Understanding Credit Bidding in Bankruptcy Sales

A creditor with a lien against property subject to a sale under the Bankruptcy Code generally is entitled to bid the value of its claim. This avenue for lenders to recover on their collateral may also be an opportunity for distressed asset investors. Looking for a market advantage, investors may seek to acquire loans and the associated liens with an eye toward foreclosure or the acquisition of the property outright through a section 363 sale. The credit bid is an attractive option to the purchaser who may have acquired the underlying loan rights at a steep discount. However, such a venture will not always be welcome by the trustee or debtor seeking to maximize the recovery from the sale of an estate asset.

11 U.S.C. § 363(k) provides as follows:

At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed 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.

This provision warrants some unpacking. While the right to credit bid is an important right to creditors, this right is by no means absolute, as the bankruptcy court may “for cause” deny the right to credit bid.

As a threshold matter, a party seeking to credit bid must have a valid secured claim. If the secured claim is subject to dispute at the time of the sale under section 363, the bankruptcy court may not allow the creditor to credit bid, or may allow the creditor to credit bid provisionally, requiring the creditor to pay in cash if the claim is reduced or the lien is invalidated.[1]

Another barrier to credit bidding is lien seniority. A junior lienholder may be barred from credit bidding where the collateral is so far underwater that the lien itself has no value.[2]

When such issues are overcome, there are yet other reasons, having more to do with the equities and the economics of the particular sale and case, that may constitute cause to deny the right to credit bid.

There is a line of cases in which the trustee or debtor-in-possession seeks to sell property without credit bidding. The most recent Supreme Court decision on the issue is RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012). The debtors in RadLAX purchased the Radisson Hotel at the Los Angeles International Airport in 2007. The debtors owed the bank $120 million when they filed for chapter 11 protection in 2009. The debtors proposed a chapter 11 plan which contemplated sale of the property, and which would require the bank to bid in cash. The bank objected. Turning to the “cramdown” provisions of section 1129(b), under which a debtor may confirm a plan over creditors’ objections, the Court determined that the denial of the right to credit bid was impermissible under the circumstances. Section 1129(b)(2)(A)(ii) provides:

For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:

(A)With respect to a class of secured claims, the plan provides—…

(ii) for the sale, subject to section 363…(k) of this title, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (iii) of this subparagraph.

The debtors argued that they need not satisfy 1129(b)(2)(A)(ii) because they satisfied 1129(b)(2)(A)(iii), which provides:

    (A)With respect to a class of secured claims, the plan provides—…

(iii)for the realization by such holders of the indubitable equivalent of such claims.

The debtors reasoned that by paying the bank from sale proceeds, the debtors would be giving the bank the “indubitable equivalent” of its secured claim. The Court rejected this argument based on a basic canon of statutory interpretation—“that the specific governs the general.” Since (A)(ii) is specific to sales, it governs. In a footnote, the Court mentioned that that the bankruptcy court had found that there was no “cause” to deny credit bidding under section 363(k).[3]

“Cause” to deny the right to credit bid is not defined in the Bankruptcy Code. Besides the circumstances concerning the validity or value of the lien addressed above, Courts have generally found “cause” to exist where denial is “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.”[4] A finding that a party has engaged in misconduct vis-à-vis the estate may be cause to deny the right to credit bid.[5] Beyond such examples, courts have found that the chilling of bidding can constitute cause.[6] The court in Fisker Automotive Holdings denied credit bidding because, under the circumstances, it determined that credit bidding would have made an auction essentially impossible.[7] These issues will be discussed at greater length in a future Inforuptcy blog post. It is sufficient for our purposes to conclude that, notwithstanding the generally accepted importance of the right to credit bid,[8] “cause” can be a fairly broad concept limiting, or eliminating, the right in many cases.

As a final consideration in this overview, it must be noted that the concept of credit bidding is enshrined under nonbankruptcy law.[9] Under nonbankruptcy law, the “full credit bid” (that is an amount equal to the unpaid principal, interest and foreclosure expense) has the effect of extinguishing the creditor’s rights and remedies, including against guarantors and insurers. Thus, it should be exercised with caution.[10]

The credit bid in bankruptcy is a potentially powerful tool and valuable asset to creditors and distressed property investors. It must however be approached and exercised with knowledge of the potential pitfalls.


[1] See, e.g., In re St. Croix Hotel Corp., 44 B.R. 277, 279 (Bankr. D.V.I. 1984).
[2] In re Valley Bldg. Supply, Inc., 39 B.R. 131, 133 (Bankr. D. Vt. 1984).
[3] RadLAX, 132 S. Ct. 2070 n. 3.
[4] In re Philadelphia Newspapers, LLC, 599 F.3d 298, 316 n. 14 (3d Cir. 2010), as amended (May 7, 2010).
[5] See e.g., In re Aloha Airlines, Inc., No. 08-00337, 2009 WL 1371950, at *8 (Bankr. D. Haw. May 14, 2009).
[6] See e.g., In re Antaeus Technical Servs., Inc., 345 B.R. 556, 564 (Bankr. W.D. Va. 2005).
[7] In re Fisker Auto. Holdings, Inc., 510 B.R. 55, 60 (Bankr. D. Del. 2014) leave to appeal denied, No. 14-CV-99, 2014 WL 546036 (D. Del. Feb. 7, 2014) and leave to appeal denied, No. 14-CV-99 (GMS), 2014 WL 576370 (D. Del. Feb. 12, 2014).
[8] In re The Free Lance-Star Publ’g Co. of Fredericksburg, VA, 512 B.R. 798, 804 (Bankr. E.D. Va.) appeal denied sub nom. DSP Acquisition, LLC v. Free Lance-Star Pub. Co. of Fredericksburg, VA, 512 B.R. 808 (E.D. Va. 2014).
[9] Cal. Civ. Code § 2924h(b) (“The present beneficiary of the deed of trust under foreclosure shall have the right to offset his or her bid or bids only to the extent of the total amount due the beneficiary including the trustee’s fees and expenses.”).
[10] See In re Miller, 442 B.R. 621, 628 (Bankr. W.D. Mich.) aff’d, 459 B.R. 657 (B.A.P. 6th Cir. 2011) aff’d, 513 F. App’x 566 (6th Cir. 2013); In re Spillman Dev. Grp., Ltd., 401 B.R. 240, 253-54 (Bankr. W.D. Tex. 2009) subsequently aff’d, 710 F.3d 299 (5th Cir. 2013).