Summary

Initially it seemed a universal truth that the holders of senior secured debt, regardless of whether purchased at a discount, had the right to credit bid at a Bankruptcy Code section 363 sale of their collateral, the face (par) value of the secured debt. However, in at least two recent cases, certain bankruptcy courts seemed to limit credit bidding rights to encourage competitive bidding at auction. Now, in the case of Aéropostale, Inc., Case Number 16-11275 (SHL), the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”), after a lengthy trial, found that the facts did not support limiting credit bidding rights – even if there might be a more robust auction.

By way of background, section 363(k) of the Bankruptcy Code provides that in a section 363 sale, property subject to a lien “that secures an allowed claim,” the secured creditors may bid at the auction the secured “claim against the purchase price of such property.” 11 U.S.C. § 363(k). However, in some less than clear language, section 363(k) limits credit bidding rights  if “the court for cause orders otherwise.”    

In the case of In re Fisker Automotive Holdings, Inc., Case Number 13-13087 (Bankr. D.Del. Jan. 17, 2014), the United States Bankruptcy Court for the District of Delaware limited the secured creditor’s credit bid to the actual amount paid by the holder of the secured debt as opposed to the actual amount of the debt. The Fisker court, relying on testimony indicating insider collusion and the prior decision in In re Philadelphia Newspapers, stated that, “[a] court may deny a lender the right to credit bid in the interest of any policy advanced by the Code, such as to . . . foster a competitive bidding environment.” Despite the bad conduct found in Fisker, the decision left open the risk that any right to credit bid may be limited by a secured creditor or a creditor that bought debt at a discount if it might chill bidding.

Subsequently, in In re The Free Lance-Star Publishing Co. of Fredericksburg, VA, 512 B.R. 798 (Bankr. E.D. Va. 2014), the court found, based on the testimony at a brief hearing, that the secured creditor had engaged in inequitable conduct which led the court to limit the amount of the secured creditor’s right to credit bid to an amount below the face value of the debt.  However, even more troubling for secured lenders, the court in the Free Lance-Star case, the Bankruptcy Court for the Eastern District of Virginia quoted Fisker and Philadelphia Newspapers for the proposition that a court may deny a lender the right to credit bid to foster a competitive bidding environment. 

This leads us to the recent decision from the Aéropostale bankruptcy case.  Prior to its bankruptcy filing, Aéropostale was a party to a loan and security agreement with MGF Sourcing Holdings, Limited and Aero Investor LLC (collectively, the “Lenders”).  The Lenders are both affiliates of Sycamore Partners (“Sycamore”), a private equity firm that specializes in retail and consumer investments.  In addition to the Lenders, Sycamore owns MGF Sourcing US, LLC (“MGF”), one of two of Aéropostale’s principal suppliers.  Due to Aéropostale’s deteriorating financial condition, MGF amended its payment terms with Aéropostale, and required Aéropostale to make up-front payments in connection with merchandise ordered with MGF.  Upon its bankruptcy filing, Aéropostale claimed that MGF “unreasonably” altered its payment terms, which led Aéropostale to file for bankruptcy.  Based on MGF’s actions, Aéropostale filed a motion seeking to subordinate the Lenders’ lien and prohibit the Lenders from credit bidding at any sale.  Aéropostale sought the requested relief based on alleged “inequitable” conduct by the Lenders and MGF, and the negative impact the Lenders’ right to credit bid would have had on the bankruptcy case.  After a lengthy trial and testimony from representatives of Aéropostale and the Lenders, the Bankruptcy Court denied Aéropostale’s motion.  In regard to Aéropostale’s allegations of inequitable conduct, the Bankruptcy Court found that: (1) based on Aéropostale’s financial condition, MGF was well within its contractual rights to amend Aéropostale’s payment terms; and (2) Sycamore and its affiliates acted reasonably in protecting their respective financial interests.

In addition to addressing Aéropostale’s claims of inequitable conduct, the Bankruptcy Court addressed whether “cause” exists to limit the Lenders’ right to credit bid. After a thorough analysis, the Bankruptcy Court rejected Aéropostale’s position, and granted the Lenders the right to credit bid the full amount of their respective claims. The Bankruptcy Court explicitly stated that the chilling of bidding alone is not sufficient grounds to limit the Lenders’ right to credit bid, and that some other factor (i.e., validity of secured status or inequitable conduct) must be present to limit a Lender’s right to credit bid. Additionally, the Bankruptcy Court looked to the factual record before it and determined that the record reflects active interest by third parties in Aéropostale’s assets.  Based on the foregoing, the Bankruptcy Court denied Aéropostale’s request to restrict the Lenders’ right to credit bid solely on the basis of the “chilling” of the bidding.

In Aéropostale, the Bankruptcy Court seems to back away from simply encouraging bidding and emphasizes that credit bidding provides a safeguard for secured creditors, by insuring against the undervaluation of their collateral at an asset sale. The court notes that the ability to credit bid helps to protect a creditor against the risk that its collateral will be sold at a depressed price and  enables the creditor to purchase the collateral for what it considers the fair market price (up to the amount of its security interest) without committing additional cash to protect the loan. 

The Bankruptcy Court here looked at the facts presented and concluded the Lenders’ right to credit bid was appropriate without consideration of the possible “chilling” of bidding.   Additionally, the Bankruptcy Court, when addressing Aéropostale’s equitable subordination claim (subordinating the Lenders’ liens solely to the extent necessary to offset the harm which the bankruptcy and its creditors suffered on account of the inequitable conduct), focused not on opening up bidding, but on truly inequitable conduct that directly impacts the estate or the bidding process. Alternatively, the court focused on limiting credit bidding when the validity of a creditor’s lien actually is in dispute.