New Ruling Affects Credit Bids in Bankruptcy Auctions
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New Ruling Affects Credit Bids in Bankruptcy Auctions

August 15, 2011


A ruling by Illinois' 7th U.S. Court of Appeals this week changes the rules for when creditors are allowed to offer a "credit bid" in bankruptcy cases, according to Thompson-Reuters News. The ruling involved two Chapter 11 bankruptcy cases, but could potentially affect Chapter 7 bankruptcy filings as well.

First, a quick vocabulary lesson. A "credit bid" is an offer made by a creditor during a liquidation sale that involves claims on the property rather than cash. In a foreclosure auction, for example, the mortgage lender may have an opportunity to buy the foreclosed property by making a credit bid. The bid allows the lender to bid the borrower's debt in lieu of cash for property.

In the 7th Court of Appeals' ruling, which involved the bankruptcy filings of River Road Hotel Partners and RedLAX Gateway Hotel, the court decided that filers cannot sell their assets in a bankruptcy sale free of liens unless creditors have the option of making a credit bid at that auction.

In other words, bankruptcy filers whose creditors have some financial claim to their property (called a "lien") must permit those creditors to make a credit bid for the property in any bankruptcy auction. That could translate to less overall money raised at an auction and distributed among creditors.

The ruling marks a change in policy from an earlier decision from a Pennsylvania appeals court, which decided that no credit bids were permitted from creditors. It remains unclear whether another court might overturn the decision or, if it stands, whether it might be applied to other types of bankruptcy (specifically Chapter 7, which may involve a liquidation sale).

If the ruling is translated to personal bankruptcy cases, it's unclear whether it would have any significant change on how those cases are carried out. A Chapter 7 credit bid, for example, may result in less overall money raised from a liquidation sale, but it would also likely mean that one secured creditor would be repaid in what's called "indubitable equivalent." That would leave one less creditor who got to split the remainder of auction profits.

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