Restructuring

Contributed by Jessica Diab

In today’s economic environment, the rights of secured creditors have become a hot topic around the figurative dinner table of bankruptcy professionals.  Inevitably, this conversation includes a discussion of those Bankruptcy Code provisions intended to protect the rights of secured creditors, including:

• Section 363(k), which permits a secured creditor with a lien on property being sold pursuant to section 363 to credit bid its claim in any such sale unless the court, for cause, orders otherwise;
• Section 1111(b)(1) which permits an undersecured creditor to assert its deficiency claim together with other unsecured creditors even though the secured debt was issued on a nonrecourse basis; and
• Section 1111(b)(2) which permits an undersecured creditor to elect to retain its lien for the full amount of its claim, avoiding the bifurcation of its claim between secured and unsecured, and foregoing any recourse that it may have as an unsecured creditor.

Recently in Baker Hughes, the Court of Appeals for the Fifth Circuit considered these two provisions and their mutual role in protecting the rights of secured creditors.
In Baker Hughes, the debtor sold substantially all of its assets pursuant to section 363 of the Bankruptcy Code as a part of the debtor’s confirmed chapter 11 plan.  Prior to confirmation, one of the debtor’s undersecured creditors, Baker Hughes Oilfield Operations, Inc. (“Baker Hughes”), which held a lien on certain of the assets subject to the sale, filed an election pursuant to section 1111(b)(2) to have its claim treated as secured to the full extent of its claim.  The proposed purchaser objected on the grounds that, pursuant to section 1111(b)(1)(B)(ii), such an election is not available where the debtor intends to sell the encumbered property pursuant to section 363.  The bankruptcy court confirmed the debtor’s plan with no objection from Baker Hughes.  Following confirmation, Baker Hughes argued again that, as a secured creditor, it either had the right to credit bid at the sale of the collateral or be granted its election under section 1111(b)(2).  Both the bankruptcy court and the district court denied Baker Hughes’s claim, and the Fifth Circuit affirmed.
The majority’s brief opinion acknowledged the importance of a secured creditor’s right to credit bid, but found that the debtor’s plan implicitly provided secured creditors the right to credit bid by proposing a sale “pursuant to § 363,” and that Baker Hughes waived its right to credit bid by neither seeking to do so nor objecting to confirmation of the plan.  The majority rejected Baker Hughes’s argument that a trustee or a debtor in possession has the responsibility to make arrangements for a credit bid.  Ultimately, the majority held that the sale was valid under section 363 and, accordingly, the secured creditors were not entitled to exercise an election under 1111(b)(2).
Judge Jones concurred with the majority’s decision; however, she took issue with the majority’s reasoning.  In concurring with the majority’s decision, Judge Jones observed that Baker Hughes’s practical position in the lien structure was at odds with its claim to having been denied a right to credit bid — Baker Hughes, as a materialmen’s lienholder, could in theory make a credit bid, but practically would never do so because of the need to pay off senior liens as part of the bid.  It was on this basis alone that Judge Jones concurred with the majority’s decision.
Judge Jones was critical of the majority’s reasoning, noting that if extended beyond the facts of Baker Hughes, the majority’s approach would effectively condone a sale of substantially all of the debtor’s assets outside of a public auction without any effort to protect the secured creditors’ right to credit bid and without the protection of the 1111(b)(2) election.  Judge Jones held that the prohibition against the 1111(b)(2) election in the context of a 363 sale should only apply where the secured creditors are, in fact, assured the right to credit bid their collateral.  Notably, Judge Jones stated that such assurance is not met by simply “attaching the statutory labels to a debtor’s proposed collateral sale.”  Judge Jones concluded her opinion with the following three practices that bankruptcy courts should implement to assure the protection of statutory rights for secured creditors:

1. when a secured creditor timely asserts an election under section 1111(b)(2) to which an objection is made, the bankruptcy court should resolve the creditor’s election before the confirmation hearing (noting that, had the court done so in this case, it could have spurred negotiations or plan revisions);
2. if the terms of the sale under section 363 of the Bankruptcy Code or the chapter 11 plan are found wanting in protection of secured creditors’ right to credit bid, secured creditors should be permitted to elect treatment under section 1111(b)(2); and
3. bankruptcy courts should order transparent, broadly publicized auctions of debtors’ assets that test the market for valuations, as well as for secured creditors’ sincerity about credit bidding.

Judge Jones’ concurring opinion is a reminder to practitioners that in today’s lending environment, mere formalities might simply not be enough to satisfy the mutually enhancing protections provided to secured creditors under the Bankruptcy Code.  Or, at the very least, the concurring opinion should serve as a conversation piece for your next bankruptcy-related dinner party!