Secured Creditors’ Subcommittee
Program Chairs:
Corali Lopez-Castro, Kozyak Tropin & Throckmorton LLP
Samuel R. Maizel, Pachulski Stang Ziehl & Jones LLP
Moderator:
Donald R. Kirk, Carlton Fields Jorden Burt, P.A.
Speakers:
Marc Carmel, Paul Hastings LLP
Robert Klyman, Gibson Dunn & Crutcher LLP
Shannon L. Nagle, Assistant General Counsel, CIT Group
Martin A. Sosland, Weil Gotshal & Manges LLP
ABA BUSINESS LAW SECTION: KNOWLEDGE | COMMUNITY | EXPERIENCE
ABA BUSINESS LAW SECTION/BUSINESS BANKRUPTCY COMMITTEE
Presented by Business Bankruptcy Committee/
Spring Meeting - April 16, 2015 – Secured Creditors Luncheon
CUTTING EDGE ISSUES IN ASSET SALES
Donald R. Kirk is the Practice Group Leader of Carlton Fields Jorden Burt’s
Bankruptcy practice group and is a resident of its Tampa, Florida office. He
represents clients in high-value bankruptcy and creditors' rights litigation, complex
workouts, financial restructurings, asset sales, commercial litigation and contract
disputes. He represents secured lenders, unsecured creditors, vendors, and
purchasers of assets from troubled companies. He also counsels debtors, trustees,
creditors' committees and other stakeholders in multi-party disputes and
reorganizations. He has handled matters in numerous state and federal courts,
including those in Delaware, New York, California, Georgia, Pennsylvania, and
Massachusetts. Mr. Kirk is board certified by the American Board of Certification
in Business Bankruptcy Law. He is the former president of the Tampa Bay
Bankruptcy Bar Association. Mr. Kirk graduated from the University of Florida
College of Law.
Representative Experience
100523063.42

Represented secured lender in restructure of $200 million in loans to
significant commercial real estate developer

Represented debtor in confirmed Chapter 11 case for 18-store fast food
franchisee (Quick Service Foods - 08-02797).

Represented Chapter 11 trustee in Premier Mortgage Funding, Inc.
Chapter 11 case (07-5713).

Defended former officers and directors of bankrupt public company.

Represented the unsecured creditors committee and the liquidation trustee
in the Tropical Sportswear Inc., et. al. Chapter 11 cases (Lead Case No.
04-24134).

Represented the ad hoc committee of 11% senior secured noteholders and
certain of those noteholders providing DIP financing in the Anchor Glass
Container Corporation Chapter 11 proceeding.

Represented the general partner in the Kaiser Aluminum Corp, et al.
Chapter 11 proceedings in the District of Delaware wherein we preserved
a right of first refusal relating to the auction of a $331 million partnership
interest.

Represented a national financing company and plan proponent in the
Optical Technologies, et al. Chapter 11 cases (Recomm) (Lead Case No.
96-00805).
2
Marc J. Carmel
Marc J. Carmel
Mr. Carmel is in the Corporate practice of Paul Hastings and is based in the firm’s Chicago
office. Mr. Carmel received his B.B.A. and M.Acc. from the University of Michigan and his J.D.
from Harvard Law School. Mr. Carmel concentrates his practice in restructuring and bankruptcy
law. Mr. Carmel has a significant amount of experience representing debtors, strategic and
financial investors, lenders, and creditors in connection with traditional, prepackaged and prenegotiated bankruptcies and out-of-court workouts. He focuses on protecting and advancing the
interests of distressed companies and parties seeking to purchase distressed assets in commercial
workouts and Chapter 11 reorganization cases.
On the transactional side, Mr. Carmel has a broad range of experience, including advising clients
with respect to restructuring planning, distressed acquisitions, negotiating lending agreements,
drafting and implementing Chapter 11 plans of reorganization, and fiduciary duties of directors
and officers. Mr. Carmel’s litigation experience includes aggressively defending his clients’
various interests in numerous contested matters and adversary proceedings.
100523063.43
3
Robert A. Klyman
Robert A. Klyman is a partner in the Los Angeles office of Gibson, Dunn & Crutcher and a
member of the Business Restructuring and Reorganization and the Energy and Infrastructure
Practice Groups as well as the Corporate Department. Mr. Klyman represents debtors, acquirers,
lenders and boards of directors. His experience includes advising debtors in connection with
traditional, prepackaged and “pre-negotiated” bankruptcies; representing lenders and other
creditors in complex workouts; counseling strategic and financial players who acquire debt or
provide financing as a path to take control of companies in bankruptcy; structuring and
implementing numerous asset sales through Section 363 of the Bankruptcy Code; and litigating
complex bankruptcy and commercial matters arising in chapter 11 cases, both at trial and on
appeal.
Mr. Klyman has been widely and regularly recognized for his debtor and lender work as a
leading bankruptcy and restructuring attorney by Chambers USA; named as one of the world’s
leading Insolvency and Restructuring Lawyers by Euromoney; listed in the K&A Restructuring
Register, a leading peer review listing, as one of the top 100 restructuring professionals in the
United States; named as a “Top Bankruptcy M&A Lawyer” by The Deal’s Bankruptcy Insider;
named as one of the 12 outstanding bankruptcy lawyers in the nation under the age of 40 (in
1999, 2000, 2002 and 2004) by Turnarounds & Workouts; and one of “20 lawyers under 40” to
watch in California by The Daily Journal.
Mr. Klyman developed, and for the past 16 years co-taught, a case study for the Harvard
Business School on prepackaged bankruptcies and bankruptcy valuation issues. He has also
taught classes on dealmaking in the bankruptcy courts at the University of Michigan Business
School and UCLA Law School. Mr. Klyman is also a member of the ABA Subcommittee
responsible for drafting a Model Bankruptcy Asset Purchase Agreement.
Mr. Klyman received both his J.D. from the University of Michigan Law School in 1989 and his
B.A. degree from the University of Michigan in 1986.
100523063.44
4
Shannon Nagle
Shannon Lowry Nagle is the Assistant General Counsel of CIT Group, Inc. Ms. Nagle most
recently was a partner in the restructuring groups at Fried, Frank, Harris & Jacobson LLP and
O’Melveny & Myers LLP in their New York City offices. Ms. Nagle's practice has included
representing bondholders, secured and unsecured creditors, debtor-in-possession lenders, ad hoc
and official committees of creditors, and other parties in interest. Ms. Nagle also has represented
debtors, including distressed portfolio companies, as well as private equity funds and others in
connection with the acquisition of distressed companies and in the sale of assets of financially
troubled entities. Ms. Nagle's experience covers a wide range of industries, including retail,
healthcare, entertainment, construction, auto, airlines, textiles, and telecommunications. She has
extensive in-court experience, having litigated before bankruptcy courts in numerous states.
Ms. Nagle is Board Certified in Business Bankruptcy. Ms. Nagle graduated from the University
of Florida (BS) and the University of Miami School of Law. In 2013, the Legal Services of
New York awarded her its Pro Bono Award for her services.
100523063.45
5
Martin A.
Sosland
Martin Sosland heads Weil’s Business Finance and Restructuring practice in its Dallas office.
Since joining the firm when the Dallas office opened in 1987, Mr. Sosland has concentrated his
practice in the area of business reorganizations, debtor and creditors’ rights, and refinancings and
acquisitions of troubled companies.
Mr. Sosland led the firm’s representation in several major chapter 11 debtor cases, including
Dallas Stars, SemGroup, Crescent Resources, Texas Rangers Baseball Partners, and Blockbuster,
and co-led the firm’s representation of Pilgrim’s Pride. He also led the firm’s representation of
AHMSI, a W.L. Ross portfolio company, in its acquisition of Option One Mortgage from H&R
Block and co-led the firm’s representation of EQT Infrastructure II in its acquisition of Synagro
Technologies. He served as one of the principal partners involved in the firm’s representation of
Enron Corp. and its affiliates in their chapter 11 cases and led the firm’s representation of Sulzer
Orthopedics in its class action product liability settlement, which allowed that company to avoid
seeking relief under the Bankruptcy Code. Mr. Sosland also was involved in the firm’s
representation of The Western Company of North America, Zale Corporation, MCorp, Edison
Brothers Stores, Inc., and PennCorp Financial Group, Inc., and led the firm’s representation of
US ONE Communications Corp., Heartland Wireless Communications, Verado Holdings, and
Hedstrom Corporation in their chapter 11 cases.
Mr. Sosland led the firm’s representation of the statutory creditors’ committee for Diagnostic
Health Systems, Inc. and has been involved in the representation of statutory creditors’
committees for First Republicbank Corporation, Texas American Bancshares, National Gypsum
Company, and New Valley Corporation. He has been involved in the firm’s representation of
aircraft lessors in a number of restructurings including TWA and Viscount Airlines, Inc., and led
the firm’s representation of a major aircraft lessor in the chapter 11 case of Express One
International, Inc.
Mr. Sosland was also involved in the firm’s representation of PennCorp Financial Group, Inc. in
its acquisition of Southwestern Life Insurance Company from ICH Corporation, and led the
100523063.46
6
firm’s representation of creditors which acquired Fitz & Floyd and Trenwick America through
chapter 11 plans of reorganization.
In addition, Mr. Sosland has led the firm’s representation of major financial institutions and other
creditors in a number of cases, including Reddy Ice, First Magnus, Harbor Financial Group,
FirstPlus Financial Group, Genesis Physicians Practice Association, Mirant, Senior Living
Properties, Williams Communications, and Covad.
Mr. Sosland is recognized by Chambers USA, Chambers Global, and Best Lawyers as a leading
bankruptcy/restructuring lawyer.
Education
University of Texas School of Law (J.D., 1983)
Rice University (B.A., 1976)
100523063.47
7
Outline of Issues with Credit Bidding in Bankruptcy
By Marc J. Carmel and Michelle E. Cline 1
I.
A.
CREDIT BIDDING - GENERALLY
Statutory Bases in the Bankruptcy Code
1.
Section 363(k) codifies a secured lender’s right to credit bid (i.e.,
to bid the amount of debt owed to it by the debtor as currency in a
bankruptcy sale under section 363 of the Bankruptcy Code):
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.
2.
1
A secured lender’s right to credit bid also exists where the sale of
the debtor’s assets occurs pursuant to a chapter 11 plan.
a.
Before the Supreme Court’s decision in RadLAX Gateway
Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012),
courts were divided as to whether a secured creditor had the
right to credit bid the value of its secured claim where a
chapter 11 plan contemplated the sale of the secured
creditor’s collateral. Certain courts had held that a secured
creditor may be denied the right to credit bid under the
“cramdown” provision of section 1129(b)(2)(A)(iii), where
the secured creditor was provided the “indubitable
equivalent” of the value of its claim. See, e.g., In re
Philadelphia Newspapers, 599 F.3d 298 (3d Cir. 2010).
b.
In RadLAX, however, the Supreme Court held that the more
specific language of section 1129(b)(2)(A)(ii) of the
Marc Carmel is of counsel in the Chicago office and Michelle E. Cline is an associate in the Washington,
D.C. office of Paul Hastings LLP in the Corporate group with a focus in Restructuring and Bankruptcy law.
The views expressed in this article reflect those of the authors and not necessarily the views of Paul
Hastings LLP or any of its past, present, or future clients. The materials do not constitute legal advice and
are offered for educational purposes only, do not form the basis for the creation of any attorney/client
relationship, and should in no way be relied upon or construed as legal advice. For specific information on
recent developments or particular factual situations, the opinion of legal counsel should be sought. These
materials may be considered ATTORNEY ADVERTISING in some jurisdictions. Paul Hastings LLP is a
limited liability partnership.
Copyright © 2015 Paul Hastings LLP.
100523063.48
8
Bankruptcy Code, which specifically refers to the right to
credit bid set forth in section 363(k), overrode the more
general language of section 1129(b)(2)(A)(iii), thereby
preserving a secured creditor’s right to credit bid in an asset
sale conducted under a chapter 11 plan. 2
B.
Parsing section 363(k) of the Bankruptcy Code reveals the following
requirements for a creditor to credit bid:
1.
A creditor desiring to credit bid must have a lien on the property
that is the subject of the proposed sale. If the creditor’s lien
attaches to other property that is not part of the sale, then the
creditor does not have the right to credit bid. See 11 U.S.C.
§ 363(k) (“[S]ale . . . of property subject to a lien . . . .” (emphasis
added)); see also, e.g., Beal Bank, S.S.B. v. Waters Edge Limited
P’ship, 248 B.R. 668, 679-80 (D. Mass. 2000) (holding that
proposed sale of equity in limited partnership was not a sale of
collateral subject to creditor’s bank lien and, thus, bank was not
entitled to “credit bid”).
2.
The claim to be credit bid must be an allowed claim that is not
subject to a bona fide dispute. See 11 U.S.C. § 363(k) (“[S]ubject
to a lien that secures an allowed claim . . . .” (emphasis added)). In
certain circumstances, however, courts have fashioned
workarounds for this requirement. See, e.g., In re Octagon
Roofing, 123 B.R. 583, 588 (Bankr. N.D. Ill. 1991) (finding that
creditor’s mortgage lien was subject to “bona fide dispute” but
allowing creditor to make credit bid of its lien on property as long
as creditor posted irrevocable letter of credit to secure bid if lien
was set aside as fraudulent conveyance).
a.
2
Generally, courts agree that a secured creditor may credit
bid the full face value of its claim rather than the economic
value of its claim. See, e.g., Cohen v. KB Mezzanine Fund
II, LP (In re SubMicron Sys. Corp.), 432 F.3d 448, 459-60
(3d Cir. 2006) (finding that “to cap credit bids at the
economic value of the underlying collateral is theoretically
nonsensical” because “any amount bid for [the collateral]
up to the value of Lender’s full claim becomes the secured
portion of Lender’s claim by definition”). However, as
discussed further below, this general rule is subject to the
Section 1129(b)(2)(A)(ii) provides, in pertinent part, “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.”
100523063.49
9
court’s ability to limit a secured creditor’s ability to credit
bid “for cause.”
II.
COURTS MAY LIMIT OR PROHIBIT A SECURED CREDITOR FROM
CREDIT BIDDING “FOR CAUSE”
A.
Although section 363(k) of the Bankruptcy Code grants secured creditors
a right to credit bid, the court may limit or prohibit credit bidding “for
cause.”
B.
What constitutes “cause” is not defined in the Bankruptcy Code, but recent
decisions from the District of Delaware and the Eastern District of
Virginia suggest that courts may apply an expansive reading to avoid “bid
chilling” and to “foster competitive a robust and competitive bidding
process.”
1.
2.
In In re Fisker Automotive Holdings, Inc., 510 B.R. 55 (Bankr. D.
Del. 2014), the Delaware Bankruptcy Court held that a creditor,
Hybrid Tech Holdings, LLC (“Hybrid”), which purchased the
Department of Energy’s secured $168 million loan to the debtors
for $25 million would not be allowed to credit bid the entire $168
million claim in a sale of the debtors’ assets.
a.
On the facts before it, the court found that “[t]he evidence
in this case is express an unrebutted that there will be no
bidding—not just the chilling of bidding—if the Court does
not limit the credit bid.” Id. at 60. According to the court,
unless Hybrid’s ability to credit bid was capped at $25
million, “bidding will not only be chilled . . . bidding will
be frozen.” Id.
b.
Significantly, the court also rejected the argument that the
“for cause” exception under section 363(k) of the
Bankruptcy Code is limited to situations in which a secured
creditor has engaged in inequitable conduct, finding 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.” Id. at 60 n.14.
Subsequently, in The Free Lance-Star Publishing Co., 512 B.R.
798 (Bankr. E.D. Va. 2014), the Eastern District of Virginia
limited a creditor’s ability to credit bid “in order to foster a robust
and competitive bidding environment.”
a.
100523063.410
In Free Lance-Star, the court was “troubled” by the
“overly-zealous loan-to-own strategy” pursued by the
creditor, which included filing UCC financing statements
10
over certain of the debtor’s assets when it knew it did not
have a valid lien over such assets, and the creditor
pressuring the debtors to shorten the marketing period for
the sale of their business and to put language in marketing
materials conspicuously advertising the creditor’s
purported credit bid rights. Id. at 806.
3.
C.
100523063.411
b.
The court found that there was “genuine confusion among
potentially interested parties” regarding which assets were
covered by the creditor’s lien. As a result, the court found
that “[p]otential bidders are now less likely to participate in
the sale process.” Id. at 807.
c.
The creditor’s less than fully-secured lien status, overly
zealous loan-to-own strategy, and the negative impact the
creditor’s misconduct had on the auction process “created
the perfect storm” that required “curtailment” of the
creditor’s credit bid rights. Id. The court found that there
was sufficient cause to limit the creditor’s credit bid to the
amount of the creditor’s valid, properly perfected lien on
the debtors’ assets. Id. at 808.
Note: Some commentators have opined that Fisker and Free
Lance-Star may not lead to enhanced willingness of courts to limit
credit bidding due to the unique facts of each case. See Adam H.
Friedman, Credit Bidding Is Alive and Well in Delaware, LAW360
(June 3, 2014). However, the decisions provide instructive
examples of courts acting to foster competitive bidding and avoid
credit bidding’s potential effect of bid chilling.
Courts also have found “cause” to limit credit bidding in other contexts;
for example, courts have limited credit bidding:
1.
Where collusion between the debtor and secured creditors prevents
other creditors from collecting on claims. See, e.g., In re Theroux,
169 B.R. 498, 499 (Bankr. D.R.I. 1994) (“While the secured
creditor’s incentive to acquire the license as proposed is
understandable, we are more concerned with the motivation of the
Trustee in co-sponsoring this procedure, given the fact that the
sale, as proposed, can benefit only the secured creditor, while
inflicting considerable financial damage upon the taxing
authorities.” (emphasis in original)).
2.
Where other interested parties, especially other secured creditors of
the same priority as the creditor seeking to credit bid, did not
receive notice of the sale. See, e.g., In re Takeout Taxi Holdings,
Inc., 307 B.R. 525, 536 (Bankr. E.D. Va. 2004) (finding that if
11
other secured creditors who did not receive notice were before the
court, they may object to another creditor in pari passu credit
bidding “because, if they are of equal priority, there would be no
cash proceeds from the sale available for distribution to them”).
III.
3.
Where a lengthy dispute regarding the validity of a creditor’s lien
would delay an asset sale needed to prevent the decline in the
estate’s value. See Morgan Stanley Dean Witter Mortgage
Capital, Inc. v. Alon USA, L.P. (In re Akard Street Fuels, L.P.),
2001 WL 1568332, at *3 (N.D. Tex. Dec. 4, 2001).
4.
Where there was a failure to comply with approved bidding
procedures. See, e.g., In re Diebart Bancroft, 1993 WL 21423, at
*5 (E.D. La. Jan. 26, 1993) (finding that “cause” existed to limit
credit bidding because the creditor failed to deposit 10% of
purchase price in escrow).
5.
Where the claims of senior creditors would not be satisfied. See In
re Valley Bldg. Supply, Inc., 39 B.R. 131, 133 (Bankr. D. Vt. 1984)
(allowing offset payment to junior lienholder on account of its
secured claim to be made only after secured claim of senior
lienholder is satisfied).
SPECIAL CONSIDERATIONS AND PRACTICE POINTS FOR
INTERESTED PARTIES
A.
Credit bidding will impact the various constituencies participating in a
bankruptcy case differently, and each constituency will need to be aware
of the potential impact of credit bidding to safeguard its own interests.
Some of the concerns that key constituencies should consider are as
follows.
B.
Prepetition Secured Lenders:
100523063.412
1.
Prepetition secured lenders considering a potential credit bid will
want to review their collateral package to assess the validity and
enforceability of their liens. Doubt as to the validity and scope of
liens could give rise to a challenge to the lender’s ability to credit
bid.
2.
Although prepetition secured lenders will need to protect their own
interests, they should consider to extent to which their participation
in a sale process provides arguments to other constituencies that
they are pushing the debtor to rush a marketing process to chill
other parties’ ability to credit bid or otherwise participate in the
process. Secured lenders should also consider the extent to which
their credit bidding or preserving any rights to credit bid may scare
off potential buyers who are not willing to invest time and money
12
in a process where the prepetition lender has the ability to credit
bid.
C.
D.
100523063.413
3.
If a prepetition secured lender intends to credit bid, it may seek a
waiver from the debtor or other constituencies of the right to argue
that “cause” exists to limit or prevent the lender from credit
bidding. Such a waiver may be included as part of an adequate
protection package, as a tradeoff to providing DIP financing, or to
induce the lender’s consent to another secured party providing DIP
financing.
4.
Lenders in a syndicated loan should review all of the loan
documents to assess whether an administrative or collateral agent
has authority to credit bid on behalf of syndicate over objections of
certain lenders.
Debtors:
1.
To pursue an effective sale process that maximizes value, a debtor
may consider whether it is appropriate to seek to limit or prohibit
credit bidding to maximize value of the assets being sold.
2.
A debtor may consider offering to waive the ability to argue that
“cause” exists to limit credit bidding to induce a prepetition lender
to provide DIP financing or to be primed by another provider of
DIP financing or grant its consent to use cash collateral.
3.
Similarly, a debtor also may consider offering to waive the ability
to argue that “cause” exists to limit credit bidding to induce a
prepetition lender who is seeking to credit bid to contribute
additional cash for a distribution to other creditors and/or to fund
the bankruptcy case post-sale.
Creditors Committee:
1.
The concerns of a creditors’ committee may overlap with those of
a debtor because, at least to a certain extent, both constituencies
are concerned with maximizing the value of the debtor’s estate.
2.
A creditors’ committee will be interested in avoiding bid chilling
that may result from credit bidding. This may involve a committee
analyzing and evaluating the validity and priority of a lender’s
liens to challenge the lender’s ability to credit bid. At the same
time, creditors’ committees should be mindful that a lender
exercising its credit bid rights could be value maximizing rather
than bid chilling.
13
3.
E.
100523063.414
A creditors’ committee may seek to negotiate with a lender who is
seeking to credit bid to contribute additional cash for a distribution
to its constituency and/or to fund the bankruptcy case post-sale
and, as part of such negotiation, may offer to waive the ability to
argue that “cause” exists to limit credit bidding.
Other Potential Bidders:
1.
Other potential bidders likely will be interested in limiting or
preventing another party from being able to credit bid. At a
minimum, other potential bidders will want to know how much
“dry power” a prepetition lender has in terms of its ability and
willingness to credit bid.
2.
Other potential bidders will be interested in determining whether
another lender really intends to credit bid, as other bidders may not
commit resources to pursuing the sale if they will just be outbid at
an auction.
3.
Where a stalking horse bidder is not able to credit bid, the stalking
horse will want to ensure that bid protections approved by the
bankruptcy court will be triggered if prepetition lenders credit bid.
14
ASSUMPTION/ASSIGNMENT & REJECTION ISSUES
IN BANKRUPTCY SALES
By Shannon Nagle
IV.
The Basics:
A.
100523063.415
Executory Contract Defined.
1.
Under Section 365 of the Bankruptcy Code, the debtor may
assume or reject any executory contract or unexpired lease subject
to the court’s approval.
2.
“Executory contract” is not defined in the Bankruptcy Code, courts
generally hold that an executory contract is a contract under which
the obligation of both the debtor and the other party to the contract
are so far unperformed that failure of either to complete
performance would constitute a material breach excusing the
performance of the other. Sharon Steel Corp. v. Nat’l Fuel Gas
Distribution Corp., 872 F.2d 36 (3d Cir. 1989); In re Wegner, 839
F.2d 533 (9th Cir. 1988). This definition, referred to as the
“Countryman test,” was first set forth by Prof. Vern Countryman in
his definitive article, Executory Contracts in Bankruptcy (Part I),
57 Minn. L. Rev. 439 (1973), and became part of the Bankruptcy
Code’s legislative history. H.R. REP. 95-595, 1978 U.S.C.C.A.N.
5963.
3.
Not every contract that appears executory in nature will fall under
the ambit of Section 365 and the debtor will not have the same
rights to assume or assign such agreements. Courts and Congress
have excepted these agreements from the debtor’s right to free
assignment of contracts.
•
Collective bargaining agreements (section 1113 of the
Bankruptcy Code).
•
Retiree benefit plans (section 1114 of the Bankruptcy
Code).
•
Pension plans (In re Philip Services Corp., 310 B.R. 802,
808-09 (Bankr. S.D. Tex. 2004); 29 U.S.C. § 1341).
•
Personal service contracts, loans and other financial
commitments and contracts for which applicable
nonbankruptcy law excuses performance by the
counterparty. (Section 365(c)).
15
•
FCC licenses, which are specific to the party to which they
are issued and are non-assignable pursuant to federal law,
would not be assignable in a bankruptcy proceeding. See 47
U.S.C. § 310(d).
•
Intellectual property licenses may or may not be assignable,
and assignability will be determined on a fact-specific
basis. See Neil S. Hirshman, Michael G. Fatall, Peter M.
Spingola, Is Silence Really Golden? Assumption and
Assignment of Intellectual Property Licenses in
Bankruptcy, 3 Hastings Bus. L.J. 197 (2007)
•
“Leases” in the oil and gas industry. Section 541(b)(4)(B)
specifically excludes from property of the estate "any
interest of the debtor in liquid or gaseous hydrocarbons to
the extent that … (4) any interest of the debtor in liquid or
gaseous hydrocarbons to the extent that—
(A)(i) the debtor has transferred or has agreed to
transfer such interest pursuant to a farmout agreement or
any written agreement directly related to a farmout
agreement; and
(ii) but for the operation of this paragraph, the estate
could include the interest referred to in clause (i) only by
virtue of section 365 or 544 (a)(3) of this title; or
(B)(i) the debtor has transferred such interest
pursuant to a written conveyance of a production payment
to an entity that does not participate in the operation of the
property from which such production payment is
transferred; and
(ii) but for the operation of this paragraph, the estate
could include the interest referred to in clause (i) only by
virtue of section 365 or 542 of this title;
Because a "production payment" is defined by
section 101(42A)(The term “production payment” means a
term overriding royalty satisfiable in cash or in kind—
(A) contingent on the production of a liquid or
gaseous hydrocarbon from particular real property; and
(B) from a specified volume, or a specified value,
from the liquid or gaseous hydrocarbon produced from
such property, and determined without regard to production
100523063.416
16
costs.)
4.
B.
Time for Assuming or Rejecting Section 365(d)(4).
1.
C.
In order to assume or reject an executory contract, the debtor must
obtain court approval. Fed. R. Bankr. P. 9014. The debtor must
also give notice to the other party to the contract and the U.S.
trustee. Fed. R. Bankr. P. 6004(c).
Timeframe to Assume or Reject Commercial Real Estate Leases
Under Section 365(d)(4).
a.
120 days to assume or reject.
b.
Only one ninety (90) day extension allowed unless landlord
consents in writing to additional extensions.
Assumption/Assignment.
1.
Section 365(b)(1) permits trustee to assume if:
a.
Cure (or adequate assurance of prompt cure) of default.
Courts usually limit to no more than one year;
b.
Compensate (or provides adequate assurance of prompt
compensation) for actual damages resulting from default;
and
c.
Adequate assurance of future performance.
2.
Ipso facto clauses unenforceable. Section 365(e).
3.
Penalty rate and penalty provision arising from nonmonetary
default unenforceable. Section 365(b)(2)(D).
4.
Debtor need not cure nonmonetary default which is impossible to
remedy at and after the time of assumption. Defaults resulting
from a lease provision that prohibits the debtor from “going dark”
may be “cured by performance at and after the time of assumption
in accordance with such lease.” The Debtor must provide an
“economic cure” for monetary losses arising pursuant to a
nonmonetary default. Section 365(b)(1)(A).
5.
Section 365(f)(1). Trustee may assign lease:
a.
100523063.417
if lease is assumed; and
17
b.
6.
V.
if Trustee provides adequate assurance of assignee’s future
performance, whether or not there has been a default in
such contract or lease.
Restrictions on Assignment.
a.
Loan or financing commitments.
b.
Terminated nonresidential real property lease.
c.
Applicable law (other than lease or contract provision
prohibiting assignment of rights or delegation of duties)
excuses party from accepting performance or rendering
performance to an entity other than the debtor or debtor-inpossession.
7.
Assignment relieves estate of liability for subsequent breach.
Section 365(k).
8.
Use restriction in non-shopping center lease may not be enforced;
assignee’s noncompliance produces no financial harm to landlord.
9.
Special Shopping Center provisions. Section 365(b)(3).
10.
Special rules on rejection of Intellectual Property contracts.
Section 365(n)(1) - (n)(4).
Intriguing issues related to the Timing for Assumption or Rejection
A.
Did the revision to Section 365(d)(4) force quick GOB sales and kill a retailer’s
ability to reorganize?
1.
After BAPCPA, retail debtors have 8 months in chapter 11 to make
decisions with respect to size (# of stores), if that, unless landlords
consent.
2.
Wary postpetition lenders further restrain ability to reorganize by
insisting on quick sales, restrictive covenants or borrowing
reserves unless and until leases are assumed or landlords provide
consent to an extension of the Section 365(d)(4) period.
a.
100523063.418
In re Caché, Inc., No. 15-10172-MFW (Bankr. D. Del.
2015); In re RadioShack Corporation, et al., No. 15-10197KJC (Bankr. D. Del. 2015); In re Ashley Stewart Holdings
Inc., Case No. 14-14383-MBK (Bankr. D.N.J. 2014); In re
Filene's Basement, LLC, Case No. 11-13511-KJC (Bankr.
D. Del. 2011); (DIP loan or use of cash collateral
18
conditioned upon approval of court-approved GOB Sales
within 45 days or less of petition date).
B.
In re Mervyn’s Holdings, LLC, et al., No. 08-11586-KG
(Bankr. D. Del. 2008) (debtors’ borrowing ability restricted
as a result of reserves for inventory at stores for which
lease had not been assigned).
c.
In re Linens Holding Co., et al., No. 08-10832-CSS (Bankr.
D. Del. 2008) (postpetition financing required 80% of
landlords to consent to extend the time for the debtor to
assume or reject leases).
What does a debtor have to do to effectuate an assumption?
C.
100523063.419
b.
1.
Debtor must file a motion within the 365(d)(4) time period.
2.
Because 365(d)(4) is a limit on the trustee/debtor’s time to make a
decision as to assumption or rejection and a debtor does not control
the court’s calendar, all the debtor must do is file the motion to
assume the time to assume within the statutory period – the order
approving the assumption does not have to be entered. In re
Filene's Basement, LLC, 11-13511-KJC, 2014 WL 1713416, at *9
(Bankr. D. Del. 2014) (citing Cousins Properties, Inc. v. Treasure
Isles HC, Inc. (In re Treasure Isles), 462 B.R. 645 (BAP 6th Cir.
2011)).
When is a lease rejected?
1.
Rejection order must be entered on the docket or time under
section 364(d)(4) expires. In re Upper Crust, LLC, 502 B.R. 1
(Bankr. D. Mass. 2013); In re Thinking Machines Corp., 67 F.3d
1021 (1st Cir. 1995).
2.
Landlords beware - retroactive rejection is permitted. Equitable
factors considered (vacating premises, surrender of keys, notice of
terminating lease, landlord’s acknowledgement or inactivity). See
In re New Meatco Provisions LLC, No. 2:13-bk-22155-PC (Bankr.
C.D.Calif. 2013); Adelphia Bus. Solutions, Inc. v. Abnos, 482 F.3d
602 (2d Cir. 2007); Pac. Shores Dev., LLC v. At Home Corp.
(In re At Home Corp.), 392 F.3d 1064 (9th Cir.2004);
In
re
Philadelphia Newspapers, LLC, 424 B.R. 178 (Bankr. E.D. Pa.
2010); In re Cafeteria Operators, L.P., 299 B.R. 384 (Bankr. N.D.
Tex.
2003);
Constant Ltd. Partnership v. JameswayCorp.
(In re Jamesway Corp.), 179 B.R. 33, 39 (S.D.N.Y.1995);
Thinking Machs. Corp. v. Mellon Fin. Servs. Corp. (In re Thinking
Machs. Corp.), 67 F.3d 1021 (1st Cir. 1995).
19
VI.
No Time to Decide – so Sell it. Designation Rights.
A.
As a result of the reduced time to assume or reject leases and pressure
from lenders, Debtors quickly file sale motions. To maximize value
obtained by the estate in such sales and curb administrative rent expense,
Debtors not only sell the right to conduct GOB sales (inventory and FF&E
in stores) but often sell the right to assume to reject the store leases as
well. The leading case to address selling the right to make the
assumption/rejection decision is re Ames Dept. Stores, Inc., 287 B.R. 112
(Bankr. S.D.N.Y. 2002).
B.
Typically the sale of designation rights is included in sale procedure
motion. Landlords beware - motion may attempt to fix cure amounts
unless an objection is filed, provide for an extremely abbreviated notice
period with respect to the proposed assignee (ultimate purchaser of the
lease) and establishing cure amount, extend the Section 365(d)(4) period
beyond 210 days or permit the designation rights owner to assign the lease
to another third party marketing agent for a fee.
•
100523063.420
Landlords have objected in the Cache, Deb Stores and
similar retail cases requesting adequate protection for
administrative rent and cure amounts. Concerns over
payment of all GOB sale proceeds to secured lender or
subsequent bankruptcy filings of purchasers of leases prior
to satisfying cure obligations. In re Caché, Inc., No. 1510172-MFW (Bankr. D. Del. 2015); In re Deb Stores
Holding, LLC et al., No. 14-12676-KG (Bankr. D. Del.
2014). See In re Whitehall Jewelers, No. 08-1126-KG
(Bankr. D. Del. 2008) (purchaser of leases from Friedman’s
bankruptcy case); In re BH S&B Holdings, No. 08-14604MG (Bankr. S.D.N.Y. 2008) (purchaser of leases from
Steve & Barry’s Manhattan bankruptcy).
C.
Liquidating Agent (often a newly formed joint venture between an
inventory liquidator and real estate marketing firm) pays rent and related
charges and performs all obligations under the lease pursuant to the terms
of the agency agreement/sale agreement until the lease is assumed and
assigned, or rejected. In re Caché, Inc., No. 15-10172-MFW (Bankr. D.
Del. 2015); In re dELiA’s, Inc., et al., No. 14-23678-RDD (Bankr.
S.D.N.Y. 2014); In re Love Culture, No.14-24508-NLW (Bankr. D.N.J.
2014); In re ALCO Stores, No. 14-34941-SGJ (Bankr. N.D.Tex. 2014).
D.
Recent retail cases expand designation rights to include the agent’s ability
to profit from selling not only store leases but also intellectual property,
licenses and a variety of assets. See Id.
20
VII.
VIII.
100523063.421
Interplay between Section 363 Sale and Rejection - Sections 365(h) and
365(n)
A.
The rejection of a lease pursuant to Section 365 does not divest the
nondebtor tenant or licensee of intellectual property of their rights in the
contract with the debtor, so long as they are willing to continue to perform
their obligations and pay. Alternatively, the nondebtor tenant or licensee
can elect to receive money damages for early termination.
B.
Section 363(f) provides assets sold pursuant to a bankruptcy sale can be
transferred free and clear of liens, claims, and interests in the property.
C.
Courts are split as to whether “interest” in Section 363(f) includes rights
that are otherwise protected under Sections 365(h) and (n). Cf. Precision
Indus., Inc. v. Qualitech Steel SBQ, LLC, 327 F.3d 537, 540 (7th Cir.
2003) (while Section 365(h) protects the rights of a lessee, possessory
interests are extinguished after a Section 363(f) sale); In re R.J. Dooley
Realty, Inc., 09-36777, 2010 WL 2076959 (Bankr. S.D.N.Y. 2010); In re
Crumbs Bake Shop, Inc., 522 B.R. 766 (Bankr. D.N.J. 2014) (sale of
intellectual property rights pursuant to Section 363(f) does not trump
rights of a licensee under Section 365(n)); In re Revel AC Inc., No. 151253-GB (Bankr D.N.J. 2015) (sale of casino property was free and clear
of nondebtor tenants’ possessory interests. Tenants granted a stay pending
appeal of that portion of the sale order).
Oil and Gas “Leases”
A.
There are many types of agreements in the oil and gas industry: agreement
with owner of real property, agreement with the exploration and
production company, agreement for mineral rights, joint operating
agreements, agreements with pipeline owner, loan agreements with
security interests.
B.
Whether an oil and gas lease constitutes a lease of real property and can be
assume, assigned and sold or rejected – or is entitled to the protections of
section 365(h), depends on how the agreement is treated under state law.
In re Foothills Texas, Inc., 476 B.R. 143, 149 (Bankr. D. Del. 2012);
Kramer v. PAC Drilling Oil & Gas, L.L.C., 968 N.E.2d 64 (Ohio Ct. App.
2011); River Prod. Co. v. Webb (Matter of Topco, Inc.), 894 F.2d 727,
740 at n. 17 (5th Cir. 1990) (in Texas an oil and gas "lease" conveys a
vested real property right in fee simple determinable so not a true lease at
all); In re Clark Res., Inc., 68 B.R. 358 (Bankr. N.D. Okla. 1986) (under
Oklahoma law, an oil and gas lease was not an unexpired lease or
executory contract subject to assumption or rejection), cf. In re J. H. Land
& Cattle Co., Inc., 8 B.R. 237 (Bankr. W.D. Okla. 1981) (oil and gas lease
created a license to enter upon the land and was subject to Section 365).
21
100523063.422
C.
If the oil and gas lease constitutes a real property interest and are not
executory contracts, operators are unable to rely on the assumption and
assignment provisions to avoid anti-assignment and lessor consent
provisions in sale situations. See, e.g., In re Frederick Petroleum Corp., 98
B.R. 762, 767 (S.D. Ohio 1989) appeal dismissed and remanded, 912 F.2d
850 (6th Cir. 1990); In re Hanson Oil Co., Inc., 97 B.R. 468 (Bankr. S.D.
Ill. 1989); In re Heston Oil Co., 69 B.R. 34 (N.D. Okla. 1986). But see In
re Gasoil, Inc., 59 B.R. 804, 808-09 (Bankr. N.D. Ohio 1986) (Section
365 does apply); In re Aurora Oil & Gas Corp., 439 B.R. 674 (Bankr.
W.D. Mich. 2010) (oil and gas lease qualified as a lease under section
365(m); In re Powell, 482 B.R. 873 (Bankr. M.D. Pa. 2012) (same);
Frontier Energy, LLC v. Aurora Energy, Ltd. (In re Aurora Oil & Gas
Corp.), 439 B.R. 674, 680 (Bankr. W.D. Mich. 2010) (oil and gas leases in
Michigan are ‘rental agreement[s] to use real property’ and therefore
‘leases’ within the meaning of Section 365 [of the Bankruptcy Code].”); In
re J. H. Land & Cattle Co., Inc., 8 B.R. 237, 238 (Bankr. W.D. Okla.
1981), (oil and gas lease may be rejected by the debtor under Section 365).
D.
Will the same interplay between Sections 363(f) and Sections 365(h) and
(n) complicate exploration and production company or real property
owner
bankruptcies?
22
PRACTICAL REMINDERS ABOUT BIDDING PROCEDURES:
LESSONS FROM RECENT DECISIONS
By Martin A. Sosland
“We are not reinventing the wheel here. We all know how to
market and sell an asset in a bankruptcy.”
–United States Bankruptcy Judge Christopher S. Sontchi,
November 3, 2014, bench ruling in In re Energy Future Holdings
Corp.
I.
ORIGINS OF BIDDING PROCEDURES – BASIS UNDER THE CODE RULE AND
NON-BANKRUPTCY LAW
A.
The Bankruptcy Code and Rules
1.
B.
a.
In a chapter 11 case, section 363 implements sections 1107 and
1108 which authorize the debtor to continue to operate in business
as a debtor in possession. The assumption underlying this
authorization is that continued operation of the chapter11 debtor
will maximize the value of the estate and promote the goal of
maximizing distribution to creditors.
b.
Bankruptcy Rule 6004 provides the procedural framework for sales
under section 363. A sale outside the ordinary course of business
may be conducted by private sale or public auction. F.R.B.P
6004(f)(1). Public sales are generally the preferred means of
obtaining the highest or best price. See Onouli-Kona Land Co. v.
Estate of Richards, 846 F.2d 1170 (9th Cir. 1988); In re Planned
Sys., Inc., 82 B.R. 919 (Bankr. S.D. Ohio 1988).
Fiduciary Duties To Maximize Value
1.
100523063.423
Section 363 of the Bankruptcy Code grants the trustee or debtor in
possession the right to use, sell, or lease a property of the estate under
certain conditions. See 11 U.S.C. § 363.
In managing the business of a corporation, directors owe fiduciary duties
of loyalty and care to the corporation and its shareholders. See Paramount
Communicators, Inc. v. QVC Network, Inc. 637 A.2d 34, (Del. 1994);
Unocal v. Mesa Petroleum G., 493 A.2d 946 (Del. 1985). Whether a
company is solvent or insolvent, the standard of case to be exercised is the
same—the making of an informed business judgment. See Committee of
23
the Creditors of Xonics Med Sys., Inc. v. Haverty, 99 B.R. 870 (Bankr.
N.D. Ill. 1989).
C.
2.
When the directors of a corporation propose to sell substantially all of a
debtor’s assets, they must act with the prudence of informed
businesspersons. See Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).
When it becomes inevitable that all or substantially all of a corporation’s
assets must be sold, its directors become responsible for achieving the best
reasonably available transaction for the company. This responsibility is
often referred to as the “Revlon duty.” See Revlon, Inc. v. Mac Andrews
& Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1986).
3.
Although cases applying the duties of directors under Revlon have often
involved public companies, the principle enunciated in Revlon applies
equally to actions taken by directors of private companies. See, e.g.,
Estate of Detwiler v. Offenbecker (S.D.N.Y. 1989).
Fiduciary Duties as Applied to Bid Procedures
“It is the debtors’ burden to establish that the bidding procedures motion was a
reasonable exercise of the debtors’ business judgment, i.e., the judgment of the directors and/or
the officers.” Tr. of Bid Procedures Hr’g at 13, In re Energy Future Holdings Corp., No. 1410979 (CSS) (Bankr. D. Del. Nov. 3, 2014) (hereafter, “EFH Transcript”).
II.
AVOIDING PRATFALLS
A.
Adhere to Precedent
Collect information on ranges of approved marketing periods, break-up fees, minimum
overbids and other auction parameters and adhere to them. “There is no reason to depart with
well-established practices that have been developed to address the unique context of selling an
asset in bankruptcy.” EFH Transcript at 21.
B.
100523063.424
Don’t Rush the Process
1.
The bankruptcy court in Fisker gave two bases for limiting Hybrid’s
ability to credit bid. One was the undetermined validity of Hybrid’s
secured status. But the first was “an unfair process, i.e. a hurried process.”
In re Fisker Automotive Holdings, Inc., 510 B.R. 55 (Bankr. D. Del.
2014). The original schedule proposed Hybrid encompassed only 24
business days, with three intervening holidays. The Court viewed the
“drop dead date” as “pure fabrication.” Id., fn. 4.
2.
The appropriate length of time to market an asset varies with the
circumstances of the debtor and the condition of the asset to be sold. An
operating asset that is not diminishing in value, and that is owned in a
highly complex capital structure, is not suggestive of an expedited sale
process. “In order for the debtors’ statement that they are open to any
24
transaction to be more than lip service, more time must be provided to
allow any such transaction to be formulated.” EFH Transcript at 22.
C.
Allow for Statutory Creditors Committee and Court Oversight
“Creditor and Court oversight of the debtors’ action outside the ordinary course of
business, including asset marketing and sales, is not only appropriate but is required by law.”
EFH Transcript at 21. Committees of creditors appointed pursuant to section 1102 of the
Bankruptcy Code act as fiduciaries for their constituencies, just as the debtor in possession is a
fiduciary for the entire estate. Including statutory committees in the sale process, at least in a
consulting role, is a sign of openness. Openness is good. Excluding committees may be
perceived as less than good.
III.
IS THERE A BETTER WAY? THE EXAMPLE OF ITR.
A.
Negotiate a Prepackaged Chapter 11 Plan
On September 21, 2014, ITR Concession Company, LLC, operator of the Indiana Toll
Road, and certain affiliates filed a prepackaged chapter 11 case in the Northern District of
Illinois. The prepackage plan impaired only prepetition secured lenders and existing equity, and
was supported by statutory majorities of both classes. The prepackaged plan contained a
“toggle” feature, providing for a marketing of the assets post-confirmation and pre-effective date.
If a satisfactory sales price could be realized, the secured lenders would be cashed out, with a tip
paid to equity. Otherwise, the debtor would reorganize with the secured lenders receiving a
combination of reduced debt and equity specified in the plan. In re ITR Concession Company,
LLC, Case No. 14-34284, (Bankr. N.D. Ill.).
B.
Run the Sale Process Post-Confirmation
On October 28, 2014, the Bankruptcy Court confirmed the prepackaged plan. A special
committee of the parent debtor’s board was authorized pursuant to the plan to conduct a sale
process, without court supervision but in consultation with a steering committee of the senior
secured lenders. The special committee and its advisors ran a robust marketing process, and on
March 11, 2015, filed notice of its selection of a successful bidder. No litigation has ensued.
100523063.425
25
Cram Down: Momentive
Implications for Asset
Sale Strategy
ABA Business Bankruptcy Committee
April 2015
Robert A. Klyman
Cram-Down Statutory Framework:
Nonconsensual Confirmation (Section 1129(b))
e.g., Unfair discrimination based on
classification of substantially similar claims
The Plan does
not
discriminate
unfairly
Two Requirements
for Non-consensual
Plan Confirmation
under Section
1129(b)
Secured Creditor Option 1: Property sold
free and clear, with liens attaching to sale
proceeds
The Plan is fair
and equitable
with respect to
impaired
claims
Secured Creditor Option 2: Secured creditor
provided with indubitable equivalent of its
claims
Secured Creditor Option 3: Secured creditor
retains lien on property and receives deferred
payments (new loan)
Gibson Dunn
Source of
Majority
of CramDown
Litigation
2
Cram-Down Option 1: Property Sold, Lien on Proceeds
The sale of the
prepetition
collateral free
and clear of the
secured
creditor’s lien,
with the lien
attaching to the
proceeds
Gibson Dunn
• Sale:
• Sale performed subject to secured creditor’s right to credit bid;
• Plan must provide for or anticipate (in context of post-confirmation
transaction) the sale; and
• Section 1123 anticipates that a sale of some or all of assets can be a
means to implement the plan.
• Lien Attaching to Proceeds: Lien must transfer to proceeds of that
collateral, be they cash, notes or other property received in
exchange. Can’t sell different collateral and transfer lien to those
proceeds.
3
Cram-Down Option 2: Examples of Indubitable Equivalence
Abandonment or transfer of
collateral to secured creditor
satisfies requirement
The realization of the
indubitable equivalent
of the allowed amount
of the secured claim
Indubitable Equivalence decided on
case-by-case basis, but payment stream
with present value of less than secured
claim will not suffice
Gibson Dunn
Returning Portion of
Collateral Generally
Will Not Suffice
“Indubitable Equivalent” – generally
must (a) provide the secured creditor
with the present value of its claim and
(b) insure the safety of its principal
Substitute collateral (if
replacement collateral is of
equal or greater value) and
does not increase risk
exposure
4
Cram-Down Option 3:
“New Loan” Approach
Requirements
• Secured creditor must retain the liens securing its claim.
• Must receive deferred cash payments:
• (i) totaling at least the allowed amount of its secured
claims, and
• (ii) equal to a value, as of the effective date of the plan,
of at least the value of the creditor’s interest in the
secured property.
Gibson Dunn
5
Face Value of “New Loan”
Must total at least the allowed amount of creditor’s secured claims
A claim is secured to the extent of the value of the creditor’s
interest in the estate’s interest in the collateral
(Valued on the Effective Date of the Plan)
Oversecured Creditor: Oversecured creditors will be limited to a face amount
of new notes in the amount of their claim(i.e. if a $50 claim is secured by
collateral worth $100, new notes will have a face value of $50).
Undersecured Creditor: Undersecured creditors will be limited to a face
amount of new notes in the amount of the collateral (i.e. if a $150 claim is
secured by collateral worth $100, new notes will have a face value of $100).
Gibson Dunn
6
Discount Rate of “New Loan”
Must provide present value (on the effective date) equal to at
least the value of the creditor’s interest in the secured property
Two Alternative Approaches to Determining “Value”
Prime Plus/Formula Approach: Interest rate on the new loan set at the prime
rate (as of the effective date) plus a nominal increase (typically 1%-3%) for
credit risk.
Efficient Market Approach: Where an efficient market for the type of loan in
question exists, the interest rate on the new loan is set at the market rate.
Gibson Dunn
7
Calculating the Rate
Calculating the Formula Rate
Calculating the Market Rate
versus
Expert
Testimony
Contract Rate
Actual Loan Offers
Gibson Dunn
Prime vs.
Treasury
Risk
Adjustment &
Evidentiary
Concerns
Accounting for the
Market
8
Case Law Prior to Momentive:
Till v. SCS Credit Corporation
•Case Facts:
•Individual Chapter 13 debtors had borrowed $8,000 to purchase a truck, with a 21% interest rate.
•In bankruptcy, the truck was valued at $4,000.
•The debtors sought to cram-down the undersecured lender by providing a new loan, secured by the truck, with an
interest rate equal to the prime rate plus 1.5%.
Supreme Court Ruling
•Present Value of Claim: The Court adopts the “Formula Approach” or “Prime Plus Rate” under which the rate
is determined independent of lender’s particular financial circumstances.
•Burden of Proof: The secured creditor must present evidence to support adopting a higher rate.
Calculating the Cram-Down Rate under Till
•Commence with Prime Rate and Risk Adjust for the following: (a) probability of plan failure;
(b) rate of collateral depreciation; (c) liquidity of capital markets; and (d) administrative expenses.
•Feasibility: Rate reflects both lender’s risk and Court’s interest in not “doom[ing] the plan.”
•The Court declined to rule on the proper scale for risk adjustment but noted past courts have used a 1-3%
estimate.
Gibson Dunn
9
Applying Prime Plus in Chapter 11:
Till’s Conflicting Guidance/Competing Footnotes
Gibson Dunn
10
Cram-Down Litigation Post Till
Multiple courts have held
that Till’s precedential
value should be limited.*
“While many courts have chosen to
apply the Till plurality’s formula
method under Chapter 11, they
have done so because they were
persuaded by the plurality’s
reasoning not because they
considered Till binding.”
- In re Texas Grand Prairie Hotel
Realty, L.L.C., 710 F.3d 324 (5th Cir.
2013).
Certain courts applying Till have adopted a
two-step “Hybrid” approach to calculate interest
rates
Determine
whether an
efficient
market exists
If there is no
efficient
market, turn
to the formula
rate approach
Calculate
postemergence
interest rate
* See In re Am. HomePatient, Inc., 410 F.3d 559 (6th Cir. 2005); In re
NW Timberline Enters., Inc., 348 B.R. 412 (N.D. Tex. 2006) (using
formula rate where no market for risky post-emergence loans exists).
Gibson Dunn
11
The Momentive Case (Facts)
• Prior to bankruptcy, the debtors had three classes of secured debt: (i) First Lien, (ii) 1.5 Lien,
and (ii) Second Lien.
• The First Lien and 1.5 Lien indentures contained a make-whole provision which was
disputed.
• The debtors filed a bankruptcy petition accompanied by a plan support agreement signed by
85% of the Second Lien holders.
• The Plan did not recognize the make-whole, but contained a toggle provision which provided
the First Lien and 1.5 Lien Holders with (i) cash payment in full if they accepted the plan, or
(ii) take-back notes with under-market interest rates (3.6% for First Lien and 4.1% for 1.5
Lien) if they rejected the Plan.
• The Second Lien Holders were to receive 100% of the equity under the plan.
• The First Lien and 1.5 Lien holders rejected the Plan, and litigated both the make-whole and
the interest rate on the cram-down paper.
Gibson Dunn
12
The Momentive Case (Arguments)
• Secured Noteholder Arguments for Market Rate:
− Secured Noteholders argued that a market rate for the notes was required to provide them with the
present value of their secured claims today.
− Heavy reliance was placed on the Till footnote stating that an efficient market approach might be
preferable in a chapter 11 context and subsequent case law applying the “hybrid” approach.
− Secured Noteholders argued that an efficient market did in fact exist, as evidenced by
commitments for exit financing received by the debtor with market interest rates of 5% (first lien)
and 7% (second lien).
• Debtor Arguments for Prime Plus Rate:
− The Debtors argued that the “value” required under the cram-down standard is value as determined
by a court, not value as determined by a market.
− The plain language of Till provides that, on a theoretical level, secured creditors in a cram-down
scenario are entitled to receive compensation for (i) loss of the time value of money (i.e. the prime
rate), and (ii) credit risk (i.e. the “plus” portion of the Prime Plus Rate). Secured lenders are not
entitled to receive the additional “profit” element of a secured loan.
Gibson Dunn
13
The Momentive Case (Decision)
• The Momentive Court ruled in favor of the Debtors’ application of the Prime Plus Rate.
• The decision was based upon both the purported terms and the logic of Till.
− Terms: The Till Court stated in its plurality opinion that the appropriate method of
calculation should apply to all chapters of the Bankruptcy Code.
− Logic: One of the guiding principles of the Till decision is that the appropriate discount
rate in a cram-down scenario should not include a profit element.
• Market rates (including the committed exit loans) inherently include a profit
element in addition to compensation for the time value of money and credit risk.
Gibson Dunn
14
The Momentive Case (Concerns/Implications)
• Concerns:
− The Court’s reasoning that the terms of Till are binding is questionable.
•
Till is a plurality opinion, which is arguably not binding other than for the specific
case at hand.
•
The “competing footnotes” may not actually be inconsistent. The “hybrid
approach” is consistent with both footnotes — it can be used for any chapter of the
Bankruptcy Code, and, in a chapter 11, would most often result in application of the
efficient market rate.
− The Court’s reasoning that the logic of Till is persuasive may be misapplied
• The Judge assumes that loans contain three compensation elements: (i) lost time
value of money, (ii) credit risk, and (iii) profit.
• It is not clear, however, that an efficient lending market will result in market interest
rates that contain a profit element above and beyond compensation for credit risk.
Gibson Dunn
15
The Momentive Case (Concerns/Implications)
• Implications:
− Secured Lenders may push for asset sales in lieu of plans to avoid cram-down
possibilities.
− One in a series of recent cases limiting the rights of secured lenders (adequate protection,
credit bid, and now protection against cramdown all under attack).
− Increases leverage of unsecured creditors and debtors
− Secured creditors will try to negotiate protections in prepetition intercreditor agreements
− Secured creditors will try to negotiate ‘first day’ protections as part of DIP / adequate
protection packages. Disputes likely to arise at final DIP hearings.
− First liens will Increases risk/rate of any lender willing to provide rescue financing (due
to subsequent cramdown concerns)
− Decreases need for exit financing commitments (borrower already has ‘committed’
financing at a “prime plus” rate)
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Analysis of These Issues Can Be Tricky, So Feel Free to Call:
Robert A. Klyman
Gibson, Dunn & Crutcher, LLP
333 South Grand Ave.,
Los Angeles, CA 90017
1 213.229.7562
[email protected]
Gibson Dunn
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Disclaimer
Although this presentation may provide information concerning potential legal
issues, it is not a substitute for legal advice from qualified counsel. This
presentation is not created nor designed to address the unique facts or
circumstances that may arise in any specific instance. You should not, nor are
you authorized to, rely on this content as a source of legal advise. This material
does not create any attorney-client relationship between you and Gibson Dunn.
© Copyright 2014 Gibson Dunn. All Rights Reserved.
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