In devising loan-to-own lending strategies, the Delaware Bankruptcy Court’s decision in In re Fisker Auto. Holdings, Inc. serves as a warning shot to secured lenders that private sales on an  expedited basis are hard sells to a bankruptcy judge.

Fisker Automotive Holdings (“Fisker”) produced hybrid electric cars but ran into financial distress due to operating difficulties.  When the company’s senior secured loan from the U.S. Department of Energy in the amount of $168 million was purchased by Hybrid Tech Holdings, LLC (“Hybrid”) for $25 million, the company entered into negotiations over the terms of its sale to Hybrid.  With Hybrid’s support, Fisker filed a chapter 11 petition with the intent to sell substantially all of its assets to Hybrid.  Hybrid’s purchase offer was a credit bid of $75 million of the $168 million loan that it purchased just prior to the bankruptcy petition date.  Fisker planned to propose a liquidating chapter 11 plan after the sale closed.

The Creditors Committee opposed Fisker’s proposed transaction with Hybrid.  The Committee’s request to limit Hybrid’s right to credit bid was predicated on the following allegations: first, Hybrid did not have a properly perfected lien on certain of the assets that would be sold; second, Hybrid’s lien was the subject of a bona fide dispute; and third, limiting Hybrid’s credit bid would facilitate a competitive cash auction.  The Committee wanted a public auction between Hybrid and another interested purchaser, Wanxiang America Corporation (“Wanxiang”).  In Wanxiang, the Committee saw a strategic buyer who could provide the bankruptcy estate with real value.  Wanxiang had just purchased certain assets of A123 Systems for $300 million, assets that included the lithium ion battery, a key component for the Fisker cars.

The Bankruptcy Court sided with the Committee, and capped Hybrid’s right to credit bid its claim at $25 million on the grounds that section 363(k) did not give creditors an unqualified right to credit bid.  The court observed that if it did not limit the credit bid of Hybrid, there would be no bidding by Wanxiang.  Furthermore, the court reasoned that neither Fisker nor Hybrid provided the court with a satisfactory reason why Fisker’s assets needed to be sold within a month of the bankruptcy filing pursuant to a private sale (i.e., no auction process).  The court ruled that such a rushed and private process was inconsistent with the notion of fairness and transparency.  Finally, and perhaps most importantly, the court was cognizant of the Committee’s concerns that the nature of Hybrid’s claim was uncertain.  In fact, Hybrid acknowledged that its lien on certain of the assets to be sold was not perfected.  Thus, while the amount of the claim was $168.5 million as of the petition date, it was unclear how much of that claim was secured by the assets being sold versus how much of the claim was unsecured or disputed.

While this ruling caused much discomfort in the loan-to-own community, it ultimately stands for an uncontroverted principle:  that the statutory right to credit bid is limited to a bid of an allowed secured claim.  Hybrid was putting the cart before the horse insofar as the validity and scope of its lien, which formed the basis for its credit bid, was in dispute.

Fisker should also be a red flag to investors in the distressed debt market that buying a claim at a deep discount prior to a bankruptcy case will not automatically allow the claim holder to bid the full amount of the claim for the assets on the back-end of a bankruptcy case.  This is especially true where the claim being purchased is subject to a bona fide dispute.  Even where a claim is not in dispute, the appearance of a Creditors Committee will inevitably slow the sale process down.  A fast-tracked private sale process should be the exception and not the rule.

In Fisker, the court’s ruling paid off for the bankruptcy estate.  The auction went 19 rounds, and resulted in a winning bid by Wanxiang in the amount of $149.2 million, six times what Fisker initially sought when it filed for bankruptcy.