Portfolio Media. Inc. 860 Broadway, 6th Floor New York, NY 10003 www.law360.com Phone: +1 646 783 7100 Fax: +1 646 783 7161 customerservice@law360.com Losing The Bid: Philadelphia Newspapers Sale Dispute Law360, New York (August 30, 2010) -- On March 22 secured creditors lost an important right they assumed they had in their quiver of remedies to maximize their recovery against debtors in Chapter 11 bankruptcies. The important right is a process known as credit bidding, which allows a secured creditor to bid the entire face amount of its claim against a debtor, including the unsecured deficiency portion, rather than cash or other currency at a sale of the debtor s assets. The secured creditor s right to credit bid is found in Section 363(k) of the Bankruptcy Code, which governs sales of the debtor s assets outside of a plan of reorganization, and in Section 1129(b) of the Bankruptcy Code, which provides the standards for whether a plan is fair and equitable in the situation where a debtor crams down the plan over the objections of secured creditors. Section 1129(b) provides three options for determining whether a plan is fair and equitable: (1) the secured parties retain their liens on the collateral, (2) the secured parties are provided the opportunity to credit bid their claims, or (3) the secured parties receive the indubitable equivalent of their claims. The lending community interpreted Section 1129(b) to provide the right of a secured lender to credit bid its claims in a sale pursuant to a plan where the secured party does not retain its liens on the collateral. The third option, or the receipt of the indubitable equivalent, was not viewed as a separate path to establishing fair and equivalent value; it was always tied to satisfaction of either of the first two options. The decision in In Re Philadelphia Newspapers LLC et al. ( Philadelphia Newspapers ) changed this longstanding assumption and resulted in the secured lenders having to raise sufficient funds to bid cash.[1] Background of the Case The facts in the Philadelphia Newspapers matter are straightforward. Philadelphia Newspapers LLC acquired The Philadelphia Inquirer and The Philadelphia Daily News, as well as philly.com, in July 2006 for $515 million. A syndicate of lenders, including Citizens Bank of Pennsylvania, provided $295 million of the purchase price pursuant to a secured lending facility. Philadelphia Newspapers LLC and certain other debtors defaulted under the terms of the facility in December 2007 and September 2008.
On Feb. 22, 2009, the debtors filed voluntary petitions under Chapter 11 of the Bankruptcy Code, and on Aug. 20, 2009, the debtors filed a joint Chapter 11 plan of reorganization. The plan provided for the sale of the debtors assets at an auction free of the lenders liens. The debtors then took a series of controversial actions, including entering into an asset purchase agreement with Philly Papers LLC. The majority and controlling equity holders of Philly Papers are the Carpenters Pension and Annuity Fund of Philadelphia and Vicinity and Bruce Toll, who also hold significant equity interests in certain of the debtors. In addition, the debtors are alleged to have conducted an advertising campaign supporting the sale of the debtors assets to Philly Papers, which became the stalking horse bidder. The plan provided that the lenders would receive about $37 million in cash and the debtors Philadelphia headquarters, which was valued by the debtors at $29.5 million. The real estate was subject, however, to a two-year rent-free lease to the debtors. To the extent additional cash was received from a higher bid at the public auction, the secured lenders would receive the excess. In seeking approval of the bid procedures, the debtors sought to prevent the lenders from credit bidding their claims. The U.S. Bankruptcy Court for the Eastern District of Pennsylvania refused to grant the debtors motion, finding that the lenders had the right to credit bid their claims in the debtors asset sale pursuant to the plan.[2] The bankruptcy court approved a revised set of plans that allowed the lenders to credit bid their claims in the sale, which the debtors then appealed to the district court. Relying on a plain reading of the language of Section 1129(b)(2)(A), the district court reversed the bankruptcy court and found that each of the three options for achieving a fair and equitable cram-down sale were separate and independent.[3] Because the debtors relied on the third prong the indubitable equivalent test, the lenders did not have a right to credit bid their claims, which is set forth in the second prong. A sale of the assets, so long as it provided the indubitable equivalent to the lenders, could establish the fair and equitable requirement. The lenders appealed the district court s order, and the U.S. Court of Appeals for the Third Circuit heard the appeal on the merits. In a divided opinion, the majority agreed with and affirmed the district court s holding and found that a plain reading of the language of Section 1129(b)(2)(A) did not require that the lenders have the right to credit bid their claims in the plan-approved sale. The majority focused on the statute s use of the disjunctive or rather than the conjunctive and. In addition, the court rejected the secured creditors' claims that the language was ambiguous and that Section 1129(b)(2)(A) should be analyzed in light of the other provisions of the Bankruptcy Code and the legislative intent, which would argue that credit bidding is required in asset sales pursuant to a plan where the liens are not retained on the collateral.
The majority emphasized that the opinion did not decide whether the debtors asset sale set forth in the plan would provide indubitable equivalence and therefore would be fair and equitable to the dissenting lenders. Instead, the court only addressed the issue of whether the Bankruptcy Court was proper in requiring that the asset sale set forth in the plan provide the lenders the right to credit bid their claims. In a vigorous dissenting opinion, Judge Ambro found that Section 1129(b)(2)(A) was ambiguous and that one could read the three prongs in a conjunctive manner. In addition, the dissent found that canons of statutory interpretation would support a reading that prong two, which provides for credit bidding, would prevail over the general, broad language in prong three requiring indubitable equivalence. The dissent also highlighted the effect of the majority s holding, which would make the credit bid prong superfluous and provide an end-run around to debtors to avoid giving secured parties the right to credit bid. The lenders sought a petition for an en banc rehearing before the entire Third Circuit, but that petition was denied. The stage was then set for the April 27 auction. After an intense 30-hour auction, the lenders emerged victorious over two other bidders: the stalking horse group supported by the debtors' management, and Stern Partners Inc. The winning bid consisted of $105 million of cash, which was funded by certain of the lenders, and the debtors' real estate, which was worth about $33.9 million. Each lender in the group was given the option to provide financing for the acquisition or to receive a "cash out" payment. Those lenders electing to cash out were provided cash by backstoppers. The plan provides all lenders with the option of electing their recovery in cash or in stock of the acquisition. Practical Impact and Consequences: Secured Lenders Pain, Private Equity and Other Purchasers Gain? Although the lenders' success in winning the bid at auction mitigates the impact slightly, it is clear that the decision in the Philadelphia Newspapers case will have a negative impact on secured lenders, simply by removing one of the options they thought they had to protect the value of their collateral in Chapter 11 cases. By having the option to credit bid at a sale of their collateral, under a plan or otherwise, secured lenders could reap any upside should the collateral later increase in value or force a purchaser to pay a greater amount than it otherwise would have, absent the credit bid. The decision gives debtors a significant amount of leverage since they can now defeat a secured lender s right to credit bid by conducting a sale under a plan rather than under Section 363 of the Bankruptcy Code. The impact of the decision is mitigated slightly, to the extent the secured lenders have liquidity to deploy at auction and can essentially "round trip" the cash back to themselves. At first glance it may seem that private equity funds that purchase distressed companies out of Chapter 11 also stand to gain, provided that they have a friendly debtor.
This may be true in those circumstances where the equity fund has not purchased any debt or provided any pre- or post-petition funding. In a number of cases, private equity companies purchase secured debt at a steep discount with the hopes of credit bidding the full amount of the debt at any auction. Just like the secured lenders in Philadelphia Newspapers, the debtor could prevent the equity fund from credit bidding by pursuing a sale under a plan. Since the debt is typically purchased from nondebtor third parties, it would be difficult for the purchaser to contract around this issue. At the end of the day, the decision has thrown uncertainty into the sales process. Along with uncertainty comes litigation, rising costs and delays. Judge Ambro noted in his dissent that allowing a sale free and clear of secured lenders liens outside of the bargained-for loan forces future secured creditors to adjust their pricing accordingly, potentially raising interest rates or reducing credit availability to account for the possibility of a sale without credit bidding. While a secured lender may contract around the issue by obtaining a debtor s agreement to provide it with an absolute right to credit bid under a plan or to conduct any sale only pursuant to Section 363 of the Bankruptcy Code, query whether such provisions would be enforceable against a debtor that changes its mind. Clearly, most lenders will insist that any DIP order include language providing them with the absolute right to credit bid. As discussed above, it could also force a the lender to come up with cash to buy its collateral only to pay itself back from the proceeds. The uncertainty will also force private equity and other purchasers, who serve as stalking horse bidders, to increase their bid protections because any sale under a plan that precludes an undersecured lender from credit bidding will almost certainly be met with protracted plan confirmation litigation over valuation and indubitable equivalent issues. Such litigation will undoubtedly cause significant delays in the sale process and negatively affect the business as a going concern. It will also give much pause to private equity funds and other acquirers considering whether to buy debt at a discount with the hopes of credit bidding the face amount of the debt. Like future secured lenders, private equity will adjust pricing, asset purchase agreements and sale orders accordingly. --By Susan F. Balaschak and Todd A. Miller, Akerman Senterfitt LLP Susan Balaschak is a shareholder in Akerman s bankruptcy and creditors rights practice group in the New York office. Todd Miller is a shareholder in the firm s corporate practice in the Orlando, Fla., office. The opinions expressed are those of the authors and do not necessarily reflect the views of the firm, its clients or Portfolio Media, publisher of Law360. [1] In re Philadelphia Newspapers LLC et al., 2010 WL 100 6647 (3d Cir. Mar. 22, 2010). [2] In re Philadelphia Newspapers LLC et al., 2009 WL 3242292 (Bankr. E.D. Pa. Oct. 8, 2009).
[3] In re Philadelphia Newspapers LLC et al., 418 B.R. 548, 552 (E.D. Pa. 2009).