Parts I and II in this series discussed certain of the statutory predicates of credit bidding and some considerations for structuring such a bid. Here in Part III, we will address some additional issues that a lender must take into account when deciding to credit bid its debt and some documentary considerations. As its name implies, the predominant form of consideration in a credit bid is often the lender’s debt. Lenders, however, cannot ignore another component of consideration often needed to consummate a transaction, cash. Cash consideration may be needed for any or all of the following reasons:
• Senior Liens. To the extent that any liens exist on the collateral that are senior to those of the lender, the debt owing respect to those liens must be paid in full. If any such debt or liens are subject to challenge, funds sufficient to satisfy payment in full will often be funded in escrow subject to future allowance. The bankruptcy case of ATP Oil & Gas Corp. provides a good example. In that instance, numerous vendors and suppliers benefitted from creditor-friendly state mechanic’s’ and materialmen’s lien laws. Although their claims related largely, if not entirely, to unpaid invoices in the few months leading up to the filing of the cases, these creditors benefited from liens that dated back to when they first provided service, pre-dating the secured financing.
• Unencumbered Collateral. A purchaser in a 363 sale, whether a third party bidder or a credit bidder, often seeks to acquire the entirety of the business as an ongoing enterprise or operating unit (although often by asset acquisition). Typical of many leveraged and other financings, the secured lenders often do not have a full blanket lien of all assets — perhaps excluding certain assets for which perfection is costly or impractical (e.g., trucks or automobiles, intellectual property or real estate in states with high mortgage recording taxes) or otherwise from unintended gaps in collateral coverage. Because the right to credit bid is limited to those assets on which the lender has a valid, perfected lien, the lenders must include cash consideration for such unencumbered items, often providing leverage to, and requiring an agreement from, other creditor constituencies looking to such assets for their recovery (e.g., an unsecured creditors’ committee).
• Wind-Up Expenses. From a practical perspective, a secured creditor should anticipate that the court will be hesitant, if not entirely unwilling, to approve a credit bid that leaves little or no recovery for other creditors, and leaves the estate with no means to wind up the case in an organized and efficient manner. Rather than infuse additional cash, the secured creditor may release its lien on unnecessary assets, including perhaps the debtor’s cash on hand, to assist with the ongoing administration of the estate.
• Operating Expenses. Many lenders are not equipped to own and operate their assets while they await a more appealing liquidity event. As a result, they will often need to retain third-party management to assist in that regard. This management can be expensive and likely require a significant payment at or around the closing of the credit bid. For other assets that may be stored pending an improvement in the business, storage costs must be addressed.
This cash consideration should often be effected through a new loan to the acquisition vehicle, extended on the closing date. This loan may be coupled with a working capital facility depending on the status of the acquired assets or business. This is particularly the case where all credit bidding lenders are not also providing new money on a pro rata basis in order to ensure that the financing is senior to the various lenders’ equity in the financing vehicle.
From the perspective of a potential purchaser, the opportunity to credit bid may make the secured lender’s debt particularly attractive as an initial acquisition target. If a potential purchaser can acquire the lender’s debt at a discount to its face value, it can enhance, perhaps significantly depending on the discount, its ability to put forth and advance the successful bid at auction by credit bidding such debt at its par value (e.g., credit bidding $100 million of debt that was purchased for $75 million). This feature may make a secured lender’s debt more attractive in the secondary market, increasing the price that might otherwise be available. Accordingly, the ability to freely assign the debt, potentially to a competitor, is paramount to ensuring a lender’s ability to explore all opportunities to maximize recovery. This, however, is not top of mind when first negotiating a credit agreement, and many agreements include considerable restrictions on the ability to assign debt without the consent of the borrower. Lenders should be careful when agreeing to broad restrictions that may capture the very parties that would be most interested in acquiring the debt to use at an auction. Unless the agreement so provides, these restrictions can have long standing effect, including following the bankruptcy of the borrower. Similar attention should be paid to confidentiality provisions that may restrict the ability to share information regarding the borrower and the credit facility with third parties, often including those competitors that may be most interested in acquiring the debt.