Restructuring

Contributed by Nelly Almeida.
The highly publicized Fisker credit bidding decision has received much attention on our blog.  As we previously wrote, while some may argue that post-Fisker credit bidding concerns are unwarranted, the decision at least raises the question of what constitutes sufficient “cause” to limit credit bidding.  Well, it did not take long for the first Fisker domino to fall. 
The issue resurfaced last week when Judge Huennekens, United States Bankruptcy Court Judge for the Eastern District of Virginia, entered his Memorandum Opinion citing to Fisker as support for his decision to cap a secured lender’s ability to credit bid in the bankruptcy case of Free Lance-Star Publishing Co.  Although some of the same factors that existed in Fisker existed in that case (a less-than-complete collateral package, inequitable conduct on the part of the secured creditor), the court’s very harsh language directed at the mere use of a loan-to-own strategy may have distressed debt investors fearing a Fisker avalanche.
The Free Lance-Star is a family owned publishing, newspaper, radio, and communications company located in Fredericksburg, Virginia.  In 2006, the debtors borrowed approximately $50.8 million from Branch Banking and Trust (BB&T).  As security for the loan, the debtors granted liens on, and security interests in, certain of the debtors’ real and personal property, but not on the parcels of real estate known as the “Tower Assets.”  Subsequently, due to strained economic conditions, Free Lance-Star fell out of compliance with certain of its loan covenants. 
In June 2013, following Free Lance-Star’s various attempts to abide by its loan covenants and obtain replacement financing, BB&T sold its loan to Sandton Capital Partners.  In July 2013, Sandton informed Free Lance-Star that it wanted the company to file for bankruptcy and sell substantially all of its assets.  Further, Sandton indicated that it intended to buy all of the debtors’ assets as part of what Judge Huennekens called Sandton’s loan-to-own strategy. 
The debtors began discussions with DSP (an affiliate of Sandton that is operated by Sandton) to implement a plan whereby the debtors would sell all of their assets to DSP.  In the course of these discussions, Sandton requested, among other things, that the debtors execute three deeds of trust to encumber the Tower Assets and insisted that the debtors include on the cover of their marketing materials a note indicating that DSP had the right to a $39 million credit bid (the balance of the BB&T loan).  According to the court’s opinion, DSP also pressured the debtors to implement a hurried sale process without properly marketing the assets.  Further, unbeknownst to the debtors, during the negotiations, DSP filed UCC financing statements covering fixtures on the Tower Assets.  The parties’ negotiations ultimately fell through and, on January 23, 2014, the debtors commenced a bankruptcy case without DSP’s support.  
On March 19, 2014, the debtors filed a motion requesting that the court limit the amount of DSP’s credit bid to the amount Sandton paid BB&T for the loan.  In doing so, the debtors explained that DSP did not have a lien on all of the company’s assets and engaged in “inequitable conduct” by trying to unilaterally expand the scope of its security interest after its requests for the debtors to grant liens on the Tower Assets failed.  Further, the debtors cited to Fisker for the proposition that the right to credit bid is not absolute and may be limited where there is an “unfair process.”  The debtors explained that “[a]s in Fisker, DSP’s attempts to place the Company into a chapter 11 bankruptcy case shortly after its purchase . . .  are inconsistent with the notions of fairness in the bankruptcy process.”  Separately, the debtors argued that the court should limit DSP’s right to credit bid to foster a competitive bidding environment.
At the hearing on the credit bidding motion, DSP failed to produce any evidence to show that it was the legal owner of the BB&T loan or to refute the debtors’ allegations that DSP’s conduct was inequitable.  Indeed, Judge Huennekens stated that “the fact that there was an attempt to expand . . . a grant of security that did not previously exist . . . was something that the lender [] set out to accomplish . . . in an improper manner.”  The court also condemned DSP’s failure to disclose in a cash collateral hearing the fact that it had filed the additional financing statements.  Additionally, the court was “bothered” by DSP’s attempts to shorten the marketing period and to “put ledgers on all marketing materials” advertising DSP’s credit bidding rights in an effort to discourage other potential bidders.
In his written opinion, Judge Huennekens noted that, in addition to the fact that DSP did not have valid liens on all of the debtors’ assets, he was highly “displeased” with DSP’s inequitable conduct and, more importantly, its “loan-to-own” strategy.  He stated that “[f]rom the moment it bought the loan from BB&T, DSP pressed the Debtor ‘to walk hand in hand’ with it through an expedited bankruptcy sales process” and that “DSP planned from the beginning to effect a quick sale . . .  at which it would be the successful bidder for all of the Debtors’ assets utilizing a credit bid.”  Thus, Judge Huennekens explained that “[t]he confluence of (i) DSP’s less than fully-secured lien status; (ii) DSP’s overly zealous loan-to-own strategy; and (iii) the negative impact DSP’s misconduct has had on the auction process has created a perfect storm, requiring curtailment of DSP’s credit bid rights.” 
The court found that the facts and circumstances of the case established sufficient cause to cap DSP’s right to credit bid at just under $14 million—less than half of what was left outstanding on the BB&T loan, an amount that would “prevent DSP from credit bidding its claim against assets that are not within the scope of its collateral pool.”  (Note that it is unclear from the opinion how the $14 million was calculated).  Notably, at the credit bidding hearing, the court noted that it wished it had more information with respect to the amount that was paid for the loan.  This leads us to wonder whether the court would have capped DSP’s bid at the price it paid for the loan had the information been available. 
What is most interesting is that rather than base the credit bidding limitations on the issues with the lender’s liens (which would have made it much less controversial), Judge Huennekens emphasized the notion of “fairness” and the importance of “fostering a competitive sale,” as Judge Gross did in Fisker.  Additionally, in language that will send shivers through the spines of distressed debt investors, the court stated the following:

The credit bid mechanism that normally works to protect secured lenders against the undervaluation of collateral sold at a bankruptcy sale does not always function properly when a party has bought the secured debt in a loan-to-own strategy in order to acquire the target company.  In such a situation, the secured party may attempt to depress rather than to enhance market value.  Credit bidding can be employed to chill bidding prior to or during an auction or to keep prospective bidders from participating in the sales process.  DSP’s motivation to own the Debtors’ business rather than to have the Loan repaid has interfered with the sales process.  DSP has tried to depress the sales price of the Debtors’ assets, not to maximize the value of those assets.  A depressed value would benefit only DSP, and it would do so at the expense of the estate’s other creditors.  The deployment of DSP’s loan-to-own strategy has depressed enthusiasm for the bankruptcy sale in the marketplace. 

Where does that leave us?  The Free Lance-Star decision leaves many of the same unanswered questions that Fisker did.  For example, which of the Fisker factors would be enough by themselves to create a “perfect storm”?  Would the inequitable conduct alone have been enough?  Would the pursuit of a loan-to-own strategy by the secured creditor be enough?  One thing that is clear is that the emphasis that both courts placed on “fairness” and stimulating “enthusiasm for the bankruptcy sale in the marketplace” should serve as a cautionary tale to lenders who may try to “rush” a debtor’s sale process or limit competitive bidding.  It also seems that in a post-Fisker, post-Free Lance-Star world, credit bidders are likely to see additional scrutiny in future bankruptcy sales. We will continue to monitor the quickly evolving credit bidding jurisprudence and keep our readers up to speed on any developments.