy Code expressly protects such non-bankruptcy rights – particularly the right of a secured creditor to look to its collateral in the event of non-payment.   

Judge Black expressly rejected the reasoning of the Philadelphia Newspapers majority, stating that he found the dissent from Judge Ambro, “well-reasoned [and] more persuasive.”      

At the River Road debtors’ request, Judge Black certified an appeal directly to the Seventh Circuit, and the court heard arguments earlier this month. The Seventh Circuit panel, consisting of Judges David Hamilton, Richard Cudahy, and Daniel Manion, presented a “hot bench”, directing numerous questions at counsel for both sides.   

Interestingly, at no point during oral argument was it noted that the Third Circuit in Philadelphia Newspapers never actually decided whether the non-credit bid plan at issue in that case could be confirmed. It only upheld the debtor’s right in that case to seek to do so. Since the lenders in Philadelphia Newspapers subsequently chose to participate in the sale auction and won with a cash bid, the ultimate question of whether such a plan would provide the secured lenders with the “indubitable equivalent” of their secured claims was never answered. 

The Seventh Circuit should affirm Judge Black’s ruling and follow Judge Ambro’s reasoning in Philadelphia Newspapers, and in doing so plainly address the unanswered open question from that case. Even if an argument could plausibly be made, through a hyper-literal reading of Section 1129(b)(2)(A), that a secured lender can be denied the right to credit bid in connection with a sale under a plan of reorganization, beyond such hyper-literalism there really is no valid basis to contend that any such plan could provide the “indubitable equivalent” of the lender’s secured claim, and such a plan should never be confirmed over the secured lender’s objection. The Bankruptcy Code contains strong protections, including the right to credit bid under Section 363(k) and the anti-lien stripping provisions of Section 1111(b), that unambiguously work to prevent a debtor from “cashing out” a secured creditor by paying such creditor a depressed value for the collateral. The cramdown provisions of Section 1129(b)(2)(A) clearly are intended to complement those protections, not abrogate them through a resort to the “indubitable equivalent” standard.

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Bankruptcy lawyers who are regularly involved in distressed m&a deals have been wondering for the past few months about the potential fallout from Philadelphia Newspapers. In that case, as previously described on this site, the Third Circuit Court of Appeals upheld the debtor's efforts to deny its secured lenders the right to credit bid in connection with an auction held under a non-consensual plan of reorganization pursuant to Section 1129(b)(2)(A) of the Bankruptcy Code. The majority opinion in Philadelphia Newspapers was met by a lengthy dissent from the leading bankruptcy expert on the Third Circuit panel, Judge Thomas Ambro. 

In what appears to be the first decision since then on an attempt to use Section 1129(b)(2)(A) to circumvent a secured lender’s right under Section 363(k) to credit bid, Judge Bruce Black of the United States Bankruptcy Court for the Northern District of Illinois denied a debtor’s proposed bidding procedures motion. Judge Black, in In re River Road Hotel Partners LLC, expressly rejected the reasoning of the Philadelphia majority, stating that he found “Judge Ambro’s well-reasoned dissent more persuasive.”  

The debtors in River Road have asked Judge Black to certify an appeal directly to the Seventh Circuit, so there may well be an opportunity shortly for another Court of Appeals to weigh in on this highly contentious issue.

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In the end, all of the maneuvering in the Philadelphia Newspapers chapter 11 case appears to have done nothing but leave behind some very bad case law and a great deal of future uncertainty. 

As previously described on this site, the Third Circuit Court of Appeals upheld the debtor's efforts to deny the secured lenders the right to credit bid in connection with an auction held under a non-consensual plan of reorganization pursuant to Section 1129(b)(2)(A) of the Bankruptcy Code.  However, at the auction held last week, the secured lenders won anyway, with a cash bid of $138.9 million.  The money, of course, will go back directly into their own pockets, and they will take control of the assets.  

Although a good outcome for the secured lenders, in a significant sense the result was the worst possible outcome for bankruptcy practitioners who regularly appear in Delaware and elsewhere in the Third Circuit.  While the Philadelphia Newspapers chapter 11 case itself has been resolved, the decision of the Third Circuit left hanging a shoe that still needs to drop.  The Third Circuit, in ruling that a sale of assets pursuant to a non-consensual plan need not include a secured creditor's right to credit bid under Section 1129(b)(2)(A)(ii), left open the the key question of whether such a sale ultimately could in fact satisfy the "indubitable equivalent" prong of Section 1129(b)(2)(A)(iii), and thus be confirmed over such a secured creditor's objection. 

The secured lenders' victory last week obviates the need for that crucial issue to be determined in the Philadelphia Newspapers chapter 11 case.  The inevitable result will inevitably be another case or cases in which the same strategy is devised as a means of exerting pressure on secured creditors.  However, it will not be until the auction in one of such cases is won by a party other than the secured creditors, for an amount less than the face amount of the debt, that we will know whether the results of such an auction can result in the realization by a secured creditor of the "indubitable equivalent" of its secured claim and thus permit a plan of reorganization to be confirmed without such creditor's consent.  Until this question is resolved, a cloud of ambiguity will hang over contested chapter 11 cases in the Third Circuit. 

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Some cases really should not be all that difficult. However, when judges choose to divorce statutory text completely from any reference to underlying legislative intent and long standing commercial practice, inexplicable results follow.  

A few months ago, I wrote of a decision by the U.S. District Court for the Eastern District of Pennsylvania that denied secured lenders the opportunity to credit bid their loans in connection with a sale under a plan of reorganization of the collateral securing their loans. While the substantive matter at issue – the ability to exercise rights against collateral is an essential part of the protection for which a secured lender bargains – was certainly important, what was more disconcerting was the court’s use of the so-called “plain meaning” rule of statutory interpretation to strike down decades of settled commercial law practice. I stated then:   

Philadelphia Newspapers stands as a quintessential example of the anomalous results that can transpire from the “plain meaning” rule. Particularly with a comprehensive statutory scheme as deeply rooted in centuries of commercial law as the U.S. Bankruptcy Code, the ability to focus in on specific language in single provisions, without relation to the greater whole or long understood practice, leads to no end of vexatious litigation and creates uncertainties and ambiguities where none should exist. The Third Circuit Court of Appeals should use this decision as an opportunity to repudiate strongly this mode of statutory interpretation in bankruptcy cases.

Unfortunately, rather than repudiate the “plain meaning” approach, a majority of the Third Circuit panel that heard this case chose to worship at its altar. Unless overturned by en banc review, or (highly unlikely) by the Supreme Court, the majority’s approach to statutory interpretation and the anomalous result engendered here are binding law within the Third Circuit, including the influential U.S. Bankruptcy Court for the District of Delaware. 

The majority opinion in Philadelphia Newspapers noted that Section 1129(b)(2)(A) of the Bankruptcy Code describes three different means by which a plan of reorganization could be confirmed without the consent of a secured lender class:

1. lender retention of liens securing the obligations and receipt of the present value of its secured claim,
2. sale of collateral free and clear of liens but subject to credit bidding, or
3. the realization by the creditor of the “indubitable equivalent” of its secured claim. 

Notwithstanding the express reference in subsection (ii) of Section 1129(b)(2)(A) to the right to credit bid in connection with a sale “free and clear” of liens, the Court held that a sale “free and clear” could also take place without allowing the lenders to credit bid under the “indubitable equivalent” prong. For the Court, the “plain meaning” of the use of the disjunctive “or” in the statute shows that subsection (ii) is not the “exclusive means” by which a secured lender’s collateral may be sold under a plan of reorganization and that, so long as the debtor or other plan proponent could show that the “indubitable equivalent” prong were being satisfied, then the opportunity to credit bid need not be provided. 

The majority opinion in Philadelphia Newspapers was met by a lengthy dissent. Not surprisingly, this came from the leading bankruptcy expert on the Third Circuit panel, Judge Thomas Ambro, a respected practitioner of many years. In addition to pointing out the flaws in the majority’s reading of the statutory language as “unambiguous”, Judge Ambro noted that the result flies in the face of both the well established principle that property rights in bankruptcy look to applicable non-bankruptcy law, and the long standing expectations that underlie secured lending transactions. Judge Ambro strongly criticized the majority’s refusal to look beyond what it viewed as the sole plausible reading of Section 1129(b)(2)(A) and consider any sense of Congressional purpose or the underlying principles of the Bankruptcy Code as evidenced by complementary Code sections. “In effect, a single ‘or’ becomes the bell, book and candle that excommunicates Congressional intent from the Bankruptcy Code . . . [and] upset[s] three decades of secured creditors’ expectations[.]”

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A recent decision regarding a secured lender’s right to credit bid its debt in the Philadelphia Newspapers chapter 11 case has raised significant concern among financial institutions and investment funds. The U.S. Court of Appeals for the Third Circuit has agreed to hear arguments on an expedited basis in the lenders’ appeal from the decision by the U.S. District Court for the Eastern District of Pennsylvania that the debtors could proceed with an auction pursuant to a plan of reorganization at which the lenders would not be permitted to bid in the face amount of their prepetition loans. Because decisions of the Third Circuit are binding in the District of Delaware, where numerous large chapter 11 cases are filed, the court’s decision could have substantial far reaching effects.

The substantive questions at issue are important, to be sure. Outside of bankruptcy, the ability of a secured lender to exercise rights against its collateral is the essential protection for which it bargains at the time that it extends financial accommodations to a borrower. If the property cannot be sold for the full amount of the debt, the right to credit bid allows the lender – not the borrower or any other party - to make the basic business decision as to whether it wishes to accept a reduced cash value of the property, or to take ownership of the property in the hope that it will appreciate. The U.S. Bankruptcy Code recognizes this elemental protection of a lender’s security interest whenever property of the bankruptcy estate is sold outside of the ordinary course of business, under Section 363(k). Similarly, Section 1129(b)(2)(A)(ii), the “cramdown” provision, permits plan confirmation over a secured lender’s objection so long as the lender has the right to credit bid at a sale of the collateral, effectively providing it with the precise benefit for which it initially contracted. For these reasons, the Court of Appeals will most likely reverse the District Court decision.

What may be even more important, however, would be a strong repudiation by the Court of Appeals of the so-called “plain meaning” mode of statutory construction employed by the District Court. In reaching its conclusion that a secured lender could be denied the right to credit bid, the District Court ignored the clear interplay of three separate Bankruptcy Code sections that address the rights of secured creditors, unambiguous statements of intent in the legislative history, several judicial interpretations and the weight of treatise authority, in favor of what it viewed as the “plain meaning” of Section 1129(b)(2)(A). As stated, that provision permits approval of a plan over a secured lender’s objection so long as one of three criteria can be satisfied:

• The lender maintains its lien on the collateral and receives the present value of its claim;
• The collateral is sold and the lender has an opportunity to credit bid; or
• The lender in some other manner realizes the “indubitable equivalent” of its claim.

The District Court determined that the “plain meaning” of the use of the disjunctive “or” in Section 1129(b)(2)(A) would permit a debtor to sell property under a plan but deny the lenders the right to credit bid, so long as the lender could still in some way realize the “indubitable equivalent” of its claim.

Philadelphia Newspapers stands as a quintessential example of the anomalous results that can transpire from the “plain meaning” rule. Particularly with a comprehensive statutory scheme as deeply rooted in centuries of commercial law as the U.S. Bankruptcy Code, the ability to focus in on specific language in single provisions, without relation to the greater whole or long understood practice, leads to no end of vexatious litigation and creates uncertainties and ambiguities where none should exist. The Third Circuit Court of Appeals should use this decision as an opportunity to repudiate strongly this mode of statutory interpretation in bankruptcy cases.
 

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