On May 29, 2012, the United States Supreme Court issued its awaited decision in RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. __ (2012), and held that a debtor cannot sell its property free and clear of liens under a plan of reorganization without allowing lienholders to credit-bid. The Court settled a circuit split on this issue between the Third Circuit (see In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010)) and the Seventh Circuit (see River Road Hotel Partners, LLC. v. Amalgamated Bank, 651 F.3d 642 (7th Cir. 2011)) by affirming the Seventh Circuit's decision in RadLAX. The main issue before the Court was whether "a Chapter 11 bankruptcy plan may be confirmed over the objection of a secured creditor pursuant to 11 U.S.C. § 1129(b)(2)(A), if the plan provides for the sale of collateral free and clear of the creditor's lien, but does not permit the creditor to 'credit-bid' at the sale." In a rare 8-0 decision,1 the Court plainly said, "No."
Generally, a bankruptcy court may confirm a Chapter 11 plan only if each class of creditors votes in favor of the plan. However, under section 1129(b)(1), a bankruptcy court can confirm a nonconsensual plan — referred to as a "cramdown" plan — if the impaired class of claims or interests is not discriminated against unfairly and is treated fairly and equitably. See 11 U.S.C. § 1129(b)(1). In order to cramdown a class of secured claims, a Chapter 11 plan must meet one of three requirements set forth in section 1129(b)(2) to be deemed as providing "fair and equitable" treatment to the nonconsenting creditor's claim(s). Section 1129(b)(2) requires that the plan must provide either:
(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.
In summary, under subsection (i), a debtor can cramdown a secured creditor if the creditor retains its lien on its collateral and receives deferred cash payments under the plan. Under subsection (ii), a debtor can sell property free and clear of liens if the creditor receives a lien on the proceeds of the sale; however, the sale is subject to 11 U.S.C. § 363(k), which provides that a lienholder may bid its claim at the sale against the purchase price of the property — a credit-bid. Under subsection (iii), a secured creditor can be subjected to a cramdown plan if the plan provides for the payment of the "indubitable equivalent" of its claim. This term has been the subject of much litigation throughout the country during the past several years.
The debtors in RadLAX proposed to cramdown the secured lender by selling the collateral free and clear of liens, and repaying the secured lender from the proceeds of the sale. However, the debtors' sale procedures prohibited the lender from credit-bidding, and the debtors attempted to circumvent the requirements of section 1129(b)(2)(A)(ii) by providing the lender the indubitable equivalent of its secured claim in the form of cash from the auction pursuant to section 1129(b)(2)(A)(iii). The United States Bankruptcy Court for the Northern District of Illinois held that the debtors' proposed auction procedures did not comply with the requirements of section 1129(b)(2)(A), and the Seventh Circuit affirmed the Bankruptcy Court. The Supreme Court affirmed the Circuit Court and found that the debtors' proposed reading of section 1129(b)(2)(A)(iii) to allow what subsection (ii) expressly prohibits would be "hyperliteral and contrary to common sense," and also contrary to well-established canons of statutory interpretation.
The Court's decision to uphold a secured creditor's right to credit-bid in a plan context is a clear win for mortgage lenders and, practically, it will reduce the likelihood of property being sold at a diminished price and will permit the lender to buy its own collateral without having to advance new funds.2
Debtors still have a few arrows in their quivers. The Court also footnoted that a debtor or other party-in-interest can still object to the right to credit-bid "for cause" under 11 U.S.C. § 363(k).3 While the term "cause" is not defined, a debtor, committee, or even junior lien creditor may be able to prevent a credit-bid by asserting legitimate claims challenging the debt or lien. Those could include asserting the senior lien is subject to avoidance as a fraudulent or preferential transfer; the debtor has a substantive state law defense to the senior debt, such as a lender liability claim; or perhaps the senior mortgage is subject to an equitable subordination or re-characterization claim. Our view is that what constitutes "cause" for this purpose will not be as easily decided as was the holding in RadLAX.
Footnotes
1 Justice Kennedy did not participate in the decision.
2 In a curious footnote, the Court mentioned how its ruling will help the government because it owns so many mortgages.
3 The Court said, however, that this issue was not one argued on appeal.
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