11 U.S.C. § 363(k) Allows A Secured Creditor To Credit Bid Up To The Full Face Value Of Its Claim, Even When The Collateral Securing The Claim Has No Economic Value
Cohen v. KB Mezzanine Fund II (In re Submicron Sys. Corp.), 432 F.3d 448 (3d Cir. 2006) (Circuit Judge Thomas L. Ambro)
The Plan Administrator for the Debtor’s estate commenced an adversary proceeding seeking to recharacterize the secured claims of insiders of the debtor from debt to equity, or in the alternative, to equitably subordinate the claims and impose a constructive trust. The District Court entered judgment in favor of the defendants, and the Third Circuit affirmed. The Third Circuit held that the creditors’ security interests were properly perfected, and that their credit bids to purchase assets of the debtor were not capped by the economic value of the collateral securing their claims. Instead, they could credit bid up to the full face value of their secured claims.
Appellant Howard S. Cohen, Plan Administrator for the SubMicron debtors, challenged the sale of SubMicron’s assets under 11 U.S.C. § 363(b) to an entity created by Sunrise Capital Partners, LP. Sunrise negotiated directly with several of SubMicron’s creditors before presenting its bid to the District Court. These creditors — The KB Mezzanine Fund II, LP, Equinox Investment Partners, LLC, and Celerity Silicon, LLC, who had, pre-petition, advanced the debtors approximately $11 million on Tranche One and Tranche Two Notes (the “1999 Fundings”) — agreed to contribute toward the purchase of SubMicron’s assets new capital along with all of their claims against SubMicron in exchange for equity in Akrion LLC, the entity formed by Sunrise to acquire the assets. Akrion in turn credit bid the full value of the Lenders’ secured claims, pursuant to 11 U.S.C.§ 363(k). The District Court (Robinson, J.) approved the sale, and Cohen appealed.Cohen first argued that the 1999 Fundings should have been recharacterized as equity. The Third Circuit noted that although there are different tests among the circuits for whether recharacterization is appropriate, the overarching test is ultimately whether the party doing the funding intended to act as a banker, being repaid with interest, no matter the debtor’s fortunes, or as an investor, with repayment tied to the fortunes of the debtor. Having decided that this is a question of fact, the Court held that appellate review is under the clearly erroneous standard.
The 1999 Notes were called “debt” on their face, and were reported by the debtors in their SEC and UCC filings as secured debt. The District Court had also considered the testimony of witnesses, and found that, even though the debtor was undercapitalized when the Lenders advanced the funds, that did not support an equity characterization.
Cohen also argued that if the 1999 Fundings were debt, then they were not secured debt. This is a state law issue, but the results would have been the same under any of the possible choices of law. Each state’s codification of U.C.C. §§ 9-203 and 9-302 in 1999 required a written security agreement in favor of the lender describing the collateral and, for the collateral in question, the filing of a properly executed financing statement. Cohen contended that the financing statements filed by the Lenders were ineffective because they listed only “Equinox Investment Partners, LLC, as Collateral Agent” as the secured party. The Court held that because the financing statements named both SubMicron as debtor and Equinox as secured party, provided mailing addresses for both entities, and described the collateral that is subject to the security agreement, any interested party would be on notice to communicate with Equinox regarding the status of its interest in SubMicron’s assets, which is sufficient for Article 9 perfection purposes. The Court also concluded that, on the record before them, there was no doubt that KB and Celerity were intended secured parties served by their agent, Equinox. In the schedule of liabilities filed with the District Court, SubMicron listed KB and Celerity as secured noteholders. Therefore, they concluded that the Lenders presented valid secured claims for the 1999 Fundings.
Cohen also argued that that the § 363(k) credit bid was improper because the Lenders did not demonstrate that some portion of their claims remained secured by collateral, as defined in § 506(a). Thus, Cohen argued that, because the secured debt had no economic value, it could not be credit bid under § 363(k). The Court, however, held that because that section empowers creditors to bid the total face value of their claims, the District Court did not err in allowing the Lenders to credit bid their claims.
Cohen also argued that because the Lenders were not partially undersecured,
but completely undersecured, this case is different. The Court, however, stated that because the Lenders have a valid security interest in all the assets sold, by definition they were entitled to the satisfaction of their claims from available proceeds of any sale of those underlying assets. Their credit bid did nothing more than preserve their right to the proceeds.
Lastly, Cohen contended that the Lenders’ claims in relation to the 1999 Fundings should be equitably subordinated. The Court held that, because the District Court found no injury resulted to SubMicron’s unsecured creditors as a result of the Lenders’ dealings with Akrion, they did not need to reach the issue of inequitable conduct in order to affirm the District Court’s equitable subordination holding.
