Lawyers for the Daily News, Inquirer and squared off with their creditors' lawyers yesterday in a key court battle over whether the creditors can bid their IOU's in a bankruptcy auction of the company.

The newspapers' attorneys sought to persuade a three-judge panel from the Third Circuit Court of Appeals to uphold a lower-court ruling allowing the company to bar so-called credit-bidding in the auction.

Circuit Judge Thomas Ambro said that the 10-month-old bankruptcy case appears to be "a case of a lot of bad blood [where] some real hardball is being played."

The company's chief executive, Brian Tierney, and his investors have proposed a bankruptcy reorganization plan in which the senior lenders would get $66 million in cash and real estate.

They hold $318 million in debt secured by virtually all the assets of the company.

The company's attorney, Lawrence McMichael, argued that an auction would show whether Tierney's group is offering the best deal, as long as the creditors are required to put up cash like everyone else.

"There is nothing unfair about putting everyone on the same footing," McMichael told the judges.

The creditors' attorney, Abid Qureshi, argued that the bankruptcy code clearly permits lenders who were promised the company's assets as collateral to bid their IOU's in an auction.

"We have a constitutionally protected interest in our collateral," Qureshi said, "and we simply can't be required to put up more cash in order to protect the value of that collateral."

Most of the arguments centered on details of the bankruptcy law and its legal interpretations.

The three-judge panel is expected to rule in a few weeks.

Outside the courtroom, Tierney said that much of the debt held by the company's senior creditors had been bought and sold for a fraction of its original value.

The company's attorneys have filed motions in the bankruptcy case seeking to force the major creditors to reveal exactly how much of the debt each owns, when it was acquired and at what price.

Company chief financial officer Richard Thayer said yesterday that many senior creditors, rather than "being people who lost a lot of money, are people who've bought in recently at distressed prices and who are looking to make money."

Company lawyers also believe that more information about recent trading of the company's debt will show that their $66 million offer is close to the actual market value of the company.

The creditors' attorneys will oppose that motion in a filing soon, and the issue will be argued in bankruptcy court Monday.