On May 29, 2012, the U.S. Supreme Court in RadLAX Gateway Hotel v. Amalgamated Bank,1 its first significant Chapter 11 opinion in several years, affirmed the U.S. Court of Appeals for the Seventh Circuit’s decision in River Road Hotel Partners v. Amalgamated Bank,2 prohibiting a debtor from selling assets free and clear of liens under a plan of reorganization without permitting a secured creditor to credit bid. RadLAX resolves a circuit split and reverses prior rulings of the U.S. Court of Appeals for the Third and Fifth circuits endorsing proposed plan sales that did not provide secured creditors with the right to credit bid.

Last July, this column urged the court to affirm the Seventh Circuit if given the opportunity, and restore secured creditors’ right to credit bid. Writing for a unanimous 8-0 court, Justice Antonin Scalia did just that. In a relatively short opinion, relying almost exclusively on a textual analysis of Bankruptcy Code §1129(b)(2)(A), Scalia characterized the decision as “an easy case” and affirmed.

Statutory Background

Bankruptcy Code §1129(b)(2), also known as the “cramdown” provision, allows a debtor to confirm a plan of reorganization over the dissent of an impaired class of secured creditors if a court determines that the proposed cramdown is “fair and equitable” with respect to any class of creditors who have voted to reject the plan.

Section 1129(b)(2)(A) provides three options that constitute fair and equitable treatment of a secured creditor. Under subsection (i), a plan is fair and equitable if the secured creditor retains its lien on the collateral and receives deferred cash payments. Under subsection (ii), the debtor may sell the collateral free and clear of the liens, but the creditor must be allowed to credit bid at such sale and retains a lien on the proceeds of such sale. Subsection (iii) provides that a plan is fair and equitable if it provides the secured creditor with the “indubitable equivalent” of the secured claim; there is no credit bid right under this prong.

Circuit Split

Until 2009, the generally accepted view among bankruptcy practitioners was that, in the event a debtor sought to sell collateral under a plan free and clear of liens, its secured creditor had a corresponding right to credit bid at the sale of such collateral.

In 2009, the Fifth Circuit in In re Pacific Lumber3 held that a plan that sold property free and clear could also be confirmed under subsection (iii) of §1129(b)(2)(A). The Fifth Circuit held that so long as the plan, which contemplated the sale of assets, provided the secured creditor with the “indubitable equivalent” of its claim, the plan could be confirmed even if the secured creditor was not allowed to credit bid.

The Third Circuit reached the same conclusion in 2010 in In re Philadelphia Newspapers, which included a notable dissent from Circuit Judge Thomas Ambro.4 In 2011, the Seventh Circuit in River Road departed from these circuit court decisions and ruled that a plan that provides for the sale of collateral free and clear of liens must be sold pursuant to subsection (ii) and grant secured creditors the right to credit bid.

Background

In 2007, RadLAX Gateway Hotel, LLC borrowed approximately $142 million from Longview Ultra Construction Loan Investment Fund (the lender) to fund the purchase and renovation of the Radisson Hotel at Los Angeles International Airport. Amalgamated Bank served as trustee on this loan, which was secured by a first lien on substantially all of RadLAX’s property in its favor.

By 2009, RadLAX was unable to complete the development of the property and service the loan. On Aug. 17, 2009, RadLAX filed a voluntary Chapter 11 case in the U.S. Bankruptcy Court for the Northern District of Illinois. Subsequently, RadLAX proposed a Chapter 11 plan that contemplated an auction of its assets under bid procedures that did not allow the lender to credit bid. The proceeds of the auction would be primarily used to pay the lender.

Because Amalgamated did not intend to accept the plan on behalf of the lender, the plan could only be confirmed non-consensually, or “crammed down,” under §1129(b)(2)(A) of the Bankruptcy Code. Amalgamated objected to the proposed bid procedures arguing that the bid procedures impermissibly vitiated its entitlement under subsection (ii) to credit bid the lender’s claims at a plan sale. RadLAX countered that it was not required to allow Amalgamated to credit bid because the plan could be confirmed under subsection (iii) as long as the court determined that the proceeds of the auction constituted the “indubitable equivalent” of the lender’s claim.

The bankruptcy court agreed with Amalgamated that RadLAX’s plan could not be confirmed under the indubitable equivalent prong because it violated subsection (ii), which requires a secured creditor the right to credit bid at the sale of its collateral.

RadLAX appealed this decision to the Seventh Circuit, which affirmed on textual and policy grounds.5 The court found that §1129(b)(2)(A) was ambiguous and that the better reading of the statute required plan sales to take place under subsection (ii). The court stated that it “could not conceive of a reason” Congress would require debtors to allow credit bidding in subsection (ii), then immediately nullify that requirement in the next subsection.6

The Seventh Circuit also held that bankruptcy sales conducted without credit bidding undermined a secured lender’s ability to obtain the indubitable equivalent of its claims. Given the Bankruptcy Code’s express endorsement of credit bidding in §§363(k) and 1129(b)(2)(A)(ii), the court concluded that Congress intended to protect secured lenders from the possibility of an underperforming auction by allowing them to credit bid. Accordingly, the court rejected RadLAX’s argument that proceeds from such a sale could satisfy the indubitable equivalent prong and held that an auction conducted without the right to credit bid lacked a “crucial check against undervaluation.”7

On Aug. 5, 2011, RadLAX filed a petition for a writ of certiorari seeking to appeal the Seventh Circuit’s ruling. On Dec. 12, 2011, the Supreme Court granted certiorari.

Summary of Arguments

In its brief before the Supreme Court, RadLAX focused on two arguments. First, it contended that use of the word “or” among the discrete prongs of §1129(b)(2)(A) allows the debtor to sell collateral under a plan by: (1) confirming a plan under subsection (ii) and allow credit bidding or (2) confirming a plan under subsection (iii) without permitting credit bidding so long as the sale proceeds comprise the indubitable equivalent of the secured creditor’s claim.

Second, RadLAX argued that allowing a sale without credit bidding satisfied the policies of the Bankruptcy Code because secured creditors are only entitled to protect the present value of their claim. Accordingly, so long as the creditor receives the present value of its claim under a plan proposed under subsection (iii)—i.e., the indubitable equivalent—the secured creditor will have received the same protection afforded under subsections (i) and (ii).

Amalgamated countered that RadLAX’s reading of the statute was flawed. First, it posited that the three subsections of §1129(b)(2)(A) are mutually exclusive, effectively channeling plans providing for the retention of a secured creditor’s lien to be confirmed under subsection (i), plans involving sales of collateral to be confirmed under subsection (ii), and all other plans to be confirmed under subsection (iii).

Second, Amalgamated cited to a well-established canon of statutory interpretation that provides when a specific statutory provision, such as subsection (ii), and a general statutory provision, such as subsection (iii), are both applicable to a given set of facts, the specific provision controls. Amalgamated also argued that prohibiting credit bidding undermines the Bankruptcy Code’s comprehensive framework of secured creditor protections, which were intended to protect secured creditors against undervaluation of their collateral.

Several amici curiae filed briefs in support of Amalgamated. Among the amici, the U.S. government argued in favor of vesting secured creditors with a clear right to credit bid at plan sales, noting that it would be adversely affected in its occasional capacity as a secured creditor if the court reversed the Seventh Circuit because, in the absence of a clear right to credit bid, it would face significant obstacles obtaining congressional authorization each time it sought to tender a cash bid. Several law professors argued that a sale of collateral without allowing credit bidding could not yield the indubitable equivalent of a secured creditor’s claim. The amici also argued that credit bidding was beneficial because it eliminates the fees associated with financing a cash bid and, ultimately, fosters greater participation at bankruptcy auctions.

The Decision

In an 8-0 opinion,8 the Supreme Court affirmed the Seventh Circuit, holding that a plan which contemplates the sale of collateral free and clear of liens must allow the secured creditor to credit bid. The court found that reading §1129(b)(2)(A) to allow a sale to take place under subsection (iii) when that sale was expressly prohibited by subsection (ii) would be “hyperliteral and contrary to common sense.”9

The court held that the canon of statutory interpretation stating that a specific provision controls over a general one applies to §1129(b)(2)(A) because subsection (ii) is a detailed provision that “spells out the requirements for selling collateral free of liens,” while subsection (iii) is “broadly worded” and does not mention a sale.10 Accordingly, although the language of subsection (iii) was broad enough to encompass a plan that proposed the sale of collateral, subsection (iii) did not apply to such a plan because such a plan was specifically addressed under subsection (ii).11

Next, the court addressed RadLAX’s argument that use of the word “or” unambiguously granted debtors the right to confirm a plan under subsection (iii), even if the plan in question could also be covered by subsection (i) or (ii). The court held that, under its interpretation of §1129(b)(2)(A), a debtor seeking to sell collateral free of liens only had to satisfy the requirements of subsection (ii)—not subsections (ii) and (iii).

The court explained that use of the word “or” merely indicated that a debtor could choose one of the three options to satisfy §1129(b)(2)(A), and as long as the debtor retained one of those options and was not required to comply with more than one subsection, the word “or” was appropriate.12

Analysis

Interestingly, the court’s focus in RadLAX on textual analysis and reticence on the policy concerns raised by the parties and the amici stands in stark contrast to colloquy between the court and counsel at oral argument. At oral argument, the court spent a majority of the time inquiring about the practical effects of its forthcoming decision; minimal time was spent on the textual interpretation. Court watchers have long noted the difficulty in predicting the court’s decisions based on the tenor of oral argument. However, it is possible that the justices’ focus on policy at the argument was intended to determine potential real-world consequences that would take place upon application of the textual analysis they ultimately deemed more persuasive as a basis for their decision.

Although most of the practical concerns discussed at the argument were not analyzed in the opinion, Scalia spent a fair amount of time at oral argument discussing how vitiating the right to credit bid as contemplated by RadLAX could leave the U.S. government with diminished secured creditor rights by forcing it to resort to obtaining congressional authorization each time it sought to cash bid at a bankruptcy sale. Although the court did not rest its decision on this issue, Scalia did note this concern in a footnote.13

Similarly, the court departed from the lower courts’ detailed analyses of the benefits of credit bidding and the extensive protections provided to secured creditors under the Bankruptcy Code. Instead, the court noted the lower courts’ discussion of the policy interests favoring credit bidding and the various secured creditor protections embedded in the Bankruptcy Code, but stated that such interests cannot interfere with the court’s duty to faithfully interpret the statute.

Unlike many prior circuit-level and Supreme Court decisions that have surprised practitioners because they rested on rationale focused solely on statutory interpretation, with little to no weight given to bankruptcy policy and practical considerations, RadLAX serves as an example in which a narrowly drawn statutory interpretation dovetails with the generally prevailing practice and policy expectations of many practitioners and bankruptcy participants.

Conclusion

Although the court did not give voice to the broader policy interests that favor a secured creditor’s right to credit bid, RadLAX unequivocally and correctly holds that a debtor cannot confirm a plan that seeks to sell collateral without granting the secured creditor a right to credit bid. This decision is a resounding victory to secured creditors and provides much-needed clarity to investors and practitioners regarding one of the most critical facets of Chapter 11 practice.

John J. Rapisardi is a partner and the co-head of the financial restructuring department of Cadwalader, Wickersham & Taft and an adjunct professor at Pace University School of Law. Michael J. Cohen and Jeffrey Taub, associates of the firm, assisted in the preparation of this article.

Endnotes:

1. 566 U.S.— (2012).

2. 651 F.3d 642 (7th Cir. 2011). The River Road lenders confirmed a plan before the Supreme Court granted certiorari, as a result, the case was restyled RadLAX Gateway Hotel v. Amalgamated Bank.

3. See Bank of N.Y. Trust v. Official Unsecured Creditors’ Comm. (In re Pacific Lumber), 584 F.3d 229 (5th Cir. 2009).

4. See In re Philadelphia Newspapers, 599 F.3d 298 (3d Cir. 2010).

5. The bankruptcy court certified the appeal directly to the Seventh Circuit which accepted the certification. No district court ruled on the case.

6. River Road, 651 F.3d at 652.

7. Id. at 651.

8. Justice Anthony Kennedy did not take part in deciding the case.

9. RadLAX, 566 U.S.—, —, slip op. at 5.

10. Id. at 7.

11. Id.

12. Id.

13. Id. at n.2.