The Supreme Court has upheld the rights of lenders to use their debt as currency in bankruptcy auctions.

The decision was unanimous (8-0) except that Justice Anthony Kennedy did not participate.

According to a Standard & Poor's note released today, “credit bidding” permits lenders the right to bid at auction by crediting the purchase price against the secured debt instead of paying cash.

S&P explained that the right to bid for collateral in this way can guard against asset under-valuations. 

The case also has far reaching importance for any party affected by a Chapter 11 plan in a business bankruptcy case, including the federal government. Banks and other secured lenders have a longstanding expectation that they'll either be repaid or permitted to take their collateral by means of a credit bid; in other words, paying for the collateral with their lien.

RadLAX Gateway Hotel, LLC and RadLAX Gateway Deck, LLC v. Amalgamated Bank, the debtor owned the secured lender $120 million when it filed for bankruptcy; nevertheless, the debtor sought to bar the lender from bidding its credit. Instead it wanted to sell the assets - an airport hotel and parking garage - to a stalking horse bidder for just $47.5 million.

The Court of Appeals for the Seventh Circuit determined that the lender must have the right to credit bid. However, this determination was contrary to other rulings on similar cases by the Third and Fifth Circuits. The Supreme Court's ruling resolves this split.

The Loan Syndication and Trading Association, which had filed an amicus brief with the Court, released a statement saying it was "extremely pleased" with the ruling.

"Without this protection, a debtor could sell the collateral to an insider at a fraction of its actual value, resulting in substantial losses for the lenders," Elliot Ganz, the general counsel for the trade group, said in the statement.

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