1. Financial Restructuring and Insolvency
North America
Client Alert Third Circuit Permits Debtors to Block Credit
Bidding in Plan Sales
March 2010
It has been a basic principle of American commercial law that secured creditors
have the right to credit bid up to the full face amount of their debt at an auction
sale of their collateral. Last week, however, the United States Court of Appeals
for the Third Circuit created a bankruptcy plan exception to this well-established
rule. It held in In re Philadelphia Newspapers, LLC1 that a debtor can prevent a
secured lender from credit bidding simply by designating its intent to provide the
secured lender with the “indubitable equivalent” of its interest in the collateral
under a bankruptcy plan, over the secured lender’s objection, forcing the secured
lender to accept the result pursuant to the “cramdown” provisions of section
1129(b)(2)(A)(iii) of the Bankruptcy Code.2
For further information please The Third Circuit’s 2-1 decision is expected to have an immediate material
contact impact, especially since it is now controlling precedent in the popular bankruptcy
venue of Delaware. The decision, however, contains two important practical
David F. Heroy limitations plus a vigorous and well-reasoned 49 page dissent from Judge
Partner
Thomas L. Ambro, a leading Circuit-level bankruptcy authority. Thus, its long-
Chicago
+1 312 861 3731 term effect may be questionable.
david.f.heroy@bakernet.com
In Philadelphia Newspapers, the Debtor owned and operated two print
Carmen H. Lonstein newspapers, the Philadelphia Inquirer and Philadelphia Daily News, and the
Partner online publication philly.com. To finance the acquisition of these assets in 2006,
Chicago
the Debtor entered into a loan agreement granting its lenders (the “Lenders”) a
+1 312 861 8606
carmen.lonstein@bakernet.com first priority lien in substantially all of the Debtor’s real and personal property. The
face amount of the loan was $318 million when the Debtor filed its chapter 11
petition in February 2009.
Contributing Author The Debtor then filed a chapter 11 plan providing for the auction sale of
Lawrence P. Vonckx
substantially all of its assets free of liens, including an asset purchase agreement
Associate with a stalking horse bidder for $37 million cash. Under the plan, the Lenders
Chicago were to receive the $37 million sales proceeds plus title to the Debtor’s
+1 312 861 8803 Philadelphia headquarters (valued at $29.5 million) subject to two year’s free rent
lawrence.p.vonckx@bakernet.com concession to the winning bidder. In addition, the stalking horse bidder had
extensive insider connections as noted by the dissent.
Baker & McKenzie LLP
One Prudential Plaza
130 East Randolph Drive The Debtors moved to prevent the Lenders from credit bidding at the sale. The
Chicago IL 60601 Lenders opposed it on the grounds that the plan with a sale that precluded credit
United States of America bidding could not be “crammed down.” The Bankruptcy Court agreed with the
Lenders and denied the motion, finding that it was a sale pursuant to the terms of
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1
In re Phila. Newspapers, 2010 U.S. App. LEXIS 5805 (3d Cir. Mar. 22, 2010).
2
11 U.S.C. §1129(b)(2)(A)(iii).

2. a plan. Specifically, the Court reasoned that subsection (ii) of the Bankruptcy
Code’s “cramdown” section 1129(b)(2)(A) expressly provides for credit bidding by
secured creditors where “the plan provides for the sale…of any property that is
subject to the liens”3 of the secured creditors.
On appeal, the District Court surprisingly reversed the Bankruptcy Court. It held
that the Bankruptcy Code provides no legal entitlement for a secured lender to
credit bid at an auction of its collateral pursuant to a plan, despite the plain
language of subsection (ii) mentioned above. Instead, the District Court ruled
that, so long as the debtor declares that it intends to seek confirmation of its plan
under subsection (iii) of section 1129(b)(2)(A) that requires a plan to provide the
secured creditor with the “indubitable equivalent” of its interest in the collateral, it
does not have to comply with subsection (ii) that allows credit bidding at the same
sale. The District Court’s technical rationale was that section 1129(b)(2)(A) was
unambiguous, containing three independent “routes” to a cramdown plan
confirmation that were separated by the disjunctive “or,” so that a debtor could
elect to proceed under any of those three, independent routes regardless of
whether the substance of the plan – in this case a sale of the lender’s collateral –
meant that another subsection should apply.
The Third Circuit affirmed, largely following the District Court’s reasoning. Judge
Ambro’s 49 page dissent, however, could not have disagreed more strongly with
the majority’s opinion. Judge Ambro observed that several rules of statutory
construction, the wording and purpose of the Bankruptcy Code taken as a whole,
plus the legislative history “all point to the conclusion that the Code requires
cramdown plan sales free of liens to fall under the specific requirements of
§ 1129(b)(2)(A)(ii)” and to provide for credit bidding by the secured lender.4
Judge Ambro also noted that it should be the plan’s content, not a debtor’s
election, that determines which of the three alternative cramdown requirements of
section 1129(b)(2)(A) must be satisfied.
Despite its novel holding, there are practical reasons why this opinion may not be
the end of the story, either for the Philadelphia Newspapers case or for credit
bidding in general. First, the Lenders could still bid cash at the auction in
Philadelphia Newspapers and have the proceeds repaid to themselves,
accomplishing essentially the same economic result as credit bidding. In fact, the
Lenders last week stated their intention to do just that.
Also, the majority opinion in Philadelphia Newspapers clearly stated that, after the
auction sale, the Debtor must still show that the Lenders received the “indubitable
equivalent” of their claim under subsection (iii) of section 1129(b)(2)(A) to confirm
its plan, which means that the sales price must have equaled the value of the
collateral despite no credit bidding. This could be impossible for the Debtor to
show because the Third Circuit has previously held that credit bidding establishes
the value of collateral sold at auction.5 For both of these practical reasons, this
case thus could prove to be a Pyrrhic victory for the Debtor.
The Lenders in Philadelphia Newspapers also stated their intention to seek an
immediate en banc review of the decision from the full panel of Third Circuit
judges. En banc review is rarely granted. Considering the strong dissent from
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3
11 U.S.C. §1129(b)(2)(A)(ii).
4
Phila. Newspapers at *58.
5
In re SubMicron Systems Corp., 432 F.3d 448 (3d Cir. 2006).
2 Third Circuit Permits Debtors to Block Credit Bidding in Plan Sales çMarch 2010

3. Judge Ambro and the history of the Third Circuit holding en banc hearings on
important bankruptcy issues, however, it is possible that the Third Circuit would
grant a request for en banc review and reverse. In addition, even though U.S.
Supreme Court review may be unlikely at this time, the importance and
controversial nature of the issue could lead to U.S. Supreme Court review after a
relatively short time period.
From a policy perspective, the Philadelphia Newspapers decision also may not be
possible to sustain in the long term. After all, its practical effect is to hold that
Congress, by enacting the Bankruptcy Code, intended to provide debtors with the
ability to circumvent well-settled common law jurisprudence that allows credit
bidding for secured lenders. No legal or factual basis has been articulated for this
result, in the Philadelphia Newspapers majority opinion or elsewhere, and other
courts likely will consider Judge Ambro’s dissent seriously before following this
ruling for this reason, too.
In summary, and despite its drawbacks, the Philadelphia Newspapers ruling
nonetheless poses a significant risk for secured lenders. Purchasers of senior
debt, particularly where credit bidding is part of a loan-to-own strategy, should
take this ruling into account as a significant risk factor. For debtors seeking to
avoid credit bidding or to obtain additional leverage over secured creditors, this
ruling provides an additional incentive for filing in Delaware so as use the ruling
as controlling Third Circuit precedent. Conversely, for debtors that rely on senior
secured creditor funding to file for chapter 11 relief, it could motivate their lenders
to insist on filing for chapter 11 relief anywhere but Delaware (or the Fifth Circuit).6
Regardless, in Philadelphia Newspapers the Third Circuit has triggered a debate
that is likely to affect secured creditors in bankruptcy and generate significant
controversy for the foreseeable future.
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6
Bank of New York Trust Co., NA v. Official Unsecured Creditors' Comm. (In re Pacific
Lumber Co.), 584 F.3d 229 (5th Cir. 2009). The Fifth Circuit in this case reached a
similar conclusion as the Third Circuit.
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3 Third Circuit Permits Debtors to Block Credit Bidding in Plan Sales çMarch 2010