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A recent Delaware bankruptcy court ruling could call into question the statutory right of a secured creditor to “credit bid” its entire secured claim in a bankruptcy sale if the creditor purchased the claim for significantly less than face value.  See In re Fisker Automotive Holdings, Inc., Case No. 13-13087 (Bankr. D. Del. Jan. 17, 2014) [Docket Nos. 482-483].

The Bankruptcy Code allows secured creditors to credit bid so that they may control the sale of their collateral.  When collateral that secures a lien is proposed to be sold at a bankruptcy sale, a secured creditor is allowed to bid up to the amount of its debt as a credit bid (i.e., as opposed to making a cash bid).  The right to credit bid, which is found principally in Section 363 of the Bankruptcy Code, gives secured creditors the ability to control their collateral when the collateral is worth less than the face amount of their claims.  For
example, if a piece of real estate that has a market value of $500,000 and is collateral for a bank loan of $750,000 was proposed to be sold, a debtor would find it difficult to sell the property for its market value over the objection of its mortgagee in a bankruptcy sale. This is because the secured lender would have the ability to credit bid the full amount of its $750,000 claim without offering any cash.  Credit bidding is seen as one of the chief rights of secured creditors in bankruptcy.

A bankruptcy court may disallow a credit bid “for cause.”  While relatively rare, courts have found that cause exists when there is a dispute as to the validity or amount of the secured claim.  Some courts have forced holders of disputed secured claims to provide security to the bankruptcy estate prior to credit bidding in the event the claim or lien is found to be invalid after the sale has closed (e.g., posting a bond or furnishing an irrevocable letter of credit).

In Fisker, however, Judge Kevin Gross, placed a rather unique limitation on a pre-petition senior secured creditor’s right to credit bid at the auction of the assets of Fisker Automotive, an equipment manufacturer of plug-in hybrid electric vehicles.  Just prior to the bankruptcy filing, Hybrid Tech Holdings, LLC purchased the secured loan with a face value of $168 million made by the United States Department of Energy to Fisker for $25 million.  In a ruling that appears to place into evidence the fairness and reasonability of this purchase price, Judge Gross will only allow Hybrid to bid the purchase price of its secured claim, not the claim’s face value.

Fisker filed its chapter 11 bankruptcy petition on November 22, 2013 and immediately moved to sell substantially all of its assets in a

private sale to Hybrid in exchange for Hybrid’s credit bid in the amount of $75 million.  Given Hybrid’s senior secured position and the market value of the assets to be sold, which was well below the face value of Hybrid’s claim, Fisker argued that opening up the sale to a public auction would be unlikely to increase the value for its creditors.

In early December 2013, the Official Committee of Unsecured Creditors of Fisker objected to the proposed sale, arguing that third-party Wanxiang America Corporation had already expressed an interest in purchasing Fisker’s assets and that opening up the sale to a public auction would encourage competitive bidding, thus increasing the return for Fisker’s creditors.

At a hearing on the sale motion, Fisker and the Committee agreed that:  (1) if Hybrid’s credit bid was capped or denied, an auction would likely create substantial value for the estate, (2) if Hybrid’s credit bid was not capped or denied, Wanxiang would not bid and an auction would be unnecessary, (3) the highest and best value for the bankruptcy estate could only be achieved through an asset sale of some kind, and (4) Hybrid’s liens on a material portion of the assets to be sold were either not properly perfected or the subject of a bona fide dispute.

In his January 17, 2014 ruling, Judge Gross capped Hybrid’s credit bid at $25 million.  In relevant part, Judge Gross stated that a competitive sale of Fisker’s assets would only occur if he limited Hybrid’s credit bid and, because of the disputed nature of Hybrid’s secured claim, it would not be unprecedented to limit the credit bid.  Judge Gross was also troubled by the fact that Fisker had only given parties-in-interest 24 business days to challenge the sale motion and even less time to the Committee, which was formed just weeks before objections to the sale were due.

Hybrid immediately appealed ruling, which appeal is pending.  Hybrid argues that Judge Gross’ ruling flies in the face of Supreme Court and Third Circuit precedent allowing secured creditors to bid the full face value of their claim.  The unique facet of the ruling is Judge Gross’ decision to cap Hybrid’s credit bid at the $25 million purchase price.  He stated that this would help determine whether

the price paid was “fair and reasonable and in the best interests of the debtors’ estates.”   On appeal, Hybrid will likely argue that there is no statutory basis to limit a credit bid to the purchase price of the claim without any evidence regarding the legitimacy of the underlying claim or the validity of the liens securing such claim.  Moreover, the fairness and/or reasonability of the purchase price for the secured claim should have no bearing on whether or not Hybrid may credit bid its claim.

Despite Hybrid’s compelling arguments on appeal, Fisker and Hybrid are probably partially responsible for complicating the sale process because they pushed for such a hasty and private sale.  Notably, because Fisker was no longer operating when it filed bankruptcy, it was unlikely that a lengthier marketing and sale process would have caused any significant reduction in the value of Fisker’s assets.  Why would Fisker and Hybrid push for such a hurried sale process if they were confident that Hybrid had valid liens worth well in excess of the market value of Fisker’s assets?

The auction is currently set for February 12, 2014.  In the meantime, Hybrid has sought an expedited hearing on its appeal in the District Court in Delaware and also the direct certification of the appeal to the Third Circuit Court of Appeals.  Unless Hybrid is successful on appeal, which appears unlikely given the short time frame, it will be forced to abide by Judge Gross’ ruling and pay cash for any part of its bid in excess of $25 million at the auction.