A recent ruling in the Chapter 11 case of Free Lance-Star Publishing limited the credit bidding rights of a secured creditor. The ruling has called into question the ability of the holder of secured debt to utilize such debt to acquire companies on a going concern basis in bankruptcy cases, particularly in instances where the debt was acquired at a discount for such express purpose. Because this has been a common strategy of numerous hedge funds and investment vehicles that have found no shortage of willing sellers among commercial banks and other traditional lenders holding large portfolios of troubled loans, the Free Lance-Star Publishing decision and an earlier substantially similar ruling in the Chapter 11 case of Fisker Automotive have justifiably received wide attention.
Less attention has been given to efforts by the secured lenders in those cases to appeal the decisions of the bankruptcy courts. DSP Acquisition, the holder of the secured debt in Free Lance-Star Publishing, sought to appeal to the U.S. District Court for the Eastern District of Virginia. In a decision handed down on May 7, 2014, the District Court held that DSP could not appeal as a matter of right, and denied DSP’s request to appeal on an interlocutory basis. Perhaps not surprisingly, just as U.S. Bankruptcy Court Judge Kevin Huennekens had looked to Fisker Automotive in determining to limit DSP’s ability to credit bid, U.S. District Court Judge Henry Hudson relied heavily on the decision denying the appeal in Fisker Automotive issued by Judge Gregory Sleet of the District of Delaware.
These decisions make clear that the ruling of a bankruptcy court judge with respect to a secured creditor’s right to credit bid will effectively be dispositive. District court judges that follow Judge Sleet’s and Judge Hudson’s rulings will not intervene to enjoin an auction process. Any vindication of a right to credit bid will therefore not occur until long after the auction has taken place and the assets have been sold.
Judge Hudson first examined whether DSP could appeal as a matter of right, either because it would suffer “irreparable harm” if the auction occurred and it was not permitted to credit bid, or because the decision to limit DSP’s credit bid constituted a “final order.” He ruled that irreparable harm did not exist because the bankruptcy court was making no determination as to how the proceeds from the auction would be allocated. Similarly, the decision was not “final” because, citing Judge Sleet’s ruling in Fisker Automotive, he held that DSP would still have an effective remedy “because the secured lender ‘could then either receive a cash return of the difference between the full credit entitled, or if a third-party bidder won the auction, [the secured lender] could receive its entitlement out of the cash paid by this party.’”
Having found that DSP could not appeal Judge Huennekens’ order as a matter of right, Judge Hudson denied leave for DSP to appeal on an interlocutory basis. He stated that interlocutory appeals should only be permitted where there is a “narrow question of pure law whose resolution will be completely dispositive of the litigation.” Although there was a legal question of whether “cause” existed to limit credit bidding under Section 363(k) of the Bankruptcy Code in order to avoid chilling the bidding process and to “restore enthusiasm” for the sale, Judge Hudson noted that Judge Huennekens had also ruled on the extent and validity of certain of DSP’s liens. Again citing Judge Sleet’s Fisker Automotive decision, Judge Hudson determined that “there is no reason why the auction . . . cannot proceed with [the secured lender] bidding alongside other parties and [the secured lender] receiving a cash adjustment should the Bankruptcy Court ultimately decide that [the secured lender’s] credit bid should not have been capped.”
One potential flaw in Judge Sleet’s and Judge Hudson’s reasoning is that credit bidding’s essential purpose is to protect a secured creditor from being forced to accept a cash payment that is below that value the secured creditor believes the collateral possesses. If the auction takes place and another bidder wins, and the secured creditor’s right to credit bid is only vindicated afterwards, then “a cash adjustment” if the purchase price is below the face value of the secured debt could be an empty remedy. Accordingly, decisions by bankruptcy judges as to whether to limit credit bidding rights “for cause” under Section 363(k) in order to foster competitive auctions will resonate all the more sharply.