What do the economic and legal landscapes mean for credit bidders? Lauren Lonergan Taylor, a partner at Duane Morris, outlined cases that have chipped away at the right of secured creditors to credit bid in a bankruptcy case.

“Credit bidding,” Taylor said, “traditionally has been like an unalienable right in bankruptcy—the right of a secured creditor to bid up its debt in lieu of paying cash when there is an auction of assets.”

A few years ago, the U.S. Court of Appeals for the Third Circuit in In Re Philadelphia Newspapers issued an opinion that limited a secured creditor’s right to credit bid when a sale of assets was being effectuated through a plan of reorganization, as opposed to through a separate Section 363 sale. The court said that a secured creditor did not have a right to credit bid as a matter of law, as long as the plan had otherwise provided it with the indubitable equivalent value of its claim. “That case was ultimately overturned by the U.S. Supreme Court, and secured creditors everywhere drew a sigh of relief,” said Taylor.

Other cases have further whittled away at creditors’ bidding, noted Taylor, including In re Free LanceStar Publishing Co., a case that involved the purchase of distressed debt at a discount by a buyer who wanted to acquire the debtor’s underlying assets. In the end, the purchaser’s right to credit bid was limited. (See Sidebar, In re Free Lance-Star Publishing Co., for a detailed discussion of this case.)

“We are already seeing the effects of these cases in practice,” said Taylor. “For example, in Delaware, some of the judges are now requiring that if a DIP order grants a right to credit bid for assets in the case, the language allowing the credit bid must also contain verbiage that protects the court’s right to find cause to limit the credit bid. It’s usually language saying secured creditors have the right to credit bid unless the court for some reason finds otherwise. So we’re seeing that the courts are certainly paying attention to these cases and putting some limitations into practice.”

“These cases are a real shot across the bow for buyers of distressed debt,” maintained Taylor. “There’s nothing impermissible per se about a loan to own strategy, but you really have to think about how that strategy is played out. These cases illustrate the erosion of predictability that we’ve seen elsewhere.”