Client Alert - Third Circuit Ruling in Philadelphia Newspapers Case


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Client Alert - Third Circuit Ruling in Philadelphia Newspapers Case

  1. 1. Financial Restructuring and Insolvency North America Client Alert Third Circuit Permits Debtors to Block Credit Bidding in Plan Sales March 2010 It has been a basic principle of American commercial law that secured creditors have the right to credit bid up to the full face amount of their debt at an auction sale of their collateral. Last week, however, the United States Court of Appeals for the Third Circuit created a bankruptcy plan exception to this well-established rule. It held in In re Philadelphia Newspapers, LLC1 that a debtor can prevent a secured lender from credit bidding simply by designating its intent to provide the secured lender with the “indubitable equivalent” of its interest in the collateral under a bankruptcy plan, over the secured lender’s objection, forcing the secured lender to accept the result pursuant to the “cramdown” provisions of section 1129(b)(2)(A)(iii) of the Bankruptcy Code.2 For further information please The Third Circuit’s 2-1 decision is expected to have an immediate material contact impact, especially since it is now controlling precedent in the popular bankruptcy venue of Delaware. The decision, however, contains two important practical David F. Heroy limitations plus a vigorous and well-reasoned 49 page dissent from Judge Partner Thomas L. Ambro, a leading Circuit-level bankruptcy authority. Thus, its long- Chicago +1 312 861 3731 term effect may be questionable. In Philadelphia Newspapers, the Debtor owned and operated two print Carmen H. Lonstein newspapers, the Philadelphia Inquirer and Philadelphia Daily News, and the Partner online publication To finance the acquisition of these assets in 2006, Chicago the Debtor entered into a loan agreement granting its lenders (the “Lenders”) a +1 312 861 8606 first priority lien in substantially all of the Debtor’s real and personal property. The face amount of the loan was $318 million when the Debtor filed its chapter 11 petition in February 2009. Contributing Author The Debtor then filed a chapter 11 plan providing for the auction sale of Lawrence P. Vonckx substantially all of its assets free of liens, including an asset purchase agreement Associate with a stalking horse bidder for $37 million cash. Under the plan, the Lenders Chicago were to receive the $37 million sales proceeds plus title to the Debtor’s +1 312 861 8803 Philadelphia headquarters (valued at $29.5 million) subject to two year’s free rent concession to the winning bidder. In addition, the stalking horse bidder had extensive insider connections as noted by the dissent. Baker & McKenzie LLP One Prudential Plaza 130 East Randolph Drive The Debtors moved to prevent the Lenders from credit bidding at the sale. The Chicago IL 60601 Lenders opposed it on the grounds that the plan with a sale that precluded credit United States of America bidding could not be “crammed down.” The Bankruptcy Court agreed with the Lenders and denied the motion, finding that it was a sale pursuant to the terms of _______________________________ 1 In re Phila. Newspapers, 2010 U.S. App. LEXIS 5805 (3d Cir. Mar. 22, 2010). 2 11 U.S.C. §1129(b)(2)(A)(iii).
  2. 2. a plan. Specifically, the Court reasoned that subsection (ii) of the Bankruptcy Code’s “cramdown” section 1129(b)(2)(A) expressly provides for credit bidding by secured creditors where “the plan provides for the sale…of any property that is subject to the liens”3 of the secured creditors. On appeal, the District Court surprisingly reversed the Bankruptcy Court. It held that the Bankruptcy Code provides no legal entitlement for a secured lender to credit bid at an auction of its collateral pursuant to a plan, despite the plain language of subsection (ii) mentioned above. Instead, the District Court ruled that, so long as the debtor declares that it intends to seek confirmation of its plan under subsection (iii) of section 1129(b)(2)(A) that requires a plan to provide the secured creditor with the “indubitable equivalent” of its interest in the collateral, it does not have to comply with subsection (ii) that allows credit bidding at the same sale. The District Court’s technical rationale was that section 1129(b)(2)(A) was unambiguous, containing three independent “routes” to a cramdown plan confirmation that were separated by the disjunctive “or,” so that a debtor could elect to proceed under any of those three, independent routes regardless of whether the substance of the plan – in this case a sale of the lender’s collateral – meant that another subsection should apply. The Third Circuit affirmed, largely following the District Court’s reasoning. Judge Ambro’s 49 page dissent, however, could not have disagreed more strongly with the majority’s opinion. Judge Ambro observed that several rules of statutory construction, the wording and purpose of the Bankruptcy Code taken as a whole, plus the legislative history “all point to the conclusion that the Code requires cramdown plan sales free of liens to fall under the specific requirements of § 1129(b)(2)(A)(ii)” and to provide for credit bidding by the secured lender.4 Judge Ambro also noted that it should be the plan’s content, not a debtor’s election, that determines which of the three alternative cramdown requirements of section 1129(b)(2)(A) must be satisfied. Despite its novel holding, there are practical reasons why this opinion may not be the end of the story, either for the Philadelphia Newspapers case or for credit bidding in general. First, the Lenders could still bid cash at the auction in Philadelphia Newspapers and have the proceeds repaid to themselves, accomplishing essentially the same economic result as credit bidding. In fact, the Lenders last week stated their intention to do just that. Also, the majority opinion in Philadelphia Newspapers clearly stated that, after the auction sale, the Debtor must still show that the Lenders received the “indubitable equivalent” of their claim under subsection (iii) of section 1129(b)(2)(A) to confirm its plan, which means that the sales price must have equaled the value of the collateral despite no credit bidding. This could be impossible for the Debtor to show because the Third Circuit has previously held that credit bidding establishes the value of collateral sold at auction.5 For both of these practical reasons, this case thus could prove to be a Pyrrhic victory for the Debtor. The Lenders in Philadelphia Newspapers also stated their intention to seek an immediate en banc review of the decision from the full panel of Third Circuit judges. En banc review is rarely granted. Considering the strong dissent from _______________________________ 3 11 U.S.C. §1129(b)(2)(A)(ii). 4 Phila. Newspapers at *58. 5 In re SubMicron Systems Corp., 432 F.3d 448 (3d Cir. 2006). 2 Third Circuit Permits Debtors to Block Credit Bidding in Plan Sales çMarch 2010
  3. 3. Judge Ambro and the history of the Third Circuit holding en banc hearings on important bankruptcy issues, however, it is possible that the Third Circuit would grant a request for en banc review and reverse. In addition, even though U.S. Supreme Court review may be unlikely at this time, the importance and controversial nature of the issue could lead to U.S. Supreme Court review after a relatively short time period. From a policy perspective, the Philadelphia Newspapers decision also may not be possible to sustain in the long term. After all, its practical effect is to hold that Congress, by enacting the Bankruptcy Code, intended to provide debtors with the ability to circumvent well-settled common law jurisprudence that allows credit bidding for secured lenders. No legal or factual basis has been articulated for this result, in the Philadelphia Newspapers majority opinion or elsewhere, and other courts likely will consider Judge Ambro’s dissent seriously before following this ruling for this reason, too. In summary, and despite its drawbacks, the Philadelphia Newspapers ruling nonetheless poses a significant risk for secured lenders. Purchasers of senior debt, particularly where credit bidding is part of a loan-to-own strategy, should take this ruling into account as a significant risk factor. For debtors seeking to avoid credit bidding or to obtain additional leverage over secured creditors, this ruling provides an additional incentive for filing in Delaware so as use the ruling as controlling Third Circuit precedent. Conversely, for debtors that rely on senior secured creditor funding to file for chapter 11 relief, it could motivate their lenders to insist on filing for chapter 11 relief anywhere but Delaware (or the Fifth Circuit).6 Regardless, in Philadelphia Newspapers the Third Circuit has triggered a debate that is likely to affect secured creditors in bankruptcy and generate significant controversy for the foreseeable future. _______________________________ 6 Bank of New York Trust Co., NA v. Official Unsecured Creditors' Comm. (In re Pacific Lumber Co.), 584 F.3d 229 (5th Cir. 2009). The Fifth Circuit in this case reached a similar conclusion as the Third Circuit. ©2010 Baker & McKenzie. All rights reserved. Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an “office” means an office of any such law firm. This may qualify as “Attorney Advertising” requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome. 3 Third Circuit Permits Debtors to Block Credit Bidding in Plan Sales çMarch 2010