Chief Bankruptcy Judge Stephen Raslavich said the lenders had the right to bid their debt - a practice known as credit bidding - when the company is put up for auction. He called the company's arguments against that as "a not-so-thinly-veiled attempt to manipulate the sale process" to the advantage of the current management team.

In a statement, the company, which owns The Inquirer, the Philadelphia Daily News, and Philly.com, said it was "disappointed" and would review its options. The statement noted that "the right to credit bid doesn't necessarily mean" the lenders will be successful at auction.

"We know how terrible it will be for these papers, our employees, and our community if these out-of-town hedge funds take over," the statement said, referring to the collection of investment banks that hold much of the company's debt.

"We will continue fighting for our newspapers and for our employees."

The company's statement also made a pointed reference to Citizens Bank, the agent for the senior lenders, suggesting that the local bank could alter the outcome by choosing not to be a party to a credit bid.

Andrew C. Kassner, the attorney representing the bank, said Citizens would "continue to take actions we believe will be consistent with the best interests of the lenders and in the best interests of the survival and growth of the two papers."

Fred S. Hodara, a lead attorney for the steering committee that represents the senior lenders, the largest debt-holders and the lenders who are first in line to be reimbursed, dismissed the company's response as "grandstanding rhetoric that has been exposed for the nonsense it is."

He said the senior lenders - a group of investment banks that include Angelo, Gordon & Co. and CIT Group Inc. - would now prepare a credit bid for the company. In anticipation that they will win at auction, the lenders were interested in starting talks with the company's unions, he said.

Their intention, Hodara said, was "to have everything in place so the newspapers can come out of bankruptcy well-capitalized and as quickly as possible."

The auction is a central piece of Philadelphia Newspapers' reorganization plan, which would pay senior lenders $66.6 million in cash and property to settle the $300 million debt. The auction was designed in part to establish a fair-market value for the company.

No date has been set for the auction. If it occurs, the process will be overseen by former federal judge Arlin M. Adams and J. Scott Victor, a former bankruptcy lawyer and managing director of SSG Capital Advisors L.P.

The company had argued that the lenders should be barred from using their debt at auction. Rather, the company said, they should have to use cash. A cash-bid requirement would have effectively barred some of the senior lenders from participating, while raising the cost of bidding for others.

The company contended that the ability of the lenders to offer up to $300 million in credit bids would have a "chilling effect" on other potential bidders, resulting in fewer bids on the company and a lower sale price.

The lenders countered that they had a right to credit bid and intended to do so if allowed.

They argued that the company's motivation had nothing to do with ensuring the highest price. Rather, the lenders argued, the company was seeking to protect the interests of the current management, led by chief executive officer Brian P. Tierney, and a three-member local investor group seeking to buy the company. That group includes two of the company's original investors - Bruce Toll, vice chairman of Toll Bros. Inc., and the Carpenters Union Pension Fund - and philanthropist David Haas.

Under the company's plan, the Toll group stood to collect a $1 million breakup fee if outbid at auction. In his opinion, Raslavich rejected that provision.