In 2007, two LLCs, RadLAX Gateway Hotel and RadLAX Gateway Deck, bought a Radisson Hotel and an adjacent lot at Los Angeles International Airport. Their goal was to renovate the hotel and build a parking garage on the lot next door. To finance the project, RadLAX took out a $142 million loan that was secured by a lien on all of its property, from Amalgamated Bank.
The renovations proved to be more expensive than anticipated, and within two years RadLAX was out of money. The company still owed more than $120 million on the loan, with more than $1 million in interest accruing every month. Out of options and with no other sources of money available, RadLAX declared bankruptcy under Chapter 11.
Generally, a Chapter 11 reorganization plan requires the approval of secured creditors. However, a bankruptcy judge can approve a plan over the objection of creditors (a so-called “cramdown” plan) if the court deems the plan “fair and equitable.”
RadLAX sought court approval of a cramdown plan in which it would sell the hotel and parking structure at auction to the highest bidder free and clear of Amalgamated Bank’s lien, and then use the proceeds to pay Amalgamated back. Amalgamated could bid in the auction, but it would have to do so using cash, not the credit it already had sunk into the project. An auction in which the creditor uses its lien as an offset against the auction price is called “credit bidding.”
The bankruptcy court refused to confirm the plan over Amalgamated’s objections, ruling that the auction must permit credit bidding. The 7th Circuit affirmed. In an 8–0 decision from which Justice Anthony Kennedy abstained, the Supreme Court on May 29 agreed that a cramdown plan must allow a secured creditor to credit bid.
“The decision gives secured creditors assurance that their rights will be upheld and will increase liquidity on the debtor side,” says Robb Tretter, a partner at Bracewell & Giuliani.
The Bankruptcy Act provides that a court should consider a cramdown plan fair and equitable under three circumstances: the debtor allows the secured creditor to retain its lien on the property and makes deferred payments; the debtor sells the property at auction, permitting the creditor to credit bid, taking amounts owed as an offset against the sale price; or the debtor sells the property, providing the secured creditor with the “indubitable equivalent” (usually cash) of what it is owed.
In RadLAX Gateway Hotel LLC et al. v. Amalgamated Bank, the debtor argued that it should be permitted under the third clause to sell the property free and clear of liens and then pay the bank back in cash in an amount equivalent to the current value of its interest in the property. The proposed plan would have allowed Amalgamated to bid on the property, but only in cash, despite the fact that RadLAX already owed the bank more than $120 million. The Supreme Court called this position a “hyperliteral” reading of the statute that is “contrary to common sense.”
Numerous amici agreed, including the federal government, trade groups and bankruptcy scholars. Even David Neff, a Perkins Coie partner who represented RadLAX in the Supreme Court concedes that “most of the common sense arguments fell on the side of the respondents.”
Still, RadLAX found support for its reading of the law in decisions of the 3rd and 5th Circuits, both of which had found that the plain language of the Bankruptcy Act permitted a debtor to do exactly what RadLAX had proposed. In the 2010 bankruptcy reorganization of Philadelphia Newspapers, for example, the 3rd Circuit ruled that the parent company of the Philadelphia Inquirer and Philly.com could prevent lenders from using their debt to try to purchase the company at auction. Likewise, in the 2009 decision Bank of New York v. Pacific Lumber Co., the 5th Circuit held that debtors could auction property free and clear of liens, so long as the creditor received a cash payment equivalent to the value of its lien.
The Supreme Court overturned the 3rd and 5th Circuits’ interpretations of the law, resolving a circuit split that had created uncertainty for potential lenders.
In addition to resolving the uncertainty of the circuit split, the Supreme Court’s decision in RadLAX is expected to bring greater liquidity to the market for secured credit. Knowing that credit bidding rights will be upheld makes it less risky for an investor to buy secured debt. More importantly, the decision gives potential lenders certainty that their rights will be upheld in the event of a bankruptcy and maximizes their potential for recouping their investment.
“If a debtor is able to prevent the secured creditor from being able to bid unless it comes up with cash, it could remove from the bidding process one of the most knowledgeable bidders and could drive down the sale price,” says Deanne Maynard, a partner at Morrison & Foerster who represented Amalgamated Bank before the Supreme Court. “It increases the risk that the property is sold below its value.”
The decision also eliminates an inherent inefficiency in the type of plan proposed by RadLAX. Under a plan that forbids credit bidding, the lender has to buy the collateral and then resell it in order to pay itself back.
“This concern comes up in almost every transaction,” Tretter says. “Especially post-Lehman Brothers, where many companies are underwater on first-lien debt and the first-lien creditors are not being paid back in full.”
RadLAX put an end to the debtor’s plan to emerge from bankruptcy by selling its property to the highest cash bidder. Two weeks after the Supreme Court decision, the lenders went back to the bankruptcy court and sought relief from the stay so they can go forward with foreclosure on RadLAX’s property. Judge Bruce Black granted the motion June 21, clearing the way for Amalgamated to foreclose on the hotel and parking garage.
“Creditors bargain for the right to either get paid or take the collateral,” Maynard says. “The debtor was advocating an interpretation of the bankruptcy code that would allow a debtor to strip the creditor of that right. This decision shut down that gambit.”