Recent Fisker Decision Provides Sound Guidance to Purchasers of Distressed Debt with a Loan-to-Own Strategy

In its recent decision in In re Fisker Automotive Holdings, Inc., 2014 Bankr. LEXIS 230 (Jan. 17, 2014), the United States Bankruptcy Court for the District of Delaware limited a secured creditor’s ability to credit bid to $25 million, the amount the creditor paid to purchase the outstanding principal of a $168.5 million loan facility. The highlights of the decision below provide sound guidance to distressed debt buyers with an intent to use their acquired debt to acquire the debtor in a bankruptcy sale.

Fisker Automotive Holdings Inc. and Fisker Automotive, Inc. (the “Debtors”) were founded in 2007 to design, manufacture and assemble hybrid electric vehicles. In April 2010, the Debtors entered into a lending agreement with the United States Department of Energy (“DOE”), which loan had an outstanding principal balance of $168.5 million when it was purchased on October 11, 2013 by Hybrid Tech Holdings, LLC (“Hybrid”). Thereafter, Hybrid and the Debtors entered into an asset purchase agreement under which Hybrid sought to purchase substantially all of the Debtors’ assets in exchange for a credit bid offer of $75 million, $500,000 of which would go to unsecured creditors. As of November 22, 2013 (the “Petition Date”), the Debtors had indebtedness and related obligations outstanding totaling $203.2 million, which included the $168.5 million due under the loan facility with DOE.

The Committee of Unsecured Creditors (the “Committee”) opposed the private sale to Hybrid in favor of an auction process that would allow another company, Wanxiang America Corporation (“Wanxiang America”), to participate. The Committee argued that Hybrid should not be permitted to credit bid or, in the alternative, its credit bid should be capped at $25 million, the amount it paid to acquire DOE’s interest. At the initial hearing on the Sale Motion and the Bidding Procedures Motion on the Hybrid sale, the Committee and the Debtors agreed to limit the issues before the Court by making the following stipulations: (1) if Hybrid were not permitted to credit bid or was limited to $25 million, there is a “strong likelihood” that an auction would create material value for the estate that exceeds the current Hybrid bid, (2) if Hybrid’s ability to credit bid is not limited there is no possibility of an auction, (3) a cap on Hybrid’s ability to credit bid would foster a competitive environment, (4) value to the estate is maximized by selling the Debtors’ assets in their entirety, and (5) the Debtors’ assets include (i) those that are subject to properly perfected liens in favor of Hybrid, (ii) those that are not subject to liens properly perfected in favor of Hybrid, and (iii) assets where it is unclear whether Hybrid has a properly perfected lien. Further, if the Court does not cap Hybrid’s ability to credit bid, there will be no auction and the Committee agreed to withdraw its opposition to the Hybrid sale.

The Committee asserted three arguments in support of its position: (1) Hybrid should not be permitted to credit bid where a material portion of the assets to be sold are not subject to a lien in favor of Hybrid, and (2) cause exists for the Court to limit the bid to $25 million, (i) to foster competitive bidding, and (ii) because of the liens on the assets to be sold are held by creditors other than Hybrid. Although not mentioned in the decision, it is also important to note David Manion, a principal of Hybrid, also served as a member of Fisker’s board of directors. Manion served on the Fisker board until the Petition Date, when he resigned, the same day he became the chief executive officer of Hybrid.

Relying on 11 U.S.C. § 363(k) and In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010), the Bankruptcy Court reasoned that Hybrid, as a secured creditor, is allowed to credit bid unless the court “for cause order[s] otherwise.” Cause may exist to further any policy interest advanced by the Bankruptcy Code. In capping Hybrid’s credit bid to $25 million, the Court determined that there will be no competitive bidding if the amount Hybrid can credit bid is not in some way limited so that other potential bidders will not be “frozen out.” Noting that the amount of Hybrid’s claim that is secured is uncertain, “the law leaves no doubt that the holder of a lien the validity of which has not been determined, as here, many not bid its lien.”

The Court next observed that the Debtors filed the sale motion three business days before Thanksgiving and insisted on a hearing date scheduled for no later than January 3, but provided no justification for the expedited schedule, even after the Court stated the timing was troublesome. The Court found, “Hybrid’s rush to purchase and to persist in such effort is inconsistent with the notions of fairness in the bankruptcy process.” Consistent with its earlier rulings, the Court enlarged the sale timetable, setting February 7, 2014 as the deadline to submit bids for the Debtors’ assets and February 12, 2014 as the auction date.

Prior to the auction, Hybrid added $30 million in cash to its $25 million credit bid, for a total pre-auction bid of $55 million, while Wanxiang America had a bid of $37.5 million in cash on the table. The auction was held from February 12, 2014 through February 14, 2014, after which Wanxiang America emerged as the highest bidder, with a bid valued at approximately $149.2 million, a result undoubtedly applauded by the Committee.

Given the interested nature of the Hybrid transaction and the expedited sale process attempted therein, it is unclear what effect the Fisker decision will have in limiting secured creditors’ right to credit bid in future cases. At a minimum, a purchaser of distressed debt who intends to credit bid as part of a strategy to purchase the company is well advised after Fisker to perform careful due diligence on the validity and priority of the liens securing the claims he or she is purchasing. A secured creditor’s credit bid is certainly less susceptible to attack when the liens are undisputed and the lien is secured by substantially all of the debtor’s assets being purchased. However, the limits of “for cause” will likely continue to be tested as bankruptcy petitioners employ Fisker to cap a secured creditor’s ability to credit bid.