Buyers and sellers of distressed debt should be aware of the recent decision in the Fisker bankruptcy case, In re Fisker Automotive Holdings, Inc., 2014 WL 210593 (Bankr. D. Del.), which drastically limited the right of a secured creditor to credit bid its $168 million claim to the purchase price of the loan, $25 million, as application of the reasoning of this case may have disastrous implications for both buyers and sellers of distressed debt.

Facts of the Fisker Case

Fisker Automotive Holdings, Inc. and Fisker Automotive, Inc. (collectively, “Fisker”) developed and sold luxury plug-in hybrid electric cars. Fisker defaulted under its secured loan, which loan was acquired by the Department of Energy (the “DOE”). The DOE sold the loan at auction. Hybrid Tech Holdings, LLC (“Hybrid”) was the highest bidder at the auction sale and purchased the secured loan for $25 million. At the time of the purchase, the unpaid principal balance was $168 million.

After buying the loan at auction, Hybrid entered into an asset purchase agreement with Fisker pursuant to which Hybrid was to acquire substantially all of the assets of Fisker for $75 million in the form of a credit bid. Fisker then filed for Chapter 11 bankruptcy relief to complete the sale and then administer the Chapter 11 bankruptcy estates through a joint liquidation plan.

Shortly after the bankruptcy case was filed, Fisker filed a motion to approve the sale of substantially all of its assets to Hybrid under the terms of the asset purchase agreement. The Official Committee of Unsecured Creditors (the “Committee”) objected to the sale on various grounds. In particular, the Committee objected to Hybrid’s right to credit bid and instead proposed an auction based on a bid received from Wanxiang America Corporation (“Wanxiang”). (Although not found in the opinion, Wanxiang was apparently an unsuccessful bidder at the auction sale for the loan to Fisker).

The Ruling in the Fisker Decision

The Delaware Bankruptcy Court sustained the Committee’s objection and denied Fisker’s motion to approve the sale of its assets. The Court required Fisker to conduct an auction and limited the amount of Hybrid’s credit bid to $25 million, the amount that Hybrid paid for the purchase of the loan at the DOE auction.

The Fisker Court’s analysis began with Bankruptcy Code Section 363(k) which provides as follows:

(k) At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed secured claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property. (Emphasis added).

Although the Fisker Court noted that Bankruptcy Code specifically authorized a secured creditor to credit bid its allowed claim, the bankruptcy court was authorized to order otherwise for cause. The Court’s primary concern was that Wanxiang expressly conditioned its bid to purchase Fisker’s assets on either eliminating Hybrid’s right to credit bid or limiting the credit bid to $25 million. The Fisker Court was concerned that if Hybrid’s credit bid was not limited, there would be no bidding thus no auction. In effect, the failure to limit Hybrid’s credit bid would not only “chill” the biding, it would “freeze” it. As a result, the Fisker Court found that limiting the credit bid furthered the public policy of “fostering a competitive bidding environment.”

The Fisker Court also noted that the Committee challenged the amount and extent of Hybrid’s secured claim and cited authority for the proposition that the holder of a lien, the validity of which has not been determined, may not credit bid its lien. However, if the Fisker Court was relying on this authority, the Court could have first determined the validity of Hybrid’s lien or denied Fisker’s right to credit bid in any amount.

Possible Implications of the Fisker Decision

The Fisker decision is disturbing on a number of fronts. Even if this decision is not precedential, it would seem that the reasoning of the Fisker decision can be used by an unscrupulous creditors committee, or a disgruntled creditor who may have unsuccessfully tried to purchase a debtor’s secured loan, to deprive a creditor of its right to credit bid by manufacturing a dispute to the creditor’s loan.

The practical implications of the Fisker decision may also greatly impair the recovery of the purchaser of the distressed loan. For example, assume a similar factual situation as the Fisker case but to keep the math simple, assume that although the amount of the Hybrid’s successful bid for the Fisker loan is $25 million, the balance owed to Hybrid under the loan is $100 million. Assume further that like the Fisker case, the borrower (Fisker) files for bankruptcy relief, seeks to sell the collateral for the loan pursuant to a sale under Bankruptcy Code Section 363. Further assume that the bankruptcy court limits Hybrid’s credit bid at $25 million, but unlike the Fisker case, the rival bidder purchases the collateral for $25,000,001. In addition, to make the hypothetical more interesting, assume that bankruptcy estate has assets of $75 million unrelated to the sale of the collateral. After the sale of the collateral at the 363 sale, Hybrid’s remaining claim is unsecured, junior to administrative claims of the debtor (Fisker) and a possible substantial tax claim for the $75 million forgiveness of Fisker’s claim to Hybrid, which tax claim may have been greatly reduced or even eliminated if Hybrid were permitted to credit bid in the full amount of its debt. Not a fair result for the buyer of the distressed loan.

Although there is little discussion in the Fisker decision as to how the court became aware of the amount of Hybrid’s successful bid for the Fisker loan, perhaps a more disturbing result for buyers of distressed debt, if the reasoning of the Fisker case is applied by other courts, is the possibility of either the court or another party compelling the purchaser of the secured debt to disclose the amount of the purchase price of the loan. Aside from an application of the Fisker decision, the purchase price should otherwise have absolutely no bearing on the amount of the purchaser’s secured claim, the amount of its credit bid or the amount of its ultimate recovery from the borrower.