Chapter V Credit Bidding in Practice

• Jurisdiction: United States

Chapter V Credit Bidding in Practice

Secured lenders often seek to protect their right to credit bid at various stages in the life cycle of the loan: when entering into the initial loan documentation (including an intercreditor agreement), upon approval of debtor-in-possession financing at the outset of a bankruptcy case (often with such financing being provided by the pre-petition secured lender), upon approval of bid procedures, and at the auction itself. This chapter addresses the actions that secured parties can take to maximize their chances of being able to credit bid at a sale of their collateral.

A. Intercreditor Provisions Protecting Senior and Junior Secured Lenders' Right to Credit Bid

When there are multiple secured creditors of a borrower, secured by the same collateral, their relative priority and rights and remedies with respect to such collateral are generally set forth in an intercreditor agreement. One of the rights that both senior and junior lienholders often seek to protect in an intercreditor agreement is the right to credit bid. Section 363(k) of the Bankruptcy Code does not address the rights or restrictions on credit bidding as between senior and junior lenders.

In negotiating an intercreditor agreement, the senior lienholder will want to ensure that the junior lienholder will not interfere with the senior lienholder's right to credit bid. While intercreditor agreements routinely provide that the senior lienholder has the exclusive right to exercise all remedies against collateral and may do so free from objection by the junior lienholder,¹⁸⁰ in order to avoid any ambiguity it is important that exercising the right to credit bid be expressly enumerated as one of those rights.¹⁸¹

From the junior lienholders' perspective, they want to make sure that they have the right to credit bid if they are willing to pay enough cash to pay off the senior lienholders.¹⁸² This is to ensure that the prohibition on junior lienholders enforcing rights and remedies against the collateral would not preclude them from offering a bid that is part cash (sufficient to pay the senior lienholders in full) and part credit bid.

B. Addressing "For Cause" Disallowance

As discussed above, a secured creditor's right to offset its allowed secured claim, including any deficiency, by credit bidding is qualified by the ability of the bankruptcy court to order otherwise "for cause."¹⁸³ The "for cause" inquiry is highly fact-intensive and thus may create substantial uncertainty regarding the secured creditor's rights in a prospective sale process. Therefore, secured creditors sometimes seek to resolve the "for cause" issue in advance of sales through language in a court order, usually in connection with debtor-in-possession financing or bidding procedures.

DIP lenders may seek language in the order approving their post-petition financing (DIP order) declaring their right to credit bid their related secured claim. For example, the DIP order in the Hawker Beechcraft case provided:

The DIP Agent, at the direction of the Required DIP Lenders, shall have the unqualified right to credit bid up to the full amount of the outstanding DIP Obligations in any sale of any DIP Collateral under or pursuant to (i) section 363 of the Bankruptcy Code, (ii) a plan of reorganization or a plan of liquidation under section 1129 of the Bankruptcy Code, or (iii) a sale or disposition by a chapter 7 trustee for any Debtor under section 725 of the Bankruptcy Code.¹⁸⁴

Similarly, the DIP order in the Coda Holdings case contained the following provision:

The DIP Agent and DIP Lenders, directly or through a designee, shall have the unqualified right to credit bid up to the full amount of the DIP Obligations, as a stalking horse bidder or otherwise, in any sale of any portion of the DIP Collateral, whether pursuant to an Auction or a plan of reorganization under section 1129 of the Bankruptcy Code or otherwise.¹⁸⁵

The provisions in the Hawker Beechcraft and Coda Holdings DIP orders expressly preserve the DIP lenders' credit bidding rights under a plan of reorganization, which, in light of the Supreme Court's decision in RadLAX, is no longer necessary to fend off an attempt to avoid the secured creditor's right to credit bid through the indubitable equivalent standard in § 1129(b)(2)(A). However, the "for cause" exception in § 363(k) is applicable to credit bidding under a plan, so if the secured creditor is aiming to ensure that it is not denied the right to credit bid "for cause" under any circumstances, it is prudent to reference both sales under § 363 and sales under a plan of reorganization, as well as sales by a chapter 7 trustee in the event that the case is converted from a case under chapter 11 to a case under chapter 7.

When sought as part of the ordinary DIP financing process, language like that quoted above raises the issue of cause early in the case, usually at the "first day" hearing. Upon entry of a final DIP order, contesting a finding that the DIP lender has "the unqualified right" to credit bid later in the case would seemingly be extraordinarily difficult, given the statutory protection of the finality of DIP orders.¹⁸⁶

It is important to note that the protection in Hawker Beechcraft and Coda Holdings was provided to the lenders providing post-petition financing, rather than the existing pre-petition secured lenders. Unless pre-petition secured lenders are providing significant value to the estate in the form of new post-petition financing or consent to use of cash collateral, it would be more challenging to obtain such a protection for a pre-petition secured lender. In the Legend Parent case, for example, the DIP order provided that "[t]he DIP Agent ... shall have the unqualified right to credit bid up to the full amount of the DIP Obligations in any sale or other disposition of the Prepetition First Lien Collateral."¹⁸⁷ However, the DIP order included similar language in favor of the pre-petition agent, but with one significant difference: Unlike the DIP agent, the pre-petition agent's right to credit bid was not truly unqualified, but rather was subject to challenge "for cause," within 60 days of entry of the final DIP order.¹⁸⁸

C. Collective Action and Credit Bidding Under a Syndicated Loan Facility

In many large chapter 11 cases, pre- and post-petition loans are structured as syndicated financings whereby there is one financial institution that serves as the administrative agent for the loan facility, but a syndicate of lenders, often a combination of banks and hedge funds, extends the credit. The issue that often arises with respect to syndicated credit facilities is whether (1) a credit bid cannot be accomplished with less than 100 percent of the lenders in support of such bid; (2) less than 100 percent of the lenders can credit bid the entire loan facility (or the administrative agent can bid on their behalf), thus dragging along the loans held by the non-consenting lenders; or (3) less than 100 percent of the lenders can credit bid their loans, leaving the loans held by the nonconsenting lenders outstanding.

In support of option (1) above, most credit facilities provide that no amendment, waiver or modification of a loan that, among other things, waives the right to receive principal and interest on the loan may be entered into without the consent of each lender. Because a credit bid of the entire loan amount would leave any nonconsenting lenders without any further right to receive principal and interest on their loans, one could argue that such a credit bid would constitute an amendment, waiver or modification of the loan agreement that would require the consent of each and every lender. On the other hand, in support of option (2) above, a typical loan facility also provides that when the borrower is in default, the administrative agent may, and shall at the request of lenders holding a simple majority or supermajority of the outstanding loan amount, exercise rights and remedies against the collateral.

The question that courts have grappled with is whether a credit bid by the administrative agent upon the direction of the required lenders is an amendment or modification of the loan document that waives the rights of nonconsenting lenders to receive principal and interest, or an exercise of rights and remedies against the collateral that can be accomplished with just required lender — instead of unanimous — consent. Recent cases have uniformly come out on the side of the latter, supporting a majority's right to "collective action" following a borrower default.

For example, in In re GWLS Holdings Inc.,¹⁸⁹ a lender holding $1 million of the $366 million in outstanding first-lien debt argued that absent that lender's consent, the first-lien agent could not credit bid. The lender relied on the following language of the credit agreement:

[N]o such waiver and no such amendment, supplement or modification shall (i) release all or substantially all of the Collateral ... without the consent of all Lenders.¹⁹⁰

The court rejected the lender's argument, relying instead on the language of § 6.6 of the collateral agreement — a document executed contemporaneously with the credit Agreement — which stated:

If an Event of Default shall occur and be continuing, the Collateral Agent, on behalf of the other Secured Parties, may exercise

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