On July 10, 2014 the US Bankruptcy Court for the Western District of Tennessee, in In re RML Development Inc., held that a potential chilling effect on third-party bids, without more, does not constitute sufficient cause to justify modifying or denying a secured creditor's right to credit bid in a sale of collateral under section 363(k) of the Bankruptcy Code (No. 13-29244, (Bankr. W.D. Tenn. July 10, 2014)).

RML Development, Inc. (Debtor) attempted to sell two residential apartment complexes in a section 363(b) sale. SPCP Group III CNI 1, LLC (Silverpoint) asserted a valid first mortgage security interest in these properties and filed a motion to allow it to credit bid its secured claims under section 363(k) of the Bankruptcy Code at the auction sale.

Under section 363(k), a holder of a secured allowed claim has the right to:

A court may limit credit bidding rights "for cause." However, the Bankruptcy Code does not define what constitutes cause. The Debtor argued that there was cause to limit Silverpoint's credit bidding rights because a bona fide dispute existed as to the extent of the amount of Silverpoint's claim, which was subject to serious allegations primarily asserting a Ponzi scheme, fraudulent transfers and breaches of fiduciary duty. Therefore, the Court found there was sufficient cause to limit Silverpoint's credit bidding rights to the undisputed portion of its claim, and ordered that any cash paid by Silverpoint in excess of its credit bid, should it be the successful bidder, be held in escrow pending resolution of the dispute.

The Court explained that a court should only modify or deny credit bidding rights when equitable concerns give it cause. Because the Bankruptcy Code does not define "cause," courts have the discretion to determine what constitutes cause on a case-by-case basis. The Court held that modifying or denying credit bidding rights should be the "extraordinary exception" and not the norm. This requires a court to balance the interests of the debtor, its creditors and other parties in interest to maximize the estate and provide an equitable distribution to all creditors. Although the standard for determining cause is not spelled out, previous cases have established that the courts may not act arbitrarily.

While the Court recognized that the right to credit bid is not absolute, it rejected the notion that a potential chilling effect on third party bids, without more, justifies modifying or denying credit bidding rights. Instead, the Court held that cause may exist where there are equitable concerns, such as competing claims, collusion or other fraudulent or bad faith acts. Therefore, if no equitable concerns exist, creditors holding allowed secured claims should ordinarily be able to credit bid at sales of their collateral.

In this case, the Court departed from two recent rulings in which courts limited credit bidding rights for cause, at least partially due to a potentially chilling effect on the auction process (see Legal Updates, In re Fisker Automotive: Delaware Bankruptcy Court Caps Credit Bid to Amount Paid for Claim and In re Free Lance-Star Publishing Co: Court Follows Fisker and Caps Credit Bidding Rights "For Cause"). In doing so, they left open the question of whether courts can limit credit bidding rights solely in the interest of promoting a competitive and robust sales process. By rejecting a broad interpretation of the for cause exception, the Court strengthened and affirmed this important secured creditor protection and provided a strong precedent for defending against future attacks on credit bidding rights.

For more information on credit bidding, see Practice Note, Credit Bidding in Section 363 Bankruptcy Sales.