Justices tackle credit bidding in bankruptcy ‘cramdown’ plan

Listen to this article

WASHINGTON – The justices of the U.S. Supreme Court took up a complicated bankruptcy case Monday, parsing the language of the Bankruptcy Code to determine if a Chapter 11 debtor must give a secured creditor the right to credit bid items being sold at auction.

The case of RadLAX Gateway Hotel v. Amalgamated Bank stems from a Chapter 11 bankruptcy filing by the owners of a failed hotel construction project. In their “cramdown” bankruptcy plan, the debtors proposed selling the hotel’s assets in an open auction.

But the creditor objected to the plan, arguing that under the Bankruptcy Code it had the right to bid on the items using its credit in the property.

The relevant section of the Bankruptcy Code, §1129(b)(2)(A), provides that a bankruptcy plan must be “fair and equitable” to a secured debtor that objects.

The debtors claimed the code does not require a debtor to give a secured creditor the right to credit-bid at an auction. Instead, they argued, there are three options open to debtors: §1129(b)(2)(A)(i) allows the debtor to pay off the creditor’s lien over time; §1129(b)(2)(A)(ii) allows creditors to credit bid on secured assets that are being sold free of the lien; and §1129(b)(2)(A)(iii) provides that a plan can be deemed “fair and equitable when it gives creditors the “indubitable equivalent” of a secured creditor’s claim.

Since the debtors in this case chose the third option, the creditor was not entitled to credit-bidding rights, the debtors claimed.

But 7th Circuit disagreed, holding that §1129(b)(2)(A) does not authorize debtors to use subsection (iii) to confirm a reorganization plan contrary to a secured creditor’s right to credit bid.

With a circuit split on the issue, the Supreme Court granted certiorari.

Feeling sorry for creditors?

David Neff, a partner in the Chicago office of Perkins Coie, argued on the debtors’ behalf that debtors have a choice of how to satisfy a secured creditor’s claims.

“The debtors have chosen to pursue a plan, a plan sale without credit bidding under subsection (iii),” Neff said. “The plain language of the statute permits that result.”

If creditors are given the unrestricted right to credit bid, Neff said, “in a case like ours, we don’t believe we will ever get to an auction because no one else will show up.”

“But you’re depriving the secured creditor of the opportunity to hold on to the asset,” said Chief Justice John Roberts Jr.

Neff replied that this was the equivalent of any of the options available under the Bankruptcy Code, including “fair market value of the collateral …over time” under subsection (i).

Justice Antonin Scalia wondered whether debtors should take pity on government creditors.

“Mr. Neff, don’t you feel sorry for the United States?” Scalia asked. “The United States is often in the creditor situation, and the United States cannot come up with cash.”

“They can seek from the Bankruptcy Court a greater role when the asset is being marketed for sale to ensure that they are receiving top dollar on their claim,” Neff replied.

Bargained-for bidding right

Deanne Maynard, a partner in the Washington office of Morrison Foerster, argued on behalf of the creditor that the statute clearly spells out creditors’ rights.

“Secured creditors bargain for the right to be repaid in full or, if not, to foreclose and take the collateral that secures their loan,” Maynard said.

“You really do just kind of elide the fact that the statute says ‘or,’” Roberts said.

“No, we give full meaning to the ‘or,’” Maynard replied. “We don’t dispute that these are three alternative ways to cram down a plan. The question here is (over) the scope of the alternatives and in which circumstances in they apply.”

When Maynard argued that valuation in the auction process is inherently uncertain, Justice Samuel Alito Jr. asked why that was so.

“What is it about the auction process that you think is likely to produce or create an unacceptable risk of producing a valuation that is too low?” Alito asked.

“If the secured creditors aren’t able to come in and bid their credit (and can’t) raise enough cash to bid the amount of their credit in cash… you are taking out of the marketplace one of the most knowledgeable bidders about this property,” Maynard replied.

Sarah Harrington, assistant to the solicitor general, argued as amicus in support of the creditors. But before she could utter a word after approaching the podium, Scalia jumped in.

“It is a big case for the government,” he said.

“It is a big case for the government,” Harrington agreed. “As you suggest, the government (has) constraints on our ability to cash bid at the sale of our collateral through a bankruptcy, and the detailed cramdown provisions of Chapter 11 are designed to protect the rights of secured creditors.”

A decision is expected before the end of the current term.