Is there a Serious Threat to a Secured Creditor's Right to Credit Bid at Bankruptcy Sales, or Is the Impact of Recent Cases Narrower?
The right to credit bid is one of the most important protections afforded a secured creditor. Recognized under both state and bankruptcy law, the right to credit bid safeguards against undervaluation at an asset sale, whether at a state law foreclosure or bankruptcy sale proceeding. Recent bankruptcy cases involving loan purchases by strategic buyers, In re Fisker Automotive Holdings, Inc., 510 B.R. 55 (Bankr. D. Del. 2014) and In re Free Lance-Starr Publishing Co., 2014 Bankr. Lexis 1611 (Bankr. E.D. Va. 2014), however, have called into question the extent of a secured creditor's right to credit bid at a bankruptcy sale. Time will tell whether the cases signal serious challenges ahead for secured creditors. What is clear, however, is the need for careful underwriting and risk assessment before purchasing a troubled loan as a vehicle to acquire the underlying collateral.
In re Fisker Automotive Holdings
In Fisker Automotive Holdings, Inc., shortly before bankruptcy, Hybrid Tech Holdings, LLC, purchased the Department of Energy's interest in a senior secured loan to Fisker. The loan had an outstanding principal balance of $168.5 million that Hybrid purchased for $25 million. Hybrid then entered into negotiations with Fisker which resulted in an asset purchase agreement for substantially all of Fisker's assets in exchange for a $75 million credit bid of the newly acquired secured loan.
To implement the purchase, Fisker filed for Chapter 11 and immediately sought approval of the sale to Hybrid on an expedited basis. The Creditors' Committee in the case objected to the sale to Hybrid, proposing instead, an auction with Wanxiang America Corporation. Wanxiang, however, refused to participate in the auction unless Hybrid's credit bid right was limited to $25 million (i.e., the purchase price of the loan rather than the amount of the outstanding indebtedness). Fisker and the Creditors' Committee then stipulated: (1) an auction creating value to the bankruptcy estate was likely if Hybrid's right to credit bid was capped at $25 million; (2) conversely, there was no possibility of an auction if Hybrid's right to credit bid was not capped; (3) limiting Hybrid's right to credit bid would foster a competitive bidding environment; and (4) some, but not all, of Fisker's property (which was to be sold in its entirety) was subject to properly perfected security interests in favor of Hybrid, but determination of the extent of Hybrid's liens was not subject to quick or easy resolution. Notably, Fisker and the Committee disagreed whether the Bankruptcy Court could, as a matter of law, limit Hybrid's credit bid rights under the circumstances.
While acknowledging "it is beyond peradventure that a secured creditor is entitled to credit bid" under 11 U.S.C. § 363(k), the Bankruptcy Court observed "the law is equally clear, as Section 363(k) provides, that the Court may for cause order otherwise." The Bankruptcy Court then held that cause existed to cap Hybrid's right to credit bid at $25 million, finding that Wanxiang would not participate in the auction if Hybrid's credit bid right was not limited, Hybrid acted improperly after acquiring the loan, and there were questions about the extent and validity of Hybrid's liens.
Wanxiang was the winning bidder at the auction of Fisker's assets. While Hybrid lost the bidding, it will receive approximately $100 million of the sale proceeds according to published reports, and Fisker's Chapter 11 plan projects a modest payout on unsecured claims.
In re Free Lance-Starr Publishing
In Free Lance-Starr Publishing Co., Branch Bank and Trust ("BB&T") loaned Free Lance-Star and its affiliates $50.8 million secured by certain real and personal property. In June 2013, after the borrowers ran into financial difficulty and attempts to refinance the loan were unsuccessful, BB&T sold the loan to Standton Capital Partners. Standton then transferred the loan to its affiliate, DSP Acquisition, LLC ("DSP"), and informed the borrowers that it wanted them to file a Chapter 11 bankruptcy case and sell substantially all of their assets to DSP. DSP then attempted to expand its lien rights by requesting the borrowers to execute deeds of trust on additional collateral, recording fixture filings and additional financing statements without providing notice to the borrowers, and, during the subsequent bankruptcy case, seeking supplemental liens for the debtors use of cash collateral.
On January 23, 2014, Free-Lance-Star filed a Chapter 11 bankruptcy case and immediately filed a motion to auction substantially all of its assets. After conducting evidentiary hearings spanning three days to determine the validity, extent and priority of DSP's liens and right to credit bid at the auction of the debtors' assets, the Bankruptcy Court ruled that DSP did not have valid, properly perfected liens on certain assets, DSP could not assert a lien against the sale proceeds of assets it did not have a valid lien against, DSP could not credit bid on assets that it lacked a valid lien against, and DSP had engaged in inequitable conduct that supported limiting its credit bid right. While acknowledging the right to credit bid under Bankruptcy Code § 363(k) is an important safeguard against undervaluation of a secured creditor's collateral at an asset sale, the Bankruptcy Court stated - consistent with Fisker - that the right is not absolute, and
[t]he confluence of (i) DSP's less than fully-secured lien status; (ii) DSP's overly zealous loan-to-own strategy; and (iii) the negative impact DSP's misconduct has had on the auction process has created the perfect storm, requiring curtailment of DSP's credit bid rights.
The Court thus limited DSP's credit bid right to $13.9 million against the assets in which DSP held valid, perfected liens (compared with the $38 million owed on the loan). At the subsequent auction of Free-Lance Starr’s assets, DSP was the winning bidder paying $16.3 million in cash in addition to a $13.9 million credit bid and the assumption of certain liabilities. DSP's liens, claims and interests (along with those of other parties) also attached to the proceeds of sale pending a determination of the extent, priority and validity of DSP's liens, claims and interests.
The Importance of Fisker and Free-Lance Starr to Secured Creditors
Fisker and Free-Lance Starr involved purchases of distressed debt at a discount by strategic buyers whose ultimate goal was to acquire the underlying collateral. In both cases, there were questions whether the loan purchasers held "blanket" liens (i.e., liens against substantially all of the debtors' assets). Both cases also involved allegations of overreaching conduct by the purchasers after acquiring the loans in an attempt to conclude the loan-to-own strategy. Fisker and Free-Lance Starr highlight the need for careful due diligence, underwriting and risk assessment before purchasing a troubled loan where the strategy is to enforce the lender's rights to acquire the collateral.
In both cases, the purchaser's right to credit bid was limited, but not eliminated. The purchasers were then free to bid at the auction using a combination of cash, credit bid, and other consideration to protect their interests. In Fisker, Hybrid will receive approximately $100 million of the sale proceeds compared to its $25 million loan purchase. In Free-Lance Starr, DSP acquired the assets at auction with DSP's liens also attaching to the sale proceeds pending determination of the extent and validity of its liens.
As the Court in RML Development, Inc., 2014 Bankr. Lexis, 3024 (Bankr. W.D. Tenn. 2014) commented in a matter decided after Fisker and Free-Lance Starr, there is no definition what constitutes "cause" under Bankruptcy Code § 363(k), which allows Bankruptcy Courts to exercise their inherent equitable powers to modify a secured creditor's rights as appropriate on a case-by-case basis.
Both Fisker and Free-Lance Starr involved a secured creditor's right to credit bid at a bankruptcy sale outside of a plan of reorganization. In RadLAX Gateway Hotel, LLCv. Amalgamated Bank, the Supreme Court affirmed the lower court's refusal to confirm a plan of reorganization that did not permit the lender to credit bid at an auction of the debtor's assets under the plan.