The hedge fund, securities and banking industries, along with other financial trade associations, filed an amicus brief in the US Supreme Court arguing that the federal bankruptcy code does not allow a debtor to bar secured lenders from credit bidding to protect themselves against the potential undervaluation of their collateral in bankruptcy. A new rule allowing debtors to bar credit-bidding would increase the risk of undervaluation, they argued, and to compensate for that risk lenders would be forced to increase the cost of capital, contended the Managed Funds Association, SIFMA, and the American Bankers Association, among others. They said that such a rule would have a significant negative impact on the market for secured financing at a moment when the ready availability of affordable credit remains essential to the national economic recovery. Generally supporting the trade groups, the US government filed an amicus brief stating that a creditor’s opportunity to bid cash at an asset sale is not an adequate substitute for the right to bid credit. The case is set for oral argument on April 23, 2012. RadLAX Gateway Hotel, LLC v. Amalgamated Bank, Dkt. No. 11-166.
According to the MFA, SIFMA and the trade groups, the debtors want to sell their assets, which secure their substantial debt, to a stalking-horse bidder with ties to debtors’ existing owners for a fraction of what they owe their secured lender. The question presented to the Court is whether secured creditors have the same right to credit-bid when their collateral is sold under a Chapter 11 plan. The secured creditors have not consented to their treatment under the proposed plan. However, that plan may nonetheless be crammed down, but only if it is fair and equitable.
To be fair and equitable regarding a class of secured claims, the plan must provide for one of three forms of treatment, laid out in the three clauses of Bankruptcy Code Section 1129(b)(2)(A). Under (i), the reorganized debtor keeps the property and may be allowed to stretch out the repayment of the debt beyond the period allowed by the loan agreement, but the lien remains on the property until the debt is repaid. Under (ii), the debtor auctions the property free and clear of the mortgage but the creditor is allowed to credit bid. Under (iii), the lien is exchanged for an indubitable equivalent, such as the collateral itself or a lien on property of unquestionably equal or greater value.
According to the trade groups, the debtors want to sell their assets, which secure their substantial debt, to a stalking-horse bidder with ties to debtors’ existing owners for a fraction of what debtors owe their secured lender. And they want to preclude their lender from credit-bidding on the assets because they are afraid the lender might outbid the stalking horse. But, amici argued that the effort to erase the lender’s lien and cash it out by giving it the proceeds of the restricted sale is precisely the ploy that credit bidding is designed to prevent.
The associations contended that the debtors’ interpretation of Section 1129(b)(2)(A) is wholly inconsistent with the structure of the Bankruptcy Code’s protections for secured creditors. The Code is meticulously designed to prevent an involuntary reduction of the amount of a creditor’s lien for any reason other than payment on the debt. Credit-bidding ensures that, if collateral is sold, the secured creditor can get the property securing its claim if the creditor values it more highly than other bidders do. According to the MFA and SIFMA, the proceeds of a sale at which the secured creditor is not permitted to credit-bid cannot be the indubitable equivalent of the right the secured creditor otherwise possesses to get the property itself.
More broadly, they argued that the plan serves no legitimate bankruptcy or commercial purpose, and sanctioning it will seriously unsettle the market for secured credit, a market in which hedge funds, securities firms and banks are essential participants. Credit-bidding can only benefit the bankruptcy estate. Creditors can bid more for their collateral if they are not required to incur the significant costs associated with a cash bid. Moreover, some secured creditors will not be able to bid at all without credit bidding.
Thus, reasoned the industry groups, allowing debtors to deny the right to credit-bid without cause serves no purpose other than to enable debtors to steer their assets to lower bidders favored by debtors’ owners or management, enriching insiders at creditors’ expense. Even more, continued amici, the debtors’ reading of the Code provides ``an invitation to mischief’’ with no offsetting benefits for the estate. Ultimately, they predicted that credit markets will respond to such inefficiencies by increasing the cost of borrowing, harming debtors as well as creditors and the economy as a whole.