The United States’ brief highlights the importance of credit bidding to parties that cannot cash bid. A brief filed on behalf of a coalition of financial-industry trade groups highlights the potential adverse effects that prohibiting credit bidding may have on credit markets.  Finally, two groups of law professors filed briefs arguing that a plan that denies a secured creditor the right to credit bid is not fair and equitable and cannot be confirmed.  Prior coverage of the petitioners’ brief can be found here and coverage of the decisions below can be found here.

Principal Argument: Alternative Grounds for Requiring Credit Bidding

Both briefs submitted by the law professors argue that a plan that provides for the sale of assets free and clear of liens and encumbrances without permitting a secured creditor to credit bid is not fair and equitable.

The U.S. and one group of law professors contend that a plan that prohibits credit bids cannot be confirmed because it does not provide the secured creditor with the indubitable equivalent of its claim.  Accordingly, even if the Court were to determine that under the plain language of section 1129[LINK] a plan proponent may – in theory – propose a sale free and clear of liens and encumbrances under section 1129(b)(2)(A)(iii), the plan cannot be confirmed if it does not allow credit bidding, because it fails to satisfy the substantive requirement that the plan provide the secured creditor with the indubitable equivalent of the creditor’s claim.

In support of this argument, the professors argue that legislative history indicates that the indubitable equivalent language found ins section 1129(B)  is intended to follow the “strict approach” taken by Judge Learned Hand in In re Murel Holding Corp., 75 F.2d 941 (2d Cir 1935) in which Judge Hand coined the phrase “indubitable equivalence.”  In Murel, the court indicated that secured creditors are entitled to receive “money or at least the property” and that the only way to deprive the creditor of that right is to provide the “most indubitable equivalence.”  Accordingly, a plan that proposes to sell encumbered property must ensure that the secured creditor has an opportunity to recover the property or the full value of the property.

To ensure that the secured creditor has the best opportunity to obtain this recovery, the sale must allow credit bids because Congress and the Court have recognized that credit bidding is an essential tool to ensure that secured creditors rights are not extinguished without the secured creditor receiving the full value of the collateral. As stated in the U.S.’s brief, the proceeds of a sale that occurred without the crucial protection provided by credit bids is not the indubitable equivalent of the claim, it is the equivalent of a third party’s valuation of the claim.

Other Considerations Raised in the Amici Briefs

The United States:

• The right to credit bid is essential because under the Anti-Deficiency Act, the federal government is prohibited from making a cash bid unless Congress has appropriated such funds.
• In this case, the likely reason that the petitioners crafted bid procedures prohibiting credit bids was to ensure that the stalking horse bidder – expected to be owned in part by current management – would be able to purchase the assets at a lower price.  Credit bidding serves to protect against management favoritism and other similar ills.

The financial-industry trade groups:

• Certain mutual funds and REMICs are prohibited under their organizational documents from raising cash to purchase new assets even if that cash is returned upon plan confirmation.
• No legitimate purpose is served by disallowing credit bids, because credit bidding results in greater recoveries to the estate.  Denying credit bidding will “enable debtors to steer their assets to lower bidders favored by . . . management, enriching insiders at creditors’ expense” and “provides an invitation to mischief with no offsetting benefits.”
• Disallowing credit bidding will lead to higher borrowing costs and ultimately harm debtors and the economy.

The law professors:

• Funds spent on fees and expenses associated with financing a cash bid are directly diverted from the estate to the party providing the financing because the secured creditor must reduce its bid to pay the fees.
• Allowing secured creditors to credit bid will not dissuade cash bidders from attending an auction because a creditor will only outbid the cash bid if the creditor truly believes that the collateral is worth more than the highest cash bid.  Creditors have no incentive to arbitrarily credit bid the maximum amount of their claim because they would then be passing up the opportunity to cash out at the true value of the collateral.
• A secured creditor’s right to credit bid has been recognized by the Court as a property right and, absent an express indication from Congress to the contrary, it is implausible that Congress intended to extinguish this right.

Restructuring Review will summarize the reply brief filed by the petitioners on March 30, 2012, and provide in-depth analysis from legal and financial observers as the scheduled date for oral arguments approaches.