Presentation on theme: "Fifth Annual American College of Bankruptcy Seventh Circuit Education Committee Seminar Moderator: Richard J. Mason, McGuireWoods LLP Panelists: Francis."— Presentation transcript:
Fifth Annual American College of Bankruptcy Seventh Circuit Education Committee Seminar Moderator: Richard J. Mason, McGuireWoods LLP Panelists: Francis X. Buckley, Jr., Thompson Coburn LLP Robert M. Fishman, Shaw Fishman Glantz & Towbin LLC Randall L. Klein, Goldberg Kohn Ltd. Undersecured Creditor’s Dilemma: Defining the Limits on Credit Bids and Lien Stripping
Fundamental issue: In bankruptcy cases, does a security interest in property create a “claim to property” or “indefeasible right in property”?
Secured Claim Determination Classification as a holder of a secured claim under the Bankruptcy Code is not synonymous with holding a security interest outside of bankruptcy. ‘Secured claim’ is a term of art within the Bankruptcy Code, and means something different than it does for a creditor to have a security interest or lien outside of bankruptcy. In re Jennings, 454 B.R. 252, 254 (Bankr. N.D. Ga. 2011)
Secured Claim Determination The Code clearly allows bifurcation of claims. Section 506(a)(1) recognizes that a creditor has a secured claim only to the extent of the value of the property securing the claim and an unsecured claim for the balance.
Lien Strip Down Section 506(d): A fair reading of Section 506(d) seems to permit stripping down: To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless-- (1) such claim was disallowed only under section 502(b)(5) or 502(e) of this title; or (2) such claim is not an allowed secured claim due only to the failure of any entity to file a proof of such claim under section 501 of this title.
Lien Strip Down Dewsnup v. Timm (1992) Notwithstanding section 506(d), in Chapter 7 cases, debtors are prohibited from “stripping down” a secured claim to the value of the collateral. The lien passes through bankruptcy unaffected. Palomar v. First American Bank, 722 F.3d 992 (7 th Cir. 2013) (Seventh Circuit upholds the principle of a lien pass-through in bankruptcy).
Treatment of Residential Mortgages Under Section 1322(b)(2) Nobleman v. American Savings Bank (1993) Section 1322(b)(2) prohibits a debtor from utilizing Section 506(a) to strip down an undersecured homestead mortgage to the value of the residence. The valuation process under Section 506 does not serve to limit the lender’s rights as a claim holder which is the thrust of Section 1322(b)(2). The Court created an analytical foothold for future cases: the starting point for the determination of the status of all secured claims in bankruptcy is a judicial valuation under Section 506(a).
Strip Offs in Chapter 20 Permissibility of Chapter 20: Johnson v. Home State Bank (1991)- a debtor can utilize a “Chapter 20” to treat the remaining lien claim of a secured creditor in Chapter 13 following the discharge of the personal liability associated with the claim in a prior Chapter 7. Despite not having a claim against the debtor, the mortgagee still holds a “right to payment” resulting from the mortgage lien, which constitutes a claim under Section 101(5).
Strip Offs in Chapter 20 BAPCPA bolstered the rights of secured creditors. Section 1325(a)(5) provides for the retention of lien until the earlier of- 1) payment or discharge of the underlying debt, and 2) upon conversion or dismissal of the case without completion of the plan. Section 1338(f) prohibits the debtor from receiving a discharge in Chapter 13 if the debtor received a Chapter 7 discharge within four years preceding the Chapter 13 filing date.
Strip Offs in Chapter 20 Three approaches to the permissibility of Chapter 20 lien stripping (i.e. strip off): 1. Impermissible because it is a “de facto discharge”, relying on Dewsnup and the discharge requirement in Section 1325(a)(5) following BAPCPA. Erdmann v. Charter One Bank (In re Erdmann), 446 B.R. 861 (Bankr. N.D. Ill. 2011) (Black, B.J.); In re Fenn, 428 B.R. 494 (Bankr. N.D. Ill. 2010) (Cox, B.J.).
Strip Offs in Chapter 20 Three approaches to the permissibility of Chapter 20 lien stripping (i.e. strip off): 2. Permissible, but after plan consummation without the grant of a discharge, the parties' pre-bankruptcy rights are reinstated because discharge is the mechanism that voids the lien and those chapter 20 plans end in dismissal. See, e.g., Grandstaff v. Casey (In re Casey), 428 B.R. 519 (Bankr. S.D. Cal. 2010); In re Trujillo, 2010 WL 4669095, 2010 Bankr.LEXIS 3834 (Bankr. M.D. Fla. Nov. 10, 2010); In re Colbourne, 2010 WL 4485508, 2010 Bankr.LEXIS 3813 (Bankr. M.D. Fla. Nov. 8., 2010).
Strip Offs in Chapter 20 Three approaches to the permissibility of Chapter 20 lien stripping (i.e. strip off): 3. Permissible because nothing in the Code prevents it. See, e.g., Wells Fargo Bank, N.A. v. Scantling (In re Scantling), 754 F.3d 1323 (11 th Cir. 2014); Branigan v. Davis (In re Davis), 716 F.3d 331 (4 th Cir. 2013); In re Fair, 450 B.R. 853 (Bankr. E.D. Wis. 2011) (Randa, D.J.); In re Jennings, 454 B.R. 252, (Bankr. N.D. Ga. 2011); In re Nwogbe, 451 B.R. 90 (Bankr. D. Nev. 2011).
Strip Offs in Chapter 20 Branigan v. Davis (In re Davis), Two separate Chapter 13 cases where the debtor sought to strip off valueless junior mortgages on their residences following receipt of Chapter 7 discharge. Fourth Circuit ruled that Section 1328(f) is not a bar to filing a Chapter 13 case even though the debtor cannot receive a discharge. Code does allow for stripping wholly underwater liens because: (1) BAPCPA did not amend Sections 506 or 1322(b); and (2) the new language in Section 1325(a)(5) applies only to allowed secured claims. If secured creditor is totally underwater, the creditor is not the holder of a secured claim under section 506(a).
Strip Offs in Chapter 20 Wells Fargo Bank, N.A. v. Scantling (In re Scantling), 754 F.3d 1323 (11 th Cir. 2014) First, value the claim under Section 506(a). Second, pursuant to Section 1322(b)(2), the creditor's “rights” are modified by avoiding the lien to which the creditor would otherwise be entitled under nonbankruptcy law. Section 1325(a)(5) is not involved, and the debtor's ineligibility for a discharge is irrelevant to a strip off in a Chapter 20 case. BAPCPA did not amend Sections 506 or 1322(b), so the analysis permitting strip offs in Chapter 20 cases is no different than that in any other Chapter 13 case.
Strip Offs in Chapter 20 Good faith is required before strip off can occur. “A central issue of a ‘chapter 20’ case is whether ‘the action of the debtor in filing the petition was in good faith’ 11 U.S.C. § 1325(a)(7), and whether ‘the plan has been proposed in good faith and not by any means forbidden by law’ 11 U.S.C. § 1325(a)(3).” In re Jennings, 454 B.R. 252, 259 (Bankr. N.D. Ga. 2011). In re Nwogbe, 451 B.R. 90, 101–03 (Bankr. D. Nev. 2011): Good faith factors- (1) whether the debtors have a need for bankruptcy other than lien avoidance; (2) whether debtors acted equitably in proposing the plan; (3) whether debtors are devoting their income to the plan; and (4) whether the debtors used serial filings to avoid paying their creditors.
Liens, Claims and Statutory Language 363(k) – “At a sale... of property that is subject to a lien that secures an allowed claim” 506(d) – “To the extent that a lien secures a claim against the debtor that is not an allowed secured claim” 1111(b)(1)(A) – “a claim secured by a lien on property of the estate shall be allowed or disallowed... as if the holder of such claim had recourse....” 1322(b)(2) - “... the plan may... modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence”
363(k) – Statutory Elements at a sale under 363(b) of property that: is subject to a lien secures an allowed claim unless the court for cause orders otherwise the holder of such claim may bid at such sale if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property see also 1129(b)(2)(A)(ii)
What 363(k) Does Not Say “For cause” only modifies the right of the holder of the allowed claim to bid at such sale. Under agented facilities, the holder of the “lien” is not the holder of the “claim”. “The agent is no more the ‘holder’ of the claim than it is a ‘lender’ under the credit agreement.” Klein and Juhle, Majority Rules: Non-Cash Bids and the Reorganization Sale, 84 Amer. Bankr. L. J. 297, 319 (2010). Compare In re GWLS Holdings, Inc., No. 08-12430, 2009 WL 453110 (Bankr. D. Del. Feb. 23, 2009)(Bankruptcy Court deemed agent to be the holder of all secured claims and allowed offset against purchase price by Newco).
More of What 363(k) Does Not Say The holder of the claim secured by the sold property may offset against the “purchase price”. 363 does not require that all bids be made in the form of cash. Higher or better vs. higher and better (cash plus promissory note may be higher but not better than all cash for lower “purchase price”). In re WestPoint Stevens, Inc., 333 B.R. 30, 51 (S.D. N.Y. 2005); aff’d in part, rev’d in part, 600 F.3d 231 (2d Cir. 2010)(senior secured claims not deemed satisfied until non-cash consideration monetized or would satisfy cram-down requirements).
What is a “Credit Bid”? Term is not used or defined in Bankruptcy Code (see also “cram down” and “carve out”). Is it a “bid” made with “secured credit”? Is it a “credit against” a bid? Is it a substantive right or merely a mechanical, administrative device? “[A] purchase by the trustee required no payment of money, beyond a sum sufficient for costs, unless the bid exceeds the sum due on the first mortgage, the purchase being made for the first-mortgage bondholders.” Sage v. Central Railroad Co., 99 U.S., 334, 344-45 (1879).
What is a “Credit Bid”? “At such a sale nothing is more common than for the mortgagee to become the purchaser…[T]he whole amount bid by [the mortgagee] at the sale…was at once credited by the principal creditors, for whom he was acting as agent, as a credit of cash upon the overdue obligations of the debtor. In fact and in law it was a payment of money to the use and benefit of the debtors in pursuance of their authority.” Easton V. German- American Bank, 127 U.S. 532, 538-539 (1888).
Historical Credit Bid Rights By 1935, the Supreme Court declared a secured creditor’s right to bid as a historically fundamental right. Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 580 (1935). Used to “protect his right to full payment or the mortgaged property” (Brandeis). The mortgagee “may offset the price against the debt” (Cardozo). Worthen Co. v. Kavanaugh, 295 U.S. 56 (1935).
Present Day Credit Bid Rights - RadLAX If a plan/auction prohibits a “credit bid” and the secured creditor “wins” the auction, what happens to the cash? A little mentioned fact: the RadLAX plan proposed to use auction proceeds to satisfy other administrative expenses, including the break-up fee payable to the insider, stalking- horse bidder. Question Presented: if collateral is to be sold under a plan, may the plan proponent rely on 1129(b)(2)(A)(iii) and avoid the sale being “subject to 363(k)” under 1129(b)(2)(A)(ii)?
RadLAX Debtor’s plan proposed to meet the requirement of 1129(b)(2)(A) by using the third statutory alternative (“(i)... ; (ii)...; or (iii)”). The secured creditor argued that the specific reference to a “sale” under clause (ii) meant that clause (ii) governed exclusively for a plan that provided for a “sale, subject to section 363(k)”. The Supreme Court found RadLAX to be “an easy case” with “no textual ambiguity” and rejected the debtor’s argument as “hyperliteral and contrary to common sense”.
What RadLAX Does Not Say The Supreme Court did not rely on the pre-Code practices or prior Supreme Court cases that stressed the importance of the right to credit bid. The Supreme Court also did not discuss the “for cause” limitation under 363(k) incorporated by reference in 1129(b).
“For Cause” The holder of an allowed claim secured by a lien on property being sold may bid unless the court orders otherwise. The right of the holder to “offset such claim against the purchase price of such property” is not expressly tied to the “for cause” limitation. Does this mean that the Court may order that the creditor cannot bid or that it cannot “credit bid”?
“Allowed Claim” To be “offset” against the purchase price, there must be a mutual debt owing to the bidder. If the claim is not “allowed”, mutuality is destroyed. 502(a): “a claim or interest, proof of which is filed under section 501 of this title is deemed allowed, unless a party in interest... objects”. 502(b): “... if such objection to a claim is made, the court, after notice and a hearing, shall determine the amount of such claim... and shall allow such claim in such amount, except....”
Poof! “A lien is parasitic on a claim. If the claim disappears --- poof! the lien is gone.” Unisys Finance Corp. v. Resolution Trust Corp., 979 F.2d 609 (7 th Cir. 1992). Similarly, if the lien securing the claim or the claim itself is subject to an objection, the procedural right of offset under 363(k) is lost until the objection is resolved See In re L.L. Murphrey Co., 2013 Bankr. LEXIS 2318 (Bankr E.D. N.C. June 6, 2013). Creditors intending to “credit bid” will want an expedited determination of the allowed claim or eliminate the “for cause” element as part of a cash collateral or financing order. See In re Radnor Holdings Corp., 353 B.R. 820 (Bankr. D. Del. 2006) (hearing held on extent and validity of secured claim prior to credit bid at auction).
Objection to Allowance Vs. Counterclaim What if the secured creditor is subject to state law counterclaims? In re Charles Street African Methodist Episcopal Church of Boston, No. 12-12292-FJB (Bankr. D. Mass. May 14, 2014): Debt and liens not subject to bona fide dispute; Objector did not assert that claims were not “allowed” under 363(k); Objector argued that existence of counterclaims constitutes “cause” to deny credit bidding; and Court ruled that no “cause” exists based on counterclaims when there is no dispute about validity or extent of secured claims.
“Such property” 363(k) applies only to the purchase price for the property subject to the lien. Allocation issues arise if collateral and non-collateral are part of the same sale: May the secured party increase its bid by increasing only its credit bid? Must the secured party allocate the same cash consideration payable by a competing bidder for the non-collateral property? Can the secured party force the sale in lots so as to bid only for the collateral? Can the debtor meet the standard required under 363(f) if the secured party would have been willing to bid more under 363(k)? See Butler, Dickerson, Meisler & Neuman, Exploring the Outer Limits of Credit Bidding When the Asset Sale Package Includes Assets Not Subject to the Bidder’s Liens, The Journal of Corporate Renewal (January/February 2011).
Fisker Delaware Bankruptcy Judge Gross capped credit bid for “cause” in order to foster competitive bidding. $25mm credit bid cap (equal to secondary market purchase price) based upon stipulation between the committee and debtor. Court determined that no competitive auction would occur without the cap on the right to credit bid. Court alternatively could have denied the credit bid based upon objection to “allowance” of secured claim. Court expressed concern over “unfair” and “hurried” sale process that “was pure fabrication designed to place maximum pressure on creditors and the court.”
More Fisker Credit bid ruling not a “final order.” Insufficient basis for interlocutory appeal: Court had discretion to determine “cause” Immediate appeal would not materially advance the litigation No exceptional circumstances Reliance on 3 rd Circuit ruling in Philadelphia Newspapers, LLC 3-day auction, won by competing bidder. Reliance by Bankruptcy Court and District Court on Section III(C) of Philadelphia Newspaper opinion not joined by Judge Smith and may have also been dicta. “A court may deny a lender the right to credit bid... to foster competitive bidding environment.” In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010).
Free Lance-Star Publishing Richmond Bankruptcy Court Judge Huennekens Debt purchaser acquired secured debt pre-petition. Debtor filed chapter 11 and immediately sought approval of bidding procedures for all assets. Court permitted credit bid only for assets that were secured by “valid” liens. Secured creditor filed complaint and motion for summary judgment in order to make credit bid.
More Free Lance Court found some assets were not subject to valid, perfected liens. Court found inequitable conduct that established “cause” to limit the right to credit bid. “The confluence of (i) DSP’s less than fully-secured lien status; (ii) DSP’s overly zealous loan-to-own strategy; and (iii) the negative impact of DSP’s misconduct has had on the auction process has created the perfect storm, requiring curtailment of DSP’s credit bid rights.” District Court denied emergency motion for expedited appeal because bankruptcy court rulings were not final and denied interlocutory appeal. Secured creditor won auction with part cash part credit bid.
SubMicron 2006 opinion from Judge Ambro where plan trustee challenged a credit bid made by the under-water junior secured creditor. In re SubMicron Systems Corp, 432 F.3d 448 (3d Cir. 2006). 363(k) allows secured creditor to bid the total face amount of claims. Limiting bid to economic value of collateral is “nonsensical”. Greater bid by the secured creditor “becomes the value of the lender’s interest in [the collateral]”. NOTE: Beware of bidding full amount if intent is to preserve deficiency against third parties.
SubMicron, 363(k) and 1111(b) The rationale for the exception in 1111(b) “presupposes 363(k) credit bidders can bid the full value of their secured claims.” “Sale of property under 363 or under the plan is excluded from treatment under 1111(b) because of the secured party’s right to bid in the full amount of his allowed claim at any sale of collateral under section 363(k).” (124 Cong. Rec. H11, 103-04 (1978)).
Section 1111(b) and the Underwater Junior Secured Creditor In re B.R. Brookfield Commons No. 1 LLC, 735 F.3d 596 (7 th Cir. 2013). “Statute does not state that the claim be secured by any value in the property” but only that a claim “be secured by a lien”. 7th Circuit rejects Judge Ginsburg’s 1993 ruling (sitting in Florida) as an “outlier opinion” that a non-recourse junior lienholder had no unsecured claim under 1111(b) because the value of the property was less than the senior secured debt. See In re SM 104 Ltd., 160 B.R. 202 (Bankr. S.D. Fla. 1993). But see 1111(b)(1)(B)(i) –no (b)(2) election for wholly underwater junior secured creditor.
Hypothetical Debtor commences chapter 11 case as owner of a building assumed to be worth $1,000,000 upon “free and clear” sale order but only $800,000 at state law foreclosure sale. Bank A holds non-recourse mortgage for $1,200,000. Bank B holds full recourse mortgage for $500,000. Plan proposes to reduce Bank A claim to $1,000,000 secured, payable over time and no secured claim to Bank B. Unsecured claims paid 10% ratably from proceeds of the sale of new equity to insiders. Exclusivity has been waived.
Hypothetical Questions Is the plan confirmable? What can Banks A and B do to protect their interests in the building if it increases in value post-confirmation? What if the plan provides for a sale of the building to a third party at or in connection with confirmation?