#6 Are you a Secured Lender?

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02/03/2011 9:53 AM

If so, there may be changes in the way your loans are handled in bankruptcy court. Although lenders never want to be creditors in bankruptcy proceedings, in the past they thought that if their collateral was sold, they could bid up to the full amount of their claim, without putting out any cash. To the contrary, in 2010, a federal appeals court ruled that secured creditors do not have an absolute right to "credit" bid when their collateral is sold under a Chapter 11 plan of reorganization.

Credit bidding allows a secured creditor to bid up to the full amount of its debt claim at a sale of its collateral, without actually having to tender cash to acquire the collateral. Traditionally, credit bidding protects secured creditors by ensuring proper valuation of the collateral at the sale and preventing other bidders from acquiring the collateral at bargain prices.

In this case, the debtor’s plan provided that almost all of its assets would be sold at auction, and the secured creditors would be given the equivalent of their claims – but not the right to credit bid. The lenders argued that if the debtor intended to sell its assets free and clear of the liens, it was required to let creditors credit bid. The court disagreed; it ruled that secured creditors do not have an absolute right to credit bid if the plan otherwise satisfies the requirements for confirmation. The court, however, did not determine that the creditors were actually receiving the "indubitable equivalent" of their claims under the debtor’s plan and left that determination to the bankruptcy court to decide.

So what does all of this mean for lenders with secured collateral and their debtors that may have to file a Chapter 11 plan of reorganization? For Maryland lenders and businesses, nothing – yet – because this court’s ruling is not necessarily binding on courts in Maryland, Virginia, and the District of Columbia), but it changes long-held expectation of lenders that they have an absolute right to credit bid when their collateral is sold under a Chapter 11 plan. The decision’s ultimate effect, however, is yet to be seen. Depending on the facts of the particular case, the decision could have little effect on lenders if they are not receiving the "indubitable equivalent" of their claim under a plan that prohibits credit bidding. Regardless, this decision may be used by businesses in bankruptcy as a tool to take bargaining power away from secured lenders when their collateral is being sold. It will be important to be alert for decisions of other courts that may, or may not, adopt this interpretation of the Bankruptcy Code.

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