On March 22, 2010, the United States Court of Appeals for the Third Circuit held that a debtor is permitted to sell a secured lender's collateral free of its liens without allowing the lender to credit bid when the sale is pursuant to a chapter 11 plan of reorganization. In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010). This decision undermines the settled expectations of secured lenders of their absolute right to credit bid their liens at a bankruptcy auction sale under a plan of reorganization.

Philadelphia Newspapers, LLC, et al. (the "Debtors") filed a plan of reorganization (the "Plan") which proposed to sell the Debtors' assets at a public auction free and clear of the liens of the secured lenders (the "Lenders") while precluding the Lenders from credit bidding their secured claim in exchange for the Debtors' assets. The Bankruptcy Court ruled that the bid procedures proposed under the Plan impermissibly deprived the Lenders of their right to credit bid. The District Court reversed, holding that the Debtors could effectuate a sale of assets under the Plan without allowing the Lenders to credit bid so long as the Lenders are provided with the "indubitable equivalent" of their secured claim under the Plan.

On appeal, the issue before the Third Circuit was whether section 1129(b)(2)(A) of the Bankruptcy Code requires that any debtor who proposes to sell assets free of liens as part of a plan of reorganization must allow secured lenders to credit bid at the auction. The Third Circuit held that the Bankruptcy Code permits a debtor to proceed with a plan that provides secured lenders with the "indubitable equivalent" of their secured interest in the assets to be sold regardless of whether the secured party was allowed to credit bid at the auction sale.

In reaching its decision, the Court concluded that the plain meaning of Bankruptcy Code section 1129(b)(2)(A) permits a debtor to conduct an asset sale under a plan without allowing secured creditors to credit bid. The Court stated that the three subsections of Section 1129(b)(2)(A), by use of the disjunctive "or", each provide separate means of satisfying a lender's lien against a debtor's assets. Subsection (i) provides for the transfer of assets with the lien intact and deferred cash payment equal to the present value of the lender's secured interest in the collateral. Subsection (ii) provides for the sale of the collateral that secures a lender's claim free and clear of liens so long as the lender has the opportunity to "credit bid" at the sale with the lien to attach to the sale proceeds. Subsection (iii) provides for the satisfaction of the claim by any means that provides the lender with the "indubitable equivalent" of its claim. The Court reasoned that, although subsection (ii) specifically refers to a sale of assets, which implicates the right to credit bid right under Bankruptcy Code section 363(k), it had no statutory basis to conclude that the "sale" prong of the three potential treatments for secured claims under a plan is the only provision under which a debtor may sell its assets free and clear of liens.

The Court concluded that that Congress' inclusion of the "indubitable equivalence" prong left open the potential for other methods of conducting asset sales, so long as those methods sufficiently protected the interests of the secured creditor. The Court emphasized that it was interpreting the requirements of section 1129(b)(2)(A) and that it is the plan of reorganization -- and not the sale -- that must generate the "indubitable equivalent." Thus, the Lenders retained the right to argue at confirmation that the restriction on credit bidding impaired the auction from generating market value, thereby preventing them from receiving the indubitable equivalent of their secured interest.

The dissenting opinion concluded that section 1129(b)(2)(A)(ii) is the sole provision applicable to the sale of assets under a plan of reorganization free of liens, and it comes with a presumptive right to credit bid. In reaching that conclusion, the dissent observed that the three alternatives under section 1129(b)(2(A) are distinct routes that apply specific requirements for providing secured claims with appropriate treatment under the Bankruptcy Code, and stated that subsection (iii), upon which the majority opinion premised its ruling, is a "catch-all" that applies to situations not covered by subsections (i) and (ii).

Ramifications of Decision and Practice Pointers

The decision may, in the near term, provide debtors (particularly in the Third Circuit) with leverage in (i) negotiating with its secured lenders the structure of sales of assets in chapter 11 bankruptcy cases, (ii) giving the debtor the ability to steer the sale of its assets toward a preferred purchaser, and/or (iii) generating cash sale proceeds that might be surcharged by the estate for the purposes of case administration and distributions to creditors. In response to this decision, lenders should include:

• in prepetition loan documents, a provision that provides for the right to credit bid in connection with a section 363 sale or a sale pursuant to a plan; and
• In any agreement providing and order authorizing debtor-in-possession financing or use of its cash collateral, the absolute right to credit bid at either a 363 sale or a sale pursuant to a plan.

A lender who is denied the ability to credit bid should object to confirmation of a plan based on its failure to receive the "indubitable equivalent" of its secured claim. Such an objection will require a bankruptcy court to examine, among other things, whether an auction sale without the ability of the secured lender to credit bid and the concomitant protection of secured creditors from sale of their collateral for an unacceptably low price, would not be deemed to have generated proceeds equal to the actual market value of the collateral or the "indubitable equivalent." Faced with this argument, a debtor may respond that the secured lender can still bid at the auction with cash, which it would then receive from sale proceeds if it is the winning bidder, a circular result without tangible economic purpose.

Although one other Circuit Court has reached a similar result, it remains to be seen whether other courts throughout the country will continue to abide by what has become the standard practice of allowing credit bidding rather than arriving at a "disjunctive" result unintended by Congress.