In connection with a proposed sale of real property, a chapter 11 debtor sought to prohibit the mortgagee from submitting a credit bid. It contended that there was "cause" based on its argument that the mortgagee's claims were subject to a bona fide dispute.
The debtor owned two contiguous properties. A bank held a mortgage on each property, with each mortgage securing a separate loan. As of the bankruptcy filing, the bank claimed ~$1.2 million was due on one loan and ~$3.8 million was due on the second loan. The two loans were not cross-collateralized – i.e. one property secured only one loan, and the second property secured only the other loan.
The debtor sought authority to sell the properties free and clear of liens, claims and encumbrances to a stalking horse bidder or to a higher qualified bidder at a proposed auction. Under the stalking horse purchase agreement, the initial bid was $2 million and the debtor was required to pay a $50,000 breakup fee to the stalking horse bidder if someone else bought the properties.
Under Section 363 of the Bankruptcy Code, a secured party holding an "allowed" claim secured by property that it is acquiring is allowed to offset its claim against the purchase price, unless the court "for cause orders otherwise."
In a motion to approve the sale, including the breakup fee and bidding procedures, the debtor asked the bankruptcy court to prohibit the bank from credit bidding for the properties. The debtor did not contend that the bank's claims were not "allowed," but instead asserted counterclaims against the bank.
Although it did not dispute the validity of the bank's claims, the debtor wanted to satisfy its own counterclaims by a setoff against the bank's claims. Otherwise, the debtor argued that its claims might not be collectable. While acknowledging that a credit risk can sometimes provide the basis for disallowing credit bidding, the court did not agree that this case was such a circumstance.
Specifically, a secured creditor generally should not receive payment on its claim before any objections to the claim are resolved. Otherwise, it might be unable or unwilling to return the payment, and the bankruptcy estate might have to incur costs to recover it. Since a credit bid is in effect a payment of a claim, outstanding objections to the claim itself could provide the basis for prohibiting or limiting a credit bid.
However, in this case the debtor was not objecting to the bank's claims. Instead in essence it was trying to obtain pre-judgment security for its independent counterclaims. The court's response was that if the debtor had concerns about the bank's collectability, it should follow normal procedures to request security.
Failing a prohibition on credit bidding, the debtor asked that the bank be required to make the same $210,000 cash deposit as other competing bidders. In part the deposit was needed to pay the breakup fee if the competing bidder won. The bank did not object to the breakup fee, and the court agreed that the fee would need to be funded if the bank was the winning bidder.
Consequently, the court determined that the bank had a right to credit bid its loans, but was required to include cash of at least $50,000 in its bid. The court also reiterated that a claim can be credit bid only for property that secures the claim. Given that the two loans were not cross-collateralized, the court noted that if the bank chose to credit bid it would have to specify the portions of the applicable loans that it wanted to apply against the purchase price for the applicable property.
People often lose sight of the fact that a credit bid is merely avoiding unnecessary transfers of cash by netting amounts to be paid by the purchaser against proceeds that would then be returned to the purchaser. Implicit is the fact that the purchaser would have been entitled to a return of the proceeds absent the credit bid.
So, for example, if a junior lender is bidding on property subject to a senior loan, proceeds would be applied first to the senior loan. In that case, it would not be appropriate for the junior lender to do a credit bid except to the extent that its bid exceeded the cash required to pay the senior lender.
This concept is what drove the court's decision in this case: $50,000 cash was required to cover the breakup fee and had to be paid before any proceeds were applied to the bank's loans, and the bank was entitled to proceeds from each parcel only to the extent that a particular loan was secured by that parcel.
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