Top restructuring officials have endorsed the right of secured creditors to use their liens on borrowers' assets as currency in “363” corporate bankruptcy sales.
The recommendation is one of the positive outcomes for lenders of a three-year process designed to make the Chapter 11 process cheaper and more efficient, giving struggling companies a better shot at survival.
Credit bids let lienholders bypass cash bids and use forgiven debt as their offer and apply it toward their purchase — ensuring the assets are not sold for less than the size of the claim. Both federal and state law allow lienholders to credit bid up to the amount of its allowed claim, though the federal Bankruptcy Code provides that a court orders otherwise, “for cause.”
The 370-page report from the American Bankruptcy Institute’s (ABI) Commission to Study the Reform of Chapter 11, published Monday, recommends upholding this principle. Moreover, it states that “the potential chilling effect of a credit bid alone” should not constitute cause, although “the court should attempt to mitigate any such chilling effect in approving the process.”
The report notes that courts typically have found cause to limit a credit bid in two types of situations, either because the amount of the creditor’s claim was disputed, or based on the conduct of the creditor. For example, In re Free Lance-Star Publishing Co., the court found cause to limit the creditor’s right to credit bid, among other reasons, because the creditor acquired the loan for the sole purpose of obtaining the right to credit bid and discourage any competitive bidding.
The Commission agreed that the conduct of a secured credit can have a chilling effect on an auction process. But it noted that all credit bidding chills an auction process to some extent, and in some cases it may be difficult to discern the chilling effect caused by the credit bid itself from the chilling effect resulting from the creditor’s conducts.
As a result, the commissioners did not believe that the chilling effects of credit bidding alone should suffice as cause.
A footnote to the report cites a written statement submitted by Danielle Spinelli, a partner at WilmerHale, in November 2012 field hearing. The argument that other potential bidders would be discouraged if they fear being outbid by a secured creditor “lacks force,” Spinelli wrote. “That would be equally true of any deep-pocketed bidder, and no auction can afford to exclude the bidders with the greatest resources on the ground that they might outbid everyone else.”
The endorsement of credit bidding was foreshadowed in a poll of ABI members taken on the Commission's website this summer in wihch the majority of respondentssaid that credit bidding should be allowed in a bankruptcy sale.
Seventy-eight percent of respondents (58 percent “disagreed strongly” and 20 percent “somewhat”) to the poll question, “Credit-bidding should not be allowed in a bankruptcy sale.” Eighteen percent thought that credit-bidding should not be allowed (8 percent “strongly” agreeing with the poll question and 10 percent “somewhat” agreeing). Three percent did not know/had no opinion on the poll.
There were 59 respondents.