Bankruptcy

Credit Bidding

By Adam Levitin

The Third Circuit has ruled in Philadelphia Newspapers that a cramdown plan that includes an asset sale not subject to credit bidding is confirmable.  The ruling overs only sales under a plan (1123(a)(5)(D) sales), not pre-plan sales (363 sales).  It is the latest example (with Chrysler and GM's plans being the next most recent) of the tension between sections 363 and 1123/1129.  In Chrysler and GM, a 363 sale was used to effectuate a plan, whereas in Philadelphia Newspapers, an 1123/1129 sale is being used to effectuate a 363 sale without credit bidding.  It's becoming increasingly clear that integrating 363 and 1129 protections for creditors is going to be at the heart of the next round of corporate bankruptcy reform.   

Some thoughts below.  I suspect that Stephen Lubben will chime in as well...

As a doctrinal matter, I think the Philadelphia Newspaper's ruling's reasoning was rather strange.  Strictly speaking, to confirm a cramdown plan, secured creditors need only receive the "indubitable equivalent" of their interest, per 1129(b)(2)(iii).  That provision does not, on its face, require credit bidding.  Indeed, it is worth contrasting with 363(k), which permits credit bidding unless the court orders otherwise.  

Now, one way to read these provisions is that the expression of the credit bid right in 363 indicates that Congress did not intend for it to exist under 1129/1123.  But that makes little sense either as a policy matter or in terms of the history of the Code.  It is hard to come up with a convincing policy reason for treating plan sales differently than pre-plan sales. The result is strange enough that one should pause about relying solely on the text itself; indeed, the 1129 statutory text's silence about credit bidding is itself sufficiently vague that it doesn't do to decide the case on the plain language; there is none directly on point.  This means we should look at the larger history and policy issues.  

The Bankruptcy Code was not written on a blank slate.  It was written against a long pre-Code background, and there is a well-established pre-Code practices doctrine that teaches that unless Congress explicitly disavowed a pre-Code practice, that practice continues to be good law.  A secured creditor's right to credit bid is a well established right, and there's little to indicate that Congress wanted to eliminate it, for sales under 1129, but not for sales under 363.  As Judge Ambro writes in a detailed dissent, it is just hard to discern any Congressional intent to eliminate credit bidding for sales under a plan, but not pre-plan sales.  

There is a larger policy question lurking in Philadelphia Newspapers, however, and that is whether credit bidding should ever be allowed.  As a policy matter, I think the ruling really depends on how competitive of a market one believes exists in bankruptcy asset sales.  

If bankruptcy asset sales markets are reasonably competitive, then eliminating credit bidding means that there is a leveling of the bidding field; secured lenders are not freed from liquidity constraints that other parties might have.  At worst, this means that there is one less bidder at the sale; at best, it encourages other parties to bid, knowing that they won't be competing against a credit bid.  If bankruptcy asset sale markets are thick, this might be a good outcome, as it would likely increase competition, which should mean higher returns for the estate.  Yet this gain would have to be netted against the possibile increase in the cost of secured credit (which would make unsecured debt more attractive, but raise the total cost of financing, and thus increase the likelihood of bankruptcy overall).  

Bankruptcy asset sales, however, are frequently not robust, competitive markets.  In these cases, eliminating credit bidding might not encourage greater entry, but might merely enable sweetheart deals. The ability to credit bid protects the estate from losing through a sweetheart asset sale.  If credit bidding isn't allowed, then asset sales are a context of new money.  When secureds are part of a syndicate (especially if they are investment funds), they might not be able to come up with new money.  In such a case, if there might be only one other bidder, such as an insider (old equity or, in GM/Chrysler, labor), who is then able to buy the assets on the cheap.  Eliminating credit bidding means that insiders might be able to win auctions, even if the assets are underpriced.   To be sure, if the stalking horse bid is too underpriced, there is always the possibility of a third-party bidder willing to pay fair value, but the debtor has some control over how vigorously the deal is shopped. 

Now all of this gets back to the question of what is a fair price, and on some level, the outcome of an asset sale is the market and shows what is fair.  Viz. BFP v. RTC and GM/Chrysler.  But what is a fair price depends on sale procedures, and if there's another sale procedure that is likely to bring in a higher net price (such as a sale with a credit bid allowed), then it doesn't do to call the price the "market" price and therefore fair.  Particularly in thin markets like most bankruptcy asset sales, credit bidding is an important protection not just for secured creditors, but also for the estate.  

Full post as published by Credit Slips on March 23, 2010 (boomark / email).