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Fostering Competitive 363 Sales Is Not Always ‘Cause’ to Limit Right to Credit Bid

Asset sales pursuant to Section 363(b) of the U.S. Bankruptcy Code have become a common staple of complex Chapter 11 bankruptcies. Major companies such as The Rockport Co. LLC, Nine West Holdings Inc., and the Weinstein Company have all used 363 sales, as they are known in bankruptcy parlance, to sell substantially all of their assets “free and clear” of all liens. This practice follows a typical pattern:

  1. A debtor enters into an asset purchase agreement establishing the baseline bid, known as a stalking-horse agreement

  2. A Bankruptcy Court approves a process for other bidders to come forward and bid for the debtor’s assets

  3. If other bids are received, an auction is held for the debtor’s assets

It is in this process that the concept of credit bidding, which is expressly permitted by Section 363(k) of the Bankruptcy Code, comes into play. Credit bidding is a mechanism that allows a secured creditor to offset its claim against the purchase price in a 363 sale. The ability to credit bid serves two purposes: (i) it protects the secured creditor from the risk of its collateral being sold at a lower price;1 and (ii) it enables the secured creditor to purchase the collateral without having to spend what it is already owed.2

However, the right to credit bid is not absolute. Section 363(k) of the Bankruptcy Code makes clear that secured creditors may credit bid “unless the court for cause orders otherwise,” though it does not define “cause.”

Recently, a secured creditor’s right to credit bid in a 363 sale has become a hot topic. Debtors, unsecured creditors’ committees, and interested parties, in an effort to assist favored purchasers or themselves, have argued that a secured creditor’s ability to credit bid does not foster a competitive bidding environment. This “chilling” effect, the argument goes, runs counter to general bankruptcy goals and is sufficient cause to limit the right to credit bid. Thus, what would otherwise be a simple concept is turned into a complex issue ripe for dispute.

Chilling the Bidding Process

Two recent cases stand for the proposition that cause exists when a credit bid prevents (or chills) a competitive bidding process in a 363 sale: In re Fisker Auto. Holdings, Inc., 510 B.R. 55 (Bankr. D. Del. 2014), and In re The Free Lance-Star Publ’g Co. of Fredericksburg, VA, 512 B.R. 798 (Bankr. E.D. Va. 2014).

In Fisker, the U.S. Bankruptcy Court for the District of Delaware limited a secured creditor’s right to credit bid for cause, given that the creditor’s credit bid would effectively “freeze” bidding in the 363 sale.3 The Fisker debtor filed its bankruptcy with the intention of selling substantially all of its assets to its senior secured lienholder.4 The senior secured lienholder was not the original holder of the senior secured lien.5 Rather, it had acquired the $168.5 million senior secured lien for $25 million.6

In an effort to quickly dispose of its assets in a 363 sale, the debtor argued that a private sale to the senior secured lienholder—which would use a substantial credit bid—would net the largest returns for the estate and avoid the added cost of a competitive bidding process.

The unsecured creditors’ committee objected to the private sale and particularly to the senior secured lienholder’s right to credit bid more than the $25 million it spent to acquire the rights to the senior secured lien. The committee advocated for a competitive bidding process, which it asserted would result in substantially better returns for the debtors’ estate. Any credit bid over $25 million would result in the committee’s favored potential buyer not participating in the bidding process.7 Therefore, the committee asserted that cause existed to limit the senior secured lienholder’s right to credit bid “because limiting the credit bid [would] facilitate an open and fully competitive cash auction.”8

The Bankruptcy Court agreed and held that cause existed to limit—though not terminate—the senior secured lienholder’s right to credit bid.9 In reaching its conclusion, the court noted that:

the [Bankruptcy] Code plainly contemplates situations in which assets encumbered by liens are sold without affording secured creditors the right to credit bid. … [Arguing] that the “for cause” exemption under § 363(k) is limited to situations in which [a] secured creditor has engaged in inequitable conduct …  has no basis in the statute. A court may deny a lender the right to credit bid in the interest of any policy advanced by the Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment.10

If the senior secured lienholder credit bid more than the $25 million it spent to purchase the secured interest, the facts demonstrated that other potential buyers would have walked away from the auction. Thus, the Bankruptcy Court concluded that the “for cause” basis to limit the credit bid was that bidding would effectively have frozen.11

In the same vein as Fisker, the Free Lance-Star Bankruptcy Court utilized Section 363(k)’s “for cause” provision to limit a secured creditor’s right to credit bid.12 The Free Lance-Star secured creditor implemented a loan-to-own strategy, whereby it acquired the debtors’ loan with the intention to purchase the company at a depressed value through an expedited 363 sale.   


 

The one thing that stands out about both the Free Lance-Star and Fisker decisions is that neither secured creditor attempted to use its credit bid with clean hands.

 


After filing for bankruptcy, the debtors quickly filed a motion to sell substantially all of their assets through a 363 sale.13 In an effort to buy the assets at a depressed price, the secured creditor pressured the debtors to not only conspicuously advertise the secured creditor’s ability to credit bid, but also to shorten the assets’ marketing period.14

At a hearing to consider the validity of the secured creditor’s liens, the Free Lance-Star court held that the secured creditor had frustrated the 363 sale’s competitive bidding process by engaging in inequitable conduct.15 In reaching its conclusion, the court reasoned as follows:

The credit bid mechanism that normally works to protect secured lenders against the undervaluation of collateral sold at a bankruptcy sale does not always function properly when a party has bought the secured debt in a loan-to-own strategy in order to acquire the target company. In such a situation, the secured party may attempt to depress rather than to enhance market value. Credit bidding can be employed to chill bidding prior to or during an auction, or to keep prospective bidders from participating in the sales process. [The secured creditor’s] motivation to own the Debtors’ business rather than to have the Loan repaid has interfered with the sales process. [The secured creditor] has tried to depress the sales price of the Debtors’ assets, not to maximize the value of those assets.16

Therefore, given the secured creditor’s efforts to depress market enthusiasm for the 363 sale, cause existed to limit the secured creditor’s right to credit bid. Despite its holding, the court did not forbid the secured creditor from credit bidding. Instead, the court limited the secured creditors’ credit bid to one-third of its claim against the debtor and allowed it to only use the credit bid on assets on which it had a valid, properly perfected lien.

Both the Free Lance-Star and Fisker opinions would lead one to think that chilling a 363 sale’s competitive bidding process alone is cause to limit the right to credit bid. However, approximately two years after those opinions, In re: Aéropostale, Inc., 555 B.R. 369 (Bankr. S.D.N.Y. 2016) would challenge this notion.

Additional Factors

The one thing that stands out about both the Free Lance-Star and Fisker decisions is that neither secured creditor attempted to use its credit bid with clean hands. This fact is what the U.S. Bankruptcy Court for the Southern District of New York used to distinguish Aéropostale from Fisker and Free Lance-Star in holding that the chilling of a 363 sale’s competitive bidding process alone does not constitute cause to limit credit bidding rights.

In Aéropostale, the debtors alleged that bidding on their assets through a 363 sale would be chilled by their term lenders’ ability to credit bid.17 Furthermore, the debtors asserted that their term lenders (and/or the lenders’ parent companies) engaged in inequitable conduct that caused the debtors’ bankruptcy filing by: (i) breaching a sourcing agreement; (ii) conspiring to buy the debtor at a discount via a secret and improper plan; and (iii) improperly trading the debtors’ stock while in possession of the debtors’ material nonpublic information.18

As to the debtors’ claims of the term lenders’ inequitable conduct, the court held that there was no evidence of such conduct. This left the debtors solely with their argument that their lenders’ credit bid would chill the competitive bidding process. The Aéropostale court rejected the merits of the argument and instead held that bid chilling alone was insufficient to justify limiting the term lenders’ right to credit bid. In reaching the latter conclusion, the court specifically addressed the Fisker and Free Lance-Star opinions. The court noted that these cases—along with others that considered chilled bidding—involved additional factors that supported limiting credit bids.19

Accordingly, the Aéropostale court denied the debtors’ request to limit the term lender’s credit bid, because the chilling effect of credit bidding alone did not suffice as cause to limit the term lender’s right to credit bid.20

The Debate Continues

A credit bid’s ability to chill a 363 sale’s competitive bidding process—so as to constitute cause to limit credit bidding rights—is determined through a case-by-case analysis. Courts have not developed a methodology for determining what constitutes cause to limit credit bidding. While it is well settled that secured creditors cannot partake in inequitable conduct in the pursuit of their credit bids, it is still up for debate whether the desire to foster a competitive bidding environment alone is considered cause to limit credit bidding rights.


  1. RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. 639, 644 n. 2 (2012) (“The ability to credit-bid helps to protect a creditor against the risk that its collateral will be sold at a depressed price. It enables the creditor to purchase the collateral for what it considers the fair market price (up to the amount of its security interest) without committing additional cash to protect the loan.”).
  2. In re Spillman Dev. Grp., Ltd., 401 B.R. 240, 253 (Bankr. W.D. Tex. 2009), aff'd sub nom. Fire Eagle, LLC v. Spillman Inv. Grp., Ltd., No. A-10-CA-894-LY, 2011 WL 13234814 (W.D. Tex. Sept. 29, 2011), aff'd sub nom. In re Spillman Dev. Grp., Ltd., 710 F.3d 299 (5th Cir. 2013) (concluding that a creditors’ purchase of assets by credit bid “is the equivalent of a cash purchase.”)
  3. Fisker, 510 B.R. at 60.
  4. Id. at 57.
  5. Id.
  6. Id.
  7. Id. at 59.
  8. Id. at 58.
  9. Id. at 59-60.
  10. Id. (citations omitted) (emphasis added).
  11. Id. at 60.
  12. Free Lance-Star, 512 B.R. at 807-08.
  13. Id. at 799-800.
  14. Id. at 806.
  15. Id.
  16. Id.
  17. Aéropostale, 555 B.R. at 416.
  18. Id. at 399-416.
  19. Id. at 417-18; For example, in Fisker, not only was the 363 sale being unreasonably rushed, but also the senior secured lienholder attempted to credit bid its entire claim against the debtor when the validity of its lien was undetermined. Fisker, 510 B.R. at 61 (noting that “the [d]ebtors and the [c]ommittee agree that [the senior secured lienholder’s] claim is partially secured, partially unsecured and of uncertain status for the remainder.”). The Fisker court’s decision to cap credit bidding ultimately centered on there being a general lack of fairness in the 363 sale process, in addition to a “frozen” bidding process. Additionally, in Free Lance-Star, the court’s limiting the secured creditor’s credit bid was also the result of the secured creditor’s inequitable conduct. Free Lance-Star, 512 B.R. at 803-04, 806-08 (noting that after the secured creditor realized it did not have a validly perfected security interest in all of the debtors’ assets, the secured creditor recorded multiple UCC financing statements—without giving the debtors notice—to perfect security interests in assets in which the secured creditor knew it did not have a valid lien.).
  20. Id. at 416-18.
Jeffrey Cohen

Jeffrey Cohen

Lowenstein Sandler LLP

Jeffrey Cohen is a partner in the Bankruptcy, Financial Reorganization & Creditors’ Rights practice of Lowenstein Sandler in New York. His practice centers on Chapter 11 bankruptcy reorganizations and related litigation. Cohen often provides advice to private equity-sponsored and venture capital-backed distressed investors, representing boards of directors and management in the out-of-court winddown or distressed M&A process in a variety of industries. He holds a law degree from St. John’s University School of Law and a bachelor’s degree from the State University of New York at Albany.

Gabriel Olivera

Gabriel L. Olivera

Lowenstein Sandler LLP

Gabriel L. Olivera is an associate in the Bankruptcy, Financial Reorganization & Creditors’ Rights practice of Lowenstein Sandler in New Jersey. He is experienced in financial reorganization and corporate bankruptcy-related litigation and has counseled creditors’ committees, trade creditors, securities class action plaintiffs, and debtors in a variety of complex restructuring matters. At another firm, he served on the team representing the Puerto Rico Financial Oversight and Management Board in its municipal bankruptcy filing. Olivera holds a law degree from Tulane Law School and a bachelor’s degree from Boston University.

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