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    Central District of California’s Judicial Practices Survey

    February 9th, 2012

    For those practitioners practicing locally here in SoCal – or for those who need to appear pro hac in one of the many Chapter 11′s pending in the nation’s largest bankruptcy district – the Central District has very recently collaborated with the local bankruptcy bar to produce a detailed list of individual judicial preferences.

    In a District with nearly 30 sitting bankruptcy judges scattered over five divisions, a “score-card” like this one is essential reading.  A copy of the survey is available here.

    Other Posts of Interest:

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    The Year in Bankruptcy – 2011

    January 30th, 2012

    JonesDay’s comprehensive and always-readable summary of notable bankruptcies, decisions, legislation, and economic events was released just over a week ago.  A copy is available here.

    As 2012 gets off to an uncertain start, some more recent headlines are accessible immediately below.

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    A Formula for Confusion

    January 23rd, 2012
    Inc

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    Thanks to an active lobby in Congress, commercial landlords have historically enjoyed a number of lease protections under the Bankruptcy Code.  Even so, those same landlords nevertheless face limits on the damages they can assert whenever a tenant elects to reject a commercial lease.

    Section 502(b)(6) limits landlords’ lease rejection claims pursuant to a statutory formula, calculated as “the [non-accelerated] rent reserved by [the] lease . . . for the greater of one year, or 15 percent, not to exceed three years, of the remaining term of such lease . . . .”

    This complicated and somewhat ambiguous language leaves some question as to whether or not the phrase “rent reserved for . . . 15 percent . . . of the remaining term of such lease” is a reference to time or to money:  That is, does the specified 15 percent refer to the “rent reserved?”  Or to the “remaining term?”

    Many courts apply the formula with respect to the “rent reserved.”   See. e.g., In re USinternetworking, Inc., 291 B.R. 378, 380 (Bankr.D.Md.2003) (citing In re Today’s Woman of Florida, Inc., 195 B.R. 506 (Bankr.M.D.Fl.1996); In re Gantos, 176 B.R. 793 (Bankr.W.D.Mich.1995); In re Financial News Network, Inc., 149 B.R. 348 (Bankr.S.D.N.Y.1993); In re Communicall Cent., Inc., 106 B.R. 540 (Bankr.N.D.Ill.1989); In re McLean Enter., Inc., 105 B.R. 928 (Bank.W.D.Mo.1989)).  These courts calculate the amount of rent due over the remaining term of the lease and multiply that amount times 15%.

    Other courts calculate lease rejection damages based on 15% of the “remaining term” of the lease.  See, e.g., In re Iron–Oak Supply Corp., 169 B.R. 414, 419 n. 8 (Bankr.E.D.Cal.1994); In re Allegheny Intern., Inc., 145 B.R. 823 (W.D.Pa.1992); In re PPI Enterprises, Inc., 324 F.3d 197, 207 (3rd Cir.2003).

    For more mathematically-minded readers, the differently-applied formulas appear as follows:

    Rent-Based Formula: Maximum Rejection Damages = (Rent x Remaining Term) x 0.15
       
    Term-Based Formula: Maximum Rejection Damages = Rent x (Remaining Term x 0.15)

    Earlier this month, a Colorado bankruptcy judge, addressing the issue for the first time in that state, sided with those courts who read the statutory 15% in terms of time:

    “In practice, by reading the 15% limitation consistently with the remainder of § 502(b)(6)(A) as a reference to a period of time, any lease with a remaining term of 80 months or less is subject to a cap of one year of rent [i.e.,15% of 80 months equals 12 months] and any lease with a remaining term of 240 months or more will be subject to a cap of three years rent [i.e., 15% of 240 months equals 36 months].  Those in between are capped at the rent due for 15% of the remaining lease term.”

    In re Shane Co., 2012 WL 12700 (Bkrtcy. D.Colo., January 4, 2012).

    The decision also addresses a related question:  To what “rent” should the formula apply – the contractual rent applicable for the term?  Or the unpaid rent remaining after the landlord has mitigated its damages?  Under the statute, “rents reserved” refers to contractual rents, and not to those remaining unpaid after the landlord has found a new tenant or otherwise mitigated.

    Colorado Bankruptcy Judge Tallman’s decision, which cites a number of earlier cases on both sides of the formula, is available here.

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    Intercreditor Agreements: How Far Can They Reach?

    January 17th, 2012
    Creditor's Ledger, Holmes McDougall

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    Can a senior secured lender require, through an inter-creditor agreement, that a junior lender relinquish the junior’s rights under the Bankruptcy Code vis á vis a common debtor?

    Though the practice is a common one, the answer to this question is not clear-cut.  Bankruptcy Courts addressing this issue have come down on both sides, some holding “yea,” and others “nay.”  Late last year, the Massachusetts Bankruptcy Court sided with the “nays” in In re SW Boston Hotel Venture, LLC, 460 B.R. 38 (Bankr. D. Mass. 2011).

    The decision (available here) acknowledges and cites case law on either side of the issue.  It further highlights the reality that lenders employing the protective practice of an inter-creditor agreement as a “hedge” against the debtor’s potential future bankruptcy may not be as well-protected as they might otherwise believe.

    In light of this uncertainty, do lenders have other means of protection?  One suggested (but, as yet, untested) method is to take the senior lender’s bankruptcy-related protections out of the agreement, and provide instead that in the event of the debtor’s filing, the junior’s claim will be automatically assigned to the senior creditor, re-vesting in the junior creditor once the senior’s claim has been paid in full.

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    Getting to the “Core” of the Matter

    January 13th, 2012
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    Last year, the Supreme Court issued one of its more significant bankruptcy decisions in recent years with Stern v. Marshall (a very brief note concerning the Stern decision as reported on this blog is available here).  Stern, which addressed the limits of bankruptcy courts’ “core” jurisdiction, has been the focus of a considerable amount of academic and professional interest – primarily because of its possible fundamental effect on the administration of bankruptcy cases.

    Three weeks ago, the Seventh Circuit capped off 2011 with a decision – the first at an appellate level – discussing and applying Stern.

    The procedural history of In re Ortiz is straightforward.  Wisconsin medical provider Aurora Health Care, Inc. had filed proofs of claim in 3,200 individual debtors’ bankruptcy cases in the Eastern District of Wisconsin between 2003 and 2008.  Two groups of these debtors took issue with these filings, claiming Aurora violated a Wisconsin statute that allows individuals to sue if their health care records are disclosed without permission.  One group of debtors filed a class action adversary proceeding against Aurora in the Bankruptcy Court for Wisconsin’s Eastern District, while the other filed a similar class action complaint against Aurora in Wisconsin Superior Court.

    For all their differences, it appears neither the debtor-plaintiffs nor Aurora wanted to have these matters heard by the US Bankruptcy Court.  Aurora removed the Superior Court Action to the Bankruptcy Court, then immediately sought to have the US District Court for Wisconsin’s Eastern District withdraw the reference of these actions to the Bankruptcy Court and hear both matters itself.  Both groups of debtor-plaintiffs, on the other hand, sought to have their claims heard by the Wisconsin Superior Court by asking the Bankruptcy Court to abstain from hearing them, and remand them to the state tribunal.

    Both parties’ procedural jockeying for a forum other than the US Bankruptcy Court ultimately proved unfruitful:  The District Court denied Aurora’s request to hear the matters, and the Bankruptcy Court declined to remand them back to Wisconsin Superior Court or otherwise abstain from hearing them.  The District Court’s and the Bankruptcy Court’s reasoning was essentially the same – since the original “disclosure” of health records took place in the context of proofs of claim filed in individual debtors’ bankruptcy proceeding, both courts believed the matters were therefore “core” proceedings which Bankruptcy Courts were entitled to hear and determine on a final basis.

    Ultimately, the Bankruptcy Court granted summary judgment and dismissed the class actions because both groups of debtors had failed to establish actual damages as required under the Wisconsin statute.  Both the plaintiffs and Aurora requested, and were granted, a direct appeal to the Seventh Circuit Court of Appeals.

    But if Ortiz’ procedural history is straightforward, the Seventh Circuit’s disposition of the appeal was not.  After the case was argued on appeal in February 2011, the Supreme Court issued its decision in Stern v. Marshall.  In that decision, the high court called into question the viability of Congress’ statutory scheme in which bankruptcy courts were empowered to finally adjudicate “core” proceedings – i.e., those proceedings “arising in a bankruptcy case or under title 11″ of the US Code.  The Stern court held that a dispute – even if “core” – was nevertheless improper for final adjudication by a bankruptcy court if the dispute was not integral to the claims allowance process, and constituted a private, common-law action as recognized by the courts at Westminster in 1789.  Such matters were – and are – the province of Article III (i.e., US District Court) judges, and it was not up to Congress to “chip away” at federal courts’ authority by delegating such matters to other, non-Article III (i.e., Bankruptcy) courts.

    In order to resolve the Aurora class actions in a manner consistent with Stern, the Seventh Circuit requested supplemental briefing, and then undertook a lengthy analysis of that decision.  To isolate and identify the type of dispute that the Stern court found “off-limits” for final decisions by bankruptcy courts, it distinguished the Aurora class action disputes from those cases which:

    -        Involved  “public rights” or a government litigant;

    -        Flowed from a federal statutory scheme or a particularized area of law which Congress had determined best addressed through administrative proceedings; or

    -        Were “integral to the restructuring of the debtor-creditor relationship” or otherwise part of the process of allowance and disallowance of claims.

    Instead, the Aurora disputes had nothing to do with the original claims filed by Aurora in the debtors’ cases, was between private litigants, and was not a federal statutory claim or an administrative matter.  Consequently, the Bankruptcy Court had no jurisdiction to determine it on a final basis.  Consequently, the Seventh Circuit had no jurisdiction to hear the appeal.

    Ortiz, like Stern, has received a considerable amount of attention within the bankruptcy community.   Among some of the community’s immediate reactions to Ortiz:

    -        Despite the fact that the class actions arose out of Aurora’s filing proofs of claim in bankruptcy cases, the bankruptcy court could not decide those class actions.  More importantly, the Seventh Circuit suggested that a bankruptcy judge may not even have “authority to resolve disputes claiming that the way one party acted in the course of the court’s proceedings violated another party’s rights.”  In other words, it seems possible to argue, under Ortiz (and Stern), that though US District Courts have authority to police their own dockets, Bankruptcy Courts do not.

    -        The Seventh Circuit’s decision appears circular in some respects.  Specifically, the Seventh Circuit declined to hear the appeals from the bankruptcy court as proposed findings of fact and conclusions of law (rather than as a final judgment), because such recommendations from a bankruptcy court are available only in “non-core” proceedings – and since the Aurora class actions were “core,” an appellate review of such proposed findings and conclusions simply wasn’t available.  But if a “core” matter is outside a bankruptcy court’s jurisdiction, is it really “core”?  In other words, wouldn’t it have been easier for the Seventh Circuit to have simply sent the matter back to the bankruptcy court as a recommended resolution, not yet ripe for an appeal?

    As the results of Stern begin to percolate their way through the bankruptcy system and other circuits weigh in on the Supreme Court’s 2011 guidance, it appears the administration of bankruptcy cases faces some significant adjustment.

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    “Collateral Damage”? Or “Credit to Whom Credit is Due”?

    December 19th, 2011
    Collateral Damage (film)

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    Outside of bankruptcy, a creditor whose loan is secured by collateral typically has the right to payment in full when that collateral is sold – or, if the collateral is sold at an auction, to “credit bid” the face amount of the debt against the auction price of the collateral.

    Inside bankruptcy, however, the right to “credit bid” is not always guaranteed.

    In July, this blog predicted Supreme Court review of a Seventh Circuit case addressing the question of whether a bankruptcy court may confirm a plan of reorganization that proposes to sell substantially all of the debtor’s assets without permitting secured creditors to bid with credit.  The courts of appeals are divided two to one over the question, with the Third and Fifth Circuits holding that creditors are not entitled to credit bid and the Seventh Circuit holding to the contrary (for a review of the more recent, Seventh Circuit decision, click here).

    The question is one of great significance for commercial restructuring practice, with several bankruptcy law scholars suggesting the answer “holds billions of dollars in the balance.”

    Apparently, the Supreme Court agrees.  Last week, the justices granted review of the Seventh Circuit decision.  For the petitioners’ brief, respondent’s opposition, and amicus briefs, click here.

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    A Chip Too Far

    December 15th, 2011
    Chip

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    Nearly 16 months ago, this blog covered the story of Qimonda AG – a German chip manufacturer whose cross-border liquidation created waves on both sides of the Atlantic.  As noted in that prior post, Qimonda’s insolvency proceeding illustrates what can happen when one country’s rules governing the treatment of an insolvent firm’s intellectual property assets collide with those of another.

    But what can happen is not always what does happen.

    As a liquidating entity, Qimonda’s primary assets were its portfolio of patents, licensed to other firms under a series of cross-licensing agreements.  Though not completely settled law in Germany, patent cross-licenses are widely viewed by German practitioners as executory agreements.  Such agreements are automatically unenforceable unless the insolvency administrator (the functional equivalent of a trustee under US bankruptcy law) affirmatively elects to perform the contracts.  In practice, to avoid any implied election of performance, an insolvency administrator will usually send a letter of non-performance to the counter-party.  Consistent with this practice, Qimonda’s administrator had issued non-performance letters to a number of licensees in connection with his proposed disposition with Qimonda’s patents, which were the company’s most valuable remaining asset following a decision to liquidate.  The business strategy was to maximize the value of Qimonda’s patents by canceling, then re-negotiating, the company’s patent licenses with Qimonda’s original licensees.

    In response, the licensees asserted rights with respect to Qimonda’s US patents under Bankruptcy Code section 365(n), which – contrary to German law – specifically protects the rights of patent licensees in the event of a licensor’s bankruptcy.  Qimonda’s recognition under Chapter 15 of the Bankruptcy Code had made Section 365 “applicable” to the company’s ancillary proceedings in the US.

    Qimonda’s administrator sought the Bankruptcy Court’s elimination or restriction of Section 365′s applicability to the company’s US patents, in light of his proposed disposition of the patents under conflicting German insolvency law.  The Bankruptcy Court restricted 365(n)’s applicability, but the District Court remanded on appeal for a determination of whether doing so was “manifestly contrary to the public policy of the United States” and whether the licensees would be “sufficiently protected” if Section 365(n) did not apply.

    After four days of evidentiary hearings and one day of argument, the Bankruptcy Court concluded that:

    - Chapter 15 of the US Bankruptcy Code, which is rooted in considerations of comity and deference to the decisions of foreign tribunals, is nevertheless limited by the “sufficient[] protect[ion] of creditors’ interests.”  Moreover, any relief requested by a foreign representative seeking recognition and relief in the US under this statute is further limited when granting such relief “would be manifestly contrary to the public policy of the United States.”

    - The protections afforded patent licensees by Section 365(n) have their origins in Congressional reaction to the Fourth Circuit’s decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), a decision involving the debtor’s rejection of a fully paid-up license to a non-bankrupt licensee for use of the debtor’s metal coating technology.  Most disturbingly for Congress, the Lubrizol court found that rejection under Section 365(a) effectively prohibited the licensee’s continued receipt of specific performance under the agreement, even if that remedy would otherwise be available under a  breach of this type of contract.  Congress’ answer to the Lubrizol decision was to pass the “Intellectual Property Licenses Act of 1987,” which included the licensee protections of Section 365(n).  According to the Congressional history behind the statute, adoption of the legislation was intended to “immediately remove [the threat of license rejection] and its attendant threat to American [t]echnology and will further clarify that Congress never intended for Section 365 to be so applied.”

    - Though the nature of patent cross-licensing made it difficult – if not impossible – for the parties to establish whether the cancellation of licenses for specific patents would put at risk the licensees’ investment in manufacturing or sales facilities in the US for products covered by US patents, the administrator’s threat of infringement litigation following cancellation of Qimonda’s patent licenses was as damaging to licensees as an actual finding of infringement of specific patents.  This risk, balanced against the loss in value to Qimonda’s patent portfolio, warranted the application of Section 365(n) to the administrators disposition of the company’s US patents.

    - Application of the German insolvency law as an exercise of comity would “severely impinge[] . . . a U.S. statutory . . . right such that deferring to German law would defeat ‘the most fundamental policies and purposes’ of such right[].’”  For the Bankruptcy Court, the question of whether or not Section 365(n) was intended to protect a “fundamental” US policy was an extremely close one.  But “[a]lthough [technological] innovation [in the US] would obviously not come to a grinding halt if licenses to U.S. patents could e cancelled in a foreign insolvency proceeding, . . . the resulting uncertainty would nevertheless slow the pace of innovation, to the detriment of the U.S. economy.”  As a result, the failure to apply Section 365(n) to Qimonda’s US patent portfolio “would ‘severely impinge’ an important statutory protection accorded licensees of U.S. patents and thereby undermine a fundamental U.S. public policy promoting technological innovation” – and as such, deferring to German law would be “manifestly contrary to U.S. public policy.”

    The Bankruptcy Court’s most recent decision is available here.

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    Proposed Amendments to the Federal Rules of Bankruptcy Procedure

    August 30th, 2011

    Last week, the Judicial Conference Advisory Committees on Appellate, Bankruptcy, Civil, Criminal, and Evidence Rules proposed amendments to their respective rules and made them available for public comment.

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    Though it frequently makes for less-than-scintillating reading, the proposed amendments are always worth a look-through.  This is especially the case in an environment such as Bankruptcy Court, where procedure can drive courtroom tactics.

    Proposed revisions to the Federal Rules of Bankruptcy Procedure (FRBP) and Official Bankruptcy Forms include:

    • FRBP 1007 — relieves individual debtors of the obligation to file Official Form 23 if the provider of a personal financial management course notifies the court that the debtor has completed the course.

    • FRBP 3007 — allows the use of a negative-notice procedure for claim objections and clarifies the manner for serving them.

    • FRBP 5009 — reflects the amendment to FRBP 1007 by providing that the Clerk of Court is not required to send notice to a debtor if a course provider has already provided notice that the debtor completed a personal financial management course.

    • FRBP 9006 — makes various changes to draw attention to the fact that the rule prescribes default deadlines for serving motions and written responses; and applies deadlines to any written response to a motion.

    • FRBPs 9013 and 9014 — conform to the amendments to FRBP 9006.

    • Official Form 6C — reflects the Supreme Court’s decision in Schwab v. Reilly by permitting the debtor to state the value of the claimed exemption as the “full fair market value of the exempted property.”

    • Official Form 7 — makes the definition of “insider” consistent with the definition in the Bankruptcy Code.

    • Official Forms 22A and 22C — align the allowable deduction for telecommunication expenses with the IRS list of Other Necessary Expenses; also amends Form 22C to conform to the Supreme Court’s decision in Hamilton v. Lanning, by directing an above-median-income chapter 13 debtor to list any changes in the reported income and expenses that have already occurred or are virtually certain to occur during the 12 months following the filing of the petition.

     The draft amendments, along with the Committee’s comments, are available here.

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    What’s In a Name?

    August 21st, 2011

    After a brief hiatus, we’re back – and just in time to discuss a recent decision of some import to trademark owners and licensors.

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    For many years, insolvency practitioners have recognized the value of the Bankruptcy Code in permitting a reorganizing firm to assign contractual rights to a third party, even where the contract itself prohibits assignment.  That power is limited, however, where “applicable [non-bankruptcy] law” prohibits the assignment without the non-bankrupt party’s consent.

    In recent years, the “anti-assignment” provisions of federal copyright and patent law have limited the transfer of patent and copyright licenses through bankruptcy.   Whether the transfer of trademark licenses is likewise limited has been an open question, at least amongst the Circuit Courts of Appeal.

    Until now.

    In late July, the Seventh Circuit Court of Appeals found in In re XMH Corp. that trademarks were not assignable.

    XMH Corp. involved the former Hartmarx clothing company’s Chapter 11, along with the related filings of several subsidiaries.  XMH ultimately sold its assets and assigned contracts to a group of third-party purchasers.  Those assets included certain trademark licenses for jeans held by one of the XMH subsidiaries.  The trademarks were owned by a Canadian firm.

    The Canadian firm objected to the trademark assignment, and the bankruptcy court agreed.  The District Court reversed, and the licensor appealed to the Seventh Circuit.

    In a succinct, 15-page decision, Judge Posner found that where “applicable law” prohibits the assignment of a trademark, it cannot be assigned through a bankruptcy proceeding absent the trademark owner’s consent.

    Judge Posner apparently reached this decision despite a lack of either party to articulate which “applicable law” actually prohibited the assignment:

    Unfortunately the parties haven’t told us whether the applicable trademark law is federal or state, or if the latter which state’s law is applicable (the contract does not contain a choice of law provision)—or for that matter which nation’s, since [the licensor] is a Canadian firm. ([The licensee's] headquarters are in the State of Washington.)  None of this matters, though, because as far as we’ve been able to determine, the universal rule is that trademark licenses are not assignable in the absence of a clause expressly authorizing assignment. Miller v. Glenn Miller Productions, Inc., 454 F.3d 975, 988 (9th Cir. 2006) (per curiam); In re N.C.P. Marketing Group, Inc., 337 B.R. 230, 235-36 (D. Nev. 2005); 3 McCarthy on Trademarks § 18:43, pp. 18-92 to 18-93 (4th ed. 2010).

    But the Seventh Circuit then turned to the question of whether the contract actually contained a valid trademark license - and found that though the agreement appeared to provide a relatively short-term license of the trademark, what remained at the time of the proposed assignment was merely a contract for services.

    Despite its brevity, XMH Corp. is instructive in two respects:

    • Trademarks cannot be assigned – at least not in the 7th Circuit.
    • Contract drafters and negotiators must be careful to identify and preserve the trademark rights at issue.
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    River Road Hotel Partners

    July 10th, 2011

    One of the time-honored attractions of US bankruptcy practice is the set of tools provided for the purchase and sale of distressed firms, assets and real estate.  In recent years, the so-called “363 sale” has been a favorite mechanism for such transactions – its popularity owing primarily to the speed with which they can be accomplished, as well as to the comparatively limited liability which follows the assets through such sales.

    But “363 sales” have their limits:  In such a sale, a secured creditor is permitted to “credit bid” against the assets securing its lien – often permitting that creditor to obtain a “blocking” position with respect to sale of the assets.

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    Until very recently, many practitioners believed these “credit bid” protections also applied whenever assets were being sold through a Chapter 11 plan.  In 2009 and again in 2010, however, the Fifth and Third Circuit Courts of Appeal held, respectively, that a sale through a Chapter 11 Plan didn’t require credit bidding and could be approved over the objection of a secured lender, so long as the lienholder received the “indubitable equivalent” of its interest in the assets (for more on the meaning of “indubitable equivalence,” see this recent post).

    Lenders, understandably concerned about the implications of this rule for their bargaining positions vis a vis their collateral in bankruptcy, were relieved when, about 10 days ago, the Seventh Circuit Court of Appeals respectfully disagreed – and held that “credit bidding” protections still apply whenever a sale is proposed through a Chapter 11 Plan.

    The Circuit’s decision in In re River Road Hotel Partners (available here) sets up a split in the circuits – and the possibility of Supreme Court review.  In the meanwhile, lenders may rest a little easier, at least in the Seventh Circuit.

    Or can they?

    It has been observed that the Seventh Circuit’s River Road Hotel Partners decision and the Third Circuit’s earlier decision both involved competitive auctions – i.e., bidding – in which the only “bid” not permitted was the lender’s credit bid.  The Fifth Circuit’s earlier decision, however, involved a sale following a judicial valuation of the collateral at issue.

    Is it possible to accomplish a sale without credit bidding – even in the Seventh Circuit – so long as the sale does not involve an auction, and is instead preceded by a judicial valuation?

    Stay tuned.

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