Decisions in two recent bankruptcy cases have challenged a common belief that
partially secured creditors have an absolute right to protect their collateral
by credit bidding their entire claim in sales held pursuant to Chapter 11 plans.
In a recent decision of the 5th Circuit Court of Appeals, In re Pacific
Lumber Co., 584 F.3d 229 (5th Cir. 2009), written by the conservative Judge
Edith Jones, the court found that the Bankruptcy Code did not always give a
secured creditor the right to credit bid at a sale of its collateral as part of
a Chapter 11 plan.
Similarly, a recent decision of the U.S. District Court for the Eastern
District of Pennsylvania in In re Philadelphia Newspapers, LLC, 418 B.R.
548 (E.D. Pa. 2009) reversed a decision of the Bankruptcy Court and found that
the Bankruptcy Court could approve certain bid procedures that specifically
prohibited a secured party from credit bidding at a sale pursuant to a Chapter
The 3rd Circuit Court of Appeals granted an appeal of the District Court’s
decision, and stayed the debtors’ proposed auction and sale pending the appeal.
The 3rd Circuit has thus set the stage for an important decision governing
secured creditors’ rights to protect their collateral in the District of
Delaware, a frequent venue for complex Chapter 11 cases.
5th Circuit Reasoning
In In re Pacific Lumber Co., the 5th Circuit, in a direct appeal of an
order rejecting the secured lenders’ objection to the plan, stated that "paying
off secured creditors in cash can hardly be improper if the plan accurately
reflected the value of the [the secured lenders’] collateral.”
Moreover, the 5th Circuit concluded that the payment of cash to the secured
lenders equal to the value of the collateral afforded them the “indubitable
equivalent” and thus satisfied the “cram down” provisions of the Bankruptcy
Code. The fact that the lenders would forego the benefit of later increases in
the value of the collateral was not important, because the Bankruptcy Code
protects a secured creditor’s “allowed secured claim” rather than the potential
upside in the value of its collateral.
Appeal to the 3rd Circuit
In the Philadelphia Newspapers case, the 3rd Circuit Court of Appeals
granted expedited appellate review of the District Court’s decision, and heard
oral argument on Dec. 15, 2009. Notably, the Loan Syndications and Trading
Association and the Commercial Finance Association filed a joint amicus curiae
brief explaining why the absolute right to credit bid is vital to secured credit
Regardless of how the 3rd Circuit rules, the issue of secured creditors’ “bid
in” rights is certain to remain a controversial subject, and to affect the
dynamics of negotiation between secured lenders and their financially troubled