In the current difficult business environment, lenders will be weighing up their options in respect of defaulting borrowers – for some lenders that might include attempting to own the underlying business through a credit bid. Where debt is trading at a discount, a credit bid can also be a cost-efficient opportunity for an opportunistic buyer to acquire assets. So, what is a credit bid and what issues might such parties need to consider in using one?
What is a credit bid?
A creditor (usually (and for the purposes of this article) a secured lender, but see our earlier article) may “bid” some or all of the amount of its debt in a sale of the underlying collateral, known as a credit bid. That sale might take place in an enforcement scenario, where the lender has enforced its security over the relevant assets, or in a consensual sale by the borrower which is agreed to by the secured lender. If the borrower is in an insolvency process, the sale may also take place between its appointed insolvency officeholders and the secured lender. Whilst a lender’s right to credit bid is enshrined in legislation in some jurisdictions, credit bidding is not formally prescribed in UK legislation. Nevertheless, it has become accepted in the UK as a debt-restructuring mechanism.
The payment mechanism is simple: if the bid is accepted, the lender offsets some or all of its secured claim against the purchase price for the secured assets on a pound-for-pound basis – £100 of debt release is treated as £100 of cash. This allows the lender to avoid having to raise new funds to cover the purchase price. The typical reason for a lender to use this credit bidding structure is to protect the collateral’s value in depressed markets, with a view to selling the asset at some point in the future when prices have risen.
In other scenarios, credit bidding can also be used in a "loan-to-own" strategy. For example, an investor may buy out an existing secured creditor’s debt (possibly but not necessarily at a discounted price), with a view to acquiring ownership of the debtor’s business or some of its assets in a subsequent debt for equity structuring or prepack administration. This process may be instigated by the investor in its new position as the successor creditor.
Credit bids give rise to various issues – in particular, a careful valuation of the asset is required to ensure a fair market value is paid. Parties will need to consider whether there are any stamp duty or other tax implications associated with the purchase of the relevant assets (which are likely to need to be settled in cash). It is also worthwhile considering the provisions of any intercreditor agreement to ensure compliance with potential distressed disposals provisions.
Self-dealing and credit bidding
Self-dealing occurs when a director, trustee or mortgagee acts in its own interests at the expense of the mortgagor or other interested parties. At its heart is the doctrine that those acquiring assets should not be the ones determining the sale price. The rule on self-dealing therefore prohibits a mortgagee from selling to itself (or its agent), unless such a sale is expressly permitted in the mortgage deed. Even if expressly permitted, the mortgagee is under a duty to act in good faith, which can give rise to an immediate conflict of interest against its own desire to obtain the best possible bargain.
The rule on self-dealing can make the credit bidding mechanism problematic. In such situations, alternative sale structures can be used to effect the sale. Common practice is for a creditor bidding for a secured asset to use another affiliate within that creditor’s group as the acquisition vehicle, although the onus remains on the mortgagee to demonstrate that this is a proper sale.
Credit bidding can be used as a strategic tool in restructuring, offering opportunities for both creditors and opportunistic investors. Ensuring a fair market value is paid, properly considering any tax implications and operating within the parameters of any existing agreements are all crucial for a successful implementation.
Matthew Padian
Daniel Fournier