The Effect Of Philly News On Credit Bidding

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1 Portfolio Media, Inc. 860 Broadway, 6 th Floor New York, NY Phone: reprints@portfoliomedia.com The Effect Of Philly News On Credit Bidding Law360, New York (July 08, 2010) -- The U.S. Court of Appeals for the Third Circuit recently affirmed a lower court s ruling in In re Philadelphia Newspapers LLC.[1] The court allowed Philadelphia Newspapers LLC to require all-cash bids for the asset sale under its proposed plan. This precluded secured creditors from credit bidding, as long as the plan provided those creditors with the indubitable equivalent of the value of their claims. In sanctioning a mechanism that would allow the debtor to trump the Bankruptcy Code s credit bidding requirements, this decision may erode the ability of secured creditors to protect their collateral. However, because the Third Circuit suggested that the failure to allow credit bidding may prevent the debtors from providing the required indubitable equivalent and, in any case, does not preclude secured lenders from bidding cash at auction, the effect of this decision may be less far-reaching than originally feared by lenders and commentators. Background The debtors own and operate print and online publications including The Philadelphia Inquirer and The Philadelphia Daily News. In July 2006 the debtors purchased Philadelphia Newspapers LLC from The McClatchy Co., financing the deal with $295 million provided by a consortium of lenders. Less than three years later, in February 2009, the debtors filed voluntary Chapter 11 cases in the U.S. Bankruptcy Court for the Eastern District of Pennsylvania. As of the petition date, the debtors prepetition secured lenders held claims exceeding $300 million. Pursuant to their plan of reorganization, the debtors proposed to sell their assets at auction, free and clear of liens, and to provide to the lenders a recovery valued (by the debtors) at $66 million, consisting of sale proceeds in the minimum amount of $30 million, and certain real estate. In conjunction with the filing of their plan, the debtors signed an asset purchase agreement with Philly Papers LLC an entity controlled by the debtors current and former management and equity holders which would act as the stalking horse bidder. On Aug. 20, 2009, the debtors filed a motion seeking bankruptcy court approval of their proposed procedures to govern selection of the winning bidder for the debtors assets (who would then purchase the debtors assets under a confirmed plan). These bidding procedures required all bids to be in cash, and prohibited the lenders from credit bidding their secured claims to acquire their collateral.

2 The lenders objected to the debtors bidding procedures, arguing that when read in concert, Sections 363(k), 1129, and 1111(b) of the Bankruptcy Code protect a secured creditor s interest in its collateral by granting the creditor the right to credit bid at a sale, whether it be a sale under Section 363 of the Bankruptcy Code or a sale pursuant to a confirmed Chapter 11 plan. The Bankruptcy Court ruled in favor of the lenders, holding that a secured creditor may, as a matter of right, submit a credit bid in a sale pursuant to a plan.[2] The debtors appealed to the U.S. District Court for the Eastern District of Pennsylvania, which reversed the decision of the bankruptcy court.*3+ The district court disagreed with the bankruptcy court s interpretation of Section 1129(b)(2)(A) of the Bankruptcy Code and held that the Bankruptcy Code provides no legal entitlement for secured lenders to credit bid at a sale pursuant to a plan.[4] The District Court relied on the plain language of Section 1129(b)(2)(A), which states: For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements: (A) With respect to a class of secured claims, the plan 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.[5] The district court held that each of the three prongs of this section is independent, separated by the disjunctive or, and the satisfaction of any prong is sufficient to establish that the plan is fair and equitable under the Bankruptcy Code.[6] Under the district court s reading, a debtor selling collateral pursuant to a plan need not permit credit bidding, so long as the debtor provides the lender with the indubitable equivalent of its interest.*7+ The district court did not specify what criteria must be satisfied to establish the existence of this indubitable equivalent. The lenders appealed the district court ruling to the Third Circuit, making three principal arguments. First, relying on the plain language of the Bankruptcy Code, they argued that only subsection (ii) of Section 1129(b)(2)(A), which expressly incorporates a secured lender s right to credit bid, applied to proposed sales of assets free and clear of liens under a plan.[8] Second, they argued that subsection (iii), calling for the indubitable equivalent of a lender s secured interest, is ambiguous, requiring the court to look to Section 1111 of the Bankruptcy Code, which the lenders argued preserves the lenders right to credit bid in a sale under a plan.*9+

3 Finally, the lenders argued that denying secured lenders a right to credit bid in a sale under a plan is inconsistent with other provisions of the Bankruptcy Code.[10] Third Circuit s Analysis The Third Circuit found the lenders first argument to be analogous to an argument raised (and rejected) in Varity Corp. v. Howe.[11] In Varity, the U.S. Supreme Court held that a specific enumeration followed by a broader catchall provision does not require application of the more specific provision.[12] Similarly, in Philadelphia Newspapers, the Third Circuit held that although subsection (ii) specifically refers to a sale and incorporates a right to credit bid under Section 363(k) of the Bankruptcy Code, there is no statutory basis to conclude that this subsection is the only provision under which a debtor may propose to sell its assets free and clear of liens under a plan. The Third Circuit opined that Congress inclusion of the indubitable equivalence alternative intentionally left open the potential for other methods of conducting asset sales, so long as those methods sufficiently protected the secured creditor s interests.*13+ Thus, according to the Third Circuit, a plain reading of Section 1129(b)(2)(A)(iii) compels the conclusion that, when a debtor proceeds under subsection (iii), Congress has provided secured lenders with no right to credit bid at a sale of the collateral.[14] The lenders countered that, even if subsection (iii) contains no explicit right to credit bid, this right is necessary to provide secured lenders with the indubitable equivalent of their claims. This argument was premised on the Third Circuit s decision in In re SubMicron Systems Corp.,*15+ where the court held that credit bidders in a Section 363(b) sale could bid up to the full dollar amount of their loan and that the amount of the credit bid became the value of the lender s secured interest in the collateral. The Third Circuit rejected the lenders argument, stating that its holding in SubMicron does not mandate that a credit bid must be the successful bid at a public auction. Rather, at plan confirmation, a court is only asked to determine whether a lender has received the indubitable equivalent of its secured interest. It is the plan of reorganization, and not the auction itself, that must generate the indubitable equivalent. *16+ For this reason, the Third Circuit noted that the lenders retain the right to argue at confirmation, if appropriate, that the restriction on credit bidding failed to generate fair market value at the auction, thereby preventing them from receiving the indubitable equivalent of their claim. *17+ The lenders arguments focused on an integrated reading of Sections 1129(b)(2)(A), 1111(b) and 363(k) of the Bankruptcy Code. The lenders argued that the Bankruptcy Code guarantees a secured lender one of two outcomes, both premised on its right to protect the value of its lien either to have its claim treated as fully secured under Section 1111(b) of the Bankruptcy Code or to bid its full claim under Section 363(k) of the Bankruptcy Code. In Philadelphia Newspapers, because the debtors plan sought to preclude the lenders from making a Section 1111(b) election, the lenders contended that they must be allowed to credit bid at the auction.[18] In support of this argument, the lenders relied on the following statement of Rep. Edwards made in connection with the enactment of Section 1111(b):

4 Sale of property under Section 363 or under a plan is excluded from treatment under Section 1111(b) because of the secured party s right to credit bid in the full amount of its allowed claim at any sale of collateral under Section 363(k) of the House Amendment.[19] The lenders maintained that this statement reflected the intent of Congress to ensure that secured lenders who are not permitted to make a Section 1111(b) election could credit bid under Section 363(k) of the Bankruptcy Code.[20] But the Third Circuit found that this argument fails in light of the plain language of the Bankruptcy Code because under Section 363(k) of the Bankruptcy Code, a secured lender has the right to credit bid unless the court for cause orders otherwise. *21+ In a variety of cases where a debtor sought to sell assets pursuant to Section 363(b) of the Bankruptcy Code, courts have denied secured lenders the right to credit bid.[22] Judge Ambro s Dissenting Opinion In his dissent from the Third Circuit s decision, Judge Thomas Ambro stated that the majority misread the relevant Bankruptcy Code provisions. He noted that Congress did not include the three subsections of 1129(b)(2)(A) as alternative routes to cram-down that would be universally applicable to any plan, but instead as three distinct routes, the application of which depends on the proposed treatment of the secured claim under a given plan. Clause (i) applies when the secured creditor retains the lien securing its claim in a given class.[23] Clause (ii) applies when the plan provides... for the sale... of any property that is subject to the liens securing such claims, free and clear of such liens. *24+ Clause (iii) applies when the plan provides... for the realization... of the indubitable equivalent of the secured creditor s claim.*25+ Judge Ambro further stated that because Congress did not enact Section 1129(b) of the Bankruptcy Code in isolation, it was necessary to read Section 1129(b)(2)(A) as a complement to Section 1111(b).[26] He explained that Congress intended to provide secured creditors with the means to guard against undervaluation of the assets securing their claims in a proposed sale under a plan.[27] Accordingly, Section 1129(b)(2)(A)(ii) of the Bankruptcy Code exclusively applied to the proposed asset sale under the debtors plan, and with it comes a presumptive right to credit bid by the secured lenders.*28+ Conclusion Although the Third Circuit s opinion initially generated widespread concern that secured lenders would not be able to protect their collateral in asset sales under proposed plans of reorganization, as a practical matter, this decision may be less draconian than originally anticipated. One key question left open by the decision is whether a below-market sale of collateral pursuant to a proposed plan could provide a secured lender with the indubitable equivalent of the value of its collateral. Another noteworthy aspect of the decision is that it does not foreclose a lender from successfully bidding cash at an auction of assets under a plan. Indeed, after the Third Circuit ruled in this case, the lenders made a successful cash bid[29] with financial backing from New York hedge fund Alden Global Capital.[30] The debtors held an auction on April 27 and 28, and the lenders winning bid of approximately $138 million consisted of $39 million in debt, $69 million in cash, plus the company s real estate valued at $30 million which remains with the debtors estates.*31+

5 This consortium outbid two other groups. On May 19 the U.S. Bankruptcy Court for the Eastern District of Pennsylvania approved the debtors disclosure statement and scheduled the plan confirmation hearing for June 24, marking the end of a long struggle between the lenders and debtors over these assets. In the future, similarly situated lenders could bid cash to acquire the assets securing their claims, thereby mitigating the adverse effect of this controversial decision. While cash bidding may be economically equivalent to credit bidding, as a practical matter, certain loan participants and other lenders may lack liquidity or be constrained from incurring fees associated with borrowing. Depending upon the extent to which this decision is followed by other circuits, legislative action may be necessary to clarify Section 1129(b)(2)(A). --By Douglas S. Mintz, Leslie Chervokas and Mark Arinci, Cadwalader Wickersham & Taft LLP The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients or Portfolio Media, publisher of Law In re Philadelphia Newspapers LLC, 599 F.3d 298 (3d Cir. 2010). 2. In re Philadelphia Newspapers LLC, case number SR, 2009 WL (Bankr. E.D. Pa. Oct. 8, 2009). 3. In re Philadelphia Newspapers LLC, 418 B.R. 548 (E.D. Pa. 2009). 4. Id. at U.S.C. 1129(b)(2)(A). 6. In re Philadelphia Newspapers LLC, 599 F.3d at In re Philadelphia Newspapers LLC, 418 B.R. at In re Philadelphia Newspapers LLC, 599 F.3d at Id. at Id. 11. Varity Corp. v. Howe, 516 U.S. 489 (1996). 12. In re Philadelphia Newspapers LLC, Id. at In re Philadelphia Newspapers LLC, 599 F.3d at Id. at Cohen v. KB Mezzanine Fund II, LP (In re SubMicron Sys. Corp.), 432 F.3d 448 (3d Cir. 2006). 16. In re Philadelphia Newspapers LLC, 599 F.3d at Id. (citations omitted) U.S.C. 1111(b) permits an undersecured creditor to waive its unsecured deficiency claim and elect to have its entire allowed claim to be treated as fully secured. The debtors plan prohibited lenders from making an election under Section 1111(b). 19. In re Philadelphia Newspapers LLC, 599 F.3d at Id. at U.S.C. 363(k). 22. In re Philadelphia Newspapers LLC, 599 F.3d at Id. at Id. 25. Id. 26. Id. at Id. at Id. 29. Shira Ovide, Financial Firms Win Auction for Philadelphia Newspapers, April 29, 2010, available at ms+win+auction+for+philadelphia. 30. Sophia Pearson, Carlyn Kolker and Steven Church, Philadelphia Inquirer Lenders $139 Million Bid Wins Auction, April 29, 2010, available at million-bid-wins-auction.html.

6 31. Christopher Hepp and Harold Brubaker, Creditors Buy Paper at Auction, April 22, 2010, available at

Credit Bidding in a Sale Under a Plan Is Not a Right: The Third Circuit s Philadelphia Newspapers Decision. Nicholas C. Kamphaus

Credit Bidding in a Sale Under a Plan Is Not a Right: The Third Circuit s Philadelphia Newspapers Decision Nicholas C. Kamphaus Secured lenders are not as protected in bankruptcy as they might have thought,