The U.S. Supreme Court has a penchant for rulings that, as a practical matter, screw up our bankruptcy world. The most recent example is the Supreme Court’s March 22, 2017, ruling in the In re Jevic case [see this article].
Another case, where the U.S. Supreme Court did us no favors in the practical world of bankruptcy, is In re RadLAX Gateway Hotel, LLC,, 132 S.Ct. 2065 (2012). This RadLAX case deals with credit bidding by a secured creditor at a bankruptcy auction.
Credit bidding is defined as a secured creditor bidding its existing debt, instead of new cash, at an auction of its collateral.
RadLAX involves a bankruptcy auction of all debtor’s assets, consisting of a hotel and parking garage with related furnishings and equipment. The debtor’s primary lender holds a $142 million secured claim against all asset. The RadLAX debtor asks that credit bidding rights of the secured creditor be limited. The bankruptcy court rejects this request, as does the Court of Appeals. And the U.S. Supreme Court affirms.
Such a result is neither surprising nor unexpected. But the Supreme Court’s analysis in a near-unanimous opinion is disappointing in this respect: it provides a one-sided explanation of credit bidding.
The Court describes (in footnote no. 2–see photo above) how credit bidding protects a creditor “against the risk that its collateral will be sold at a depressed price.” While this description is certainly true, it’s not the whole story.
What the Court fails to mention is that credit bidding can have a funny-money component, in which an under-secured creditor bids far beyond the market value of its collateral—to the disadvantage and damage of everyone else. This is a pathology: it’s a defect in our bankruptcy system.
Credit Bidding and Funny-Money
Bankruptcy is very good at a few things. One of those things is selling a debtor’s assets.
Bankruptcy sales work well because buyers know the sale will actually happen and will be, (i) free and clear of liens and encumbrances, and (ii) governed by the market value of assets. This knowledge gives buyers confidence to spend time, effort, and money on preparations for bidding and to show up at the auction ready to bid.
Such confidence evaporates, however, when credit bidding by an under-secured creditor is involved: when the value of the creditor’s collateral is less than the creditor’s remaining loan balance.
Credit bidding gets out-of-whack when an under-secured creditor has an incentive to credit bid more than the market value of its collateral. This is “bidding funny-money.”
–If, for example, a creditor has a $100,000 loan balance, but its collateral has a market value of only $50,000, this creditor might have an incentive to bid more than $50,000—that’s the funny-money. The creditor knows it has a bidding advantage, because the creditor is bidding dollars it will never recover (i.e., the funny-money) against real-dollar bids from others.
–Reasons for a secured creditor’s funny-money bid might include, (i) testing how high other bidders will actually go, (ii) wanting to re-market the collateral later, or (iii) preventing someone else from getting the collateral.
Competing bidders understand this funny-money problem. So, they tend to back-away from sales where credit bidding can occur. This is a huge problem. It chills competitive bidding and accounts for many failed bankruptcy auctions.
A Funny-Money Example
Here’s an example of a funny-money credit bid that actually happened:
There is a bankruptcy auction of a closed-down processing facility in the upper Midwest. Extensive advertising efforts result in a $13 million opening cash bid from a highly qualified buyer, who intends to reopen the facility immediately and start employing many people, purchasing huge quantities of goods and services, paying large amounts of Federal, state, and local taxes, etc. Whereupon, the under-secured creditor counters with a $32 million credit bid . . . and that’s the end of the auction. Thereafter, the facility remains closed for a long time.
There is no way this facility had a fair market value, in that auction, anywhere near the $32 million credit bid. Why did the secured creditor make such a high bid? Only they know. But the immediate effect of their bid is to bury any possibility of an ongoing business that would maximize value for many, many people.
This lender presents a funny-money credit bid. And everyone else pays a heavy price in lost opportunities!
The RadLAX Analysis
The Supreme Court’s analysis in its RadLAX opinion is, almost entirely, a grammatical parsing of Bankruptcy Code language. For example, the Court writes:
“The general/specific canon [of statutory interpretation] is perhaps most frequently applied to statutes in which a general permission or prohibition is contradicted by a specific prohibition or permission. To eliminate the contradiction, the specific provision is construed as an exception to the general one. . . . But the canon has full application as well to statutes such as the one here, in which a general authorization and a more limited, specific authorization exist side-by-side. There the canon avoids not contradiction but the superfluity of a specific provision that is swallowed by the general one, “violat[ing] the cardinal rule that, if possible, effect shall be given to every clause and part of a statute.”
I’m fine with this kind of analysis, of course. Heck, they know vastly more than I about such things.
But what’s disappointing is this:
Not once does the Supreme Court opinion, in RadLAX, even mention the need for market-driven bidding in bankruptcy auctions to maximize value for everyone. And not once does the Supreme Court give even a nod-of-the-head or of-the-keyboard to the funny-money problem.
–And that’s despite references in the opinion to such statutory criteria as, (i) “common sense” in interpreting §1129(b)(2)(A), (ii) a “fair and equitable” standard for plan confirmation, and (iii) limiting credit bidding rights “for cause” under § 363(k).
In a ruling like RadLAX, it would be helpful to know that the Justices, (i) acknowledge the existence of the funny-money component of credit bidding, and (ii) are making a conscious choice in favor of continuing the funny-money pathology over a more market-driven approach. Otherwise, it looks like they don’t understand what happens out here in the real world of day-to-day bankruptcy cases—or don’t care.