On May 29, 2012, the Supreme Court of the United States, in the chapter 11 cases of RadLAX Gateway Hotel, LLC, and RadLAX Gateway Deck, LLC (the "RadLAX Cases")1 held by a vote of 8-02 that a chapter 11 plan cannot be confirmed if the plan (i) is rejected by a class of secured claims, (ii) provides for the sale of collateral free and clear of liens securing such claims, and (iii) deprives the holders of such claims of the right to credit bid at the sale of collateral.

By resolving a circuit split among the Third, Fifth and Seventh Circuits3, the Supreme Court's decision provides certainty to troubled borrowers and secured creditors. In the cases of In re Philadelphia Newspapers, LLC, and In re Pacific Lumber Co., the Third and Fifth Circuits held that a chapter 11 plan that denies an objecting class of secured creditors the right to credit bid its claims when the creditors' collateral is sold may be confirmed if the plan otherwise provides secured creditors with the "indubitable equivalent" of their secured claims. The Seventh Circuit, with consolidated appeals from a chapter 11 case involving River Road Hotel Partners, LLC, and the RadLAX Cases, rejected the reasoning of the Third and Fifth Circuits and held in In re River Road Hotel Partners, LLC that a class of secured creditors that rejects the plan may not be deprived of the right to credit bid at such a sale. The Supreme Court decision in RadLAX affirmed the result in River Road.

Cram-Down Requirements for Confirming a Plan

Typically, a chapter 11 debtor operating under the protections of the Bankruptcy Code may sell its assets pursuant to either section 363 of the Bankruptcy Code or pursuant to a chapter 11 plan that meets the requirements set forth in section 1129 of the Bankruptcy Code.

Section 363(b) of the Bankruptcy Code provides that during a bankruptcy case, a trustee or debtor in possession may, after notice and a hearing, use, sell, or lease property of the estate outside the ordinary course of business. Section 363(f) provides that, under certain circumstances, such property may be sold to a third party free and clear of liens and other property interests. If a secured creditor's collateral is sold free and clear of its lien, the lien attaches to the proceeds of the sale for the benefit of the secured creditor. In addition, section 363(k) of the Bankruptcy Code provides that the secured creditor may bid up to the amount of its secured claim at the sale (commonly referred to as "credit bidding").

Section 1129 of the Bankruptcy Code sets forth the requirements for the confirmation of a chapter 11 plan. Under section 1129(a)(8) of the Bankruptcy Code, in order to confirm a chapter 11 plan, among other requirements, each class impaired under the plan must vote to accept the plan. However, if all of the section 1129(a) requirements are satisfied, except for subsection (8), under section 1129(b) of the Bankruptcy Code, a nonconsensual plan – or "cram-down" plan – may be confirmed over the objection of a class that votes to reject the plan.

Under section 1129(b), a plan may be confirmed if the plan is, among other things, "fair and equitable" with respect to the rejecting class. With respect to a rejecting class of secured creditors, section 1129(b)(2)(A) provides that in order for a plan to be "fair and equitable," the plan must provide:

(i) (I) that the holders of such claims retain the liens securing such claims, whether the property subject to such liens is retained by the debtor or transferred to another entity, to the extent of the allowed amount of such claims; and (II) that each holder of a claim of such class receive on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder's interest in the estate's interest in such property;

(ii) for the sale, subject to section 363(k) of this title, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (iii) of this subparagraph; or

(iii) for the realization by such holders of the indubitable equivalent of such claims.

The RadLAX Cases

RadLAX Gateway Hotel, LLC and RadLAX Gateway Deck, LLC filed chapter 11 petitions with the Bankruptcy Court for the Northern District of Illinois and filed a chapter 11 plan, which provided for the sale at public auction of substantially all of the Debtors' assets free and clear of the respective lenders' security interests, with the sale proceeds to be distributed among creditors in accordance with their priorities under the Bankruptcy Code. With respect to the sale of the assets contemplated by the Debtors, the bidding procedures proposed by the Debtors provided that the lenders would not have the right to credit bid at the sale. Amalgamated Bank, on behalf of the secured lenders, filed an objection to the proposed bidding procedures for the Debtors' proposed plan because such procedures deprived the lenders of the right to credit bid at the auction.

The Bankruptcy Court denied the Debtors' motion seeking approval of the bidding procedures, holding that a chapter 11 plan providing for the sale of collateral of a non-accepting secured creditor class free and clear of liens could not satisfy the "fair and equitable" requirement for cram-down plan confirmation unless section 1129(b)(2)(A)(ii), which expressly provides for the right to credit bid by stating that the sale is subject to section 363(k), is satisfied. The Bankruptcy Court found that the Debtors improperly sought plan confirmation under section 1129(b)(2)(A)(iii), which requires that the secured lenders receive the "indubitable equivalent" of their secured claims and does not mention the right to credit bid. The secured creditors' right to credit bid under subsection (ii) is designed to protect against undervaluation of the collateral by ensuring that the collateral is not sold free and clear of the secured creditors' liens at a price that does not maximize the value of the collateral.

Upon the Debtors' motion, the Bankruptcy Court certified the decision for direct appeal to the Seventh Circuit Court of Appeals, where it was consolidated with an appeal from the similar chapter 11 cases of In re River Road Hotel Partners, LLC.4 The Seventh Circuit affirmed the Bankruptcy Court's order, and held that cram-down plan sales for encumbered assets free and clear of liens at an auction must satisfy the requirements set forth in subsection 1129(b)(2)(A)(ii) of the Bankruptcy Code, rather than subsection (iii), affording secured creditors the right to credit bid at plan sales. The Debtors then filed a petition for certiorari, which was granted by the Supreme Court.5

The Supreme Court's Analysis

The Supreme Court based its analysis on the plain meaning of section 1129(b)(2)(A) of the Bankruptcy Code. As the Court found that there was no textual ambiguity in the statute, the Court did not find it necessary to provide a detailed analysis of, among other things, the policy considerations behind the enactment of section 1129(b) or the protections provided to secured creditors under the Bankruptcy Code, including credit bidding, to aid in its interpretation of the statute. Instead, the Supreme Court focused on the interplay of subsections (i), (ii) and (iii).

In that regard, the Supreme Court employed the "specific governs the general" canon of statutory construction, noting that where general and specific authorizations exist side-by-side, the canon avoids "the superfluity of a specific provision that is swallowed by the general one...."6 Applying this canon of statutory construction to section 1129(b)(2)(A) of the Bankruptcy Code, the Court explained that subsection (ii) is a more detailed provision that sets forth the requirements for the sale of collateral free and clear of liens pursuant to a chapter 11 plan, while clause (iii) is a broadly worded provision that provides no textual indication in connection with such a plan sale. Therefore, the Court found that "[subsection] (ii) is the rule for plans under which the property is sold free and clear of the creditor's lien, and [subsection] (iii) is a residual provision covering dispositions under all other plans...."7

Based primarily on statutory construction and analysis, the Supreme Court held that a chapter 11 cram-down plan that provides for the sale of collateral free and clear of a secured creditor's lien, but does not permit the secured creditor to credit bid at the sale, cannot be confirmed if the secured creditor's class votes to reject the plan.

Conclusion

The Supreme Court's decision resolves an important issue regarding the right to credit bid at plan sales that has been closely monitored by bankruptcy practitioners and scholars. Unlike the Seventh Circuit in its River Road holding, the Supreme Court did not look to policy considerations or legislative history in reaching its decision. Instead, the Court focused on the language of section 1129(b)(2)(A), which the Court found clear and unambiguous in supporting the conclusion that a non-accepting class of secured creditors may not be deprived of the right to credit bid at plan sales. Ironically, the Third Circuit in Philadelphia Newspapers also found that the language of section 1129(b)(2)(A) was clear and unambiguous, but held that the "clear meaning" supported the conclusion that a non-accepting class of secured creditors may be deprived of the right to credit bid at plan sales as long as they receive the indubitable equivalent of their claims. Although the Supreme Court decided the issue based solely on plain meaning and ignored policy considerations, its holding is correct from a policy standpoint as well because it appropriately protects the secured creditor against undervaluation of its collateral when sold under a chapter 11 cram-down plan.

Footnotes

1 RadLAX Gateway Hotel, LLC v. Amalgamated Bank, No. 11-166, 2012 U.S. LEXIS 3944 (U.S. May 29, 2012).

2 Justice Scalia wrote the opinion for the Court and Justice Kennedy did not take part in the decision.

3 See, e.g., In re Phila. Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010); Bank of N.Y. Trust Co. v. Official Unsecured Creditors' Comm. (In re Pac. Lumber Co.), 584 F.3d 229 (5th Cir. 2009); River Road Hotel Partners, LLC v. Amalgamated Bank, 651 F.3d 642 (7th Cir. 2011).

4 See River Road Hotel Partners, LLC v. Amalgamated Bank, 651 F.3d at 645 (On November 4, 2010, the Bankruptcy Court entered certifications for direct appeal to the Seventh Circuit in connection with both cases. In addition, on November 30, 2010, the Seventh Circuit entered an order authorizing and consolidating the appeals of both the RadLAX and River Road debtors).

5 RadLAX Gateway Hotel, LLC v. Amalgamated Bank, No. 11-166 (U.S. Dec. 12, 2011).

6 RadLAX Gateway Hotel, LLC v. Amalgamated Bank, No. 11-166, 2012 U.S. LEXIS 3944 at *11.

7 Id. at *14.

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