Supreme Court Issues Important Clarification of Bankruptcy Law

June 5, 2012

By: John Clark

This week, the U.S. Supreme Court ruled that a bankruptcy court cannot deny secured creditors their right to make a so-called “credit bid” as part of a Chapter 11 bankruptcy reorganization plan, according to a report from Reuters.

This important clarification of bankruptcy law means that creditors have a right to place a bid on items of property or other assets that are involved in bankruptcy sales.

In recent years, several lower courts have denied the right of creditors to place these bids, which allow creditors to try to purchase the collateral for their loans at auctions. And creditors are often allowed to credit the purchase price towards the secured debt, rather than paying cash for the property.

In its ruling, the Supreme Court simply affirmed to the right of creditors to try to perform this maneuver, which clarifies a piece of Chapter 11 bankruptcy law that has seen different treatment in different federal circuits.

Before reaching its decision, the Supreme Court heard arguments from attorneys representing both creditors and debtors, who obviously had different takes on the issue.

From the debtors’ perspective, credit bids can discourage third parties from participating in bankruptcy auctions, which could theoretically reduce the price of the items sold at auction, and lead to less debt relief for the filers.

In response, however, creditors argued that denying them their right to bid at these auctions could force them to receive less than the full value of the assets.

The Court, it seems, sided with the creditors in this particular case, which won’t affect many personal bankruptcy filings, but could have an impact on future corporate bankruptcies. The Court’s decision affirmed an opinion that was reached by the Seventh Circuit Court of Appeals, which is based in Chicago.

In the Court’s opinion, Justice Scalia claimed that the “jargon” in the case was “complicated,” but observed that the “statutory interpretation question is an easy one.” So, for what it’s worth, Justice Scalia did not see the dispute as a difficult one.

Interestingly, attorneys for the U.S. government sided with the creditors in the case. They claimed that the right to credit bid was an important right for federal agencies that are often unable to make cash bids at bankruptcy auctions.