Credit Bids: Buyer Beware

Emerald Capital Advisors v. Victory Park Capital Advisors, LLC (In re KII Liquidating, Inc.) 607 B.R. 398 (D. Del. 2019)

A chapter 11 unsecured creditors’ committee sought to recharacterize or equitably subordinate and to avoid claims for advances made by a stalking horse bidder that it used in a credit bid. The bankruptcy court granted the stalking horse’s motion to dismiss the committee’s complaint, and the committee appealed to the district court.

Chapter 11 debtors entered into a purchase agreement with a stalking horse to sell substantially all of their assets. The stalking horse’s bid was ~$63 million consisting of (1) a credit bid and offset of ~$36.7 million and (2) assumed liabilities of $26.3 million. The credit bid included a $7.5 million outstanding under a prepetition second lien loan and postpetition advances.

The committee asserted that the claims for postpetition advances should be avoided under either section 544 or 549 of the Bankruptcy Code. The bankruptcy court rejected this argument because (1) section 544 applies only to prepetition transfers, and (2) although section 549 addresses postpetition transfers, it applies only to transfers that have not been authorized by the court. Since the credit bid of postpetition advances occurred postpetition and was specifically authorized by the sale order, it could not be avoided under either section 544 or 549.

The bankruptcy court chose not to address the merits of recharacterization or equitable subordination of the $7.5 million prepetition debt. The committee’s claims were not adjudicated until after the sale order was entered in the sale closed. The court first questioned whether the committee had reserved the right to raise objections post sale.

However, even assuming the committee could still raise its objections, the bankruptcy court concluded that there was no practical, useful remedy that would result in additional recovery to the estate. It speculated that if the $7.5 million credit bid was disqualified, the stalking horse would have simply reduced its bid. Given that there were no other qualified bidders, the stalking horse would still have been the successful purchaser.

On appeal the district court summarized the bankruptcy court’s conclusions with respect to the $7.5 million credit bid as “simply different ways of saying that the entry of the Sale Order and/or the closing of the sale transaction served to cut off the Committee’s rights and remedies with respect to its ‘Challenge’ under the Final DIP Order.” However, the sale order specifically provided:

Notwithstanding anything to the contrary contained in this [Sale] Order or in the Final APA, entry of this Order and approval and consummation of the transactions contemplated hereby shall not limit or otherwise affect the rights or remedies of the Debtors’ estates or the Committee with respect to any “Challenge” as defined in paragraph 26 of the Final DIP Order.

Thus, the district court found that the parties expressly reserved the right to relitigate things that otherwise would have been barred.

Turning to the credit bid, section 363(k) provides that when property is subject to a lien that secures an allowed claim, the holder of the claim can be add it to its bid, and if the holder is the successful purchaser, it can offset the claim against the purchase price. The district court noted that at the time the sale order was entered, the “allowed” amount of the $7.5 million claim was still subject to the committee’s challenge rights. As noted above, those challenge rights clearly survived both entry of the sale order in closing of the sale.

The stalking horse argued that under the plain text of section 363 a debt cannot be credit bid unless it is an allowed claim. Thus, if a court authorizes a sale that includes credit bidding, it necessarily includes that the underlying debt is an allowed claim.

The district court was not persuaded. It noted that the purchase price was defined as “an amount equal to” the sum of various items that included all amounts outstanding under the second lien that. The court noted that the Final APA was not conditioned in any way on allowance of the credit bid claims. Thus, even if the “credit bid currency” was eliminated by the committee challenge, the stalking horse would still have been obligated to close the sale at the agreed-upon purchase price of $63 million.

The stalking horse also argued that the challenge was not timely unless the committee both commenced and adjudicated its claims prior to closing of the sale. The District Court brushed that aside because the Final DIP Order only required commencement of a challenge prior to the stated deadline.

Accordingly, the district court reversed the bankruptcy court with respect to the issues that have been appealed.

This does not necessarily mean that the stalking horse purchaser will lose. The bankruptcy court still had to address the merits of the recharacterization and equitable subordination issue. However, any party making a credit bid would be well advised to consider (1) whether there are any remaining opportunities to challenge the claim that is being bid (paying particular attention to DIP orders), and (2) the consequence if the claim is disallowed. Undoubtedly a bidder that discovers it is required to put up hard cash in place of “credit bid currency” is going to be very unhappy.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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