Credit Bidding and Sears


The Sears' auction is a really valuable teaching moment, I think (and perfectly timed for the start of the semester)—does Sears have going concern value that merits a sale of substantially all assets as a going concern, or is an immediate liquidation the value maximizing move?  

I don't have an opinion on that issue, but something strikes me as rather strange about ESL's bid for a sale of substantially all assets.  Very little of the now $5B in consideration offered is cash, less than 20%.  Instead, a large chunk is in the form of debt assumption and another large chunk is in the form of a credit bid.  It's the credit bid that looks odd to me.  ESL seems to be trying to credit bid three different loan facilities, including a second lien facility.  Here's the thing--ESL should only be able to credit bid against its collateral and then only in the amount of its collateral. I don't know what exactly is covered by the liens on each of the facilities, but I suspect that the assets being sold include things that are not covered by the liens. That would seem to create a Free-Lance Star problem for ESL.  And then there's the problem of the valuation.  In order to know what ESL can credit bid, we need to know to what extent it is secured.  To wit, consider a second lien facility.  If the collateral is worth $100 and the first lien debt is for $80 and the second lien debt for $30, the second lien debt shouldn't be able to credit bid $30 because it would only recover $20 from the sale in foreclosure.  The second lien's credit bid should be capped at $20.

The language of 363(k) is not as clear as it could be about this issue:  

At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed claim, the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.

Does "such claim" mean just "an allowed claim," or does it mean "an allowed secured claim".  The former reading is literal, but only the second reading makes sense.  Otherwise we could end up with absurdities:  imagine now that the collateral is worth $100, the first lien debt is for $80 and the second lien debt is for $150.  In that scenario, the second lien holder credit bids $150 and wins the auction, but has just paid with funny money, as $130 of that bid was a deficiency claim that might not even be enforceable at state law.  (Obviously there is something strange about doing a valuation before we have an auction--we might posit that the collateral is worth $100, but what if it sells only for $90 or for $110?  The opposite would also be silly--if we had cash bids, the credit bid by definition couldn't top the highest cash bid because the top cash bid would set the collateral price.)  I think this probably points to a need to limit credit bidding by junior lien holders, which can be done for cause under 363(k).  

The problem here reflects two basic misconceptions about secured credit.  First, is the idea that lenders actually have blanket liens that cover everything.  While that is an easy short-hand for liens that cover substantially all assets, substantially is not the same as all.  A financing statement might list "all assets," but that's not going to work for the security agreement itself under Article 9, and there are some assets that aren't lienable.  The second misconception is treating asset-based priority as part of the same system as entity-based priority.  A lien on an asset doesn't translate into priority in other assets.  Again, it's handy to talk of secured creditors having senior priority, but they only do in their collateral.  To the extent their undersecured, their just hoi polloi.  

These are just some off-hand musings.  Ted Janger has thought quite deeply about this problem.  Ted and I have some further thoughts at the end of this piece.  But I find myself uneasy with the use of credit bidding by ESL.