Bankruptcy Credit Bids Put to Test in Courts

A powerful investment group seeking a delay in a company bankruptcy auction was rebuffed by a Third Circuit three-judge panel, and the auction remains set for April 27. The investors were planning to use the increasingly common, but controversial, credit bid method in an attempt to buy assets of Philadelphia Newspapers LLC and may be unable to do using debts owed to them because of seperate appeal working its way through the court system.

The U.S. Court of Appeals Third Circuit panel rejected a request from a group that includes Angelo, Gordon & Co. and Credit Suisse to delay the company auction until at least May. The investor group's intentions to use a credit bid, in which it would use debt owed to them by the company to then buy its assets largely without cash, were also denied in a previous court proceeding to use such a strategy in the Philadelphia News situation. The credit bid appeal remains in limbo in the Third Circuit, as well. For its part, Philadelphia Newspapers officials alleged the move was a blatant attempt to impair the organization's ability to emerge from bankruptcy restructuring before slipping into financial ruin.

The rise in credit bidding is partly attributable to the spike in pre-negotiated bankruptcies, which are less settled than a pre-pack filing plan. In essence, some non-traditional lenders such as hedge funds can buy into more second-lien debt-which is more speculative and thus cheaper than first-lien debt-and use it to position themselves to emerge as buyers of the filing company through a quick sale. In essence, the new creditor can use its newfound leverage by threatening to stop lending to the reorganizing company unless the filing company capitulates.

A recent Standard & Poor's study raised significant concerns over the fairness of the practice. S&P, among others, believes the practice often leaves out some of the lower level creditors and pays off some handsomely at the expense of others. Credit bids essentially allow the creditor "to seize the collateral being sold if the auction does not result in an offer above the amount of allowed claims, effectively setting a floor price to the auction," said S&P.

"It can present a challenge for a debtor to conduct a robust auction process with full due diligence processes when the time frame that DIP lenders set is very short," the S&P report argued.
This topic is also discussed in the last section of a Business Credit Magazine story focused on the risk associated with the newfound trend of rapid bankruptcy proceedings. The story is featured in the upcoming May Business Credit issue, due out later this month.

Brian Shappell, NACM staff writer

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