Chapter II Credit Bidding Generally

• Jurisdiction: United States

Chapter II Credit Bidding Generally

A. The Policy Behind Credit Bidding

Credit bidding allows a secured creditor to compete with cash bids from third parties by allowing the secured creditor to bid up to the full amount of the secured obligation in a sale held by the debtor's estate of the property subject to the secured creditor's lien. Credit bidding enables the secured creditor to realize what it believes to be the full value of its collateral, insulates the secured creditor from being cashed out at a time of depressed asset values, and protects the secured creditor from the risk of suffering a "bankruptcy discount," which some assert can occur in connection with chapter 11 sales.³

While a secured creditor is generally not entitled to recover in bankruptcy more than the allowed amount of its claim, if the secured creditor views the proposed cash sale price of its collateral to be inadequate and the proceeds do not pay its claim in full, it can, by making a credit bid, obtain possession of its collateral rather than accept the proceeds of a sale. Credit bidding avoids the transaction costs associated with preparing and financing a cash bid (even one where most or all of the cash would ultimately be returned to the secured creditor), and, by permitting the secured creditor to bid with money already invested, it eliminates liquidity constraints that might otherwise prevent the secured creditor from bidding. The right to credit bid in effect permits the secured creditor to establish an "upset price" at the bankruptcy sale, thereby affording the secured creditor a "seat at the table" when the sale of its collateral is contemplated.

In addition to protecting secured creditors, credit bidding can provide meaningful benefits to the bankruptcy estate. By hypothesis, the estate is seeking to maximize the value of the collateral (and to reduce unsecured deficiency claims against the estate when the proceeds of a sale are applied to the secured obligations). Credit bidding both enlarges the frequently small pool of bidders capable of submitting meaningful bids on the often-compressed timetable for a bankruptcy sale (theoretically leading to higher and more competitive bids), and discourages favoring "white knight" or insider bidders, who may have perverse incentives and may not offer the "highest and best" bids.⁴

On the other hand, it has been argued that credit bidding "chills" bidding by third parties by permitting the secured creditor to "overbid" with currency that may be of little or no value (namely, the secured creditor's deficiency claim). Secured creditors would argue that this criticism is misplaced. If the value of the collateral is less than the amount of the secured creditor's claim, the argument goes, the secured creditor would not credit bid if it expected third parties to offer a fair price in the absence of a competing bid from the secured creditor. The secured creditor would be the one who would suffer if appropriately priced bids were deterred.

B. In re Delphi Corporation: An Illustration of the Value of Credit Bidding

The chapter 11 case of Delphi Corp., an automotive parts supplier (and former unit of General Motors Corp.), provides a useful illustration of how credit bidding can serve the interests of both secured creditors and the estate.⁵ In the spring of 2009, Delphi disclosed its proposal to sell the majority of its assets to a company organized by Platinum Equity (a private-equity firm) in a sale pursuant to § 363 of the Bankruptcy Code.⁶ The proposed transaction with Platinum Equity had the backing of the U.S. government, having been brokered in part by the government's auto task force and General Motors.

The administrative agent for Delphi's secured post-petition debtor-in-possession credit facility and certain lenders thereunder objected to the proposed sale of their collateral, alleging that the deal, which would have left the lenders with a substantial loss, was for a woefully inadequate price and was "negotiated secretly without a proper auction."⁷ These parties requested additional time to evaluate the proposed transaction and to determine whether to counterbid (including by way of a full or partial credit bid).⁸ In response, Delphi argued that the offer by Platinum Equity was the only feasible deal on the table.⁹

U.S. Bankruptcy Judge Robert Drain sided with the lenders, agreeing to allow them the opportunity to formulate a competing bid. Among other things, in response to Delphi's efforts to consummate the sale to a third party without a proper auction or at least giving the lenders the opportunity to credit bid, Judge Drain observed, "What's so special about Platinum?... As far as I'm concerned, they're just guys in suits. Why can't other guys in suits pay more?"¹⁰ When the sale process opened, the lenders struck a deal with Delphi and General Motors,¹¹ pursuant to which the lenders would forgive a substantial portion of the $3.5 billion owed under the post-petition debtor-in-possession facility (a "credit bid" of such amount) in exchange for the transfer of a majority of Delphi's assets to a new company, Delphi Automotive, owned in part by the lenders and General Motors. This transaction ultimately was approved by Judge Drain and closed on July 30, 2009.

On March 31, 2011, Delphi redeemed the equity interests in Delphi Automotive owned by General Motors and the Pension Benefit Guaranty Corporation at a price representing a substantial premium over the amount of the secured post-petition debtor-in-possession credit facility.¹² On Nov. 16, 2011, Delphi priced its initial public offering at $22 a share, raising $530 million and valuing the company at approximately $7.22 billion. As this transaction demonstrates, Delphi is a prime example of how credit bidding in bankruptcy can protect secured creditors when the bankruptcy process fails to elicit an adequate sale price for their collateral. Importantly, the concerns of the secured lenders about the proposed § 363 sale in Delphi could equally have arisen in connection with a sale under a plan.

C. Credit Bidding Under...