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Chapter 11 is becoming an increasingly flexible, market-driven forum for determining who will become the owners of financially troubled enterprises. With increasing frequency, distressed companies are sold in Chapter 11 as going concerns. At the same time, distressed investors, including hedge funds and private equity investors, are actively trading the debt of such companies in much the same way that equity investors trade the stock of solvent companies. Market forces drive the troubled company's debt obligations into the hands of those investors who value the enterprise most highly and who want to decide whether to reorganize or to sell it. One way or the other, the Chapter 11 process is used to effect an orderly transfer of control of the enterprise into new hands, whether the creditors themselves or a third party. But if the market-oriented elements of this new reorganization process promise to increase creditor recoveries and preserve the values of corporate assets, other recent developments could present obstacles to achieving these goals. In particular, the increased complexity of corporate capital structures and investment patterns—including the issuance of second-lien debt and the dispersion of investment risks among numerous parties through the use of derivatives and other instruments—threatens to increase inter-creditor conflicts and reduce transparency in the restructuring process. These factors, coupled with provisions added to the Bankruptcy Code that selectively permit “opt-out” behavior by favored constituencies, could interfere with the ability of troubled companies to reorganize as the next cycle of defaults unfolds.

Outside of bankruptcy, the right of a secured creditor to “credit bid” allows the secured creditor to compete with cash bids in foreclosure to assure that the secured creditor’s collateral is not sold for less than the secured creditor thinks it is worth. In reorganization cases under chapter 11 of the Bankruptcy Code, credit bidding performs a similar function: it insulates the secured creditor from being cashed out at a time of depressed asset values and protects the secured creditor from the risk of suffering a “bankruptcy discount,” which some assert can occur in connection with chapter 11 sales.In RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (May 29, 2012), the Supreme Court resolved an important circuit split concerning the right of secured creditors to credit bid in cases under chapter 11 of the Bankruptcy Code – disagreeing with decisions reached by the Third and Fifth Circuits and holding that under section 1129(b)(2)(A) of the Bankruptcy Code, secured creditors may not be denied the right to credit bid at a sale of their collateral pursuant to a chapter 11 plan of reorganization.This article first explores secured creditors’ rights to credit bid at both sales of real and personal property under state law, as well as pre-Bankruptcy Code law supporting the right in bankruptcy of a secured creditor to credit bid. Next, it reviews the case law addressing the right to credit bid in cases under the Bankruptcy Code, including the rarely disturbed right to credit bid at pre-plan sales conducted pursuant to section 363 of the Bankruptcy Code and the interplay between sections 1111(b) and 1129(b)(2)(A) of the Bankruptcy Code in connection with credit bidding in sales of collateral under a plan. Finally, the conflicting opinions of the Third, Fifth and Seventh Circuits and the Supreme Court’s RadLAX decision are considered, together with a key issue never reached by the Supreme Court – the proper interpretation of the “indubitable equivalence” standard under section 1129(b)(2)(A)(iii).

In a Chapter 11 reorganization, senior creditors are entitled to insist upon being paid in full before anyone junior to them receives anything. In practice, however, departures from such “absolute priority” are commonplace. Explaining these deviations has been a central preoccupation of reorganization scholars for decades. By the standard law-andeconomics account, deviations from absolute priority arise because well-positioned insiders take advantage of cumbersome procedures and inept judges. In this paper, we suggest that a far simpler and more benign force dominates bargaining in reorganization cases. “Deviations” from absolute priority are inevitable even in a world completely committed to respecting priority as long as asset values are uncertain. Uncertainty accompanies any valuation procedure. Bargaining in corporate reorganizations takes place in the shadow of this uncertainty, and standard models of litigation and settlement show that valuation uncertainty alone can explain many of the departures from absolute priority we see in large corporate reorganizations. Even where rational and well-informed senior investors expect the absolute priority rule to be strictly enforced, they must account for the uncertainty associated with any valuation. The possibility of an unexpectedly high appraisal will cause them to offer apparently out-of-the-money junior investors contingent interests in the reorganized business. The debate over absolute priority, the central principle of modern corporate reorganization law, has been misdirected for decades. It has failed to recognize that a substantive rule of absolute priority does not lead to an absolute priority outcome. A coherent account of absolute priority must incorporate relative priority. It must take account of the option value implicit in the junior investors’ right to insist on an appraisal. This paper offers an explanation for one of the most important and persistent puzzles in corporate reorganizations. In a Chapter 11 reorganization, senior creditors are, in principle, entitled to insist upon “absolute priority.” They have a right to be paid in full before junior investors receive anything. This “fixed principle” has been the foundation of our corporate reorganization laws for decades. In practice, however, departures from ab