On June 28, 2011, the US Court of Appeals for the Seventh Circuit (Seventh Circuit) issued an opinion affirming the decision of the US Bankruptcy Court for the Northern District of Illinois (Bankruptcy Court) on October 5, 2010, denying the bid procedures motion of the debtors which prohibited credit bidding in a sale of assets conducted under a plan of reorganization. For more on the background and the issues litigated in the case and the Bankruptcy Court's decision, see Legal Update, River Road Hotel Partners Bankruptcy Court Rejects Third Circuit's Philadelphia Newspapers Credit Bidding Decision .

The central question that the Seventh Circuit considered in the appeal hearing was whether the Bankruptcy Court's interpretation of section 1129(b)(2)(A) of the Bankruptcy Code was correct.

Section 1129 of the Bankruptcy Code sets out the criteria that a debtor's Chapter 11 reorganization plan must satisfy to be confirmed by a bankruptcy court. Generally, reorganization plans must be accepted by each class of claimants. However, section 1129(b)(1) provides that a plan can be confirmed over the objection of a class of creditors if it is "fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan." Section 1129(b)(2)(A) of the Bankruptcy Code defines what is "fair and equitable" in the context of secured creditors' claims and sets out the following three alternative requirements for a fair and equitable plan in subsections (i) through (iii) of section 1129(b)(2)(A):

For more information on the confirmation of plans of reorganization over the objection of a class of creditors, see Practice Note, Chapter 11 Plan Process: Overview: Confirmation of a Plan: Cramdown Plans.

Before affirming the decision of the Bankruptcy Court, the Seventh Circuit analyzed the meaning of section 1129(b)(2)(A) of the Bankruptcy Code.

As a first step, the Seventh Circuit considered whether the language of section 1129(b)(2)(A) unambiguously authorized the confirmation of reorganization plans that propose the sale of encumbered assets free and clear of liens. The debtors argued that the plain language of section 1129(b)(2)(A) requires courts to approve such a plan if it provides the secured creditors with the "indubitable equivalent" of their claim, as contemplated in section 1129(b)(2)(A)(iii).

The Seventh Circuit rejected the debtors' argument, finding that section 1129(b)(2)(A) does not have a single plain meaning. Nothing in section 1129(b)(2)(A) directly indicates whether either:

In pursuing their argument that their plan was fair and equitable because it fell within subsection (iii), the debtors argued that the open auction proposed in their plan would ensure that the secured creditors received the indubitable equivalent of their secured claims by receiving the proceeds of the highest cash bid for the assets.

The Seventh Circuit rejected this argument, holding that because the debtors' plan proposed an auction of assets at which the secured creditors were not permitted to credit bid their claims, the secured creditors had no means to protect themselves from the risk that the winning auction bid would not capture the actual market value of the assets. Because of the risk that the debtors' plan would result in a sale that undervalued the assets, the Seventh Circuit held that subsection (iii) of section 1129(b)(2)(A) of the Bankruptcy Code cannot be used to confirm plans that propose auctioning off a debtor's encumbered assets free and clear of liens without allowing credit bidding.

The Seventh Circuit held that the debtors' interpretation of section 1129(b)(2)(A) was flawed, because it would mean that plans could be granted fair and equitable status under subsection (iii) even if they sought to dispose of encumbered assets in ways contemplated in subsections (i) and (ii), but failed to meet the requirements of those subsections. This reading of subsection (iii) would render the other subsections of section 1129(b)(2)(A) superfluous.

The Seventh Circuit's decision was also influenced by the fact that the debtors' interpretation of section 1129(b)(2)(A)(iii) was at odds with the way that secured creditors' interests are treated in other parts of the Bankruptcy Code. The Seventh Circuit found that in those sections of the Bankruptcy Code that address plan sales of encumbered property free of liens and the protections afforded to secured creditors, the Bankruptcy Code has an expressed interest in insuring that secured creditors are properly compensated. By contrast, they found that the Bankruptcy Code contained no provisions recognizing an auction sale where credit bidding was unavailable as a legitimate way to dispose of encumbered assets.

Therefore, the Seventh Circuit held that the Bankruptcy Code requires that cramdown plans that contemplate selling encumbered assets free and clear of liens at an auction must satisfy the requirements in subsection (ii) of section 1129(b)(2)(A) and therefore must allow credit bidding.

Recent decisions regarding secured creditors' rights to credit bid in cramdown plans have adopted a narrow view, most notably in the US Court of Appeals for the Third Circuit's decision in In re Philadelphia Newspapers, LLC. For more on that decision, see Practice Note, In Dispute: Philadelphia Newspapers. The more expansive view of secured creditors' rights in the River Road decision may make it more likely that the issue will eventually need to be decided by the Supreme Court of the United States. In the meantime, however, debtors may be more cautious about formulating bid procedures for auctions of assets that prohibit creditors from credit bidding.