CONC

uRRE

NT s

EssI

ON

Joel H. Levitin, ModeratorCahill Gordon & Reindel LLP

Daniel A. CelentanoEvercore Partners

Hon. Shelley C. ChapmanU.S. Bankruptcy Court (S.D.N.Y.)

William H. HenrichGetzler Henrich & Associates LLC

Flip HuffardThe Blackstone Group

Gary L. KaplanFried, Frank, Harris, Shriver & Jacobson LLP

Jeffrey S. SabinBingham McCutchen LLP

George MackBarclays Capital

How to Conduct a Better Sale Process: 363 Sale Issues and Bid Procedures

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A/74878348.1

How to Conduct a Better Sale Process: 363 Sale Issues and Bid Procedures

by Jeffrey S. Sabin, Scott K. Seamon and Matthew J. Cursio1 I. INTRODUCTION AND BACKGROUND

Section 363 Sales have become one of the most popular restructuring mechanisms, as debtors, asset purchasers and secured creditors are often looking for a quick and predictable outcome, while keeping administrative costs of running a bankruptcy case at a minimum. Rarely do we see the “free fall” bankruptcy these days, but instead, the constituents show up at the proverbial courthouse steps (although there really aren’t any steps in Delaware or at the Southern District) with many questions answered and documented in a plan support agreement, a sales procedures motion and an agreement on debtor-in-possession financing or consensual cash collateral use, which together serve as a roadmap for how the case is intended to proceed. Along with this roadmap, debtors often have a stalking horse purchaser in tow to purchase substantially all of the assets of the company and have negotiated for a limited budget from the secured creditors to allow the sale process to occur and to fund a liquidating plan (or in some cases, a structured dismissal). If there is no third party stalking horse purchaser locked up, the secured creditors often will step up and become the stalking horse purchaser, utilizing the credit bid provisions permitted by the Bankruptcy Code. The hope is that any unsecured creditors committee will acquiesce, while hoping that the assets fetch an amount greater than the current secured debt, or in the event that it does not, agree to some kind of tip-- the quid pro quo of today’s typical liquidating chapter 11 case. Sound familiar? This is where we are and seems to be how many cases will proceed for the foreseeable future. With the above as the backdrop, the panel discussion (and these materials, which are designed to supplement the panel discussion) will focus on some of the recent trends with respect to Section 363 sales and asset sales through a plan, including the very timely “hot topic” of credit bidding in a plan, which will have been heard by the Supreme Court at oral argument by the time the panel discussion begins. We will also discuss typical provisions in a bidding procedures order, successor liability issues, the receipt of late bids and the role of a secured creditor in bankruptcy, each of which demonstrate the tightrope act that must be done in order for a successful asset sale to be conducted under the auspices of the bankruptcy court.

A. Background: § 363 Sales

There are a number of reasons why we are seeing more asset sales than ever (as opposed to reorganizations). At the height of the economic crisis in 2008 and 2009, there was simply no financing available in the marketplace. The ability to come out of bankruptcy with newly restructured debt was simply not possible. Asset sales were, and still remain, a very attractive way for creditors to extricate themselves from a money-losing proposition. Although capital is now more easily attainable (and at much lower rates), there is still a lack of willingness for a troubled company’s secured creditors to “throw good money after bad,” especially in businesses

1 Jeffrey S. Sabin is a partner in Bingham McCutchen LLP's New York Office, and co-head of the firm’s

global Financial Restructuring Group. Scott K. Seamon is a Counsel and Matthew J. Cursio is an Associate in the group.

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that do not seem to be sustainable. Secured creditors would much rather cut their losses, realize upon their collateral and move on to other investments. In doing so, they are seeking a quick exit at a minimum cost and in an expedited and protective mechanism afforded by a bankruptcy. Potential strategic and other distressed asset purchasers are also looking for a quick and predicable process, one which provides the buyer with the very important court order enabling them to take the assets free and clear of all liens and claims. The § 363 process also gives the secured creditors a chance for a market test (to see what their collateral is worth) before they ultimately decide whether to credit bid and own the assets. The days of significant valuation and plan confirmation fights appear limited to those cases where the underlying business is believe to be viable but changes must be made to the capital structure and/or critical components thereof (e.g. labor, pension etc). More often than not, the real action in a case will be happening within the first few weeks, as the debtor seeks to sell substantially all of its assets by seeking approval of a bidding procedures order on day one, along with its plan to finance the case.

B. Statutory Framework

There are a number of sections of the Bankruptcy Code that are relevant for a discussion of § 363 issues, as set forth below. § 363(b)(1)2 allows the Debtor to sell assets after a notice and hearing, while § 363(f)3 provides for the all-important free and clear order and § 363(m) the good faith purchaser protection under § 363(m)4 that all buyers require. § 363(k)5 addresses the right of secured creditors to credit bid and §§ 1123(a)(5)(D)6 and 1123(b)(4)7 give a debtor the 2 The trustee, after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate. 11 U.S.C. §363(b)(1). 3 The trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate only if: (1) applicable non-bankruptcy law permits sale of such property free and clear of such interest; (2) such entity consents; (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property; (4) such interest is in bona fide dispute; or (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest. 11 U.S.C. §363(f)

4 The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal. 11 U.S.C. §363(m). 5 At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases the property, such holder may offset such claim against the purchase price of such property. 11 U.S.C. §363(k).

6 Notwithstanding any otherwise applicable nonbankruptcy law, a plan shall-- …. (5) provide adequate means for the plan's implementation, such as-- . . . (D) sale of all or any part of the property of the estate, either subject to or free of any lien, or the distribution of all or any part of the property of the estate among those having an interest in such property of the estate. 11 U.S.C. §1123(a)(5)(d).

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ability to sell its assets free and clear of liens and claims pursuant to a plan of reorganization. Finally, § 365’s executory contracts sections are also intertwined with § 363, as asset sales typically include material executory contracts to be assigned to third party purchasers under § 365(f)8. The Bankruptcy Code permits such contracts (other than certain personal services contracts9) to be assigned to a third party despite provisions in the contract that restrict transfers to third parties.

A sale of assets pursuant to a plan is obviously a much slower process and typically

would not be done in a situation in which the value of the assets could dissipate over time-- the “so-called” melting ice cube. A sale of assets pursuant to a plan also typically requires more funding and longer maturity of DIP loans and also raises additional issues with respect to the ability of a secured creditor to credit bid, as discussed in greater depth in Section VI below. II. CONDUCTING AN ASSET SALE; BID PROCEDURES AND BID PROTECTIONS

A. Standard for Approval of § 363 Sales.

Generally, courts within the Second and Third Circuits10 apply the business judgment test in determining whether to approve a § 363 Sale. The most commonly cited case in the Second Circuit is In re Lionel Corp., 11 in which the court held that “the rule we adopt requires that a judge determining a § 363(b) application expressly find . . . a good business reason to grant such an application”. In the Third Circuit, the seminal case for approval of a § 363 sale is In re

7 Subject to subsection (a) of this section, a plan may-- . . .

(4) provide for the sale of all or substantially all of the property of the estate, and the distribution of the proceeds of such sale among holders of claims or interests;

11 U.S.C. §1123(b)(4) 8 (1) Except as provided in subsections (b) and (c) of this section, notwithstanding a provision in an

executory contract or unexpired lease of the debtor, or in applicable law, that prohibits, restricts, or conditions the assignment of such contract or lease, the trustee may assign such contract or lease under paragraph (2) of this subsection.

(2) The trustee may assign an executory contract or unexpired lease of the debtor only if-- (A) the trustee assumes such contract or lease in accordance with the provisions of this section;

and (B) adequate assurance of future performance by the assignee of such contract or lease is

provided, whether or not there has been a default in such contract or lease. (3) Notwithstanding a provision in an executory contract or unexpired lease of the debtor, or in applicable

law that terminates or modifies, or permits a party other than the debtor to terminate or modify, such contract or lease or a right or obligation under such contract or lease on account of an assignment of such contract or lease, such contract, lease, right, or obligation may not be terminated or modified under such provision because of the assumption or assignment of such contract or lease by the trustee.

11 U.S.C. §363(f). See also In re Rickel Home Ctrs., Inc., 209 F.3d 291, 300-04 (3d Cir. 2000) (holding statutory mootness provision of § 363(m) applied to assumption and assignment of unexpired leases under § 363 sale).

9 Personal services contracts are an exception to the rule that contracts are assignable despite anti-assignment provisions. 11 U.S.C. §365(c).

10 For purposes of these materials, we have, for the most part, focused on the Southern District of New York and Delaware, which are two of the busiest courts in the country.

11 722 F.2d 1063, 1071 (2d Cir. 1983).

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Abbotts Dairies of Pa., Inc.,12 which adopted the sound business purpose test. Specifically, in order to receive approval of a § 363 sale, the debtor typically must establish the following four elements: (1) that a sound business purpose justifies the sale of assets outside the ordinary course of business; (2) that accurate and reasonable notice has been provided to interested persons; (3) that the trustee or the debtor-in-possession has obtained a fair and reasonable price; and (4) good faith. 13

B. § 363 Sale Process

The most standard asset sale structure seen in large cases involves the use of a “stalking horse purchaser”. The debtor will engage an investment banker and law firm and negotiate pre-petition with multiple third parties, including a mix of strategic purchasers and distressed investors willing to purchase the business and meet its funding needs going forward. This first “auction” culminates with the selection of a stalking horse purchaser and the negotiation of an asset purchase agreement executed contemporaneously with the filing of the bankruptcy petition. In agreeing to the asset purchase agreement, this stalking horse purchaser agrees to purchase the assets subject to higher and better bids and subject to approval by the bankruptcy court. The stalking horse is essentially providing a backstop and certainty of sale. A debtor could choose to sell the assets without a stalking horse, but there is a risk that no bidders show up. The stalking horse can either be a third party or a secured creditor who intends to invoke its ability to credit bid pursuant to § 363(k).

After the stalking horse is chosen, the Debtor will then seek authority of the bankruptcy court to approve the bidding procedures, which are the procedures which will govern the marketing and sale of the assets. As the § 363 process is designed to achieve the highest and best price and recovery for creditors, the bidding procedures typically provide for an auction of the assets, with the agreed upon price of the stalking horse serving as the floor price. After the auction is concluded, the debtor then seeks court approval of the asset sale, typically one or two days after the conclusion of the auction. After an order approving the sale is entered, the consummation of the sale is then completed through a more standard deal closing mechanism.

C. Bid Procedures and Bid Protections

One of the key documents that is negotiated in any § 363 bankruptcy sale process is the bid procedures order, which contains, typically as an exhibit thereto, the procedures that ultimately govern the conduct of the sale. The motion to approve bid procedures will also seek the bankruptcy court’s authority to provide certain bid protections to a stalking horse purchaser. The negotiation and the approval of the bidding procedures order and the bid protections involves delicate balancing between protecting the stalking horse purchaser and crafting a process that does not serve to chill bids. It becomes even more delicate when the secured creditor is serving as the stalking horse purchaser through a credit bid, as the secured creditor is wearing two hats-- both as a potential purchaser and the party that is funding the bankruptcy case. The following is a non-exhaustive list of bid procedures and protections that are commonly

12 788 F.2d 143 (3d Cir. 1986). 13 Titusville Country Club v. Pennbank (In re Titusville Country Club), 128 B.R. 396, 399 (Bankr. W.D. Pa.

1991).

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negotiated, including some which can and have been contested and litigated, as noted in the case law cited below, and others which are just par for the course:

1. Expense Reimbursements.

Stalking horse purchasers will typically insist on the debtor paying the fees and expenses it incurs in conducting due diligence, negotiating the asset purchase agreement and attending various court hearings. If permitted by the debtor and approved by the court, expense reimbursements become an administrative claim of the estate and will be paid regardless of whether the stalking horse purchaser is ultimately the winning bidder. Courts will typically approve expense reimbursements as long as they are reasonable-- the rule of thumb is that an expense reimbursement cap of 1% of the purchase price is considered reasonable.

In the recent Asarco LLC case, 14 a debtor was able to receive bankruptcy court approval (which was later affirmed by the district court on appeal) to pay the expenses of multiple bidders who participated in an auction process in which a debtor was selling a fraudulent transfer judgment. The debtor solicited 100 potential parties (primarily hedge funds) with an introductory letter, with parties invited to make non-binding offers. After going through these offers, the debtor selected a group of qualified bidders who would be given the opportunity to conduct more in-depth due diligence, for which the debtor sought the approval of expense reimbursements. Ultimately, four parties participated in this phase of due diligence for which the expense reimbursements were sought. The debtor sought the approval of multiple expense reimbursements because of the unique nature of the asset being sold, as potential bidders would have to invest significant time and expense assessing various legal issues involved in determining whether to bid on the fraudulent transfer judgment. Without such a reimbursement, the debtor argued, the prospective bidders would be reluctant to participate, and in fact, the debtor noted that some of the bidders actively sought the payment of a work fee from the debtor in order to participate. The district court held that the debtor was within its business judgment in allowing the payment of the expenses of multiple bidders (i) as it could attract bidders who ordinarily would have been deterred from participation due to the uniqueness of the asset, (ii) because time was of the essence and (iii) as it would aid in ascertaining the value of the asset that would assist the court in assessing the two competing plans filed in the case. 15

2. Break up Fees and Topping Fees

One of the mostly heavily litigated bid protections within bankruptcy courts has been that of break up fees. In addition to the expense reimbursements, stalking horse purchasers often require debtors to compensate them (typically in an amount equal to a percentage of the purchase price contained in the stalking horse asset purchase agreement) for their time and effort in conducting due diligence and serving as the base-line bid in the event that the stalking horse does not ultimately purchase the assets (either due to a failure of the debtor to consummate the sale or due to a third party winning the auction for the assets at a higher price). The rationale for break up fees is that by investing their time and money in due diligence and in waiting for the chapter 11 process to play out, the stalking horse is foregoing other opportunities in the marketplace to

14 In re Asarco LLC, 441 B.R. 813 (S.D. Tex. 2010). 15 Id. at 831.

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purchase other assets or enter into other business transactions (opportunity costs) and should be compensated for it. Opponents of break up fees will argue that such fees are unnecessary, as those who are interested in purchasing the assets will bid regardless of whether they get a break up fee and break up fees reduce the funds available to the estate. While courts have not set a cap on breakup fees, the generally accepted range in the market for break up fees has been between 2 and 3% of the purchase price. There is no universal standard for approval of bankruptcy fees among the bankruptcy circuits, which has let to a great deal of uncertainty in this area.

Recent cases from within the Second Circuit indicate that courts employ a “fair and reasonable” standard in the approval of break up fees, which is a variation on the debtor’s business judgment rule.16 In applying this standard, courts have applied the following three-part test set forth in In re Integrated Resources17 when considering whether break up fees should be approved:

- Was the negotiation of the break up fee tainted by self-dealing or manipulation - Does the fee discourage rather than encourage bidding? - Is the fee unreasonable relative to the purchase price? Courts within the Third Circuit have followed a stricter approach, applying the standard

espoused in the O’Brien case.18 In O’Brien, the Third Circuit held that while bidding incentives are measured against a business judgment standard in non-bankruptcy transactions, the administrative expense provisions in §503(b) of the Bankruptcy Code govern in the bankruptcy context. Therefore, to be approved, bidding incentives such as a break up fee must be necessary for the preservation of the debtor’s estate. In O’Brien, the Third Circuit ultimately upheld the bankruptcy court’s denial of the approval of the break up fee,19 holding that under the facts of the case, the fees were not necessary to induce other parties to bid, did not create a floor for the asset sale price and that awarding the fees would be uneconomical.20 A significant finding in the O’Brien case was evidence that the stalking horse purchaser would have made its bid even without the assurance of a break up fee.

16 In re Metaldyne Corp., 409 B.R. 661 (Bankr. S.D.N.Y. 2009); In re Ray Realty Fulton Inc., No. 09-41225, 2009 WL 2600760 (Bankr. E.D.N.Y. Aug 21, 2009); In re 995 Fifth Avenue Assocs., L.P., 96 B.R. 24 (Bankr. S.D.N.Y. 1989); In re Integrated Res., Inc., 147 B.R. 650 (S.D.N.Y. 1992).

17 In re Integrated Res., Inc., 147 B.R. at 657. 18 Calpine Corp. v. O’Brien Envtl. Energy Inc. (In re O’Brien Envtl. Energy), 181 F.3d 527 (3d Cir. 1999).

19 The bankruptcy court in O’Brien had identified 9 factors in determining the viability of a break up fee: (1) is the relationship of the parties who negotiated the break-up fee tainted by self-dealing or manipulation; (2) does the fee hamper, rather than encourage bidding; (3) is the amount of the fee unreasonable relative to the proposed purchase price; (4) did the unsuccessful bidder (Calpine) place the estate property in a sales configuration mode to attract other bidders to the auction; (5) did the request for a break-up fee serve to attract or retain a potentially successful bid, establish a bid standard or minimum for other bidders, or attract additional bidders; (6) does the fee requested correlate with a maximization of value to the Debtor’s estate; (7) are the principal secured creditors and the official creditors committee supportive of the concession; (8) were safeguards beneficial to the debtor's estate available; and (9) was there a substantial adverse impact on unsecured creditors, where such creditors are in opposition to the break-up fee? Id. at 536.

20 Id. at 536-537.

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The Third Circuit revisited the issue of break up fees recently in the Reliant case.21 In Reliant, the stalking horse asset purchase agreement purported to give the stalking horse purchaser of a power plant a $15 million break up fee (3% of the purchase price) and an expense reimbursement of up to $2 million in the event it was not determined to be the highest bidder. The bankruptcy court approved certain of the bid protections (specifically, the expense reimbursement as well as a $5 million overbid requirement), but would not approve the break up fee as the court was not convinced that it was necessary to preserve the value of the estate. The Third Circuit reaffirmed the standard set forth in O’Brien, holding that the business judgment rule is not applicable in determining the approvability of break up fees, but that §503(b) is the applicable standard. While recognizing that the stalking horse purchaser does take a risk when it negotiates to be the stalking horse, the court did not believe that the break up fee was necessary in order to induce the stalking horse purchaser to bid. A key fact was that the stalking horse asset purchase agreement only provided that the debtor would “seek” the entry of an order approving the break up fee, not that they were able to terminate the asset purchase agreement if they did not get such approval. The Third Circuit also upheld the bankruptcy court’s determination that the inclusion of the break up fee would be a deterrent to other parties bidding, thus, outweighing any possible benefit to the estate.22 The Third Circuit also rejected the argument of the stalking horse purchaser that the business judgment rule should apply because none of the debtor’s creditors or equity holders had objected to the payment of the break up fee.23

Other courts have adopted a third approach to evaluate break up fees: The court in the recent Sea Island case24 adopted a hybrid standard (first set forth in the America West Airlines case25) in which the court must determine whether the transaction will “further the diverse interests of the debtor, creditors and equity holders, alike.” In Sea Island, the Bankruptcy Court for the Southern District of Georgia ultimately held that a 3% break up fee met the applicable requirements under the facts of that case.

The appropriateness of break-up fees when the stalking horse agreement contains conditions under which the stalking horse may opt out of the agreement may also be an issue worth raising. For instance, in In re Metaldyne Corporation, the prepetition term lender argued that break-up fees coupled with a “due diligence out” made the proposed bidding procedures “egregious.”26 The bankruptcy court, however, approved the bidding procedures before the diligence period concluded (and after the debtor and stalking horse agreed to lower the break up

21 In re Kelson Channelview LLC v. Reliant Energy Channelview LP (In re Reliant Energy Channelview

LP), 594 F.3d 200 (3d Cir. 2010). 22 Id. at 208. 23 Id. 24 Sea Island Coastal Props. LLC v. Official Comm. of Unsecured Creditors (In re Sea Island Co.), No. 10-

21034, 2010 WL 4393269 (Bankr. S.D. Ga. Sept. 15, 2010). 25 166 B.R. 908 (Bankr. Ariz. 1994). 26 Objection of the Prepetition Term Lenders to the Motion of Debtors and Debtors In Possession for (I)

and Order (A) Approving Bidding Procedures For the Sale of the Debtors’ Powertrain Group, (B) Approving Certain Bidder Protections And (C) Scheduling A Final Sale Hearing And Approving the Form and Manner of Notice Thereof; And (II) An Order (A) Authorizing the Sale of Certain Assets Related to the Debtors’ Powertrain Group Free and Clear of Liens, Claims, Interests, and Encumbrances And (B) Authorizing the Assumption and Assignment of Certain Executory Contracts and Unexpired Leases In Connection Therewith at 2-3, In re Metaldyne Corp., No. 09-13412 (Bankr. S.D.N.Y. June 23, 2009). A “due diligence out” allows the purchaser to walk away if it unearths something damaging during the due diligence process.

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fee at oral argument), finding the bidding procedures to be “essential inducements and conditions” to the stalking horse entering into the stalking horse purchase agreement. 27

3. Topping Fees

A “topping fee” is a fee paid to a stalking horse purchaser only in the event that another bidder is the successful purchaser. The amount of a topping fee is typically a percentage of the amount over the purchase price contained in the stalking horse asset purchase agreement. Topping fees differ from break up fees in that topping fees do not compensate the stalking horse purchaser in the event that the stalking horse purchaser is the winning bidder but the debtor is unable to close (break up fees are typically earned either upon a failure of the debtor to consummate the transaction or if the stalking horse purchaser is outbid). There is very little case law with respect to topping fees, although the cases that do discuss topping fees appear to follow the same analysis as with respect to break up fees.28

4. More on Break up Fees and Expense Reimbursements: Orleans Homebuilders Case

As we discuss in greater depth later in these materials, the asset sale process is often part and parcel with a comprehensive strategy agreed to by and among the debtor, the prepetition secured creditors and the stalking horse purchaser. The secured creditors will often agree to fund the case for a specified period of time in order to allow for the assets to be sold and a plan to be confirmed. They (and their counsel) will be involved in the negotiation and drafting of all of the relevant financing and sale pleadings, including the bid procedures governing the marketing and sale process and the bid protections to be provided to the stalking horse purchaser. Now, what happens if the secured creditors sell their debt to a third party who wants to change strategies midstream? This issue arose recently in the Orleans Homebuilders case.29

In Orleans Homebuilders, the debtor executed an asset purchase agreement post-petition with a stalking horse buyer, NVR, Inc. (“NVR”), to purchase substantially all of the assets of the debtor for a total purchase price of $170 million. The transaction was approved by the debtor’s board of directors and consented to by the pre-petition and post-petition lenders. The parties negotiated a standard bidding procedures order which provided for, among other things, a 10% cash deposit, overbid protections, minimum bidding increments of $1 million and a termination fee of 2% of the purchase price ($3.4m) plus an expense reimbursement of $150,000 plus out of pocket expenses, subject to a $1 million cap. The debtor then sought orders approving the sale procedures and the bidding protections (the “Sale Motion”). Prior to the hearing to consider the

27 Order (A) Approving Bidding Procedures For the Sale of Certain Assets Related to the Debtors’ Powertrain Group, (B) Approving Certain Bidding Protections and (C) Scheduling A Final Sale Hearing And Approving the Form and Manner of Notice Thereof at 4, In re Metaldyne Corp., No. 09-13412 (Bankr. S.D.N.Y. June 25, 2009).

28 In re App Plus, Inc., 223 B.R. 870 (Bankr. E.D.N.Y. 1998) (court acknowledged the ‘dearth of cases’ regarding topping fees, but used break up fee precedent to analyze the issue; in this case, the court authorized a break up fee, but denied the topping fee because it was not necessary to increase bidding); In re Twenver, Inc., 149 B.R. 954 (Bankr. D. Colo. 1992) (court applied break up fee case law precedent and rejected the proposed topping fee); In re Bidermann Indus., 203 B.R. 547 (Bankr. S.D.N.Y. 1997) (same). Each of these cases followed the business judgment rule standard as set forth in In re Integrated Resources (described above).

29 NVR, Inc., v. Orleans Homebuilders, Inc. et. al, Adv. Pro. 10-51083 (Bankr. D. Del. 2010).

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sale procedures, the secured creditors sold their debt to certain distressed debt investors who no longer wanted to pursue an asset sale strategy, instead focusing on a reorganization of the debtor. As a result, the debtor ultimately withdrew the Sale Motion and NVR filed an adversary proceeding nine days later against the debtor seeking, among other things, the payment of the $3.4 million termination fee as well as the expense reimbursement.

There were very interesting argument raised by both sides in the pleadings that ensued over the next six months. The debtor argued that the asset purchase agreement was never approved by the court and, therefore, never became enforceable against the debtors (i.e. the debtor cannot engage in transactions outside the ordinary course without court approval under § 363(b)). They also argued that because the secured creditors, as well as other key constituents in the case, now opposed the asset sale, the sale never would have been approved by the court. In its opposition, NVR focused on arguments of promissory estoppel (based on the debtor’s promise that they were committed to sale process) and an argument that the obligation to seek court approval of the asset purchase agreement was enforceable. An additional argument of unjust enrichment was raised, as NVR argued that it was their stalking horse bid that served as a catalyst for the increased interest in the assets, which culminated in the change in strategy in the first place.

Fortunately for the parties, but unfortunately for the inquisitive bankruptcy scholars among us, a settlement was reached almost a year after the original stalking horse APA was executed. Although it has not yet been approved by the court, the settlement agreement provides for an allowed administrative claim for NVR of $425,000, which is approximately 10% of the total amount of the termination fee and expense reimbursement. While it appeared that the debtor had the better statutory argument in the case, it did not leave this altercation unscathed, having to spend considerable time, energy and cost defending the complaint (as well as the ultimate amount of the settlement). It will be interesting to see whether this case has any lingering effects on future debtors (who could insist on a holdback amount from secured creditors’ cash collateral or from sale proceeds to fund potential lawsuits like this), future stalking horse purchasers (who may lose confidence in judicial sales and shy away from expending time and lost opportunity cost pursuing an asset sale with parties who could change courses at any time before the gavel is struck) and secured creditors (who could find themselves having to fund additional administrative expenses caused by a strategy change). One takeaway for stalking horse purchasers is for them to require provisions that bind the secured creditors’ successors and assigns to the stalking horse asset purchase agreement. This could potentially avoid what happened in the Orleans case.

5. Minimum Overbids and Bid Increments

One key term in the asset purchase agreement negotiated with the stalking horse purchaser is price. If there are no other bids received, the stalking horse purchaser purchases the assets for the price contained in the asset purchase agreement. If there are additional “Qualified Bids” (see below for a discussion on what is deemed to be a qualified bid) an auction takes place where the assets are sold to the highest bidder. One protection that a stalking horse purchaser typically negotiates for (and receives) is a minimum overbid requirement, such that if a bidder wants to participate in the auction, it must be willing to bid an amount that is measurably higher than the stalking horse price. A typical overbid requirement would be the purchase price under

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the asset purchase agreement plus the amount of any breakup fees and expense reimbursement plus an additional overbid amount (such as 10%). At this amount, if the third party bidder is successful, it will result in a minimum measurable benefit to the estate (10%).30 Without such protection, if the asset purchase agreement provides for a $1 million purchase price, a third party could participate in the auction by bidding only $1 million and $1 dollar. After paying the expense reimbursement and break up fee, the estate would be worse off than if it just sold the assets to the stalking horse purchaser. By having a meaningful overbid requirement, the debtor is able to maximize value to the estate, while providing the stalking horse purchaser with a bit of a leg up on the competition, thus compensating it for the time and effort it put in to negotiate the asset purchase agreement. Along the same vein, once the auction begins, there are typically minimum bidding increments (such as $100,000 in the example of a $1 million purchase price) in which the successive bids must be increased. In addition to providing a convenience to the parties attending the auction (imagine how long an auction would take where parties could raise their bids by $1), it also provides comfort to the leading bidder at the time to know that they will only be trumped by bids which are materially greater than their bids.

6. Deposits and Bid Packages

Once an asset purchase agreement is agreed to with a stalking horse purchaser, it is standard for the stalking horse purchaser to provide a cash deposit of a meaningful percentage of the purchase price (10% is commonplace). In addition, one protection common to many bid procedures orders is a requirement that third party bidders also provide a cash deposit along with its bid (the overall submission by the other bidders, along with its bid amount, is typically referred to as a “bid package”). Such deposits are typically held by the debtor or its counsel and would be returned to the prospective bidder in the event that they are not selected as the highest and best bid. Deposits allow debtors (and stalking horse purchasers) to weed out parties that are merely kicking the tires and therefore can create an efficient and effective auction. Obviously, requiring a more substantial deposit could result in bid chilling, so the deposit amount tends to be around 10%.

Other items required to be included in the bid package include the following: the purchase price to be paid (often which must be in cash only), a list of the assets to be purchased, an asset purchase agreement which is marked up against the stalking horse asset purchase agreement to show requested changes, a list of the executory contracts to be assumed and evidence of board approval and financial wherewithal to consummate a transaction. Often, prospective purchasers will also be required, as a condition to its bid, to serve as a back-up bidder in the event that they are the second-highest bidder. If the highest bidder is unable to close, the back-up bidder will then be required to consummate the transaction.

7. Qualification of Bidders

30 There is not an abundance of case law discussing minimum overbids, as it is a fairly unchallenged bid

protection. See In re Greater Miami Neighborhoods, No. 08-10694, 2008 WL 4397425, at *2 (Bankr. S.D. Fla. Sept 26, 2008) (“The purpose of this minimum overbid was to assure that a competing bidder would have to beat POAH's “stalking horse" bid by $100,000, thereby assuring that the estates would receive at least $100,000 for the expense and effort of going through an auction process.”).

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Debtors tasked with officiating auctions also want to know that the parties that are interested in participating have the financial wherewithal to close a transaction (in addition to a bidder’s ability to provide a 10% cash deposit). While the debtor is typically familiar with and comfortable with the financial picture of the stalking horse purchaser after negotiating with them for a substantial period of time, the debtor typically knows practically nothing about the financial condition of parties who would like to become “Qualified Bidders” and participate in the auction. By requiring potential bidders to provide financial information in its bid package, the debtor is able to make a determination as to whether a potential bidder should be deemed a Qualified Bidder. Such information is also important with respect to the ability of a debtor to assign contracts in connection with the sale, as purchasers who are assuming certain executory contracts must demonstrate adequate assurance of future performance to the satisfaction of the contract counterparties.

One sneaky way of trying to eliminate the secured creditors’ ability to credit bid would be to require that deposits and bids be all cash. Of course, a seasoned secured creditor’s counsel will never let this happen and will often require, as a condition to financing or cash collateral use, that the right of the secured creditor to credit bid is expressly preserved and permitted.

Many bidding procedures orders contain provisions that allow a non-qualified bidder a short period of time to correct the infirmity that resulted in it being determined not to be qualified. Whether a bidder deemed not to be qualified has any standing to object to such decision is a separate question. While it is generally the case that non-winning bidders do not have standing, there is some case law that goes both ways on the issue.31 The issue of standing is also discussed in greater depth in connection with re-opening auctions, as discussed in Section II(D) below.

8. Marketing and Due Diligence Period

By the time that the stalking horse purchaser has executed the asset purchase agreement, they have typically already completed much of their financial and legal due diligence with respect to such purchase. The question then becomes the length of the due diligence period and mechanism available to third party purchasers who may be interested in submitting a bid and attending the auction. Debtors need to balance the stalking horse purchaser’s desire to complete a quick sale with their duty to run a process designed to maximize value to the estate. The length of the period is also often informed by the amount of financing and/or cash collateral the debtor has been allotted (often there are provisions in the financing orders which spell out the length of the asset sale process). It is standard for the due diligence period to begin on the date that the bid procedures order is entered and last until the Bid Deadline.

9. Competing Bids and Contingencies

31 See Squire v. Scher (In re Squire), 282 Fed. Appx. 413, 416 (6th Cir. 2008) (denying unqualified bidder

standing absent allegations of bad faith by auction participants). But see In re Fin. News Network, Inc., 126 B.R. 152 (S.D.N.Y. 1991) (opining that “‘disqualified’ bidder, one whose bid was not even considered by the bankruptcy court . . . appears to have alleged a sufficient basis for it to have standing”).

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Another concept that is often related to the due diligence period is whether parties submitting bid packages may include certain contingencies, such as a financing or due diligence contingency, a material adverse change clause or some kind of requirement for the bidder to receive internal board approval, each of which would serve to allow a potential bidder to withdraw its bid at or prior to the closing. Mechanically, with the bid packages, the potential bidder is required to submit an asset purchase agreement that contains any requested changes from the stalking horse asset purchase agreement. The debtor, usually in consultation with the secured creditors, must make the determination as to which bid is highest and best.

What we have seen more and more recently are requirements in the bid procedures that require third party bids to have no contingencies, such that the potential bidder must agree to terms no less favorable to the estate than the terms contained in the stalking horse asset purchase agreement. This enables a debtor to compare apples to apples to determine what truly is a higher and better bid, both when determining which bids are deemed to be Qualified Bid and during the auction when the debtor must decide which bids are the highest and best ones. For example, without such a provision in the bid procedures, it is left to the debtor to determine whether a bid for $1 million with a financing and due diligence contingency is better than a $500,000 bid with no such contingencies.

If called on to make a ruling on which bid is “higher and better” between bids, courts will generally defer to the debtor’s business judgment, even in the event that a debtor selects a lower monetary bid versus a higher bid with contingencies. Published decisions with respect to this issue confirm this.32

10. Requirement that Auction be “Open”

Bidding Procedures typically provide for a restriction on who can be in attendance at an auction. Typically the bidding procedures restrict access to only include the debtor, bidders, secured creditors, official committee representatives, a court reporter as well as the professionals that represent each of these parties. It is often infeasible, impractical and unwieldy to allow unlimited persons to attend the auction, as auctions take long enough without such distractions.

32 See In re Gulf States Steel of Ala., 285 B.R. 497, 517 (Bankr. N.D. Ala. 2002) (upholding trustee’s

decision to accept bid with higher monetary amount even though lower bid might have created more jobs in community and local government preferred lower bidder over higher bidder because Trustee believed higher bid would be of greater benefit to estate; court explained that “the Trustee has ‘great judicial deference’ in deciding which bid to accept as the best and highest bid”); In re Bakalis, 220 B.R. 525, 530, 532 (Bankr. E.D.N.Y. 1998); In re Bakalis, 220 B.R. 525, 530, 532 (Bankr. E.D.N.Y.1998) (explaining trustee’s recommendation for accepting bid at § 363 sale is subject to business judgment rule and upholding trustee’s decision to accept monetary bid with second highest monetary value because trustee had concerns that highest bidder could not close the transaction); In re Landscape Props., Inc., 100 B.R. 445 (Bankr. E.D. Ark. 1988): (explaining “[t]he Court believes that it cannot choose between two competing bidders because to do so would be to undertake a congressionally prohibited administrative function . . . [t]he Court then can do no more than disapprove the Trustee's proposed sale if it believes that there is a higher offer and better offer for the estate's assets citing” and “[i]n deciding whether to approve a purchase offer or in choosing which is the better offer when competing offers have been made, courts generally consider factors in addition to a higher dollar amount . . . in a liquidation case it is ‘legally essential’ to approve the highest offer, although this statement assumes that the offers and offerors are in all other respects comparable”); G-K Dev. Co. v. Broadmoor Pl. Inv., L.P. (In re Broadmoor Pl. Inv., L.P.), 994 F.2d 744, 745-46 (10th Cir. 1991) (upholding bankruptcy approval of lower bid that bankruptcy court viewed as having “fewer contingencies and facilitated a more immediate closing”).

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In addition, it is often the case that confidential information is discussed during the auction process, so there is a strong desire to have only parties in attendance who are subject to a confidentiality agreement (the parties described above are all typically parties to a confidentiality agreement with the debtor).

The issue of auction attendees was recently addressed in the Aloha Airlines case33. In Aloha Airlines case, two persons were denied permission to attend the auction, specifically a news reporter and counsel for the debtor’s employees’ union. Ultimately, the secured creditors were chosen as the highest bidder at the auction pursuant to a credit bid, but the bankruptcy court invalidated the auction results and would not approve the sale. Pursuant to Bankruptcy Rule 6004(l), a sale of assets outside the ordinary course of business can be done by “private sale” or by “public sale”.34 The court held that there should be no exclusion of the press or the public without the prior approval of the court. The takeaway from this case is to ensure that the court-approved bidding procedures order sets a limit on those parties who may attend. Otherwise, debtors should be prepared to rent out Yankee Stadium to conduct their auctions.

11. “No-shop” or “window shop” clauses

In standard M&A transactions, it is not uncommon for a prospective purchaser to negotiate for and receive a “no-shop” or “window-shop” provision which provides that a seller is not permitted to solicit or encourage third parties to bid on particular assets to be purchased. In the bankruptcy context, however, a provision that restricts a debtor from shopping the assets goes against the very fabric of conducting an open and fair sale process. What a stalking horse purchaser can do, however, is to negotiate a no-shop provision pre-bankruptcy which says that the debtor will not solicit another stalking horse purchaser. It can sometimes go further to restrict the debtor from shopping the assets to third parties until the bidding procedures are approved by the court.

Practically speaking, the debtor will have very limited bandwith to be negotiating with prospective purchasers anyway, while preparing to file for bankruptcy and contemporaneously negotiating a stalking horse asset purchase agreement, arranging for financing and attempting to have bidding procedures approved. Once the bidding procedures are entered, the marketing process is officially underway and the debtor, with the help of its professionals, will be able to respond to diligence requests and other questions from prospective bidders up until the Bid Deadline. A limited no-shop provision provides the stalking horse purchaser with the comfort that they have a deal with the seller, but which they ultimately know will become subject to higher and better bids once the bankruptcy case is filed, the bidding procedures are approved and the auction occurs. Although these provisions restrict the company from actively soliciting offers, they do not typically restrict the company from receiving unsolicited offers. In such cases where unsolicited offers are deemed by the company to be higher and better, the company may consider switching to another party. These types of no-shop or window shop arrangements happen without issue in the § 363 sale context.

12. Shortening Notice

33 In re Aloha Airlines, Inc., No. 08-00337, 2009 WL 1065162, at *2 (Bankr. D. Haw. 2009). 34 See Fed. R. Bankr. P. 6004(l).

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A debtor may conduct a sale of assets upon notice and a hearing, with such hearing to occur upon 21 days notice to all creditors.35 There is often a situation where a debtor will want to sell assets on a shorter timeframe, such as the case where the assets are decreasing in value. Courts have recognized this so-called “melting ice cube” situation and have approved bidding procedures on shortened notice.36 While courts do allow for shortened notice for the approval of the bidding procedures and/or the approval of a sale, upon a showing of cause, it is important to demonstrate to the court that all potentially interested parties will have the opportunity to participate in the sale and all creditors are given the opportunity to object to the bidding procedures and the sale. Courts will often extend the objection deadline until the day of the relevant bidding procedures and/or sale hearing to make sure that parties in interest are given the opportunity to be heard. In addition, in some cases, it becomes economically burdensome to provide notice to all creditors for every asset sale. In such cases, a debtor may seek either a waiver of the notice requirement for a particular sale or the approval of a procedure by which it may sell miscellaneous assets on more limited notice throughout the case.

13. Modification of Bid Procedures

Despite the often laborious negotiation of many of the bidding procedures described herein, followed by third parties meticulously trying to wade through the details required to submit a bid package, debtors will try to include some kind of reservation of rights to allow the bidding procedures to be modified at or before the auction. This enables a debtor to make certain changes in order to maximize the return to the estate. While a modification provision typically encompasses all of the bidding procedures, the most common modifications that we see relate to the determination of Qualified Bidder status, the deadline for submission of bids, the potential relaxation of the deposit requirement, the removal of certain assets from the pool of assets being sold, and certain auction mechanics such as the overbid requirements, auction attendance and the ability to suspend the auction. Oftentimes, a blanket ability to modify bid procedures will be met with strong objection by certain constituencies in the case. As a result, the debtor will often modify the reservation of rights section of the bidding procedures to provide prior notice and consultation rights to the secured creditors, the stalking horse purchaser and/or the creditors’ committee before any bidding procedures are modified. The issue of bid procedure modifications is also discussed in greater depth in connection with re-opening auctions, as discussed below.

D. Accepting Non Conforming Bids, including after the auction

35 See Fed. R. Bankr. P. 2002 (a), 6004(a). 36 There are a number of recent cases in which courts have approved bidding procedures on shortened

notice, recognizing the “melting ice cube” situation. See In re GSC, Inc., 453 B.R. 132 (Bankr. S.D.N.Y. 2011) (“a sale should be approved when the court is faced with the situation of a so called ‘melting ice cube,’ a sale that would prevent ‘further, unnecessary losses.’” (quoting In re Lehman Bros. Holdings, Inc., 445 B.R. 143, 180 (Bankr. S.D.N.Y. 2011); In re Chrysler LLC, 576 F.3d 108, 114 (2d Cir. 2009) (automobile manufacturing business fell within the “melting ice cube” theory of § 363(b)”); In re Borders Grp., Inc., 453 B.R. 477, 485-86 (Bankr. S.D.N.Y. 2011) (approving five-day notice for de minimis sale of assets); In re Lehman Bros. Holdings, Inc., No. 08-13555, 2011 WL 722582, at *6 (Bankr. S.D.N.Y. Feb. 22, 2011) (explaining reason for reduced notice in Lehman Brothers’ asset sale was necessary because “[t]he particular circumstance that prevailed at the time of the Sale Hearing was a profound emergency of historic proportions, and the Loaned Shares at issue [for that hearing] were held as part of a book of financial assets that was thought to be quickly losing value”); In re Haven Eldercare, LLC, 390 B.R. 762, 769 (Bankr. D. Conn. 2008) (approving two day notice for sale of assets).

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Every once in a while, despite the publishing of notice of the auction sale, the extensive marketing that the debtors and their professionals conduct, and the very detailed step-by-step process for completing the bid packages and for bidding at the auction, there is a party that shows up in court on the day of the sale hearing and tries to re-open the bidding. These potential bidders either failed to show up at the auction or failed to bid high enough at the auction but now have a change of heart. Should they be able to submit a bid at the sale hearing? Debtors and courts are tasked under the Bankruptcy Code to determine whether the proposed sale to the highest bidder is indeed the highest and best offer. If someone is standing up in court waiving a check for a higher amount, shouldn’t the court entertain it? Short of clogging the court dockets by hosting auctions in the courtroom (which was suggested by at least one court recently, as discussed below), these issues are bound to continue to pop up.

1. Courts that have reopened auctions prior to sale hearing

As the Court of Appeals for the 7th Circuit held in the Corporate Assets case,37 courts must balance the need to preserve (i) the finality and integrity of the bidding process and meeting the reasonable expectations of the participants against (ii) the purpose of a § 363 sale to maximize recovery for the estate and creditors. In this case, an auction was held and a bidder was selected as the highest and best bidder at a price of $2.25 million, with the sale to be approved at a sale hearing two days later. The day after the auction, the second-place bidder offered the debtor a price of $2.45 million. After discussions with the secured creditors and the committee, the debtor determined to hold a second auction and continued the sale hearing until then. Ultimately, at the second auction, the original high bidder won again, this time with a bid of $2.6025 million, but argued to the court that the second auction should never have happened. The bankruptcy court overruled their objection, as the governing principle of the sale was to secure the highest price for the estate and that the second auction was contrary to neither the reasonable expectations of the bidders nor the integrity and finality of the auction process.38 As discussed above, the bidding procedures had contained a provision allowing the debtor to make modifications at any time prior to the entry of the sale order.

The court of appeals held that these cases reflect a continuum, along which a bankruptcy courts discretion to reopen bidding decreases as the sale becomes closer to being a fait accompli.39 For example, the court indicated that once a sale order has been entered, only a narrow set of circumstances could result in vacating the sale order (such evidence of fraud or evidence that the initial sale price was grossly inadequate). In this case, the court of appeals held that prior to the entry of the sale order, the bankruptcy court has considerable discretion to allow the debtor to reopen the bidding by holding a second auction. There are number of additional cases that have taken this approach and have allowed bidding to be reopened.40

37 Corp. Assets, Inc. v. Paloian, 368 F.3d 761, 767 (2004). 38 Id. at 766. 39 Id. at 768. 40 See Four B. Corp., v. Food Barn Stores (In re Food Barn Stores), 107 F.3d 558 (8th Cir. 1997) (bidding

was reopened when higher offer was received during confirmation hearing); Consumer News & Bus. Channel P’ship v. Fin. News Network, Inc. (In re Fin. News Network, Inc.), 980 F.2d 165, 170 (2d Cir.1992) (debtor moved to delay approving auction sale when it received a higher bid after close of auction; winning bidder appealed reopening of bidding because as result of reopening, it had to increase its original winning bid); In re Hart’s Mfg. Co., Inc., 383 B.R. 720 (2008) (debtor had moved to set aside auction sale as not in best interest of creditors and winning bidder objected to motion); In re Muscongus Bay Co., 597 F.2d 11, 12-13 (1st Cir.1979) (bidder with highest bid objected

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2. Courts which have chosen not to reopen bidding, despite higher offers

On the other hand, there are a few reported decisions in which courts have determined not to reopen the bidding, this indicating that sanctity of the bidding procedures had outweighed the potential additional value to the estate.41

In a recent case, In re Bigler, LP, 42 the bankruptcy court for the Southern District of Texas refused to reopen the bidding after an auction had concluded, holding that “when the bid procedures are clear; the bid procedures are not complex; the parties are sophisticated; there is no collusion or fraud; and the auction price is not grossly inadequate—the highest priority should be placed on maintaining the integrity of the system.” In the Bigler case, a party who had attended the auction and lost filed a pleading prior to the sale hearing indicating that they intended to tender a sealed bid which was higher and better than the winning bidder’s offer. Despite language in the bidding procedures order that stated that the debtors would be deemed to have accepted a bid when such bid is approved by the court, the court held (despite arguments by the new bidder and the debtor to the contrary) that such language did not mean that more bids could be made at or prior to the sale hearing. The court held as follows43:

While the Court certainly appreciates the need to maximize payment of claims, the Court must also always keep one eye cocked on promoting and preserving the integrity of the judicial process. Reneging on clearly established and properly conducted procedures in order to generate some additional dollars for the estate undermines the integrity of the judicial process; indeed, it can undermine the integrity and reputations of the individual litigants and lawyers. The public in general, and all participants at auctions in particular, need to have confidence in the judicial system. A court order reopening the auction process when procedures were clearly established, when the auction was conducted without fraud or collusion and in compliance with the procedures, and when an adequate bid was accepted, will undercut such confidence and faith in the system. This, the Court will not allow, even if reopening the auction would generate more proceeds for the estate.

to allowance of late bidder who eventually prevailed at auction); In re Payless Cashways, Inc., 281 B.R. 648 (8th Cir.BAP 2002) (chapter 11 trustee had moved to hold an open auction after a higher bid was received); In re Edwards, 228 B.R. 552 (Bankr. E.D. Pa. 1998) (court rejected debtor’s argument that a bid received after auction was invalid because it was untimely).

41 See Evangelist v. Opperman (In re Craig Sebert), No 07-15509, 2008 WL 686264 (E.D. Mich. Mar. 11, 2008); Davis v. Lifetime Capital, Inc., No 03-0059, 2006 WL 1580211 (S.D. Ohio June 02, 2006); Matter of Chung King, Inc., 753 F.2d 547 (1985) (bankruptcy court should not have vacated sale order); Sea Island Coastal Props. LLC v. Official Comm. of Unsecured Creditors (In re Sea Island Co.), No. 10–21034, 2010 WL 4393269, at *5 (Bankr. S.D. Ga. Sept. 15, 2010).

42 443 B.R. 101, 117 (Bankr. S.D. Tex 2010). See also In re Cloverleaf Enters. Inc., No. 09-20056, 2011 WL 873145 (Bankr. D. Md. 2011) (citing In re Bigler).

43 Id. at 115.

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3. Standing Issue

A related issue that comes up in this situation is whether an unsuccessful bidder even has standing to object to a § 363 sale. This issue arises in the event that a debtor does not entertain the reopening of bidding, but the potential bidder seeks a ruling from the court reopening the bidding. In many cases on this issue, courts have denied standing to an unsuccessful bidder.44 Other courts have held that potential bidders do have standing under certain limited circumstances.45 In In re Colony Hill Associates,46 the court held that an unsuccessful bidder whose only pecuniary loss is the speculative profit it might have made had it succeeded in purchasing property at an auction usually lacks standing to challenge a bankruptcy court’s approval of a sale transaction, but that in this case, a bidder who filed a bid after initial bid deadline had standing to challenge whether the winning bidder was a good faith purchaser.

One easy and available way for a prospective buyer to gain standing would be to buy a claim in the bankruptcy case. This would allow them standing under § 1109 of the Bankruptcy Code which gives creditors the right to be heard on any issue in the case.

4. Potential solution?

In an almost shocking conclusion (at least to those who do this for a living), Judge Bohm in the Bigler case suggested that the best way to minimize these issues from occurring is to have the auctions conducted in the courtroom.47 While we are not sure that courts really have the time or the inclination to referee the standard 12+ hour auction, he does raise a good point. With an in-court auction, there would be no ambiguity as to the time for bids to be received, the starting time of the auction and, most importantly, there would be a real-time court determination of “higher and better”. As Judge Bohm noted, this would also result in parties providing their top offer as they will know that they will not get a second chance to bid. Very interesting and novel concept.

III. FINANCING AND CONTROLLING A BANKRUPTCY SALE PROCESS

In many situations emanating from the financial crisis, asset values have dropped precipitously such that a secured creditors’ collateral is worth much less than the debt that it secures. After making an internal investment decision to not throw good money after bad, it

44 See Davis v. Lifetime Capital, Inc., No 03-0059, 2006 WL 1580211 (S.D. Ohio June 02, 2006) (denying right of original high bidder to intervene as a matter of right or permissibly); In re Nepsco, Inc., 36 B.R. 25 (Bankr.D.Me.1983) (holding there was no standing for potential bidder); Davis v. Seidler (In re HST Gathering Co.), 125 B.R. 466 (W.D. Tex. 1991) (holding there was no standing for unsuccessful bidders and prospective purchasers); Big Shanty Land Corp. v. Comer Props., Inc., 61 B.R. 272 (N.D. Ga. 1985) (holding unsuccessful bidder lacks standing).

45 See In re Fin. News Network, Inc., 126 B.R. 152 (S.D.N.Y. 1991) (opining that “‘disqualified’ bidder, one whose bid was not even considered by the bankruptcy court . . . appears to have alleged a sufficient basis for it to have standing”); Lithograph Legends, LLC v Polaroid Corp., No. 09-943, 2009 WL 1209469 (D. Minn. Apr 30, 2009) (court stated that it assumed losing bidder had standing to appeal sale order without resolving question because it found standing on other grounds); Cedar Island Builders, Inc. v. South County Sand & Gravel, 151 B.R. 298, 300-02 (D.R.I. 1993) (holding that potential bidder that was denied the opportunity to bid because debtor failed to publish notice of the sale had standing to challenging sale).

46 111 F.3d 269 (2d Cir. 1997). 47 In re Bigler, LP, 443 B.R. at 115-116.

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becomes apparent that the best exit strategy for such creditors may be a sale of substantially all of the assets under § 363. Secured creditors do not often want to exercise state law foreclosure remedies because they very rarely want to incur the costs to own and operate the underlying assets or business that serves as collateral. They would much rather see a swift and effective bankruptcy court-sanctioned marketing and auction process, with all of the bells and whistles described above, and in which buyer delivers cash proceeds which are then paid over to the secured creditors. The bankruptcy sale context gives the secured creditors the very much desired “market test” valuation of its assets, while buyers have grown more and more comfortable with bankruptcy court sales over the years. As discussed in greater detail below, if the secured creditor is not happy with the results of the market test, it is always free to credit bid and take the assets. An important issue that invariably comes up in a sale of substantially all of the assets of a debtor, especially early in case, is financing the costs to administer the asset sale and the chapter 11 case thereafter. Who should fund the inherent costs? In these “liquidating chapter 11” cases, the argument goes, there is no need for a chapter 11 case as there is no potential for a reorganization. Upon a default, instead of clogging up the bankruptcy court dockets, the secured creditor should foreclose on their collateral under state law. Chapter 11 is not something that should be used to liquidate collateral. Bankruptcy judges are keen to these arguments and want to ensure that debtors that have filed such liquidating chapter 11 cases do not leave the cases administratively insolvent. What has developed over time, and is much more commonplace over the last few years, is the concept that if secured creditors want to use the bankruptcy court to liquidate collateral, they must pay the freight involved in doing so. The following is a summary of some of the issues that arise with respect to financing an asset sale process in chapter 11:

A. 506(c) Waiver/Carve-Out dance

Generally, absent the agreement of the secured creditors, a debtor is permitted only to use unencumbered assets of the estate in order to fund a case. Section 506(c) of the Bankruptcy Code, however, provides an exception to this rule. Under § 506(c), “the trustee may recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving or disposing of, such property to the extent of any benefit to the holder of such claim ….”48 This is the Code section that essentially causes the secured creditors to “pay to play,” as it is exists so that unsecured creditors are not required to bear the brunt of administrative costs in administering a case for the benefit of the secured creditors.

Secured creditors providing DIP Financing or agreeing to allow the use of its cash collateral have sought and have received § 506(c) waivers to avoid uncertainty caused by lower courts surcharging collateral. For the most part, uncertainty has already been relieved by the Supreme Court in the “Hen House” case.49 Prior to Hen House, courts had been split as to whether the trustee was the sole person who may surcharge a lender’s collateral under section § 506(c) or whether administrative claimants could seek to surcharge collateral. The best reading

48 11 U.S.C. § 506(c). For a very recent case discussing the process of seeking a § 506(c) surcharge, see In

re Strategic Labor, Inc., No. 10-43245, ---- B.R.. ----, 2012 WL 707175 (Bankr. D. Mass. Mar. 05, 2012). 49 Hartford Underwriters Inc. Co. v. Union Planters Bank, N.A., 530 U.S. 1 (2000).

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of Hen House is that only the trustee could surcharge collateral.50 In many circumstances, this requirement alone will prevent unpaid administrative claimants from seeking refuge in § 506(c). Nevertheless, secured creditors still insist on § 506(c) waivers to avoid frivolous litigation. 51 Courts will allow such waivers, however they will typically not be granted pursuant to an interim financing order and will only be permitted pursuant to a final order (as at the later stage, a creditors committee will have been formed and can object if it desires). Once a creditors committee is formed, negotiation between the secured creditor and creditors committee typically involves a trade of the § 506(c) waiver for a carve-out. Such a trade has been standard fodder over the past few years and a carve-out has been couched as “the price of admission” by at least one prominent bankruptcy judge.52 The carve-out is essentially the equivalent of a limited surcharge of the secured creditor’s collateral.

A related issue that has garnered some attention has been whether a § 506(c) waiver is binding on a later-appointed chapter 7 or chapter 11 trustee. First of all, financing orders typically contain language providing for such a waiver to be binding on later-appointed trustees and successor cases. Secondly, there have been a few cases that have addressed the issue, with such courts in agreement that future appointed trustees are bound by the § 506(c) waivers authorized by the bankruptcy court under the theory of res judicata. One court went as far as to come out very strongly against the trustee who sought to overturn the 506(c) waiver. 53

50 See also In re Debbie Reynolds Hotel & Casino, Inc., 255 F.3d 1061, 1065-66 (9th Cir. 2001) (“Hartford

Underwriters makes clear that [unsecured creditors] cannot, under any circumstances, seek a surcharge because [they have] no standing to do so.”); In re Suntastic USA, 269 B.R. 846, 849 (Bankr. D. Az. 2001) (interpreting In re Debbie Reynolds as precluding derivative standing to bring a surcharge action under § 506(c). Some courts have noted that Hen House left open the possibility of a creditors committee seeking a surcharge on a derivative standing theory, although there does not appear to be any reported decisions in which this has happened. See In re Concord Mktg., Inc., 268 B.R. 415, 429 (Bankr. D. N.J. 2001) (keeping open possibility of derivative standing in surcharge actions but denying it to party in instant case); In re Smith Bros. Motors, Inc., 286 B.R. 905, 908 (Bankr. N.D. Cal. 2002) (analyzing and keeping open issue of derivative standing under § 506(c) because, even if doctrine was applicable in general, it wasn’t applicable in instant case); Reed v. Cooper (In re Gary Cooper), 405 B.R. 801, 809-14 (Bankr. N.D. Tex. 2009) (explaining that Hartford Underwriters left question of derivative standing pursuant to § 506(c) open).

51 It should be noted that under the Delaware local rules, debtors must provide justification for provisions that seek to waive, without notice, whatever rights the estate may have under 11 U.S.C. § 506(c). Del. Bankr. Ct. Loc. R. 4001-2(a)(i)(c). This is also the case in New York under those certain Financing Guidelines: United States Bankruptcy Court Southern District of New York General Order No. M-274 Re: Adoption of Guidelines For Financing Requests, dated September 9, 2002 (“Financing Guidelines”). Under the Financing Guidelines, certain “extraordinary provisions” (which includes 506(c) waivers) require separate justification.

52 See Letter of Hon. Peter J. Walsh, United States Bankruptcy Judge for the District of Delaware, dated April 2, 1998.

53 See In re InteliQuest Media Corp, 326 B.R. 825 (B.A.P. 10th Cir. 2005) (involving DIP financing order which contained § 506(c) waiver). A Chapter 11 Trustee was appointed four months after final DIP order was entered, ultimately continuing as Chapter 7 Trustee. The Trustee then sought a surcharge of the banks collateral to pay outstanding attorney’s fees and expenses associated with the sale of the underlying assets. The BAP upheld the bankruptcy court’s denial of § 506(c) surcharge based on doctrine of res judicata, thus respecting the § 506(c) waiver included in DIP Order. The BAP went even further, holding that “for the Trustee to have disregarded these binding Orders to seek § 506(c) treatment of the Appellants’ attorney's fees would not only breach the letter of the Orders but would also constitute a significant breach of faith with [the secured lender]. These kinds of agreements are among the building blocks upon which successful estate administration is based. If trustees were allowed to disregard these terms at the behest of debtors’ professionals, what secured creditor would consider making either post-petition financing or cash collateral concessions to a debtor or a trustee? Holding otherwise would seriously

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B. DIP Financing and/or Cash Collateral Use

The mechanic that is used to fund the costs of the chapter 11 case is either debtor-in-possession (DIP) financing and/or consensual use of cash collateral. Without DIP financing or consensual cash collateral use, the debtor must get court approval for the ability to use cash collateral, something that a court may allow for a very short period of time, but which is an uphill battle to get for any extended period of time. Whether through DIP financing or cash collateral use, the secured creditors will provide the debtor with a tight budget, often on a line-item by line-item basis (but with the ability for a slight variance), to complete the necessary tasks of running the case. A typical budget will allow for the payment of the following administrative costs:

• professionals • court and US Trustee fees • employees and other costs in running the business such as rent, utilities,

and insurance • 503(b)(9) claims (for vendors providing goods within 20 days prior to the

bankruptcy) • Landlord stub rent claims (rent for post-petition, pre-rejection period) • Tax claims, including ad valorem taxes, which may be senior to the DIP

liens • Utilities • Claims by sureties

At the time of a bankruptcy filing, debtors are often given an interim budget that covers expenses through the first few weeks of the case, with the understanding that the budget will be extended as long as the secured creditors believe that the debtors are running the case properly.

C. Maintaining Control over Case Through Financing Orders

Through the order approving the financing mechanism, the secured creditor is typically able to effectuate control over many of the key happenings in the case. A failure of the debtor to stay on track will give the secured creditor the right to terminate financing and essentially end the chapter 11 case, causing it to be converted to a chapter 7 liquidation. The financing order (and credit agreement if a DIP facility is in place) will contain certain milestones by which the debtor must complete tasks, such as the entry of bidding procedures by a certain date, a bid deadline by a certain date, the completion of an auction by a certain date and sometimes the filing of a plan of reorganization by a certain date. The budget allotted for the case will usually be tied to these milestones and will often only be extended if the debtor is staying on target.

Financing orders will also contain termination provisions in the event that certain actions are taken in a bankruptcy case, including, without limitation, a failure to stay within the budget or meet the milestones discussed above, the conversion or dismissal of the case, the appointment of a trustee or examiner, a successful lien challenge by a party in interest or a default in the

undercut future efforts of debtors in possession or trustees to secure these concessions and hinder their ability to efficiently administer estate assets.” See also In re Molten Metal Tech., Inc., 244 B.R. 515 (Bankr. D. Mass. 2000).

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reporting requirements contained in the financing arrangement. A financing order will also contain many key stipulations made by the debtor in favor of the secured creditor, such as the priority, perfection and validity of the secured creditor’s liens, setting the amount of their claim, stipulating that the debtor is in default under the prepetition documents and waiving the debtor’s ability to otherwise seek financing from another source. Through the budget mechanism, the termination events in the financing order and through the bid procedures, the secured creditors are able to exert a great deal of control over the asset sale process.

D. Maintaining Control Through Credit Bidding

1. General credit bidding summary

Pursuant to § 363(k) of the Bankruptcy Code, a secured creditor is provided with the ability to “credit bid” the amount of their lien, which means that they can serve as a bidder at an asset sale auction without having to use cash. Instead, they have “Monopoly Money” equal to the face amount54 of their debt with which it can bid at the auction. This is a very valuable protection for secured creditors, as they have a strong interest in not seeing their collateral sold at a fire sale (as they are entitled to the proceeds), but are unable to come up with additional cash above and beyond their initial investment. Secured creditors are also permitted to bid only a portion of their claim, with any left over dollars remaining as an unsecured deficiency claim. Because of the ability of the secured creditor to bid the face amount of their debt (and not just the value of the collateral securing the debt), we often see distressed investors engaged in a strategy whereby they purchase the secured debt at a discount to par amount and then exercise their ability to credit bid up the face amount of the debt at the auction. This is often called a “loan to own” strategy. These investors often believe that they have a better idea on how to use the assets more effectively than the debtor or traditional bank lenders. In addition to relying on the Bankruptcy Code’s credit bidding statute, secured creditors will often insist on language in the financing order which specifically reserves the secured creditor’s right to credit bid. The worry is that without this language, debtors could design bidding procedures which would effectively eliminate the ability to credit bid, such as a requirement of an all-cash bid.

2. Credit bidding as stalking horse

In many cases, either due to a lack of stalking horse bidders stepping up, personal preference of the secured creditors, or sometimes due to a lack of time to run a stalking horse selection process (which often takes longer than the main marketing and auction process), we will see a credit bid by the secured creditors serving as the stalking horse bid. This often works well, as the secured creditors are very well aware of what the collateral is and is debating internally whether it wants to own and operate the collateral. By serving as a stalking horse, they are given the ability to see a true market test before ultimately deciding whether to exercise their credit bid rights or not. They are also able to negotiate the asset purchase agreement to their own specifications and include various bells and whistles in both the asset purchase agreement as well as the bidding procedures order, thus being able to control the process.

3. Release Prices

54 See In re Submicron Sys. Corp., 432 F.3d 448 (3d. Cir. 2006) (explaining that § 363(k) speaks to full face value of a secured creditor’s claim, not to portion of claim that is actually collateralized as described in § 506(a)).

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Debtors and secured creditors must be careful, however, as the ability to credit bid can often serve as a black cloud hanging over an auction. With enough “Monopoly Money” to bid up to the face amount of their debt, potential bidders often shy away from participating in the auction with the belief that they will be bidding against themselves, as the secured creditor could just swoop in at any time and trump their bids. Very rarely these days do we see assets selling for the full amount of the secured creditors’ claim, so this becomes a real concern in all auction situations, including cases where the secured creditor is the stalking horse as well as cases where there is either a third party stalking horse or no stalking horse at all. Secured creditors rarely tip their hand as to what value they will “allow” their collateral to be sold, which can be frustrating to debtors and potential bidders. There is a fix, however. Debtors are often able to negotiate a “release price” to be included in the bidding procedures. A release price is a price at which the secured creditors have agreed in advance they will not try to outbid a potential bidder. The negotiation of the release price can often be very delicate, as debtors will not want to set a price that is too high as it may dissuade potential bidders from participating. On the other hand, secured creditors will not want the number to be so low that it encourages bidding to center around such a low number.

4. Credit bidding during Lien Challenge Period

With many cases involving a marketing and asset sales process kicking off within the first days of a case, an interesting issue may arise. While debtors and secured creditors have already had months of negotiation with its secured creditors and are aligned at the hip, there is usually one party that is not yet on the field at the time of kickoff, the unsecured creditors. While the debtor has already had time to assess the validity of the secured creditors’ liens (and often has stipulated to the validity of such liens in the financing orders), it is incumbent on the newly formed creditors committee to come into the case to test whether such stipulated liens are valid. Often, creditors committees will object to bidding procedures motions filed early in cases on the grounds that they have not had time to investigate prepetition liens.55 Financing orders attempt to deal with this issue by providing for a 60-90 day period by which the committee may challenge the secured creditors’ liens and typically provide the creditors committee with a small sum of money from its cash collateral to do so.

An issue may come up as to whether the secured creditor can bid its full claim amount during this lien challenge period. Judges are left to balance the debtor’s alleged necessity of the need to sell the assets quickly and the secured creditors’ statutory credit bid rights, against the duties of the committee to maximize recovery to the unsecured creditors. There is typically not enough time to resolve a lien dispute without risking a decrease in the value of the collateral in the meantime. Section 363(k) of the Bankruptcy Code provides: At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of

55 For example, in In re Radnor Holdings, Corp., 353 B.R. 820, 826, 846 (2006), the bid procedures order

was approved a little over one month after the petition date and the right for a lender to credit bid was contingent upon the outcome of an adversary proceeding in which the creditors committee challenged that lender’s claim. Id. at 826. The court later authorized credit bidding because there was no evidence to support the creditors committee’s challenge to the creditor’s claim. Id. at 845-46. See also Nat’l Bank of Commerce of El Dorado v. McMullan (In re McMullan), 196 B.R. 818 (Bankr. W.D. Ark. 1996), aff'd, 162 F.3d 1164 (8th Cir. 1998) (holding that if validity of lien has not been determined, holder may not bid its lien).

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such claim purchases such property, such holder may offset such claim against the purchase price of such property (emphasis added). Section 502(a) of the Bankruptcy Code provides: A claim or interest . . . is deemed allowed, unless a party in interest . . . objects. There have been a number of cases adjudicating this issue over the years, including a couple of recent cases that are instructive.

In In re St. Croix Hotel Corp.,56 the debtor had objected to a proof of claim filed by the secured creditor by commencing an adversary proceeding which had not been adjudicated at time of sale. The debtor argued that because of the pending adversary proceeding, the secured creditor did not have an “allowed claim” under §§ 363(k) and 502 and could not credit bid, but instead should put up cash in the amount of the bid. The court held that if the secured creditor were required to put up cash notwithstanding its assertion of a secured claim, such cash would be available for other expenses of the estate and there was no guarantee that such funds would still be available after the lien validity issue was finally determined. This would be an “elemental unfairness” to the secured creditor. The Court ultimately permitted the credit-bid on an interim basis, to become permanent or negated upon the final determination of whether it is entitled to an allowed claim. If the debtor prevailed and the claim was not allowed, the bank would be required to pay in cash (plus interest) the amount of its bid. This is the same result that occurred in In re Octagon Roofing57 and In re Diebart Bancroft,58 in which the court held that a secured creditor could credit-bid the full amount of its claim if it provides a letter of credit or cash deposit protecting the estate from the lien being avoided.

In one case, the court actually went as far as allowing the secured creditor to credit bid while there was a lien dispute, without requiring any kind of deposit or escrow. In In re Miami Gen. Hosp., Inc.,59 the district court affirmed a bankruptcy judge’s equitable remedy, which permitted the secured creditor to credit bid subject to the trustee’s right to challenge the lien in an adversary proceeding in the future. The district court recognized that there was an emergency situation and that the bankruptcy judge was under intense pressure to act expeditiously to save a hospital from being shut down (if the hospital was shut down for more than 48 hours, it would lose its license).

There are also two recent cases in South Carolina that addresses the issue. In In re Merit Group, Inc.,60 the bankruptcy court held that there is “cause” pursuant to § 363(k) to deny credit bidding rights when a “sufficient dispute exists regarding the validity of the lien forming the basis of the credit bid.” In the case, however, the court held that suspicions of the committee that there may be a basis to reclassify the secured claims as equity was not a sufficient basis to deny the credit bid. The court reviewed the merits of the reclassification argument and refused the committee’s request to require the secured creditor to place cash in escrow equal to the amount of the credit bid pending an adjudication. The court, instead, reserved the right to revisit the issue after the auction.

56 44 B.R. 277 (Bankr. D. V.I. 1984). 57 123 B.R. 583 (Bankr. N.D. Ill. 1991). 58 No. 92-3744, 1993 WL 21423 (E.D. La. Jan. 26, 1993). 59 181 B.R. 682, 688 (S.D. Fla. 1988). 60 464 B.R. 240, 252 (Bankr. D.S.C. 2011).

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In another South Carolina case, In re Daufuskie Island Props., LLC,61 the court denied a junior lienholder the right to credit bid while the validity of its lien was subject to a lien dispute which was the subject of an adversary proceeding. In this case, there were a number of claims made in the adversary proceeding, including one for equitable subordination. The court held that “[b]ased on the assertions, and the adversary proceedings filed, the Court finds that [the creditor’s] mortgage and claim are disputed, and thus [the creditor] is not eligible to credit bid his asserted mortgage to purchase property under 11 U.S.C. § 363(k).”62 In addition, the credit bid was held to be invalid as the junior lienholder would also have been required to satisfy the senior liens.

The takeaway from these cases is that a secured creditor who intends on exercising its credit bid rights should be prepared to place cash proceeds in escrow in the event that their lien is challenged and a court requires such an escrow. This is especially true with asset sales processes conducted early in cases, before the committee is able to fully investigate the secured creditors’ liens. While it is usually the case that the liens are ultimately deemed to be valid (or sometimes the committee gives up their rights to challenge in exchange for a tip), the committee can usually make a colorable argument to the court at an early bidding procedures hearing that it must be afforded, at a minimum, the time required and the reimbursement of costs expended in conducting its investigation. If the debtor and secured creditors do not do so, they risk a lien challenge which could disrupt the credit bid strategy that has been implemented.

5. Selling Assets During Ownership Dispute

What happens when there is an issue as to ownership of the assets to be sold in a § 363 sale? This issue recently came up in the Kodak bankruptcy case in which Apple sought relief from the automatic stay to resolve an ownership dispute related to a patent that the debtor was going to be selling in a future asset sale.63 As set forth in Apple’s motion, the patent in dispute relates to technology that enables a digital camera to capture an image while previewing the scene to be captured on an LCD screen.64 It was Kodak’s intention to sell this patent, along with its digital imaging patent portfolio within approximately five months of the petition date, as required pursuant to certain milestones set forth in the DIP financing documents.65. Apple argued for relief form the automatic stay such that the ownership dispute could be adjudicated in federal court prior to any sale (an action had already been filed and, subsequently, stayed in federal court). The main thrust of the debtor’s argument was that any dispute over ownership of the patent should be adjudicated in the bankruptcy court, as it involves property of the estate, to

61 441 B.R. 60 (Bankr. D.S.C. 2010). 62 Id. at 64. 63 In re Eastman Kodak Co., No. 12-10202, (Bankr. S.D.N.Y. 2012). 64 See Motion of Apple Inc. Seeking Relief from the Automatic Stay to Facilitate Resolution of Patent

Ownership Disputes Prior to the Debtors’ Sale of Those Patents, In re Eastman Kodak Co., No. 12-10202 (Bankr. S.D.N.Y. February 4, 2012), ECF No. 344 [hereinafter Apple’s Motion].

65 The Motion provides that the DIP Facility requires that Kodak file a motion requesting approval of bid procedures relating to a sale of all or substantially all of Kodak’s digital imaging patent portfolio on or prior to June 30, 2012. See Apple’s Motion, supra at ¶ 20.

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which the bankruptcy court has exclusive jurisdiction.66 The debtors separately filed a motion seeking Rule 2004 discovery of Apple relating to the patent dispute.

The bankruptcy court denied Apple’s motion for relief from stay. Although there is no published decision on the issue, the transcript is informative.67 At the hearing, Apple’s counsel argued that now is the right time to adjudicate the ownership dispute, before the sales procedures motion is filed.68 Debtors’ counsel’s solution was to investigate the claims in the 2004 discovery process and then either file an adversary proceeding or a sale motion to tee up the ownership issue.69 Debtors’ counsel argued that the only way to administer the estate is to allow Debtors to address ownership issues in the bankruptcy court when they arise. Counsel for the second lien holders argued that allowing proceedings to occur outside the bankruptcy court would be damaging to the reorganization effort, primarily due to the time it would take, in light of the milestones set forth in the DIP financing documents.70

The bankruptcy court ultimately denied Apple’s motion for relief from the stay, holding that the proposed relief “would not move the matter forward with the expedition needed for there to be any hope of a determination on the ownership issue or related issues in a timely fashion . . . .”71 Ultimately, Judge Gropper held that the issue of ownership is an important issue- but for another day. He indicated that he was open to an agreed to procedure among the parties that would allow for a quick resolution of the ownership issue.

One interesting issue to follow, now that a challenge has been raised by Apple, will be how Kodak addresses the ownership issue in its schedules of assets and liabilities, which are filed under penalty of perjury. Kodak has sought and received an extension of the time to file their schedules until April 18, 2012.

IV. SUB ROSA PLAN AND STRUCTURED DISMISSAL

A. Sub Rosa Plans

The concept that a § 363(f) sale might be an objectionable “sub rosa” plan of reorganization originated in In re Braniff Airways, Inc.72 and often raise the ire of creditors committees across the nation (yet the argument is very rarely a winner). Whether the respective § 363(f) sales were sub rosa plans were highly contentious issues in both the Chrysler and General Motors bankruptcy cases. In both cases, the Bankruptcy Court for the Southern District of New York held that the sales were not sub rosa plans. A summary of the court’s holdings is as follows:

66 See Debtor’s Objection to Apple Inc.’s Motion Seeing Relief from the Automatic Stay to Facilitate

Resolution of Patent Ownership Disputes Prior to the Debtors’ Sale of Those Patents, In re Eastman Kodak Co., No. 12-10202 (Bankr. S.D.N.Y. March 2, 2012), ECF No. 468.

67 Transcript of Oral Argument, In re Eastman Kodak Co., (No. 12-10202) (Bankr. S.D.N.Y. Mar. 08, 2012) [hereinafter Transcript].

68 See Id. at 36-37. 69 See Id. at 48-49. 70 See Id. at 54-55. 71 See Id. at 64-66. 72 700 F.2d 935 (5th Cir. 1983).

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1. In re Chrysler LLC, 405 B.R. 84 (Bankr. S.D.N.Y., 2009):

The § 363(f) sale was not a sub rosa plan because (i) a lien on the funds from the sale – which were higher more than it would have been under if the assets were liquidated – would only go to the first priority secured lenders, (ii) § 365 permitted New Chrysler to dictate which contracts “Old Chrysler” would assume and subsequently assign to it and, thus, neither action was indicative of a sub rosa plan when viewed together with the asset sale, and (iii) unsecured creditors were receiving equity in New Chrysler based on giving new value to New Chrysler, not their respective prepetition claims.

On appeal, the Second Circuit held that there was no abuse of discretion by the bankruptcy court in holding that the § 363(f) sale was not a sub rosa plan.73 The Second Circuit also expanded on the reasoning of the bankruptcy court by noting that, though New and Old Chrysler will look similar, there were several differences between the two entities. New Chrysler would (i) make newer and smaller cars by using technology that became available from Fiat as a result of the sale, (ii) have a new Chief Executive Officer, and (iii) its unionized employees would be working under a new collective bargaining agreement.74

2. In re General Motors Corp., 407 B.R. 463 (Bankr. S.D.N.Y., 2009):

Viewing In re Chrysler as “directly on point and conclusive,” the bankruptcy court held that the sale of substantially all of “Old G.M.’s” assets to “New G.M.” was not a sub rosa plan. The court explained that the purchase agreement simply brought in value to the estate rather than dictating how Old G.M. would subsequently reorganize and distribute its assets. As in In re Chrysler, the court noted that a purchaser has the right to have the executory contracts of its choosing assigned to it after the purchase and enter into new agreements with creditors who had a lower distribution priority than those who object to the sale. Finally, New G.M.’s election to assume some but not all of Old G.M.’s liabilities did not make the sale a sub rosa plan. As in In re Chrysler, the district court subsequently affirmed the bankruptcy court’s decision.75

Since the Chrysler and General Motors decisions were released, courts have only found contested § 363 sales to be sub rosa plans when the sales would have benefited insiders of the debtor to the detriment of creditors.76 The only other opinions on this topic since the Chrysler

73 In re Chrysler LLC, 576 F.3d 108 (2d Cir. 2009). 74 For a more substantive discussion of the issues raised by the Chrysler and General Motors bankruptcy

cases, please see Joseph Warburton, Understanding the Bankruptcies of Chrysler and General Motors: A Primer, 60 Syracuse L. Rev. 531 (2010).

75 In re Motors Liquidation Corp., 430 B.R. 65, 84-86 (S.D.N.Y. 2010). 76 In re Oakwood Country Club, Inc., No. 10-60246, 2010 WL 4916436 (Bankr. W.D. Va. April 6, 2010)

(holding that sale was sub rosa plan because proposed sale would result in insiders of debtor receiving payments while unsecured creditors would not); In re Cloverlear Enter., No. 09-20056, 2010 WL 1445487 (Bankr. D. Md. April 02, 2010) (refusing to allow sale of substantially all assets because, among other reasons. sale would not net any money for most unsecured creditors but would net substantial dividend for debtor’s parent company and sole shareholder).

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and General Motors bankruptcies – all of which were issued within the Second and Third Circuits – have held that the significant asset sales at issue were not sub rosa plans.77

B. Structured Dismissal

The idea that a “structured dismissal” could be used as a means to conclude a chapter 11 case after a sale of substantially all assets has made its way into practice and scholarly dialogue. A structured dismissal is a dismissal pursuant to either § 1112(b) or § 305(a)(1) that occurs following a sale of substantially all of the debtor’s assets. 78 In filing a motion to approve a structured dismissal, the debtor recognizes that there is not enough money left in an estate after the asset sales are completed to complete a plan of reorganization. The debtor is also unable to meet the plan confirmation requirements as it cannot pay administrative expense claims in full. Rather than having an administratively insolvent debtor, administrative creditors, such as the professionals in the case, will often agree to some kind of haircut of its fees and expenses or will subordinate its claims to other non-professional administrative expense claims, thus allowing the debtor to satisfy all administrative and priority claims, prior to seeking a dismissal order in the case. The other option, a conversion to chapter 7, would not provide any benefit to the creditors, as any unencumbered assets would be used to fund the expenses in the chapter 7 case, thus cutting into any recovery that the administrative expense creditors would receive. The key terms agreed to in a structured dismissal are the distribution scheme to which the debtor distributes any remaining cash to its secured lenders, administrative expense creditors and to the US Trustee (for any unpaid fees).

To date, there do not appear to be any published or unpublished opinions regarding structured dismissals, but it has been used in practice. However, in a 2011 American Bankruptcy Institute Journal article, high ranking individuals from the U.S. Trustee’s office theorized that a structured dismissal may amount to an “updated sub rosa plan.”79 The U.S. Trustee’s office argued that structured dismissals could be used to avoid the application of “confirmation safeguards” that would normally apply in the chapter 11 process following a § 363 sale of substantially all of the debtor’s assets.80 If structured dismissals ever do fall out of vogue (or there is any judicial authority that rejects the concept), debtors and secured creditors will likely move towards funding a chapter 11 liquidating plan instead.

V. HOW FAR DOES FREE AND CLEAR GO? SUCCESSOR LIABILITY ISSUES

Though most sale orders expressly state that the purchaser of a debtor’s assets pursuant to a § 363 Sale will not be subject to successor liability, the issue is still litigated frequently on both the federal and state levels. Under § 363(f), a bankruptcy court has the power to authorize a sale of an asset “free and clear of any interest in such property” as long any one of five conditions is

77 In re GSC, Inc., 453 B.R. 132 (Bankr. S.D.N.Y. 2011); In re Boston Generating LLC, 440 B.R. 302 (S.D.N.Y. 2010); In re Shubh Hotels Pittsburgh, LLC, 439 B.R. 637 (W.D. Pa. 2010); In re Capmark Fin. Grp., Inc., 438 B.R. 471 (Bankr. D. Del 2010).

78 For a thorough summary of structured dismissals in both theory and practice, see Norman L. Pernick and G. David Dean, Structured Chapter 11 Dismissal: A Viable and Growing Alternative After Asset Sales, 29 Am. Bankr. Inst. J. 1, 55 (June 2010).

79 Nan Robert Eitel, T. Patrick Tinker, Lisa L. Lambert, Structured Dismissals, or Cases Dismissed Outside of the Code’s Structure, 30 Am Bankr. Inst. J. 20 (March 2011).

80 Id. at 20.

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met.81 As the Third Circuit stated in 2003, “the trend seems to be towards a more expansive reading of [the § 363(f) term] ‘interests in property’ which encompasses other obligations that may flow from ownership of the property.”82 Below are summaries of the most recent holdings on the issue, which also support the trend analysis of the Third Circuit:

A. Chrysler and GM

1. In re Chrysler LLC83

In this monumental (and lengthy) bankruptcy opinion, the Southern District of New York Bankruptcy Court held that all liens and successor liability claims were extinguished by the sale of substantially all of Chrysler’s assets pursuant to § 363(f)(5). The court found that, through their collateral trustee, the first-priority secured lienholders consented to the free and clear sale. The court then followed Third Circuit precedent to reject the objections to the sale by current and future tort claimants because such claims are “interests in property” under § 363(f). Furthermore, the court held that § 363(f) encompasses both in personam and in rem claims. Accordingly, Chrysler’s assets were taken free and clear of all tort claims. On appeal, the Second Circuit confirmed the bankruptcy court ruling for “substantially the reasons stated in the opinions below.”84 However, the Second Circuit left open the possibility that future tort claims against the purchaser – “New Chrysler” – might be actionable. The court declined to “delineate the scope of the bankruptcy court’s authority to extinguish future claims, until such time as we are presented with an actual claim for an injury that is caused by Old Chrysler, that occurs after the Sale, and that is cognizable under state successor liability law.”

2. In re General Motors Corp85

A little over a month after the Chrysler decision, the Bankruptcy Court for the Southern District of New York permitted an almost similar sale in General Motors. Finding a textual analysis inconclusive as to the extent that § 363(f) precludes successor liability, the court relied on In re Chrysler and the Second Circuit’s subsequent affirmation to conclude that the sale of substantially all of General Motors’ assets pursuant to § 363(f) was free and clear of all liens and tort claims. On appeal, the district court held that, because the sale was not stayed on appeal, it could not be modified to strike the provision selling the assets free and clear of any successor liability. Once the sale closed, any appeal was moot under both § 363(m) and the doctrine of

81 The conditions being as follows: (1) applicable nonbankruptcy law permits sale of such property free and

clear of such interest; (2) the lienholder consents; (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property; (4) such interest is in bona fide dispute; or (5) the lienholder could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest. 11 U.S.C. § 363(f).

82 In re Trans World Airlines, Inc., 322 F. 3d 283, 289 (3d Cir. 2003) (internal quotations omitted). For an L.L.M Thesis asserting the argument that this trend is inconsistent with the Bankruptcy Code, see Rachel P. Corcoran, Why Successor Liability Claims are Not “Interests In Property” Under Section 363(f) , 18 Am. Bankr. Inst. L. Rev. 697 (Winter 2010).

83 405 B.R. 84 (Bankr. S.D.N.Y., 2009). 84 In re Chrysler LLC, 576 F.3d 108 (2d Cir. 2009). 85 407 B.R. 463 (Bankr. S.D.N.Y. 2009).

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equitable mootness.86 However, the district court did interpret § 363(f) as allowing bankruptcy courts to authorized the sale of an asset free of successor liability.

B. Other Successor Liability Cases in the Wake of Chrysler and GM

1. Douglas v. Stamco87

In this tort case brought against the purchaser at a § 363(f) sale, the Second Circuit explained the public policy behind precluding successor liability. The court explained that the “free and clear nature” of the § 363(f) sale at issue was a “crucial inducement in the sale’s successful transaction.” Therefore, “it is evident that the potential chilling effect of allowing a tort claim subsequent to the sale would run counter to a core aim of the Bankruptcy Code, which is to maximize the value of the assets and thereby maximize potential recovery to the creditors.”

2. In re Grumman Olson Indus., Inc.88

The bankruptcy court held that (i) a bankruptcy court has continuing jurisdiction to interpret its prior sales order in a dispute between two non-debtor parties and (ii) while § 363(f) sales can shield purchasers from in personam successor liability, the products liability tort claimants in this case could proceed against the purchaser in state court. The court validated the products liability claims because the accidents occurred after the § 363(f) sale. Accordingly, (i) there was no “claim” under § 101(5)(A)’s definition of “claim” at the time of the sale even though the defective products were manufactured before the sale and (ii) due process notice requirements were not met.

On appeal, the district court recently affirmed the bankruptcy court’s ruling on the grounds that precluding successor liability in this case would violate both (i) constitutional due process and (ii) the requirement under the Bankruptcy Code that those affected by a bankruptcy court’s order must be given notice and an opportunity to be heard. 89 However, the district court limited its holding to the circumstances of this case and did not decide “whether or not there may be circumstances under which a Section 363 sale order could extinguish the claims of future claimants who, because they were not injured before the close of the bankruptcy, had no way to receive notice of the bankruptcy proceedings.” The district court also left open the question of whether § 363 sale orders preempt claims brought under state successor liability doctrines. In Lefever v. K.P. Hovnanian Enterprises, Inc.,90 the New Jersey Supreme Court held that a sale of assets pursuant to either § 363 or chapter 11 prohibits state law successor liability claims because of the supremacy of federal bankruptcy law. However, the court qualified this holding by explaining that state law is only preempted “if the federal bankruptcy court has ‘dealt with’ the claim” (i.e., the plaintiff was a claimant or contingent creditor in the bankruptcy case). In In re Grumman Olson, the § 363 purchaser argued, on appeal, that Lefever was incorrectly decided and that it would violate the supremacy of federal bankruptcy law to impose successor liability in

86 In re Motors Liquidation Co., 428 B.R. 43 (S.D.N.Y. 2010). 87 363 Fed. Appx. 100 (2d Cir. 2010). 88 445 B.R. 243 (Bankr. S.D.N.Y. 2011). 89 Memorandum and Order, Morgan Olson L.L.C. v Frederico (In re Grumman Olson Indus., Inc.), No. 11-

2291 (S.D.N.Y. Mar. 29, 2012) ECF No. 14. 90 734 A.2d 390 (N.J. 1999).

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the instant case because the sale order precluded successor liability. However, the district court declined to rule on this argument, holding that (i) it was inappropriate to address preemption on appeal because the issue was not decided by the bankruptcy court and (ii) the instant case presented “the more basic question” of whether the sale order at issue could be “enforced to extinguish those claims where no injury occurred to the claimant until after the bankruptcy closed, such that the claimant was not provided with notice of, or an opportunity to participate in, the bankruptcy proceedings that gave rise to that order.” Accordingly, the “interesting questions about the intersection of state tort law and bankruptcy law” were left for another federal court to decide.

3. Nationwide Mut. Ins. Co. v. Eagle Windows and Doors, Inc.91

The South Carolina Supreme Court, citing In re Grumman Olson Industries, held that the § 363(f) sale order did not preclude a contribution action against the purchaser because the tort plaintiffs never had a “claim” under § 101(5) against the debtor. The court interpreted the sale order as allowing post-sale in personam actions against the purchaser. Because the tort plaintiffs only interacted with the tort defendant, who was neither the debtor nor the purchaser, there was no pre-petition claim that could attach to the proceeds of the § 363(f) sale. Furthermore, the court held that the bankruptcy court did not retain jurisdiction under the sale order because it involved the purchasers “post sale conduct.”

4. In re PBBPC, Inc.92

The court held that the “experience rating” of the debtor under Massachusetts unemployment compensation law could be not be imputed to the § 363(f) sale purchaser. The Massachusetts Department of Unemployment Assistance’s right to taxation was an “interest” in the property of the estate within the meaning of § 363(f). Accordingly, the purchaser was not required to pay higher contributions to the state’s unemployment compensation fund.

5. Dunope v. Weirton Steel Corp.93

The court denied the plaintiff’s motion to substitute the § 363(f) sale purchaser as a defendant in her employment discrimination case. Under Third Circuit precedent, an employment discrimination claim is an “interest” under § 363(f).

6. Vornado Realty Trust v. Castlton Environmental Contractors94

The court held that bankruptcy courts are not required to order a § 363(f) sale to be free and clear of all successor liability, even though they have the ability to do so. Reading the plain language of the sale order, the court held that it only precluded successor liability “by reason of the transfer” and that other state law grounds for successor liability could apply.

7. In re Polyurethane Foam Antitrust Litigation95

91 714 S.E. 2d 322 (S.C. 2011). 92 No. 09–16725, 2012 WL 629057 (Bankr. D. Mass Feb 27, 2012). 93 No. 01-2017, 2012 WL 366595 (W.D. Pa. Feb. 02, 2012). 94 No. 08-04823, 2011 WL 4592800 (E.D.N.Y. Sept. 30, 2011).

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At issue was whether a § 363(f) sale precludes successor liability for antitrust claims. The court left this issue open because it held that the purchaser may be liable under other legal theories, such as co-conspirator joint liability for activities after the asset sale. However, the court explained that if the plaintiff was unable to produce evidence to support an alternative theory, the court would revisit the topic.

8. In re Skyline’s Woods Country Club96

The court declined to enjoin a state court decision that held restrictive land-use covenants on the purchased property were valid against the § 363(f) sale purchaser. The purchaser attempted to reopen the bankruptcy case to enjoin enforcement of the state court judgment, but the circuit court affirmed the bankruptcy court’s decision not to do so. The court reasoned that the state court had, that the very least, concurrent jurisdiction over this post-bankruptcy dispute, and thus, the state court judgment would be entitled to full faith and credit in a reopened bankruptcy case.

9. Maguire v. Capmark Fin.97

The court rejected the plaintiff’s motion to amend the complaint in order to add the § 363(f) sale purchaser because under Third Circuit precedent, employment discrimination claims are “interests” under 363(f).

10. Otoski v. Avidyne Corp.98

The court held that the bankruptcy court was “well within its authority to include the condition that [§ 363 sale] purchase was free and clear of all successor liability claims based upon products manufactured, sold, and delivered prior to closing.”

VI. SUPREME COURT TO HEAR RADLAX CASE

On April 23, 2012, the Supreme Court is scheduled to hear oral arguments in RadLAX Gateway Hotel, LLC v. Amalgamated Bank.99 The question presented in RadLAX is whether 11 U.S.C. § 1129(b)(2)(A) vests secured creditors with the right to credit bid when their collateral is to be sold free and clear pursuant to a Chapter 11 plan of reorganization.100 The Supreme Court granted certiorari because of a circuit split that had developed over this issue. In June 2011, the Seventh Circuit went against prior precedent from the Fifth and Third Circuits to hold that § 1129(b)(2)(A) guarantees such a right to credit bid. The circuit split and parties’ respective positions are summarized below. Following those summaries is a discussion of the implications that RadLAX may have on secured lending policies, practice, and markets.

A. Circuit Split

95 799 F.Supp.2d 777 (W.D. Ohio 2011). 96 636 F.3d 46 (8th Cir. 2011). 97 No. 09-0692, 2010 WL 5067672 (E.D.P.A. Dec. 06, 2010). 98 No. 09-3041, 2010 WL 4739943 (D. Or. Oct. 6, 2010). 99 Supreme Court Docket No. 11-166 100 See Question Presented in RadLAX Gateway Hotel, LLC v. Amalgamated Bank , Supreme Court Docket

No. 11-166, available at http://www.supremecourt.gov/qp/11-00166qp.pdf.

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In Scotia Pacific Co., LLC v.Official Unsecured Creditors’ Comm. (In re Pacific Lumber Co.)101 and In re Philadelphia Newspapers102, both the Fifth and Third Circuits, respectively, held that the “fair and equitable” cram down requirement of § 1129(b)(2) can be met if a plan provides for the “indubitable equivalent” of a creditor’s claim under § 1129(b)(2)(A)(iii), even absent the right to credit bid for the collateral. Last year, in River Road Expansion Partners, LLC v. Amalgamated Bank (In re River Road Hotel Partners, LLC),103 the Seventh Circuit created a circuit split by rejecting the reasoning of both Pacific Lumber and Philadelphia Newspapers and permitted secured lenders to credit bid in an asset sale pursuant to a plan.

1. Scotia Pacific Co., LLC v.Official Unsecured Creditors’ Comm. (In re Pacific Lumber Co.)

In Pacific Lumber, a group of noteholders (the “Noteholders”) had a claim secured by 200,000 acres of redwood timberland in California and the principal debtor’s other interest. The reorganization plan at issue - proposed by a secured creditor and a competitor of one of the principal debtors - proposed a free and clear sale of the debtors’ assets to two newly created entities without credit bidding. Both newly created entities would be owned by the plan proponents. The plan also proposed (i) paying the Noteholders the present value of their collateral in cash., (ii) granting the Noteholders a lien on proceeds from a pending, unrelated litigation, and (iii) granting the Noteholders an unsecured deficiency claim of over $200 million. During the confirmation hearings, the bankruptcy court concluded that the plan provided the Noteholders with the “indubitable equivalent” of their claim, and thus, the plan was subsequently confirmed via the cram down section of the Bankruptcy Code.

On appeal, the Fifth Circuit held that the plan could be crammed down without allowing for credit bid rights because it met the “indubitable equivalent” standard under § 1129(b)(2)(A)(iii).104 The court first rejected the statutory construction argument that § 1129(b)(2)(A)(ii) must prevail over Subpart (iii) because the former is a “more specific provision” than the latter. The court concluded that § 1129(b)(2)(A)(ii) does not exclusively govern free and clear asset sales for the following reasons: (a) the “or” that separates the subparts of § 1129(b)(2)(A) make those subparts alternatives to each other; (b) the word “includes” in the introduction of § 1129(b)(2) demonstrates that the subsequent list of what constitutes “fair and equitable” is not exhaustive; and (c) the instant situation demonstrates that the Noteholders’ receipt of the “indubitable equivalent” of their secured claims deems the protections of Subpart (ii) unnecessary to ensure that the plan is “fair and equitable.” The Noteholders also argued that they could not have received the “indubitable equivalent” of their claims because they “forfeited the possibility of later increases in the collateral’s value” by not having the ability to credit bid and foreclose on the collateral. The court rejected this argument, opining that the Bankruptcy Code and the preceding subparts of § 1129(b)(2)(A) only protect a creditor’s allowed claim, not the “upside potential” of the collateral.

2. In re Philadelphia Newspapers

101 584 F.3d 229 (5th Cir. 2009). 102 599 F.3d 298 (3d Cir. 2010). 103 651 F.3d 642 (7th Cir. 2011). 104 The opinion also addressed issues unrelated to the right to credit bid.

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The Third Circuit reached a similar conclusion as the Fifth Circuit in In re Philadelphia Newspapers. In Philadelphia Newspapers the debtors owed a syndicate of lenders (the “Lenders”) $318 million, which was secured by substantially all of the debtors’ real and personal property. Under the debtors’ plan for reorganization, (a) substantially all of the debtors’ assets were to be sold at public auction without any lien holders having the right to credit bid and (b) the Lenders would receive approximately $37 million in cash generated from the stalking horse bid (if it succeeded), a rent-free lease of the debtors’ Philadelphia headquarters, and any cash that is received in excess of the stalking horse bid. Though not mentioned by the majority opinion, there were additional facts regarding the stalking horse bidder that were pointed out by the dissent. First, the stalking horse bidder was composed mostly of the debtors’ current and former management and equity holders. Additionally, there was an extensive “Keep It Local” advertising campaign in the Philadelphia region to rally public support for the stalking horse. Finally, the bankruptcy court had opined that credit bidding seemed necessary to ensure fairness in the bidding procedure because it was perceived that the procedure was aimed at allowing the stalking horse to acquire the assets “on the cheap.”

The Third Circuit majority produced a thirty page opinion, to which there was a vigorous dissent by Judge Thomas Ambro. The main dispute between the two opinions was whether under a plain language analysis, § 1129(b)(2)(A) was ambiguous or unambiguous. The majority came down on the side of unambiguous. The Lenders set forth several arguments analyzing the following: (a) canons of statutory interpretation as they apply to § 1129(b)(2)(A); (b) § 1129(b)(2)(A) in the context of other relevant Bankruptcy Code provisions; and (c) the legislative history of Section 1129(b)(2)(A). The court analyzed and rejected each argument, but allowed the sale to proceed on the sole ground that the plain language of the § 1129(b)(2)(A) “unambiguously permits a debtor to proceed with any plan that provides secured creditors with the ‘indubitable equivalent’ of their secured interest in the assets and contains no statutory right to credit bidding.” Citing to § 102(5)105 and Pacific Lumber, the majority explained that the use of the disjunctive “or” in § 1129(b)(2)(A) “operates to provide alternatives,” each of which are sufficient to satisfy the “fair and equitable” requirement for a cram down. The majority also rejected the Lenders’ structural argument that when read together with § 1111(b) and § 363(k), § 1129(b)(2)(A) guarantees the right to credit bid. However, the majority made clear that its opinion only addresses whether there is an “absolute right” to credit bid when collateral is being sold pursuant to a plan of reorganization. It left open the possibility that a plan that precludes credit bidding may not provide the secured creditor with the “indubitable equivalent” of its claim, and the court expressly stated that this opinion allows creditors to object to a plan on those grounds.

To the contrary, Judge Ambro opined in his dissent that there are two plausible interpretations of the plain language of § 1129(b)(2)(A) as it applies to free and clear sales of collateral under a plan of reorganization. The first being the majority’s opinion that the three subparts of § 1129(b)(2)(A) are equal alternatives to satisfy the “fair and equitable” standard. The second – to which he subscribed – being that each subpart only applies to the specific situation that it addresses. In particular, the dissent points out sections of the Bankruptcy Code

105 The court cited both to the rule of construction set forth by § 102(5) - “’or’ is not exclusive” - and its

legislative history - “if a party may do (a) or (b), then the party may do either or both. The party is not limited to a mutually exclusive choice between the two alternatives.” In re Philadelphia Newspapers, 599 F.3d at 305.

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where “the alternative options render the [statutory] ‘or’ exclusive.”106 Furthermore, the dissent argues that the use of the word “provides” in the introduction of § 1129(b)(2)(A) is operative to that section, not the word “includes” in the introduction of § 1129(b)(2). Accordingly, Congress set forth specific requirements to meet the “fair and equitable” requirement for cram downs that depend on how a plan treats secured creditors’ claims.

Because he views the plain language of § 1129(b)(2)(A) to be ambiguous, Judge Ambro applied the following analyses to conclude that free and clear sales of collateral under a plan must be conducted pursuant to Subpart (ii): (a) canons of statutory interpretation that (1) a specific statutory provision (i.e. § 1129(b)(2)(A)(ii)) governs over a more general provision (i.e. § 1129(b)(2)(A)(iii)) and (2) the application of one statutory provision cannot make another superfluous; (b) a structural analysis of Bankruptcy Code provisions related to § 1129(b)(2)(A); and (c) a legislative history analysis of § 1129(b)(2)(A). Under his structural analysis, the dissent reads § 1123(a)(5)(D), § 363(k), and § 1111(b) in conjunction with § 1129(b)(2)(A). The dissent argues that those four sections are part of a “comprehensive arrangement enacted by Congress to avoid the pitfalls of undervaluation, regardless of the mechanism chosen, and thereby ensure that the rights of secured creditors are protected while maximizing the value of the collateral to the estate and minimizing deficiency claims against other unencumbered assets.” The dissent concludes his legal argument by analyzing the legislative history of § 1129(b)(2)(A). Of note, the dissent explains how § 1129(b)(2)(A) was added to the Bankruptcy Code to create stronger creditor safeguards than those available under the Bankruptcy Act of 1898, so “it would be anomalous for Congress to draft a specific provision, clause (ii), providing protections above and beyond those given to secured creditors under the Bankruptcy Act, only to allow clause (iii) to be used to circumvent those protections and return to the precise mechanism under prior to the Code.” The dissent concludes with a policy argument, which is explained below.

3. River Road Expansion Partners, LLC v. Amalgamated Bank (In re River Road Hotel Partners, LLC)

The River Road decision encompassed two consolidated bankruptcy cases - In re RadLAX Gateway Hotel, LLC and In re River Road Hotel Partners, LLC - with similar facts. However, only RadLAX is being reviewed by the Supreme Court because a plan was confirmed in River Road after the Seventh Circuit ruled on the credit bidding issue. In RadLAX, a lender (the “Lender”) held a lien on RadLAX’s property. The reorganization plan sought to sell substantially all of RadLAX’s assets free and clear at a public auction without allowing the Lender to credit bid. RadLAX also obtained a stalking horse bidder. As was the case in Philadelphia Newspapers, insiders of the debtor were involved with the stalking horse, and the stalking horse bid was well below the value of the Lender’s lien. A corporation owned and controlled by the debtor’s principal had the right to purchase a minority interest in the stalking horse. Additionally, if the stalking horse were to acquire RadLAX’s assets, the existing management would continue to manage the main asset, a hotel. The bankruptcy court rejected the sale without undertaking its own analysis. Rather, the bankruptcy court succinctly stated that

106 The dissent pointed out the following sections: § 365(g)(2)(B)(i)-(ii), § 506(d)(1)-(2), § 1112(b)(1), §

1325(a)(5)(B)-(C), § 1325(b)(3)(A)-(C), § 1325(b)(4)(A)(i)-(ii). In re Philadelphia Newspapers, 599 F.3d at 324 (Ambro, T., dissenting).

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it “finds Judge Ambro’s well-reasoned dissent in Philadelphia Newspapers more persuasive” than the majority opinion upon which the Debtors relied.107

The Seventh Circuit affirmed the bankruptcy court decision in an opinion that is similar to Judge Ambro’s dissent in Philadelphia Newspapers.108 First, the court found Judge Ambro’s view that § 1129(b)(2(A)(ii) has two plausible interpretations “to be “compelling” and, thus, adopted it. The court addressed the use of the disjunctive “or” in a footnote by stating that the “mere presence of the term ‘or’ is insufficient to resolve this issue.” Furthermore, the plain text of Subpart (iii) does not unambiguously indicate that a plan that precludes credit bidding can meet the “fair and equitable” standard. The court explained that both § 363(k) and § 1129(a)(B)(ii) grant creditors protection against their collateral being undervalued at auction. The absence of credit bidding would remove a “crucial check against undervaluation,” and “[n]othing in the text of Section 1129(b)(2)(A) indicates that plans that might provide secured lenders with the indubitable equivalent of their claims can be confirmed under Subsection (iii).” Accordingly, the plain language of Subsection (iii) cannot be unambiguously read to allow collateral to be auctioned free and clear under a plan without credit bidding.

Having found the plain language of § 1129(b)(2)(A) to be susceptible to two meanings, the court then applied canons of statutory interpretation. Like Judge Ambro, the court applied the “anti-superfluous” and the specific governs the general canons of statutory interpretation. The court held that allowing the general requirement of § 1129(b)(2)(A)(iii) to govern over situations that are specifically addressed by Subsections (i) and (ii) would render the latter sections superfluous. Rather, the “infinitely more plausible interpretation,” is that Congress wrote each Subsection to govern for the specific situation that the respective subsection addresses. The court next contrasted § 1129(b)(2)(A)(iii) with other sections of the Bankruptcy Code that address the interests of a secured creditor. The court quoted Judge Ambro to explain that § 363(k), § 1129(b)(2)(A)(ii), and § 1111(b) all reveal “that the Code has an expressed interest in insuring that secured creditors are properly compensated.” By contrast, nowhere in the Bankruptcy Code is a debtor empowered to conduct an auction sale without the protection of credit bidding. Accordingly, the more plausible interpretation of § 1129(b)(2)(A) is that Subsection (ii) is the exclusive means by which a plan to sell collateral free and clear under a plan can be conducted. Allowing free and clear sales that only meet the provisions of Subsection (iii) would “not provide secured creditors with the types of protections that they are generally accorded elsewhere in the code.”

Following the Seventh Circuit ruling, the Supreme Court granted certiorari.

B. The Parties’ Arguments to the Supreme Court:

Not surprisingly, the parties’ arguments in RadLAX are similar to those of the majority and dissent in Philadelphia Newspapers. This section outlines their respective legal arguments and the supporting legal arguments of the amicus briefs. Five amicus briefs were filed, and

107 In re River Road Hotel Partners, LLC, No. 09-30029, 2010 WL 6634603 (Bankr. N.D. Ill. Oct. 05,

2010). A shorter order was issued in the RadLAX case that ruled the same way for the reasons stated in the River Road order. Order Denying Debtor’s Bid Procedure Motion, In re RadLAX Gateway Hotel, LLC (Bankr. N.D. Ill. Oct. 05, 2010) (No. 09-30047), ECF No. 336.

108 The court also addressed the issue of mootness of the appeal.

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support the Respondent. The amicus parties are as follows: (a) a group of prominent law professors (the “Professors”);109 a group of prominent bankruptcy scholars (the “Bankruptcy Scholars”);110 (c) well-known bankruptcy scholar and practitioner Eric Brunstadt111; (c) the U.S. Government;112 and (d) a group of lender, mortgage, and financial services trade associations (the “Trade Associations”).113

1. Plain Language Arguments

First, the parties dispute the meaning of § 1129(b)(2)(A)’s plain language. Like the majority in Philadelphia Newspapers, the Petitioners’ cite to § 102(5) and its statutory note as proof that the use of “or” in § 1129(b)(2)(A) means that the section’s three subparts are alternatives. The Petitioners also view the use of the words “the plan provides” and “includes” in the introductory language of Section 1129(b)(2)(A) and 1129(b)(2), respectively, as indicative of the three subparts being equal and sufficient alternatives to meet the “fair and equitable standard.”

To the contrary, the Respondent reads the disjunctive “or” as only meaning that a plan need not satisfy all three clauses. The Respondent also disputes the Petitioners’ interpretation of the introductory language. First, it notes that the word “includes” is in the introduction of § 1129(b)(2), not § 1129(b)(2)(A). Thus, the use of the word “includes” only sets forth the minimum requirements for a plan to be “fair and equitable” rather than making the three subparts of § 1129(b)(2)(A) merely illustrative of what can constitute “fair and equitable.” However, even if the three subparts are only illustrative, Supreme Court precedent in Bloate v. United States114 still holds that situations falling within a specific statutory provision on an illustrative list must be governed by that provision. Furthermore, the term “provides” in the introduction of § 1129(b)(2)(A) demonstrates that the subsequent subparts are not merely illustrative. The debtor can choose how to dispose of collateral, but the flexibility to make that decision does not allow it to choose the option addressed by Subpart (ii) and use the standard of Subpart (iii).

In their amicus brief, the Professors support the Respondent’s position, but set forth a different statutory analysis. Citing Supreme Court precedent under the Bankruptcy Act of

109 Brief in Support of Respondent for Amici Curiae Professors Richard Aaron, Laura Beth Bartel, Jagdeep

S. Bhandri, Susan Block-Lieb, Robert, D’Agostino, Jessica Dawn Gabel, Kenneth N. Klee, George W. Kuney, C. Scott Pryor, Nancy B. Rapoport, Marie T. Reilley, Lynne F. Reilly, Keith Sharfman, and Michael Sousa, RadLAX Gateway Hotel, LLC v. Amalgamated Bank, --- U.S. --- (2012) (No. 11-166), 2012 WL 748409.

110 Brief for Bankruptcy Scholars as Amici Curiae in Support of Respondent, RadLAX Gateway Hotel, LLC v. Amalgamated Bank, --- U.S. --- (2012) (No. 11-166), 2012 WL 822948.

111 Brief of Amicus Curae G. Eric Brunstad, Jr. in Support of Respondent, RadLAX Gateway Hotel, LLC v. Amalgamated Bank, --- U.S. --- (2012) (No. 11-166), 2012 WL 822952.

112 Brief for the United States as Amicus Curiae Supporting Respondent, RadLAX Gateway Hotel, LLC v. Amalgamated Bank, --- U.S. --- 2012) (No. 11-166), 2012 WL 765217.

113 Brief for the Loan Syndication and Trading Association, The American Bankers Association, The Clearing House Association, The Commercial Finance Association, The Commercial Real Estate Finance Council, The Equipment Leasing and Finance Association, The Financial Services Roundtable, The Managed Funds Association, The Mortgage Bankers Association, and the Securities Industry and Financial Markets Association as Amici Curiea in Support of Respondent, RadLAX Gateway Hotel, LLC v. Amalgamated Bank, --- U.S. --- (2012) (No. 11-166), 2012 WL 822951.

114 130 S. Ct. 1345, 1354 (2010).

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1898,115 the Professors argue that the right to credit bid is an important property right that is vital to protecting a creditor’s Fifth Amendment right to full payment of its mortgaged property. The Professors argue that there is no indication in the Bankruptcy Code that Congress intended to abolish the property right to credit bid. Rather, that right is set forth in § 363(k) and § 1129(b)(2)(A)(ii), and therefore, it is “implausible” that free and clear sales under a plan may be conducted without credit bidding.

The Bankruptcy Scholars also set forth a different statutory analysis while drawing the same conclusion as the Respondent. The Bankruptcy Scholars agree with the statutory analyses of the Petitioners and the Fifth and Third Circuits that read § 1129(b)(2) as being satisfied if any of its three subparts are met. The Bankruptcy Scholars also agree that (a) the Respondent’s position “would impermissibly convert the word “or” to “and” and (b) the statutory cannon that a specific provision governs over a more general one only applies when one statutory provision is a subset of another. However, the Bankruptcy Scholars diverge with the Petitioners’ by arguing that the “requirements of § 1129 (b)(2)(A) are necessary but insufficient.” The Bankruptcy Scholars contend that a plan of reorganization cannot meet the “bedrock rule of cram down” – that a plan be “fair and equitable” to each impaired class – if it proposes to sell substantially all of the debtor’s secured assets while barring credit bidding. The Bankruptcy Scholars offer two rationales to support this position: (a) credit bidding maximizes the value of the estate and (b) credit bidding is a safeguard under state law that the Bankruptcy Code should not be read to eliminate. As to the second rationale, the Trade Associations also point out that the Bankruptcy Code does not abrogate state law property rights without a “’clear and manifest’ contrary intention.” Under state law, a mortgagee has the right to full payment or to foreclose on the collateral, and § 506, § 1111(b), and § 1129(b)(2)(A)(iii) are structured to preserve those rights under the Bankruptcy Code.

2. Canons of Statutory Interpretation

The two sides also vigorously debate the application of statutory canons of interpretation to § 1129 (b)(2)(A). Like the majority in Philadelphia Newspapers, the Petitioners analyze canons of statutory interpretation while explaining that, even if the canons favored the Respondent, these “rules of thumb” cannot trump the plain meaning of the statute. First, they argue that Subpart (ii) is not more specific than Subpart (iii). Rather, the former is a procedural protection (i.e. right to credit bid regardless of the outcome of the auction) whereas Subpart (iii) is a substantive protection (i.e. right to indubitable equivalent of the collateral regardless of how the plan is implemented); the difference being process versus outcome. The Petitioners contend that this interpretation is in accordance with the Bloate decision, in which the Petitioner’s claim the “specific governs the general” cannon was only applied because the specific provision was a subset of the general one. Accordingly, Subpart (ii) does not limit Subpart (iii) under the specific governs the general cannon. Second, Subpart (iii) does not render Subpart (ii) superfluous. The Petitioners list several hypothetical situations in which a debtor may choose to conduct an auction with credit bidding, even if it had the ability to preclude bidding by only providing the creditor with an “indubitable equivalent.”

115 Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555 (1935).

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The Respondent incorporates its canons of interpretation argument into its plain language argument. The Respondent advocates that a debtor cannot use the broad language of Subpart (iii) to circumvent the “detailed and carefully tailored language of” Subpart (ii).” The Respondent cites Bloate for the contention that “where Congress has provided a list of specific subparagraphs addressing particular circumstances, those options should ‘govern conclusively unless the subparagraph itself indicates otherwise.” Contesting the Petitioners’ interpretation of Bloate, the Respondent explains that a specific provision governs over a more general one even if the specific provision is not a subset of or not in the same statute as the general provision. The Respondent expands on this argument by noting that § 1129 (b)(2)(A)(iii) has been incorporated into Subpart (ii) to have the former govern the lien on the sale proceeds from the auction. Thus, allowing Subpart (iii) to exclusively control a free and clear sale of collateral under a reorganization plan would “skip a critical step” that protects collateral from being undervalued at auction. Lastly, like the Seventh Circuit and Judge Ambro, the Respondent argues that reading Subpart (iii) as controlling would render Subpart (ii) superfluous. The Respondent disputes the Petitioners’ substance versus procedural argument by noting that the substantive requirement of § 1129(b)(2)(A) as a whole is to treat objecting creditors “fair and equitable,” which is accomplished by the three subparts. However, regardless of the substance versus procedure argument, the Respondent contends that the more specific provision of a statute must govern over a more general one and that the Petitioners’ interpretation of §1129(b)(2)(A) would render Subpart (ii) superfluous.

3. Structural Arguments

Third, the two sides engage in a heated structural debate. The Petitioners’ begin by pointing out that Congress did limit the application of the “indubitable equivalent” standard in § 361(3) – the only other Bankruptcy Code Section to use that standard – but did not do so in § 1126(b)(2)(A). Likewise, Congress could have inserted a right to credit bid into § 1123(a)(5)(D) – which would be the “most logical place to include that right” for plan sales – or § 363(l) like it did for sales under § 363(k). Accordingly, the contrast between the express grant of credit bidding rights outside of a plan in § 363(k) and the statutory silence regarding those rights in § 1123(a)(5)(D) is indicative that Congress did not grant a right to credit bidding in chapter 11 sales. To support this position, the Petitioners cite the Court’s January 12, 2012 decision in Pacific Operators Offshore v Valladolid,116 in which the Petitioners’ argue that the Court did not “impose an extra-textual limit on a similarly constructed statute.

The Petitioners also contend that their position is consistent with the provisions of § 506(a), § 361, and § 362(d)(1) when read together. Individually, each section enables a creditor to realize and protect the present value of its collateral. Accordingly, reading the plain language of § 1129(b)(2)(A) as setting forth three alternatives means to ensure that a creditor receives the value of the collateral at the time of the plan is consistent with the aforementioned Bankruptcy Code sections. Furthermore, in their argument regarding canons of interpretation, the Petitioners dispute Judge Ambro’s argument that § 1111(b) and § 363(k) should be read together with § 1129(b)(2)(A) to establish that the Bankruptcy Code always protects creditors against undervaluation of their collateral. The Petitioners cite the following Bankruptcy Code provisions that do not grant the rights set forth in § 1111(b) or § 363(k): (a) transfers that are “sales” under §

116 No. 10-507, 132 S. Ct. --- (Jan. 11, 2012).

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1129(b)(2)(A)(i); (b) § 363 sales where the court finds cause to deny credit bidding rights; (c) § 1111(b)(1)(B)(i) when the collateral is of no value; and (d) § 1123(a)(5)(E)’s provision that allows a debtor to modify a lien to implement its plan of reorganization. Finally, the Petitioners point out the following additional creditor protections within the Bankruptcy Code: (a) Section 506(a)’s provision of a deficiency claim; (b) the “best interests” test; and (c) the absolute priority rule. These sections provide a broad range of creditor protection in Chapter 11 cases, so the Petitioners argue that it is not necessary to create an additional protection by “stray[ing] outside the plain language of § 1129(b)(2)(A).” Taken together, these provisions of the Bankruptcy Code establish a structural basis for supporting their position.

The Respondent also sets forth a lengthy structural argument. Like Judge Ambro, the Respondent reads § 363(k) and § 1111(b) as working in tandem with § 1129(b)(2)(A) to protect secured creditors against the undervaluation of their collateral. Allowing a debtor to sell collateral free and clear under a plan without credit bidding would disrupt these “interlocking Code provisions” that were diligently crafted by Congress. The Respondent then methodically disputes the Petitioners claim that the Bankruptcy Code sections that do not afford § 1111(b) or § 363(k) protection weaken its structural argument. First, the exception under § 363(k) for cause is strictly limited to extreme situations such as malfeasance. Second, a transfer under § 1129(b)(2)(A)(i) is not a “sale” that precludes an § 1111(b) election, and in practice, it is unlikely that an under secured asset will be sold subject to a lien. Third, the inconsequential argument and modification of a lien argument miss the point because the protections of § 1111(b) and § 363(k) protect the present value of collateral, which isn’t necessary under those circumstances. The Respondent also attacks the assertion that the bifurcation of secured claims under § 506(a) is proof that § 1129(b)(2)(A) does not provide a creditor with additional protections because bifurcation is irrelevant to protecting the present value of collateral.

The Respondent also disputes the Petitioners’ § 1123(a)(5)(D) argument. The Respondent notes that § 1123 only lists general provisions that may be included in a plan, but it does not set forth any substantive rights. Rather, a party’s substantive rights under a reorganization plan are set forth in § 1129. As such, it is also incorrect to view the absence of an express right to credit bid in either § 1123 or § 363(l) as indicative that Congress did not set forth that right for free and clear sales under a plan. To the contrary, Congress expressly guaranteed the right to credit bid in plan sales in § 1129(b)(2)(A). Furthermore, the Respondent disputes the Petitioners’ argument that the “indubitable equivalent” limitation in § 361 and the absence of such a limitation in § 1129 demonstrates that Congress did not intend to limit the application of § 1129(b)(2)(A)(iii). Rather, canons of statutory interpretation “foreclose [the Petitioners’] resort to the more general section (iii) in the case of Congress’s carefully drawn scheme for sales free and clear in clause (ii).”

Brunstad’s amicus brief focuses mainly on the right to credit bid being critical to the absolute priority rule. Brunstad explains that the “overarching principal” behind § 1129(b)’s “fair and equitable” standard is the absolute priority rule. Furthermore, the absolute priority rule has two main functions: (1) to preserve the “hierarchical priorities in bankruptcy” and (2) to prevent “collusive arrangements designed to erode this hierarchical order.” Brunstad argues that credit bidding is critical to the latter function because it makes it easier for creditors to “police and enhance the auction process.” Without credit bidding, it is much more difficult for secured creditors to outbid a favored stalking horse because of transaction costs and the inherent

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difficulties coordinating funds among a syndicate of lenders. Brunstad points to the instant case as an example of how a prohibition on credit bidding enables a debtor to transfer assets for the benefit of insiders at a potentially below market price. The Respondent also notes that credit bidding is a necessary protection against insider manipulation or discount sales to insiders.

In its amicus brief, the U.S. reinforces many of the points made in the plain language, canons of interpretation, and legislative history arguments set forth by the Respondent, Professors, and Bankruptcy Scholars. Of note in its structural analysis, the U.S. argues that reading § 363(k), § 1111(b), and § 1129(b)(2)(A) together demonstrate Congress’s intention to protect secured creditors from having their collateral undervalued during the bankruptcy process and from being “cashed out” by debtors when the value of the collateral “is at a low point.” Accordingly, if a plan precludes credit bidding, “giving an objecting creditor a lien on sale proceeds cannot constitute ‘fair and equitable’ treatment of the creditor’s claim” under the “indubitable equivalent” standard. In their amicus brief, the Trade Associations similarly note that an § 1111(b)(2) election protects against judicial undervaluation of the collateral when it is applied in a situation governed by § 1129(b)(2)(i). Furthermore, the U.S. argues that the Petitioners’ invocation of § 363(l) or § 1123 are misplaced because the issue is “not whether a no-credit bidding asset sale can ever be held in a Chapter 11 case, but whether it can be held over a secured creditor’s objection.

In their amicus brief, the Trade Associations, in addition to reinforcing the statutory, structural, and policy analysis of the Respondent, expand on the Respondent’s counter argument to the Petitioners’ “inconsequential value” argument. The Trade Associations note that the reason an § 1111(b) election is unavailable in those situations is to prevent creditors with very little rights in the collateral – such as junior lender with a lien on an underwater asset – from holding up confirmation. Likewise, the Trade Associations note that the Petitioners are correct that an § 1111(b) election does not guarantee a creditor’s right to future appreciation of the collateral, but contends that argument is irrelevant because the issue at hand is how to determine the current value of the Respondent’s collateral. The Bankruptcy Code strongly prefers competitive bidding as a means for valuing collateral - a point made by the Professors as well - so the proceeds of an auction cannot represent the true present value of the collateral if the creditor was denied the right to credit bid.

4. Legislative History

As expected, the two parties have different interpretations of § 1129(b)’s legislative history and its importance. The Petitioners argue that the legislative history is at best unclear and cannot be used to override the plain language of the statute. The Respondents cite a statement by one of the Bankruptcy Code’s drafters to support its position that § 1111(b) and § 363(k) should be read in tandem with § 1129(b)(2)(A)117 and that § 1129(b)(2)(A)(ii) is “self-explanatory.”118 Finally, the Respondent points to the discussion of § 1129(b)(2)(A)(iii) in the legislative history. During that discussion, the drafters suggested that Subpart (iii) would only

117 “Sale of property under section 363 or under the plan is excluded from treatment under section 111(b)

because of the secured party’s right to credit bid in the full amount of his allowed claim at any sale of collateral under section 363(k).” 124 Cong. Rec, 32,407 (1978) (Statement of Representative Edwards).

118 Id.

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apply to situations not covered by Subpart (ii), such as when the debtor abandons the collateral or gives the creditor a replacement lien.119

The Professors set forth a very detailed historical argument in support of the Respondent’s position. The Professors explain that credit bidding is a centuries-old practice that has been “recognized by the courts as an inherent ingredient in the foreclosure process.” Neither the language of the Bankruptcy Code nor its legislative history indicate that Congress intended to abolish the right to credit bid, so § 1129(b)(2)(A) should not be interpreted to the contrary. Furthermore, it should be assumed that Congress intended to allow credit bidding because credit bidding is analogous to the equitable principal of setoff, which is “favored and encouraged by law.”

The Professors also explore the history of the “indubitable equivalence” standard to argue that a reorganization plan that precludes credit bidding cannot meet that standard. In In re Murel Holding Corp.,120 Judge Learned Hand set forth a “strict approach” that a plan must allow a secured creditor to “‘get his money or at least the property’, unless the creditor is given a ‘substitute of the most indubitable equivalence.’” Congress stated that it followed Judge Hand’s approach when drafting § 1129(b)(2)(A)(iii).121 The Professors contend that, under the Murel precedent, a plan of reorganization must provide an objecting creditor with the “best chance to get full payment of the debt in cash at an auction” or “the opportunity to own the property by means of credit bidding.” A plan that precludes credit bidding from a free and clear sale of collateral limits a secured creditor’s right to take the collateral rather than accept cash that is less than its lien. Accordingly, credit bidding is the only way to ensure that a plan grants creditors the “indubitable equivalent” of a secured creditor’s claim. “[T]here is no equivalent that can be substituted for credit bidding and thus not substitute that can satisfy the ‘indubitable equivalent’ standard.” This interpretation of the Murel precedent’s application to the instant case was also mentioned by the U.S. and briefed by Brunstad.

C. Policy Implications of RadLAX

Outside of the above statutory arguments, the issue of credit bidding rights raises many important economic and bankruptcy policy concerns. Below is a summary of the bankruptcy policy arguments for and against credit bidding rights raised by the parties involved in Philadelphia Newspapers and RadLAX. This section concludes with a discussion of the practical and economic impact that RadLAX decision could have on the credit market.

1. Policy Arguments Against Credit Bidding Rights in Chapter 11 Plan Sales

The Petitioners conclude their brief with a policy argument, albeit a shorter one than that of the Respondents. The Petitioners argue that reading the plain language of § 1129(b)(2)(A) as allowing a debtor the choice of three alternatives is “consistent with the flexible and rehabilitative purposes of the Bankruptcy Code.” To the contrary, a right to credit bid in all plan sales “effectively provides the secured creditors with an unconditional veto over the Chapter 11 process when the secured creditor’s total claim far exceeds the present value of the collateral.”

119 Id. 120 75 F.2d 941 (2d Cir. 1935). 121 S. Rep. 95-989 at 127 (1978).

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Under such a scheme, a creditor would always have the option of credit bidding more than cash buyers, which would defeat the purpose of the auction and hinder the debtor’s implementation of its rehabilitation efforts. Accordingly, such a power would tie the hands of debtors and preclude rehabilitation in situations where credit bidding does not benefit the debtor.

2. Policy Arguments for Credit Bidding Rights in All Plan Sales

With Judge Ambro’s vigorous dissent in Philadelphia Newspapers and the number of amicus briefs filed in support of the Respondent, more policy arguments in support of credit bidding rights have been set forth have been lodged in favor of credit bidding rights.

In his dissent in Philadelphia Newspapers, Judge Ambro makes an impassioned policy argument to support the rights for credit bidding under a reorganization sale. First, if a debtor was not required to include credit bidding rights in a reorganization plan sale, it would only do so when it is an advantage to the debtor. This defies the logic of the Bankruptcy Code because credit bidding is incorporated into the Code for the benefit of a creditor, not a debtor. Furthermore, allowing the debtors to preclude credit bidding in Philadelphia Newspapers “undermine[s] the Bankruptcy Code by skewing the incentives of the debtor to maximize benefits for insiders [the stalking horse], not creditors.”

The Respondent in RadLAX sets forth policy arguments that are similar to those of Judge Ambro. The Respondent also explains how credit bidding maximizes the value of the estate by increasing competition for the assets, which benefits both debtors and other creditors. Credit bidding both ensures a maximum bid at auction and eases the bidding process for creditors, some of whom cannot make a cash bid or would incur transaction costs to secure the necessary cash. Furthermore, credit bidding makes it more likely that a secured creditor’s special knowledge of the collateral will be brought to the bidding process.

Like Judge Ambro’s view of the bidding procedures in Philadelphia Newspapers, the Respondent points out how the only beneficiary of the bidding procedures in RadLAX is the stalking horse and insiders of the debtor. Similar arguments that credit bidding prevents “mischief and manipulation” are made by the Trade Associations and Bankruptcy Scholars. Brunstad expands on this argument as well. He points out that, in both Philadelphia Newspapers and RadLAX, the debtors had and have, respectively, a favored stalking horse. If those stalking horses were to prevail at auction, insiders of the debtors would benefit while the assets would be sold for less than the value of the collateral. In Philadelphia Newspapers, the buyers and debtors went so far as launching a media campaign to “Keep it Local.” Likewise, in Pacific Lumber, the plan proponents, one of whom was a competitor of the debtors, were also the buyers. In Philadelphia Newspapers, the Third Circuit majority addressed what it viewed as the weakness of a policy argument in light of an unambiguous statute. The court opined that “[t]o the extent this holding permits a course of conduct not contemplated or not desirable under the Code, as the Lenders argue it does, it is the sole province of Congress to amend a statute that carries out by its plain language an undesirable end.” However, Brunstad’s brief frames the issue under the banner of the absolute priority rule, so prevention of this type of questionable insider favoritism in the three cases may have a basis in the Bankruptcy Code.

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The Respondent, Bankruptcy Scholars, Brunstad, and the Trade Associations all contest the Petitioners’ argument that credit bidding makes a debtor’s rehabilitation efforts more difficult. The Respondent contends that it should make no difference to the debtor who wins at auction as long as the asset is sold for the highest sum possible. Similarly, the Trade Associations argue that there is no legitimate reason why a bankruptcy estate should prefer cash bids to credit bids. Also, the Respondent believes that by ensuring at least one bidder for the collateral, credit bidding increases the likelihood that a plan will eventual be confirmed. According to Brunstad, Congress believed that credit bidding enhanced the auction process, as is evidence by the inclusion of a right to credit bid in both § 363(k) and § 1129(b)(2)(A)(ii). The Bankruptcy Scholars and Trade Associations also counter the common argument among opponents of credit bidding rights that cash bidders are discouraged from participating in an asset sale because of the creditors ability to credit bid. The Bankruptcy Scholars draw the analogy of a potential bidder being discouraged by the presence of a wealthier entity such as Warren Buffet, which should not be viewed as precluding the bidding process since the higher bidder will prevail regardless.

In their amicus brief, the U.S. advocates that cash bidding is not an adequate substitute for credit bidding from the unique standpoint of a government agency. The U.S. government often relies on credit bidding because of the legal hurdles it faces when cash bidding. Federal law requires appropriations be made to a government agency before the government can enter into a monetary obligation. At the same time, federal law requires the U.S. government to take a lien on collateral when it grants certain types of loans. Accordingly, the U.S. government often relies heavily on credit bidding to realize the full value of collateral in bankruptcy cases. An “after-the-fact judicial approval of the sale price” is not a sufficient against undervaluation of the collateral at auction, which is not “fair and equitable” to secured creditors.

Furthermore, citing, Supreme Court precedent from the case Bank of America National. Trust and Savings Association v. 203 North LaSalle Street Partnership,122 all five amici argue that a market test is necessary for the proper valuation of collateral in a chapter 11 plan sale. The Professors contend that market tests, which require credit bidding, are absolutely necessary to meet the indubitable equivalent standard. Likewise, the Bankruptcy Scholars cite 203 North LaSalle to make a similar point. The Bankruptcy Scholars note that market tests are not possible in chapter 11 reorganizations in which the debtor keeps its assets and emerges with a clean balance sheet. However, the Bankruptcy Scholars note that while in those situations, “[a] neutral judge’s estimate [of the value of the debtor’s property] is the best measure,” an “open auction, where feasible, is better.” Brunstad analogizes the weaknesses in the plan that was proposed in 203 North LaSalle - that the plan gave the “old equity holders a right of purchase ‘without extending an opportunity to anyone else either to compete for that equity or propose a competing reorganization plan’” - to the sale at issue in RadLAX. He contends that “[t]he proper way to superintend proposed transactions of this kind and ensure that they do not violate absolute priority is through the increased market-driven competition that credit bidding fosters.” Accordingly, there appears to be strong support for the idea that credit bidding is necessary to

122 526 U.S. 434, 457 (1999) (“Under a plan granting an exclusive right, making no provision for competing bids or competing plans, any determination that the price was top dollar would necessarily be made by a judge in bankruptcy court, whereas the best way to determine value is exposure to a market. . . .This is a point of some significance, since it was, after all, one of the Code’s innovations to narrow the occasions for courts to make valuation judgments . . . .”).

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meet the market test standard set forth by the Supreme Court in 203 North LaSalle and thus, necessary for the proper valuation of collateral that is sold free and clear under a chapter 11 plan.

Though not raised by any of the parties or amici in RadLAX, the fiduciary duties that state law imposes on corporate management may also support the argument that credit bidding rights are necessary in free and clear sales pursuant to a chapter 11 plan. Some states, such as Delaware, impose a duty on corporate directors to maximize the value of the corporation prior a pending transfer of control or dissolution (e.g. the “Revlon Duties” in Delaware). 123 In their brief, the Petitioners argue that allowing debtors to preclude credit bidding in plan sales gives the “debtor flexibility to fulfill its fiduciary obligation to confirm a chapter 11 plan for the benefit of all its creditors, not just the secured creditor.” However, state-imposed fiduciary duties to maximize the value of the corporation may also apply in chapter 11 cases.124 It can be convincingly argued that a duty to maximize the value of the corporation for the benefit of shareholders prior to sale or dissolution under state law complements the duty to maximize the value of the estate for the benefit of creditors under the Bankruptcy Code.125 Accordingly, the only way to fulfill both duties simultaneously is to maximize the price of collateral at auction, which according to the amici in RadLAX, can only be accomplished by allowing credit bidding.

D. Pragmatic Approach. Is this much ado about nothing?

Considering the positions taken for and against credit bidding rights, it is important to ask whether this is much ado about nothing.

In practice, requiring cash bidding by secured lenders may result in secured creditors “round tripping” their money. Creditors would bid cash in an auction for their collateral and then subsequently recover that cash because their lien would have attached to the auction proceeds under the Bankruptcy Code. Accordingly, it is reasonable to question whether a holding that there is no right to credit bid in all plan sales will have a significant impact on § 363 sales pursuant to a reorganization plan. For instance, in Philadelphia Newspapers, the Lender eventually acquired the debtors’ assets at auction for cash. The day that the Third Circuit decision was released, the plan proponents in Philadelphia Newspapers filed a proposed order to set an auction date and bid deadline.126 Within five weeks, the auction was conducted, with the lenders outbidding the stalking horse. Exactly four months after the auction, Chief Bankruptcy Judge Raslavich signed the order confirming the reorganization plan.127 Despite the lengthy legal battle - which they lost - the Lenders still acquired the collateral.

123 For a detailed discussion of how the Revlon Duties apply under the Bankruptcy Code, see Dennis

Dunne, The Revlon Duties and the Sale of Companies in Chapter 11, 52 Bus. Law. 1333 (1997). • 124 See id. at 1339-59; see also In re Los Angeles Dodgers, LLC, No. 11-12010, 2011 WL 6257336, at *8

(Bankr. D. Del. Dec. 15, 2011) (holding prepetition “no shop” clause that would prevent marketing of debtor’s asset was invalid under Bankruptcy Code and explaining “[t]he same is true under Delaware law which prohibits such clauses where, as here, the clause would prevent the exercise of the fiduciary duty to maximize value”).

125 See Dunn, supra note 123, at 1339-40. 126 Proposed Order Setting Auction Date and Bid Deadline, In re Philadelphia Newspapers, No. 09-11204

(Bankr. E.D. Pa. Mar. 22, 2010), ECF No. 1802. 127 Order Confirming Fourth Amended Joint Chapter 11 Plan As of June 28, 2010, In re Philadelphia

Newspapers, No. 09-11204 (Bankr. E.D. Pa. June. 29, 2010), ECF No. 2253.

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However, precluding the right to credit bid may have a significant financial impact on secured lenders, which is unnecessary. In their amicus brief, the Trade Associations contend that credit biding increases bidding costs for creditors. Creditors will often need to borrow the money to bid cash, for which they will incur transaction costs. Furthermore, a creditor loses the time-value of its money while it remains with the estate after the auction. In a similar manner, the Respondent argues that it is senseless to shuffle funds to and fro by making it credit bid for an asset on which it already holds a lien. Doing so would result in ‘the absurdity of making A pay B when B owes A,” which the equitable right of setoff is intended to prevent. Finally, the Trade Associations and Brunstad both point out the practical difficulties of coordinating cash bids among a syndicate of lenders. Coordinating or obtaining the funds necessary to cash bid may be impossible in some circumstances, with one hold-out or insolvent lender precluding the entire syndicate from bidding.

Furthermore, a holding in RadLAX that § 1129(b)(2)(A) does not grant creditors the right to credit bid in all plan sales may impact credit markets. In his dissent, Judge Ambro explains that secured creditors bargain for the right of favored treatment when seeking repayment. According to the Judge Ambro, “Congress has determined that credit bidding is necessary to ensure proper valuation of the collateral at a sale free of liens.” Therefore, “[d]enying secured creditors the right to credit bid in those cases allows debtors to lessen the likelihood of repayment of the full value of the collateral.” The Respondent echoes this argument in its brief. The Respondent contends that, if the possibility of a free and clear sale without credit bidding rights exists, creditors will lose a part of the benefit of the bargain. This loss will likely lead to increased interest rates or tighter credit markets. Likewise, the Trade Associations cite to Judge Ambro’s dissent to argue that, when extending credit, secured creditors will have to factor in the risk of not being able to realize the full value of their collateral or of not being able to reacquire it in a bankruptcy proceeding if they do not have the right to credit bid in chapter 11 plan sales. Accordingly, the Trade Associations warn that the cost of lending will increase, the availability of credit will decrease, and the credit markets will be become more uncertain as they try to recover from the current recession.

Therefore, the Supreme Courts upcoming decision in RadLAX may have significant implications on credit markets and lending practices. By the time this article is published, oral arguments should have concluded in the RadLAX case and the bankruptcy bar should be awaiting a decision with bated breath.

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proposition that the Debtors were required to proceed with a hearing on the Sale Motion

even when a negative outcome was assured.

NATURE AND STAGE OF THE PROCEEDINGS

On July 14, 2010, the Debtors filed the Motion to Dismiss and the Debtors’

Moving Brief. At a status conference on August 6, 2010 this Court permitted NVR to

engage in limited discovery related to the Motion to Dismiss. (8/6/2010 Hr’g Tr. 18:4-6.)

On August 30, 2010, the Court entered an initial scheduling order in this adversary

proceeding [Adv. Docket No. 42] setting forth the briefing schedule for the Motion to

Dismiss and acknowledging NVR’s waiver of any further notice if the Court elected to

treat the motion to dismiss as one for summary judgment under Fed. R. Civ. P. 12(d) and

56. On September 15, 2010, the Debtors responded to NVR’s first set of document

requests (the “Document Requests”) and the Debtors subsequently produced

approximately 365 documents—comprising some 1285 pages—in response to the

Document Requests.

By order of this Court dated September 20, 2010 (the “Scheduling Order”) [Adv.

Docket No. 46], this Court extended the time, through October 8, 2010, for NVR (i) to

oppose the Motion to Dismiss and (ii) to file a motion for summary judgment in its favor.

In the Scheduling Order, the Court also fixed October 29, 2010, as the date by which the

Debtors may submit reply papers in further support of the Motion to Dismiss and oppose

any motion for summary judgment of NVR. On October 8, 2010, NVR filed the Motion

for Summary Judgment and a memorandum of law in support thereof (the “NVR Mem.”)

[Adv. Docket No. 48].

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