The recent turn in the credit cycle has featured more complex capital structures with multiple tranches of secured debt. For years, commentators have written about the proliferation of secured debt and considered how this would impact in-court and out-of-court restructurings. However, few commentators foresaw the current issues swirling around an aspect of the Bankruptcy Code — credit bidding — that prior to the recent bankruptcy wave rarely drew much attention. This article focuses on the ability of a secured creditor to credit bid its claims at a sale under § 363(k) or § 1129(b)(2)(A)(ii).
Credit Bidding Under the Code
Under § 363(k), "unless the court for cause orders otherwise," the holder of a secured claim can use its claim as currency in a bankruptcy sale and bid in (i.e., credit bid) the par value of the claim at the sale, irrespective of the value ascribed to the collateral. Under § 1129(b)(2)(A)(ii), a debtor may "cram down" a Chapter 11 plan notwithstanding the non-acceptance of such plan by a secured creditor class, where the plan provides for the sale of property securing such claims, subject to § 363(k), with any liens attaching to the proceeds of such sale. Under both sections, a lender's ability to credit bid protects the lender's view of the valuation of its collateral at a sale of that collateral, by allowing the lender to retain the collateral if the proposed purchase price is, in its view, too low. In effect, assuming the court does not find "cause" to order otherwise, Sections 363(k) and 1129(b)(2) (A)(ii) give a secured creditor a statutory right of first refusal to purchase its collateral in a bankruptcy sale. While a full consideration of "cause" under § 363(k) to preclude a secured creditor from credit bidding falls beyond the scope of this article, courts can find cause where the creditor's lien is questioned or otherwise in dispute. See, e.g., In re Akard St. Fuels, L.P., 2001 WL 1568332 (N.D. Tex. 2001) (denying secured creditor's right to credit bid where its liens were the subject of a bona fide dispute); In re McMullan, 196 B.R. 818 (Bankr. W.D. Ark. 1996) (denying secured creditor's right to credit bid where the validity of its liens was in question); In re Diebart Bancroft, 1993 WL 21423 (E.D. La. 1993) (allowing secured creditor to credit bid but requiring bid to include enough cash to cover potential lien challenge, with cash held in escrow until lien challenge resolved).
This two-part article focuses on two issues that are the subject of recent court decisions: 1) a majority group of secured lenders under a credit facility "dragging along" the minority group into a credit bid under § 363(k); and, in Part Two, 2) the ability of a debtor to prevent a secured creditor from credit bidding at a sale under a plan by providing the creditor with the indubitable equivalent of its claim under § 1129(b)(2)(A)(iii).
Recent Drag-Along Cases
The recent cases involving overleveraged companies and undersecured creditors have resulted in lenders being more willing to own and operate their collateral. In addition, financial and strategic investors have seen opportunities to buy distressed debt at a discount, with the aim of using that debt as currency in a bankruptcy sale. The application of credit bidding at a sale is relatively straightforward where an asset is encumbered by one lien held by one creditor. However, difficult questions quickly arise where multiple tranches of liens encumber the same assets, and each lien secures debt held by multiple parties.
For example, who has the right to actually bid in the debt — the agent or indenture trustee under a syndicated credit facility or note issuance, or the actual lenders or noteholders themselves? Can a credit bid be made where certain holders do not support the credit bid and, if so, what value will the non-participating holders receive on account of their claims? And in what form of currency will that value be delivered?
Credit and security agreements generally have not expressly addressed these issues. In recent decisions, the trend has been for courts to allow secured creditors to participate in § 363 sales of their collateral and act on their assessment of asset values while facilitating sales that maximize estate value. In these cases, courts have focused on the language of the relevant credit agreements in permitting credit bids backed by groups of lenders directing an agent or indenture trustee.
In re Chrysler LLC
While not a credit bidding case, In re Chrysler LLC, 576 F.3d 108 (2d Cir. 2009) endorsed the notion of a trustee or agent vested with authority under the applicable agreements to take action on behalf of the lender group. In doing so, the Second Circuit enunciated the reasoning for permitting a majority (in dollar amount) of holders under a facility to direct the agent or trustee to "drag along" non-participating holders into a credit bid.
In Chrysler, a majority of the lenders under the first lien credit agreement instructed the agent to release collateral to the buyer in exchange for a cash recovery well below the par value of the debt. The holdout lenders insisted that such action required amendment or waiver of the credit agreement (which required a unanimous vote of the lenders) and thus that the agent could not release the collateral at the direction of only a majority. The Second Circuit disagreed. In so holding, the panel affirmed the bankruptcy court ruling, wherein Judge Arthur J. Gonzales stated: "The Court concludes that the purpose of the relevant provisions of the [credit, collateral and security agreements] is to have the Administrative Agent and Collateral Trustee act in the collective interest of the lenders. Restricting enforcement to a single agent to engage in unified action for the interests of a group of lenders, based upon a majority vote, avoids chaos and prevents a single lender from being preferred over others." In re Chrysler LLC, 405 B.R. 84, 103 (Bankr. S.D.N.Y. 2009)
GWLS and Metaldyne
The Second Circuit's decision in Chrysler adhered to the rationale advanced by bankruptcy courts in approving "drag-along" bids by agents on behalf of majority lenders, and also set the stage for subsequent endorsements of this approach. In In re GWLS Holdings, Inc., 2009 Bankr. LEXIS 378 (Bankr. D. Del. Feb. 23, 2009) and In re Metaldyne Corp., 409 B.R. 671 (Bankr. S.D.N.Y. 2009), Judge Peter Walsh and Judge Martin Glenn, respectively, found that language in loan documents similar to the language at issue in Chrysler permitted a majority of lenders to instruct the agent to submit a credit bid under § 363(k) on behalf of all lenders and concurrently release liens on collateral as part of that transaction. Among other rationale, this authority was found under the loan documents pursuant to the agent's power to dispose or deliver the collateral on behalf of the lenders under any "applicable law," which the GWLS and Metaldyne courts determined included the Bankruptcy Code.
As in Chrysler, the courts in GWLS and Metaldyne overruled the objection of dissenting lenders, who argued that the actions of the majority lenders effected an amendment or waiver of the loan documents and thus required unanimous consent of the lenders. It is worth noting that the credit bidding lenders in Metaldyne did not have senior liens on all of the assets being purchased. Certain of Metaldyne's non-bidding lenders (including its DIP lenders) held senior, priming liens on certain assets included in the sale. As a result, the bidding lenders (with junior liens on certain assets) included a cash component sufficient to repay the claims secured by the senior liens. With those senior claims repaid in cash, the sponsors could obtain Metaldyne's assets free and clear of liens, claims, and other encumbrances under § 363(f).
An Affirmation with a Different Result
The approach of relying on prepetition credit agreements was recently reaffirmed, with a somewhat different result, in In re Electroglas, Inc., No. 09-12416 (PJW) (Bankr. D. Del. Sept. 23, 2009). In Electroglas, Judge Walsh ruled that holders of secured notes issued by Electroglas could not bypass the indenture trustee and directly credit bid their claims at a § 363 sale of their collateral. In doing so, Judge Walsh denied two competing groups of noteholders the right to credit bid, each of which had attempted to credit bid its claims without the indenture trustee. Even though one noteholder group controlled a majority of the notes, Judge Walsh held that the majority group could not force the indenture trustee to credit bid because the language of the indenture and security agreement only allowed a majority group of noteholders to prescribe procedures for the trustee's enforcement of remedies, not to direct the trustee to take substantive action. Judge Walsh found that the language of the indenture provided the lenders with a right to request that the trustee take certain action to exercise remedies, such as submitting a credit bid at a sale of the collateral, but that the discretion to act belonged solely to the trustee. Furthermore, it appears from Judge Walsh's opinion that the majority noteholders never formally requested that the trustee submit a credit bid. Thus, Electroglas is consistent with GWLS and Metaldyne in that the court, guided by the terms of the prepetition credit agreement, held that only the indenture trustee under a syndicated loan facility had the authority to submit a credit bid.
In other cases, such as In re Foamex Int'l Inc., No. 09-10560 (KJC) (Bankr. D. Del.) and In re Propex Inc., No. 08-10249 (JCC) (Bankr. E.D. Tenn.), a majority of lenders directing the administrative agent funded pro rata cash recoveries for lenders that decided not to participate in the credit bid and receive equity in the new company owning the debtor's assets. This structure allows non-participating lenders to opt out and receive a cash payment where they would otherwise be subject to the "drag-along" procedure effected in GWLS and Metaldyne (and attempted in Electroglas). While this structure requires participating lenders to put up more cash than a pure credit bid, such lenders receive more equity than that to which they would otherwise be entitled on account of their loan holdings. Ultimately, these cases demonstrate that, to date, courts have relied on prepetition credit contracts in ascertaining and applying credit bid rights in bankruptcy cases.
Next month's discussion concludes with a look at indubitable equivalent cases.
To read Part Two of the article, please click here.
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