CORRECTED - Philly publisher, lenders battle over "credit bid"

(Corrects spelling of Larry Adelman in paragraph four)

By Tom Hals

WILMINGTON, Del. Dec 14 (Reuters) - The publisher of the Philadelphia Inquirer newspaper goes to a federal appeals court on Tuesday to argue for a bankruptcy reorganization that could favor management and shareholders over banks and set a precedent for other cases.

The controversy centers on the publisher's proposed sale of the company's operating businesses and the requirement that all bidders use cash, rather than the value of their secured debt, which is known as a credit bid.

The company argues that cash-only bidding levels the playing field, but it also changes an essential element of bankruptcy sales such as the one used by Chrysler.

"Excluding credit bidding is new and it's a major issue," said Larry Adelman, of AEG Partners in Chicago. "There's been an assumption that you can credit bid up to the amount of the debt and it's been going on for a long, long time."

The case could provide a precedent used by other companies to thwart secured creditors from bidding in bankruptcy sales, said Stephen Lubben, a professor of law at Seton Hall Law School in Newark, New Jersey.

"If the company's shareholders want to retain control, this might be important," he added.

The Loan Syndications and Trading Association and Commercial Finance Association said in court papers that denying credit bidding could deepen the credit crunch.

It could "dramatically increase the cost, and reduce the availability, of secured credit in general, at a time in our economic history when the United States can least afford it," the group said in the court papers.

A credit bid essentially allows the creditor to seize the collateral being sold if a sale does not fetch a price above the value of the debt. Banks have long used credit bids in mortgage foreclosures to take homes rather than accept prices produced by a sheriff's sale.

Philadelphia Newspapers planned sale differs from most bankruptcy auctions because it is part of the company's reorganization plan, rather than an incremental event during its stay in Chapter 11.

The publisher proposed a plan in August to bring the company out of bankruptcy through a sale to a group that included two insiders, a local union and a local real estate developer, Bruce Toll, which added to the outcry over the plan.

The plan would wipe out $300 million in secured debt in return for $36 million in cash and real estate the company has valued at $30 million.

The bidding proposal was rejected by the U.S. Bankruptcy Court for the District of Eastern Pennsylvania, a decision that was overruled on an appeal to the District Court. Secured lenders appealed to the Court of Appeals for the Third Circuit, which will hear the case on Tuesday.

"The auction procedures seem to be designed in a manner to potentially eliminate banks as future owners of business," said Adam Harris, an attorney with Schulte Roth & Zabel in New York. "The question is, why is that?"

Harris points out that, in the majority of bankruptcy cases, the company does not care who ends up with the assets.

"There's some kind of soap opera going on here," he said.

The publisher tumbled into Chapter 11 in the wake of already soured relations with its banks.

At prebankruptcy meetings with its secured lenders, an audio recording was made without permission of those attending, which was the center of an early dispute in the case.

The company also ran "Keep it Local" ads in its papers, urging readers to support the bid by insiders for the company against "out-of-town corporate ownership" by hedge funds and banks that they warned might cut news coverage.

Specialists said that denying credit bids did not prevent holders of secured debt from bidding cash, which essentially would come back to them as creditors along with the newspapers. But it would impose added fees and other expenses and was complicated by the fact the secured loans were held by a group of investors, not one bank as in the case of residential foreclosure.

The precedent also only applies to companies that are worth less than the secured debt.

The case is In re Philadelphia Newspapers LLC, U.S. Bankruptcy Court, Eastern District of Pennsylvania, No. 09-11204.

The Appeals Court case is The Steering Group of Prepetition Lenders and Citizens Bank of Pennsylvania, as agent for the prepetition lenders v Philadelphia Newspapers LLC et al.; U.S. Court of Appeals for Third Circuit, No. 09-4266 (Reporting by Tom Hals; editing by Andre Grenon)