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Free Lance-Star and Fisker Automotive: Development of the ‘For Cause’ Exception to Credit Bidding

Posted on Apr 17, 2014 in Bankruptcy Sales, Business Bankruptcy, Chapter 11, Chapter 7 Trustee

On April 14, 2014, the Bankruptcy Court for the Eastern District of Virginia issued an opinion limiting the credit bid of a party asserting that it held senior secured position in all assets of the debtors. In re The Free Lance-Star Publishing Co. of Fredericksburg, VA, et al., Case No. 14-30315-KRH (Bankr. E.D.Va. April 14, 2014).  The Free Lance-Star opinion coupled with the Bankruptcy Court for the District of Delaware’s opinion in In re Fisker Automotive, Inc. et al., Case No. 13-13087-KG (Bankr. D.Del. January 17, 2014) should be viewed as instructive for chapter 11 debtors, creditor committees, and aggressive lenders seeking to employ a loan-to-own strategy through a quick section 363 sale process.

In 2012, the Supreme Court in Radlax Gateway Hotel, LLC v. Amalgamated Bank, 132 S.Ct. 2065 (2012) clarified that the holder of a senior secured debt may credit bid in a chapter 11 plan auction. However, Free Lance-Star and Fisker demonstrate footnote 14 from In re Philadelphia Newspapers survives. Footnote 14 of Philadelphia Newspapers provides, in relevant part, “A court may deny a lender the right to credit bid in the interest of any policy advanced by the Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment. See, e.g., 3 Collier on Bankruptcy 363.09[1] (“the Court might [deny credit bidding] if permitting the lienholder to bid would chill the bidding process.”).” In re Philadelphia Newspapers, 599 F.3d 298, 316 fn. 14 (3d Cir. 2010)(emphasis added).

While Fisker is an opinion limited to the facts of the case, the arguments raised by the Committee may be instructive – in the right situations – to frustrate, limit or deny a secured creditor’s attempt to credit bid. In Fisker, the debtor sought to sell the debtor’s assets through a private sale in connection with the secured party providing a $75 million credit bid. The debtor and committee presented a set of stipulations related to, among other issues, the committee’s motion to limit the secured creditor’s right to credit bid. The stipulations served as the factual basis for the court’s decision to limit the secured creditor’s credit bid. Therein, the competing bidder provided that it would not participate in an auction if the secured creditor was allowed to bid more than $25 million, or the purchase price of the DOE loan. As a result of the unresolved issues as to the validity of the debt buyer’s lien, and no bidding would take place unless the credit bid was capped, the court found ‘cause’ under section 363(k). The debt buyer’s bid was capped at $25 million. The debt buyer’s attempt to appeal the court’s decision were futile. As a result, a public auction went forward and the competing bidder purchased the debtor’s assets for $149.2 million. The unsecured creditors went from receiving approximately $500,000 under the debt buyer’s original credit bid, to potentially receiving approximately $35 million under a proposed settlement post-auction sale.

Fisker’s result and reasoning may be clear, however, the manner in which the court determined the amount to limit the credit bid is open to discussion. It must be assumed that the stipulations drove the court’s decision. This gives rise to a different issue: If the facts justify limiting a secured party’s right to credit bid, how should a court determine the appropriate amount of the credit bid?

The Free Lance-Star case may provide an answer. In Free Lance-Star, the debtor was a family-owned publishing, newspaper, radio and communications company. After securing a $50 million loan from Branch Banking and Trust (BB&T), the company fell on hard times. The loan was secured by certain assets of the Debtor. However, it was not secured by the debtor’s “tower assets” associated with the debtor’s radio broadcasting operations.

Eventually, BB&T sold its loan to Sandton Capital Partners (“Sandton”) in late June 2013. Sandton wanted to push the debtor through a chapter 11 case and sell substantially all the assets to a related entity of Sandton, DSP Acquisition LLC (“DSP”). DSP took certain actions pre-petition which put the scope of DSP’s security interest at issue, and lead to the debtor seeking to limit DSP’s credit bid under §363(k). The debtor, similar to Fisker, sought to limit DSP’s credit bid on the grounds that the validity and scope of DSP’s lien was at issue, DSP engaged in inequitable conduct, and limiting the credit bid would foster a robust bidding process.

At the combined evidentiary hearing on the debtors’ motion to limit credit bidding and cross-motions for summary judgment filed in an adversary proceeding seeking a determination as to the extent, and validity of DSP’s lien, the court determined DSP acted improperly and ‘cause’ existed to limit DSP’s credit bid. The court asked for testimony from DSP as to how much Sandton paid for the BB&T loan. No such testimony was provided. Typically, a debt buyer considers this information confidential. It was only known in Fisker because the debt buyer purchased a Department of Energy loan at a public auction a month prior to the filing of the Fisker case. The court, having determined that DSP acted improperly and did not have a valid perfected security interest in all of the debtors’ assets, found ‘cause’ pursuant to section 363(k) to limit the debt buyer’s credit bid.

Without any evidence being offered by DSP, the court requested that the debtors’ expert witness provide testimony on the best procedure for fashioning a competitive auction sale and credit bid price. Here, the debtor’s expert eliminated the unencumbered assets (as determined by the court) and applied a market analysis to develop an appropriate cap for the credit bid. The court accepted this approach and limited DSP’s credit bid of approximately $38 million to $13.9 million. DSP has filed an appeal.

Depending on the outcome of the appeal, employing a market analysis in connection with determining what amount a credit bid should be limited in order to generate a competitive environment for an auction is a novel, creative approach. This approach may lay the ground work for other courts to employ such a valuation method to reduce a credit bid where the facts justify limiting a secured party’s right to credit bid. No matter the outcome of DSP’s appeal, Fisker and Free Lance-Star demonstrate that debtors and committees have grounds to challenge a credit bid, especially where the validity of a secured party’s lien is questioned.  Holders of secured debt, whether debt buyers or the loan originators, should evaluate their lien rights and develop options in advance of a chapter 11 filing when using a credit bid in a loan-to-own strategy in a section 363 sale process.

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