The decision overturns a bankruptcy court ruling that seemed likely to give The Philadelphia Inquirer and Philadelphia Daily News to creditors by year's end.
The newspapers had appealed in an effort to keep the company in local hands. They also argued that few others would consider bidding if creditors were holding $300 million in "house money" or "IOU's" with which to bid.
U.S. District Judge Eduardo Robreno agreed the newspapers do not have to allow credit bidding.
"This will encourage bidding," said lawyer Larry McMichael, who represents Philadelphia Newspapers and said a number of potential buyers have expressed interest. "How many of them will bid, I don't know."
The bankruptcy auction is scheduled for Nov. 18, with bids due two days earlier. However, McMichael expects creditors to seek a stay of the proceedings while they appeal the credit-bid issue.
The senior lenders include the Royal Bank of Scotland Group PLC and the CIT Group Inc., which itself filed for bankruptcy this month. Their lawyers did not immediately return phone messages Tuesday.
A group of local investors led by public relations executive Brian Tierney and luxury-home builder Bruce Toll bought Philadelphia Newspapers in 2006 for $515 million, most of it borrowed. Tierney took over as chief executive officer and pledged to reinvigorate the broadsheet Inquirer and tabloid Daily News.
But within months, amid a sharp industrywide downturn in advertising and circulation revenue, he instead announced the first in a series of layoffs.
The company filed for bankruptcy in February, citing $400 million in total debt to secured and unsecured creditors.
Philadelphia Newspapers then proposed the auction as part of its Chapter 11 reorganization plan. The plan includes an opening bid of $37 million cash posted by Toll, a union pension fund and Rohm & Haas heir David Haas, the only new investor.
Under the plan, secured creditors would get the auction proceeds plus the newspaper building, valued at $30 million, to settle $300 million in debt. If the opening bid prevails, they would recoup about 22 cents on the dollar.
They believe the company is worth more than that $67 million package, although far less than the $300 million owed them.
Unsecured creditors, owed another $100 million, are expected to recover almost nothing.
Chief U.S. Bankruptcy Judge Stephen Raslavich must still approve the auction results at a confirmation hearing now set for Dec. 4. Raslavich ruled last month that creditors had the right to credit bid, in the ruling that Robereno overturned.
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