U.S. Supreme Court: Secured Creditor Has Right to Credit Bid Under Chapter 11 Plan
In RadLax Gateway Hotel LLC v. Amalgamated Bank, No. 11-166 (May 29, 2012) (“RadLax”), the United States Supreme Court unanimously ruled that when a chapter 11 debtor pursues a plan to sell its assets free and clear of all liens, a secured creditor is allowed to “credit bid” up to the full amount of its claim. This decision resolves a split among the federal circuit courts and rejects the notion (which recently found support in the Third Circuit and Fifth Circuits’ decisions in Philadelphia Newspapers and Pacific Lumber ) that the proceeds of such sale could satisfy the “indubitable equivalent” cramdown standard of section 1129(b)(2)(A)(iii). It also substantially strengthens a secured creditor’s ability to maximize its recovery against its collateral in the face of a sale proposed under a plan.
In RadLax, the debtors filed for chapter 11 protection after defaulting on construction financing for development of a Radisson Hotel near LAX. The debtors proposed a plan that involved the liquidation of virtually all of their assets whereby secured creditors would receive the net proceeds from the sale of their collateral in satisfaction of the “indubitable equivalent” cramdown standard of section 1129(b)(2)(A). In their motion to establish bidding procedures, the debtors sought to prohibit secured creditors from making credit bids at the auction.
The bankruptcy court denied the debtor’s request, holding that a creditor must not be precluded from exercising its credit-bid rights granted by section 363(k) of the Bankruptcy Code. The debtor appealed directly to the Seventh Circuit Court of Appeals, which affirmed the bankruptcy court’s ruling. The Seventh Circuit ruled that if a debtor proposed to sell encumbered assets through a plan, a secured creditor's right to credit bid cannot be compromised because such protection is designed to ensure that the encumbered assets are not sold for less than their fair-market value (whether or not the sale occurs under a plan). The Seventh Circuit reasoned that to hold otherwise and allow a debtor to resort to the “indubitable equivalent” standard under any plan scenario would render the remaining cramdown provisions of section 1129 superfluous.
The Supreme Court Ruling
The Supreme Court affirmed the Seventh Circuit decision. In its opinion, the Supreme Court noted that when attempting to confirm a plan over the objection of a certain class of creditors, the plan must be “fair and equitable” with respect to the claim of the nonconsenting class of creditors. Section 1129(b)(2)(A) provides the standard by which a plan can be deemed “fair and equitable” and therefore can be confirmed despite the objection of a class of secured creditors. Generally, a plan is “fair and equitable” if it provides for:
(1) retention by the secured creditor of its liens and receipt of deferred cash payments over time;
(2) sale of the secured creditor’s collateral, subject to the creditor’s bid rights under 363(k); or
(3) realization by the secured creditor of the “indubitable equivalent” of the secured creditor’s claim.
The debtors argued that section 1129(b)(2)(A) does not require that a secured creditor be afforded the right to credit bid at a bankruptcy auction.
However, the Supreme Court noted that clause (ii) of section 1129(b)(2)(A) is a detailed provision that sets forth the requirements for confirming a plan that seeks to sell property free and clear of liens while clause (iii) is a more broadly worded provision that says nothing about a sale. The Court held, by relying upon a well-established canon of statutory interpretation that “the specific governs the general,” that the general language of clause (iii), although technically broad enough to include the outcome the debtor was seeking, would not be appropriate where specific language exists to deal with an identifiable situation. Further, the Supreme Court found that clause (ii) protects the right of a secured creditor to credit bid. The Supreme Court refused to allow the debtor to circumvent that right by utilizing the broad “catch all” language of clause (iii).
RadLax works to protect the benefit of a secured lender’s bargain. When making a secured loan, the creditor has bargained for the right to foreclose and take possession of that property in the event of default. The RadLax decision affirms that these bargained-for rights are protected in a chapter 11 bankruptcy proceeding. The right to credit bid does not ensure that the secured lender will win at a bankruptcy auction because there is nothing preventing another bidder from outbidding a secured creditor if that credit bid is perceived to be below the market-value of the property being sold. Previously, two other federal courts of appeal held to the contrary in Philadelphia Newspapers and Pacific Lumber. These holdings caused lenders great uncertainty regarding the treatment of their secured claim in bankruptcy sales. With RadLax, the Supreme Court has resolved the ‘split’ in the circuits in favor of upholding the secured creditor’s credit-bidding rights.
 All section references are to 11 U.S.C. § 101, et seq. (the “Bankruptcy Code”).