Authored by: David Simonds and Edward McNeilly (both of Hogan Lovells)
Bankruptcy Court Denies Secured Creditor’s Right to Credit Bid for Assets Under Section 363(k)
In In re Figueroa Mountain Brewing, LLC, 2021 WL 2787880 (Bankr. C.D. Cal. Jul. 2, 2021), the United States Bankruptcy Court for the Central District of California (the “Bankruptcy Court”) refused to permit a secured creditor to credit bid for the debtor’s assets under section 363(k) of the Bankruptcy Code, finding that the secured claim was subject to a genuine dispute that constituted “cause” to deny credit-bidding rights.
Figueroa Mountain Brewing, LLC (the “Debtor”) commenced a chapter 11 case in the Bankruptcy Court. Rather than reorganize its business through a chapter 11 plan, the Debtor determined to sell its assets pursuant to section 363 of the Bankruptcy Code. White Winston Select Asset Funds, LLC (“White Winston”), a secured lender to the Debtor with liens on substantially all of the Debtor’s assets, sought to credit bid its debt pursuant to section 363(k) of the Bankruptcy Code. In response, the Debtor filed a motion seeking an order preventing White Winston from credit bidding at the sale (the “Credit Bid Motion”). Both when the Debtor filed and the Bankruptcy Court decided the Credit Bid Motion, an adversary proceeding was pending between the Debtor and White Winston in which, among other things, the Debtor objected to White Winston’s claim and sought to avoid as fraudulent transfers all obligations incurred under the loan from White Winston and all accompanying liens.
Section 363(k) of the Bankruptcy Code provides that, “unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.” In the Credit Bid Motion, the Debtor alleged that four grounds constituted “cause” to prohibit White Winston from credit bidding: (1) White Winston did not hold an allowed claim; (2) permitting White Winston to credit bid would chill the bidding process; (3) White Winston had engaged in inequitable conduct; and (4) the claim was subject to a genuine dispute.
The Bankruptcy Court rejected the Debtors’ first three arguments. First, the Bankruptcy Court held that the mere filing of an objection containing allegations-without more-was insufficient to limit or deny a credit bid. Second, the Bankruptcy Court held that the Debtor had not provided any evidence that bidding would be chilled by White Winston’s exercise of a credit bid in the full amount of its secured claim – cases in which a court limited or denied credit bidding to foster a competitive bidding environment were distinguishable. Third, the Bankruptcy Court held that, while the evidentiary record was adequate to establish a genuine dispute with respect to White Winston’s claim (the Debtor’s fourth argument), the evidentiary record was not adequate to establish definitively that White Winston had engaged in inequitable conduct.
However, relying on cases in which bankruptcy courts found “cause” under section 363(k) to bar credit bidding when the creditor’s lien was questioned or in dispute, the Bankruptcy Court held that White Winston’s claim was subject to genuine dispute. The Bankruptcy Court applied the test for whether a dispute was a “bona fide dispute” under section 363(f)(4) of the Bankruptcy Code, which permits sale of estate property free and clear of a third-party’s interest (such as a lien) that is in “bona fide dispute.” That requires the court to determine “whether there is an objective basis for either a factual or a legal dispute as to the validity of the claim.”
In reaching its decision, the Bankruptcy Court highlighted evidence that, at the time the Debtor entered into the agreement, it had unreasonably small capital and did not believe it would be able to make debt service payments as they came due, and the loan agreement did not provide sufficient funds to address these deficiencies. The Bankruptcy Court also relied on evidence that the Debtor did not receive reasonably equivalent value in exchange for its obligations under the loan agreement due to excessive fees related to roll-up transactions, unnecessary consulting, travel, and legal reimbursements, and excessive interest charges under the agreement. The Bankruptcy Court further determined that White Winston did not establish that the value it conferred on the Debtor, if any, was provided in good faith, as there was evidence that the loan agreement rights and contractual provisions allowed White Winston to exert financial and operational control over the Debtor, exacerbate the Debtor’s financial difficulties, and increase the Debtor’s indebtedness, with White Winston having the “ultimate objective of acquiring ownership of [the Debtor’s] assets.”
Because the Debtor had presented evidence showing an objective basis for its causes of action to avoid the White Winston loan and related transactions, the Bankruptcy Court held that there was a genuine dispute and, thus, cause existed to deny White Winston’s credit bidding rights under section 363(k) of the Bankruptcy Code.
Credit bidding rights, while powerful, are not absolute. While it is unusual for a court to deny, rather than merely limit, credit bidding, the Bankruptcy Court may in this instance have been influenced by what it saw as credible evidence of fraudulent transfers and lender misconduct.