Corinne Ball ()
In 2010, the U.S. Court of Appeals for the Third Circuit caused a stir in the secured creditor and claims trading communities by ruling in Philadelphia Newspapers that a debtor could propose a plan involving the sale of a secured creditor’s collateral free and clear of liens without allowing the secured creditor to credit bid its claim.1 Following a circuit split with the Seventh Circuit on the issue, the U.S. Supreme Court granted certiorari in RadLAX Gateway Hotel v. Amalgamated Bank and effectively overruled Philadelphia Newspapers.2 However, despite being overruled, the spirit of Philadelphia Newspapers may still be alive and well, as evidenced by the recent decisions by the bankruptcy and district courts in Fisker Automotive.
Section 363(k) of the Bankruptcy Code sets forth a creditor’s right to credit bid. It authorizes a creditor to bid its secured debt claim to purchase the assets subject to the creditor’s lien, unless the court orders otherwise “for cause.” In Fisker Automotive, the Bankruptcy Court for the District of Delaware held that a secured creditor’s right to credit bid its $168 million claim would be capped at $25 million, the amount the secured creditor had paid for its claim.3 In support of its ruling, the court cited to Philadelphia Newspapers, where, in a footnote, the Third Circuit stated that “[a] court may deny a lender the right to credit bid in the interest of any policy advanced by the [Bankruptcy] Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment.” On appeal, the district court also cited approvingly to the Philadelphia Newspapers footnote.
Thus, despite the fact that the secured creditor argued the footnote was not controlling law and the decision as a whole had been overruled, both the bankruptcy and district courts ultimately cited to the Philadelphia Newspapers footnote as precedent. In the wake of Fisker Automotive, secured creditors may think twice before acquiring secured debt with a view towards using that debt as acquisition currency through credit bidding.
Fisker Automotive Holdings (Fisker or the Company), was founded in 2007 with the goal of designing, assembling, and manufacturing premium plug-in hybrid electric vehicles in the United States. To finance its business, Fisker obtained a $530 million loan commitment (the Loan) from the U.S. Department of Energy (DOE). The Loan was secured by substantially all of Fisker’s assets.
The Company faced many difficulties that prevented it from operating as planned, subsequently defaulted under the Loan, and began to explore strategic alternatives. During the same time, the DOE decided to sell the Loan in the secondary market. In October 2013, after extensive marketing efforts, five bids were submitted, including one from Wanxiang America and one from Hybrid Tech Holdings, an affiliate of Fisker. On Oct. 11, 2013, Hybrid was the successful bidder at the auction and purchased the DOE’s position of outstanding principal of $168.5 million for $25 million and, for all practicable purposes, succeeded to the DOE’s position as Fisker’s senior secured lender.
After the DOE’s Loan sale to Hybrid, Fisker entered into discussions with Hybrid regarding a potential acquisition of the Company’s assets through a credit bid of all or part of the Loan. The Company filed for Chapter 11 on Nov. 22, 2013 and immediately sought approval of a private sale of its assets to Hybrid and approval of debtor-in-possession financing (the DIP Loan) from Hybrid. The sale motion sought authority to sell substantially all of Fisker’s assets in exchange for (a) $75 million in the form of a credit bid of claims owned by Hybrid under the Loan; (b) waiver of $4 million of claims held by Hybrid under the DIP Loan; (c) the assumption of certain liabilities by Hybrid; and (d) certain cash payments, a portion of which would be left behind for unsecured creditors.4
The creditors’ committee (the Committee) appointed in the Company’s bankruptcy case objected to the sale and requested instead to hold a competitive bidding process, in part due to the fact that Wanxiang had stepped in with an alternative proposal days before the court was to consider the Company’s sale motion. Wanxiang’s offer was supported by the Committee as one that would result in a better recovery for unsecured creditors. In addition, the Committee requested Hybrid’s credit bid be capped at the $25 million purchase price Hybrid had paid for the DOE Loan based on the argument that Hybrid’s liens on certain of Fisker’s assets were the subject of an ongoing dispute, and further that the $25 million purchase price reflected a “market-tested (and government-approved)” valuation of the underlying DOE Loan collateral, despite the fact that this amount did not directly correspond to the amount of liens in dispute.
Bankruptcy Court Caps Credit Bid
On Jan. 10, 2014, the Bankruptcy Court held a hearing to consider the Committee’s objection to the Company’s sale motion. At the hearing, the parties agreed to limit the issue before the court to a determination of whether Hybrid could credit bid its secured claim and, if so, whether cause existed to cap Hybrid’s right to credit bid in order to create a more competitive auction. At the time of the hearing, Hybrid’s bid stood at $55 million with $30 million in cash and the rest as a credit bid while Wanxiang’s offer stood at $35.25 million in cash and a 20 percent equity stake in the acquired assets.
After the hearing, the court issued a nonprecedential5 ruling from the bench that “there ought to be an auction and that the only way for there to be an auction is to … place a cap on the credit bidding.”6 Following the bankruptcy court’s ruling from the bench, Hybrid immediately sought leave to appeal the decision limiting its credit bid.7 After a hearing on Hybrid’s motion for leave to appeal, the bankruptcy court subsequently restated and supplemented its bench ruling with a written decision on Jan. 17, 2014.
In its written decision, the court began its analysis with the text of §363(k) of the Bankruptcy Code, which provides that a secured creditor may credit bid (i.e., offset its secured claim against the purchase price) in a sale of its collateral “unless the court for cause orders otherwise.”8 The bankruptcy court cited to the Third Circuit decision in Philadelphia Newspapers, where the court stated:
[T]he Code plainly contemplates situations in which assets encumbered by liens are sold without affording secured lenders the right to credit bid … [t]he most obvious example arises in the text of §363(k), under which the right to credit bid is not absolute.9
In particular, the bankruptcy court focused on footnote 14 of Philadelphia Newspapers, where the court stated:
A court may deny a lender the right to credit bid in the interest of any policy advanced by the Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment.10
According to the bankruptcy court, in the case of Fisker, evidence showed that there would be no bidding, not just the chilling of bidding, if the court did not limit Hybrid’s credit bid.
Hybrid’s rush to purchase and persistence in essentially short-circuiting the bankruptcy process, in addition to concerns regarding the uncertain actual amount of Hybrid’s secured claim, further persuaded the bankruptcy court that a competitive auction and capping Hybrid’s credit bid would be appropriate.
The court was particularly disturbed by the quick timetable for the sale process. The schedule for the sale provided only 24 days for parties to challenge the sale motion and even less time for the Committee to represent the interests of unsecured creditors. And yet, neither Fisker nor Hybrid could provide a satisfactory reason why the sale of the non-operating assets required such speed.11 The court was also concerned about the validity of Hybrid’s liens that were still subject to dispute.
Three factors supported the court’s determination that “cause” existed to limit Hybrid’s credit bid: (1) Hybrid “insisted on an unfair process, i.e., a hurried process;” (2) the validity and extent of Hybrid’s lien was disputed; and (3) there would be no competitive bidding process at all if the court did not limit Hybrid’s credit bid. In capping Hybrid’s bid, the court did not explicitly provide a reason for capping the credit bid at the price Hybrid paid for the Loan, nor did the court discuss its continued reliance on Philadelphia Newspapers in the wake of the Supreme Court’s decision in RadLAX.
Hybrid’s Motion to Appeal Fails
The District Court for the District of Delaware denied Hybrid’s motion for leave to appeal.12 The district court disagreed with Hybrid that the bankruptcy court’s ruling to cap its credit bid was a final, appealable order. Hybrid argued that the bankruptcy court’s order should be deemed final because whether Hybrid’s credit bid was capped would dictate how the sale process would proceed and thus have a substantial impact on the Company’s Chapter 11 case. However, the court found Hybrid’s arguments on this issue “overstated.”13 The court found the Committee’s argument persuasive that there were many issues other than Hybrid’s credit bid yet to be resolved by the bankruptcy court that would impact the process and results of the sale, including the nature of Hybrid’s statutory rights and the validity of Hybrid’s lien.
The district court also sided with the Committee that Hybrid had not established the factors required to support an interlocutory appeal, notably that there were substantial grounds for differences in opinion on the controlling question of law, and exceptional circumstances justified a departure from the basic policy of postponing a review until after the entry of final judgment. The district court determined that earlier decisions establishing the importance of the secured creditor’s right to credit bid were not sufficient to establish that substantial grounds for a difference of opinion exist. The district court relied heavily upon the plain text of §363(k), which authorizes the bankruptcy court to disallow credit bidding by a lien-holder “for cause,” and the Third Circuit’s observation in Philadelphia Newspapers that “foster[ing] a competitive bidding market” was good reason to limit a lender’s right to credit bid.
Thus, similar to the bankruptcy court, the district court cited approvingly to the footnote in Philadelphia Newspapers in denying Hybrid’s motion for leave to appeal.
Wanxiang Wins at Fisker’s Auction
Fisker’s auction was set for Feb. 12, 2014, with a dual stalking horse scheme with both suitors eligible for $750,000 in expense reimbursements. The auction lasted for three days and involved 19 rounds of bidding. No bidders other than the co-stalking horses participated in the auction. At the conclusion of the auction, the Company and the Committee jointly identified Wanxiang as the successful bidder.14 Wanxiang’s bid consisted of $126.2 million in cash, 20 percent of common stock to be issued by a designated affiliate of Wanxiang, and the assumption of $8 million in unspecified unsecured administrative and priority claims. The Company and the Committee agreed, solely for purposes of the auction, to ascribe a value to the common stock of $15 million. Thus, the total consideration ascribed to the winning bid by the Company and the Committee was $149.2 million. Accordingly, the amount of the successful bid by Wanxiang was less than the amount of Hybrid’s prepetition secured claim of $168.5 million. The court approved the sale to Wanxiang at a hearing held on Feb. 18, 2014.
While the bankruptcy court may have attempted to mitigate the potential chilling effect on future credit bidding by stressing that its ruling in Fisker Automotive was nonprecedential, the district court’s further reliance on the footnote in Philadelphia Newspapers on appeal, as well as the attention Fisker Automotive has received, suggest that distress investors must take heed of two lessons. First, purchasers of secured claims who intend to credit bid should take note of the risk that such right to credit bid may be limited to the purchase price, rather than the face amount, of the claim, particularly if the lien is disputed. Undoubtedly, following Fisker Automotive, committees and other interested parties are likely to rely on Philadelphia Newspapers and Fisker Automotive as a litigation tactic for limiting the amount of the secured creditors’ credit bid. Second, distress investors should appreciate the need for a robust sale process when a credit bid is involved. Judge Kevin Gross was unhappy with the sale process. Fisker Automotive underscores the importance of a “fair” process with adequate time at any sale involving a credit bid.
Corinne Ball is a partner at Jones Day.
1. In re Phila. Newspapers, 599 F.3d 298 (3d Cir. 2010).
2. RadLAX Gateway Hotel v. Amalgamated Bank, 132 S. Ct. 2065 (2012).
3. In re Fisker Auto. Holdings, No. 13-13087-KG (Bankr. D. Del. Jan. 10, 2014).
4. In re Fisker Auto. Holdings, No. 13-13087-KG (Bankr. D. Del. Nov. 22, 2013).
5. Transcript of Hearing 135:1-15, In re Fisker Auto. Holdings, No. 13-13087-KG (Bankr. D. Del. Jan. 10, 2014) (“The Third Circuit has this procedure for issuing nonprecedential opinions. And those apply just to the parties and are not to be precedent. And I think that that’s the case here, because really bankruptcy judges have the unenviable duty of keeping a case moving, and that doesn’t always permit time for the kind of consideration that you would want to put into a decision under normal circumstances.”).
6. Id. at 135:23-25.
7. In re Fisker Auto. Holdings, No. 13-13087-KG (Bankr. D. Del. Jan. 14, 2014).
8. 11 U.S.C. §363(k).
9. Phila. Newspapers, 599 F.3d at 315-16.
10. Id. at n.14.
11. In re Fisker Auto. Holdings, No. 13-13087-KG (Bankr. D. Del. Jan. 17, 2014).
12. In re Fisker Auto. Holdings, No. 14-CV-99 (GMS) (D. Del. Feb. 7, 2014).
13. Id. at 6.
14. In re Fisker Auto. Holdings, No. 13-13087-KG (Bankr. D. Del. Feb. 14, 2014).