Important Secured Creditor Protection Upheld by Supreme Court
In a unanimous decision, on May 29, 2012, the Supreme Court of the United States upheld an important protection against “cramdown” afforded to lenders in Chapter 11 cases. RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. , No. 11-166 (May 29, 2012). In RadLAX, the Supreme Court held that a Chapter 11 debtor could not deprive a secured creditor of its right to credit bid for property to be sold under a plan of reorganization.
RadLAX Gateway Hotel, LLC and RadLAX Gateway Deck, LLC (the “debtors”) obtained financing in 2007 to purchase and renovate the Radisson Hotel at Los Angeles International Airport and to purchase an adjacent lot and construct a parking structure on the lot. Constructing the parking structure was more expensive than the debtors anticipated, and by 2009, the debtors had run out of funds and had to halt construction. By August 2009, the debtors owed more than $120 million on the loan and were accruing more than $1 million in interest on the loan each month. Unable to obtain additional financing, the debtors filed voluntary petitions under Chapter 11 in the United States Bankruptcy Court for the Northern District of Illinois.
Debtors Submit a Chapter 11 Plan
In 2010, the debtors submitted a Chapter 11 plan which provided for the dissolution of the debtors, the sale of substantially all of their assets free and clear of liens, and the use of the sale proceeds to fund the plan, including payment to the secured creditor. The sale of the debtors’ assets was to be governed by sale and bid procedures set out in a contemporaneously filed motion.
Under the proposed bid procedures, the secured creditor was forced to bid cash and was not permitted to bid for the property using the debt it was owed to offset the purchase price ? a practice known as “credit-bidding.” The debtors stated their concern that allowing credit-bidding would discourage other bidders from participating in the sale process and, as a result, depress pricing. The debtors expected that the secured creditor would object to the cash bid requirement, and accordingly, sought confirmation of their plan under section 1129(b) of the Bankruptcy Code, known as the “cramdown” provision.
Cramdown of a secured creditor, which is just the colloquial term for plan confirmation over the objection of a “class of secured claims,” requires that the plan may not discriminate unfairly against and must be “fair and equitable” with respect to that class. In order for a Chapter 11 plan to be fair and equitable with respect to a class of secured claims, section 1129(b)(2)(A) provides
(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 debtors asserted before the Supreme Court that the secured creditor’s receipt of the proceeds of the sale of the collateral complied with the “fair and equitable” requirement by affording the secured creditor the “indubitable equivalent” of its claim under clause (iii). The secured lender asserted that any plan sale could not rely on clause (iii), but had to comply with clause (ii) which, through its reference to the credit-bidding rights set forth in section 363 (k) of the Bankruptcy Code, meant that its right to offset the amount of its claim against any bid that it might submit had to be recognized.
The Specific Governs the General
The Supreme Court determined that the structure of the statute was more consistent with a reading that:
clause (i) deals with the situation in which a secured creditor retains its lien regardless of whether the debtor retains the property
clause (ii) addresses the situation in which property is to be sold free and clear of liens, as was the case in RadLAX
clause (iii) covers dispositions under all other plans, e.g., one under which the secured creditor receives the property itself as the “indubitable equivalent” of its secured claim
In other words, clauses (i) and (ii) deal with two specific situations, while clause (iii) is a more general, residual provision, addressing situations other than those addressed under clauses (i) and (ii).
The Supreme Court noted further that clause (ii), which addresses the proposed sale of collateral free and clear of liens, is specifically made subject to section 363(k) which provides that a secured creditor may bid on its collateral and offset its secured claim against the purchase price of the collateral, i.e., that the secured creditor may credit bid in connection with a sale of its collateral. The Supreme Court succinctly described the debtors’ reading of clause (iii) to permit exactly what clause (ii) prohibits to be “hyperliteral and contrary to common sense,” even though clause (iii) was broad enough to include a situation addressed under clause (ii). Instead, the Supreme Court invoked the well-established canon of statutory construction that “the specific governs the general.” The Court noted that the canon was particularly true when, in a statutory scheme, Congress “has deliberately targeted specific problems with specific solutions.”
Debtors’ Bid Procedures Are Insufficient as a Matter of Law
The Supreme Court gave short shrift to the debtors’ various objections to the general/specific canon, including that they be allowed to have the auction and then leave it to the Bankruptcy Court to determine at the confirmation stage of the case whether the resulting plan provided the secured creditor with the “indubitable equivalent” of its claim. The Court noted that under its approach, an argument that the debtors’ plan should be allowed to go to confirmation was “simply a nonstarter” because “[a]s a matter of law, no bid procedures like the ones proposed here could satisfy the requirements of [cramdown]” (emphasis in original).
A secured creditor’s right to credit bid in connection with any proposed sale of its collateral, although not unlimited,1 is an important protection under the Bankruptcy Code. Consistent with the RadLAX decision, unless a debtor can demonstrate why a bankruptcy court should not allow a secured creditor to credit bid, any bid procedure, disclosure statement provision or term of a Chapter 11 plan which provides that a secured creditor must cash bid on a sale of its collateral, or which otherwise eliminates a secured creditor’s right to credit bid, does not “as a matter of law” satisfy the “fair and equitable” requirement of the cramdown provision under the Bankruptcy Code. Consequently, RadLAX instructs that no good purpose is served for a bankruptcy court to allow a Chapter 11 plan to go to confirmation in the face of such a requirement.
1 Section 363(k) of the Bankruptcy Code, incorporated into the "fair and equitable" requirement of section 1129(b)(2)(A)(ii), provides that a secured creditor may offset its claim against the purchase price of its collateral "unless a court for cause orders otherwise." 11 U.S.C. § 363(k). In RadLAX, the Bankruptcy Court determined that there was no "cause" to deny credit-bidding, a holding which was not appealed by the debtors.