An undersecured mechanic’s lien claimant contended that it was entitled to elect to treat its claim as fully secured under Section 1111(b) of the Bankruptcy Code. Both the bankruptcy court and the district court rejected the election as invalid, and the creditor appealed to the 5th Circuit.
The debtor obtained confirmation of a plan of reorganization that proposed to sell a substantial mineral interest, including “some 90 mineral leases and several wells,” to a purchaser pursuant to Section 363 of the Bankruptcy Code for more than $3.4 million. The plan acknowledged that the mechanic’s lien creditor had a lien on one well and four of the leases. The claim on the well was for a total of ~$321,000, of which only ~$39,000 was shown as secured.
The creditor did not appear at the confirmation hearing, did not raise any objections or appeal any decisions of the bankruptcy court prior to confirmation, and did not appeal the confirmation order. After confirmation it asserted its Section 1111(b) election.
There is an exception to the right to make an 1111(b) election when collateral is sold under Section 363 or under a plan, and the Supreme Court has ruled that “debtors may not sell their property free of liens without allowing a lienholder to credit bid. So the creditor argued that either it had a right to make a credit bid at the sale or its election to be treated as fully secured should be granted.
According to a majority of the court: “The Plan appears to provide that the sale pursuant to §363 gives the secured creditors the right to credit bid.” Thus, the creditor was not entitled to any additional relief. However, the creditor argued that the plan addressed only the bulk sale, which in effect did not give the creditor a right to credit bid with respect to the small portion of the sale assets that constituted its collateral.
In response the court emphasized that the creditor never gave any indication that it actually wanted to do a credit bid and noted that the creditor’s rights could have easily been resolved during the confirmation hearing or even on appeal of the confirmation order. Technically the creditor had a right to credit bid, and its collateral was sold in a 363 sale under a plan, so it was not entitled to make a Section 1111 election.
The concurring opinion provides an interesting perspective. The analysis in the concurring opinion was that the creditor’s position was not consistent with its claim that it was “denied” the right to credit bid. Given that the liens were on only a few of the wells, it was highly unlikely the creditor would credit bid since it would have to pay off senior liens on the rest of the collateral. So, it is likely what was really going on was that the creditor was “trying to take advantage of the bankruptcy court’s error in failing to rule on the §1111(b) election before it confirmed the Chapter 11 Plan.”
The concurring judge agreed with the result of the majority on the basis that the creditor had waived its right to make an election by failing to pursue it at the confirmation hearing. (In fact, FRBP 3014 requires that the election be made before conclusion of the disclosure statement hearing unless the court fixes a later date.)
However, the judge also felt there was a very serious question about whether there was adequate protection of the secured creditor’s rights through credit bidding. Both the right to credit bid and the right to make a Section 1111(b) election are for the purpose of protecting a creditor against loss of its lien rights. Although liens can be altered in bankruptcy, this is “only against the backdrop that if a secured creditor chooses, it may decline to participate in the case and its lien will then ‘ride through’ bankruptcy unaffected.”
Simply labeling something as a Section 363 sale or a plan sale with credit bidding rights does not mean that there is an actual right to credit bid. To illustrate, the concurring opinion posed three hypotheticals:
- A debtor proposes to reorganize through a bulk sale of its manufacturing plant and assets to a third party. Separate liens exist on the facility, its machines, inventory, and the real property. This transaction could ensnare creditors secured by first liens on the various pieces of collateral such that none could effectively credit bid for its discrete interest.
- A real estate developer in Chapter 11 proposes selling several tracts, each with a separate lien, to one purchaser for a fixed price. Although the developer formulaically defines the sale as falling under § 363, no single secured creditor could protect its lien with a credit bid against the total package.
- A debtor proposes to sell real property secured by liens “under the plan” “in the ordinary course of business” following reorganization but without any specifics for dates, prices, or methods of sale. The right to credit bid in connection with the plan is defeated.
There was no need to resolve these issues given the creditor’s waiver, but the concurring opinion expressed concern that the majority opinion should not be extended beyond the specific facts of this case.
The concurring opinion highlights an important issue: A simple case involving a senior secured creditor with a lien on all of the debtor’s assets is easy. Similarly, if a sale is limited to collateral of a secured creditor, credit bidding still works. However, once you start mixing lien collateral and priorities, a simple statement that a creditor has a right to credit bid may be illusory.
Vicki R. Harding, Esq.