Chrysler Files Bankruptcy - Part II: Testing The Limits Of Section 363 Sales
"Be careful what you wish for," the old saying goes, and so too for those who wished for Chrysler to file for bankruptcy in order to achieve their objectives. Chrysler and all its major constituents will argue that the house is on fire and absent a quick sale on the agreed-upon terms (well summarized in this Treasury release), asset values (whatever's left of them) will be irrevocably destroyed. The dissident lenders will argue that the fire is an ingenious illusion meant to force them to accept a deal that denies them their first priority rights to Chrysler's assets and is merely a disguised plan of reorganization that a Court has no authority to approve in the 363 sale context.
So what's the risk for the proponents of the sale? As Chrysler's own counsel at Jones Day wrote in this 2002 publication:
[U]nder certain circumstances a debtor may sell all or substantially all of its assets without making the sale part of a plan of reorganization. Where a chapter 11 debtor proposes to sell its assets or business "outside of a plan of reorganization," creditors are entitled to notice of the sale and an opportunity to voice any objections they may have with the court. However, the sale will not be subject to the same creditor disclosure and voting rights attendant to a sale as part of a plan of reorganization. Moreover, the proposed sale will be subject to the less exacting "business judgment" standard of review. For this reason, some courts refuse to approve a proposed sale outside of a plan of reorganization if it appears that the transaction is really a "sub rosa" or "de facto" plan because the terms of the sale will necessarily dictate the provisions of any future plan.
You don't have to be a bankruptcy maven to see from the face of the term sheet that the proposed sale dictates the provisions of a future plan of reorganization and sure has the feel of a "sub rosa" or "de facto" plan under which:
- Lenders with a first priority interest in Chrysler's assets will receive $2 billion, nothing more.
- The junior VEBA claimants will receive a $4.6 billion note payable over 13 years at a 9% rate of interest and additionally will receive 55% of the equity of New Chrysler.
- Unsecured trade payables of about $1.5 billion get paid in full.
- The US Treasury will receive 8% of the equity of New Chrysler as repayment of its $4 billion junior TARP loan while the Canadian government gets a 2% stake for its junior loans.
What's the governing law? Well, since the case was filed in New York, the law of the Second Circuit Court of Appeals applies. The latest pronouncement from the Second Circuit on whether 363 sales are disguised "sub rosa" plans came in Motorola, Inc. v. Official Comm. of Unsecured Creditors, 478 F.3d 452 (2007), where the Court wrote:
The trustee is prohibited from such use, sale or lease if it would amount to a "sub rosa" plan of reorganization. The reason "sub rosa" plans are prohibited is based on a fear that a debtor-in-possession will enter into transactions that will, in effect, “short circuit the requirements of [C]hapter 11 for confirmation of a reorganization plan.” Pension Benefit Guar. Corp. v. Braniff Airways, Inc. (In re Braniff Airways, Inc.), 700 F.2d 935, 940 (5th Cir. 1983). In this Circuit, the sale of an asset of the estate under § 363(b) is permissible if the “judge determining [the] § 363(b) application expressly find[s] from the evidence presented before [him or her] at the hearing [that there is] a good business reason to grant such an application.” Comm. of Equity Sec. Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063, 1071 (2d Cir. 1983).
The Court noted in a footnote a "number of factors that a judge might consider when determining whether there is a 'business justification' for the asset's sale." These factors include, but are not limited to, the following:
- the proportionate value of the asset to the estate as a whole;
- the amount of elapsed time since the filing, the likelihood that a plan of reorganization will be proposed and confirmed in the near future;
- the effect of the proposed disposition on future plans of reorganization;
- the proceeds to be obtained from the disposition vis-a-vis any appraisals of the property; and
- "most importantly perhaps," whether the asset is increasing or decreasing in value.
The best recent case I've seen analyzing whether a 363 sale is a disguised "sub rosa" plan is an unreported decision from Houston's fiery Judge Wesley W. Steen in In re Gulf Coast Oil Corp., 2009 WL 361741 (Bankr. S.D. Tex. 2/11/09) (pdf). Judge Steen methodically reviews case law, articles, treatises, and even this story from the WSJ Bankruptcy Beat Blog, in drawing the following conclusion:
"It would be very helpful if the Fifth Circuit were to take another look at the boundaries of § 363(b) sales to provide more guidance to the bankruptcy courts in the circuit. Under the existing jurisprudence;
- The debtor in possession or trustee in a chapter 11 case must consider its fiduciary duties to all creditors and interest holders before seeking approval of a transaction under § 363(b).
- The movant must establish a business justification for the transaction and the bankruptcy court must conclude, from the evidence, that the movant satisfied its fiduciary obligations and established a valid business justification.
- A sale, use, or lease of property under § 363(b) is not per se prohibited even though it purports to sell all, or virtually all, of the property of the estate, but such sales (or proposed sales of the crown jewel assets of the estate) are subject to special scrutiny.
- Parties that oppose § 363(b) transactions on the basis that they constitute a sub rosa chapter 11 plan must articulate the specific rights that they contend are denied by the transaction.
- Although the bankruptcy court need not turn every § 363(b) hearing into a mini-confirmation hearing, the bankruptcy court must not authorize a § 363(b) transaction if the transaction would effectively evade the “carefully crafted scheme” of the chapter 11 plan confirmation process, such as by denying §§ 1125, 1126, 1129(a)(7), and 1129(b)(2) rights.
- If the bankruptcy court concludes that such rights are denied, then the bankruptcy court can only approve the transaction if it fashions an appropriate protective measure modeled on those which would attend a reorganization plan.
- Transactions that explicitly release all (or virtually all) claims against the estate, predetermine the structure of a plan of reorganization, and explicitly obligate parties to vote for or against a plan are not authorized under § 363(b)."
Judge Steen's analysis provides a wonderful guide on how to analyze the strength of Chrysler's position. In concluding that the debtor in that case did not meet its burden of establishing that the assets of the debtor should be sold outside of the context of a reorganization plan, he asks:
- Is there evidence of a need for speed?
- What is the business justification?
- Is the case sufficiently mature to assure due process?
- Is the proposed APA sufficiently straightforward to facilitate competitive bids or is the purchaser the only potential interested party?
- Have the assets been aggressively marketed in an active market?
- Are the fiduciaries that control the debtor truly disinterested?
- Does the proposed sale include all of a debtor's assets and does it include the "crown jewel" (noting that "the likelihood of approval of the § 363 sale is inversely proportional to the percentage of the value of the debtor's assets that are to be sold")?
- What extraordinary protections does the purchaser want?
- How burdensome would it be to propose the sale as part of confirmation of a chapter 11 plan?
- Who will benefit from the sale?
- Are special adequate protection measures necessary and possible?
- Was the hearing a true adversary presentation? Is the integrity of the bankruptcy process protected?
- What other factors apply to the case at hand that tip the balance or that overweigh the evaluative factors set forth above?
Looking at the pleadings filed thus far in the Chrysler case, Chrysler's CFO lays out the business justifications for the sale at pages 38-41 of this affidavit in support of the first day pleadings. In the end, however, the matter will be determined by the opinion testimony elicited from the parties' opposing experts (with Houlihan Lokey's Eric Siegert representing the dissenting lenders and Capstone Advisory Group's Robert Manzo, who prepared this 166 page first day affidavit / expert report, representing Chrysler). Notably, Manzo concludes in his affidavit (pp. 26-27) that:
Based on the Liquidation Analysis, the First Lien holders are expected to recover between 9% and 38% of their claims, on a net present value basis, [which] translates into a range of between $654 million and $2.6 billion. It is my professional opinion that given the market developments subsequent to this analysis, coupled with the limited success of other OEM effort to move individual car lines, the First Lien holders would likely recover at the low end of this range as part of any liquidation of the Company. The U.S. Treasury is only expected to recover between 3% and 6% of its claims.
In effect, Chrysler is arguing that the Court should not be concerned that other junior creditors are receiving value while senior lenders are not paid in full because absent such payment to the other constituent groups, Chrysler would be forced to liquidate and the senior lenders would do worse than they will under the proposed alliance with Fiat. An additional supporting affidavit on the need to consummate the transaction with Fiat and the marketing efforts undertaken to sell Chysler was submitted by Tommy LaSorda (no relation to this guy), Vice Chairman and President of the Board of Managers for Chrysler.
Finally, never forget that in litigation, nothing is guaranteed. Indeed, much depends on the judge drawn. The judge overseeing this case is Judge Arthur Gonzalez, who proved here in the Enron case that he will adhere to what he believes the law requires, even if the financial markets turn upside down because of it.
So, who will win? Really, only the true speculator and/or holder of Chrysler credit default swaps will (and perhaps Fiat if they--unlike their predecessors--can make it work), as my first post on the financial carnage at Chrysler demonstrates. My guess is that after much briefing, discovery, and expedited litigation over the next 60 days, Judge Gonzalez will show enough angst to worry both sides that they stand to lose, thus resulting in a compromise that settles the matter and allows the transaction to go forward. But with all Chrysler plants and operations now idled pending a final sale, the pressure to get the deal consummated and return people to work will be so overwhelming that it's hard to imagine Judge Gonzalez not approving the transaction in some form that's acceptable to everyone (except perhaps the dissenting lenders).
© Steve Jakubowski 2009
5/1/09 Update: Special thanks to the following sites, some new, some favorites, who linked to this post:
Calculated Risk, Volokh Conspiracy, The Wall Street Journal, Truth About Cars, Daily Bankruptcy News (the best daily collection of links to bankruptcy-related stories around), ABI Blog Exchange, Simoleon Sense, i-Stock Analyst, Fear and Greed, Underbelly.
These are great posts...keep them coming. Where can I find online access to the filings in this bankruptcy?
Ed Note: Type in EPIQ and CHRYSLER into your search engine and that should take you to the noticing agent's web page set up for Chrysler. Here's the website that leads to the same page: www.chryslerrestructuring.com.
I enjoyed your comments and I appreciate your analysis. I particularly appreciate the link to the case in South Texas.
I have posted the DIP Term Sheet on my blog (http://www.lawrencedloeb.com/blog_documents/Chrysler_DIP_Term_Sheet.pdf); and I found an update of Corrine Ball's article (http://law.lexisnexis.com/webcenters/link.aspx?b=YIr938UyAoM=).
I would be interested in your impression of my thoughts on Chrysler (http://blog.lawrencedloeb.com/2009/05/are-hedge-funds-morally-bankrupt.html).
Thank you for your work on all this. I will be putting your blog on my recommended list.
By the way, I tried to use html for the links, but lexBlog wouldn't allow it.
By the way, you might find this blog interesting as well: http://www.distressed-debt-investing.com/.
I think that common sense tells one that this is a sub rosa re-organization plan and not a true sale. To me the most telling point is that there is no “third party” bidder. The proposed purchaser is a new Chrysler company – that is clearly a re-organization. I suppose that the government can hang their hat on the idea that Fiat is a new party to the “transaction”. In contrast, if Fiat was providing the 2 Billion Dollars then a better case could be made for the transaction as a sale. In a similar way, what consideration has the UAW provided to the NEW Chrysler to received 55 percent ownership? It seems clear that this consideration is for the OLD Chrysler VEBA debt.
My quick reading was that the 2 Billion Dollars provided by the government in the sale process is to go to the OLD Chrysler estate – NOT directly to the Secured Creditors. The bankruptcy expenses and other Administrative Claims would be reduce the final payout to the Secured Creditors. How do you read this?
Question: Was it proper for the President and members of congress to take such anti-creditor public position on the Chapter 11 filing.?
I was personally amazed that the President would attack and vilify citizens for asserting their legal rights and refusing to be bullied by the government into a "settlement." Whether the bondholders made the right decision financially is hard to say. But, they are certainly not obligated to "sacrifice" for the benefit of any other constituency. They are entitled to the benefit of their bargain, whatever it may be. I don't know if you have been watching the "Tudors" series on Showtime, but Obama's attitude with resepct to those creditors is starting to remind me of Henry the VIII going after the leaders of the Pilgrimage of Grace.
Ronmacr asked: "Question: Was it proper for the President and members of congress to take such anti-creditor public position on the Chapter 11 filing.?"
My reply: I am not a lawyer, but I believe the federal government should not demonize the creditors.
The government knew the offer of 33 cents on the dollar to secured creditors would appear much lower than they should expect in bankruptcy. Fund managers would be forced to violate their fiduciary duties to their investors to settle for that.
The correct approach for the Federal government would have been to use eminent domain to take all the Chrysler bonds for the public good. The price to be paid for those bonds would be decided by standard court procedure.
I suspect there are many reasons why the Federal Government has decided not to use eminent domain to seize the bonds and keep Chrysler out of bankruptcy court. I am afraid none of them are good.
Great post. Quick question: Is the $2B payment that existing 1st lien creditors will be receiving under the 363 funded by the UST DIP. Where is that $2B coming from if not the Treasury? I don't see the $2B in the DIP budget thought (Manzo document). Thanks for any thoughts.
Thanks for your excellent and erudite analysis of this case of great national importance.
I offer a different approach to the issue. Fiat and UAW, financed by the federal government, are offering $2 billion cash for most of the assets of Chrysler. Anyone else is free to bid. VEBA and trade debt are making deals with NewCo, but that is largely irrelevant, because they are being paid by NewCo not by the Debtor. If NewCo wants to give stock to VEBA and to pay trade debt to ensure peace going forward, that is NewCo's right because it is NewCo's money.
Not sure if $2 billion is a fair price for the assets from a first lien holder perspective. According to the Manzo affidavit, Chrysler has 1.3 billion in cash and domestic inventory of $5.6 billion. That, along with property, plant and equipment, seems worth more than 2 billion. If the first lien holder foreclosed, claims of the trade, UAW and government for TARP loans would be wiped out.
Thoughts on this comment? http://online.wsj.com/article/SB124113528027275219.html
Help me here-Assume the sub rosa plan problem is resolved but that one of the dissenting secured creditors objects to the sale-and is not being paid in full (obviously or it would not object).
f) The trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate, only if--
(1) applicable nonbankruptcy law permits sale of such property free and clear of such interest;
(2) such entity consents;
(3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property;
(4) such interest is in bona fide dispute; or
(5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.
#1 and #2 don't apply (obviously) and there appears to be no dispute regarding the claim eliminating #4. I know of no way (under Missouri law at least) to force a secured creditor to take less than it is owed (and under the bankrutpcy code the creditor could credit bid.) so #5 would not seem to apply leaving only #3
---but hasn't this section been interpreted to mean the amount of the claim NOT the value of the lien?
Thus if a single secured creditor objects how does this sale get done or does this statue only apply in small cases?
Norm raises a good issue. A 2008 BAP decision from the 9th Cir, known as Clear Channel, says a sale that does not pay liens in full cannot go forward absent lien holders consent.
Summaries are here:
However, there is case law to the contrary saying that lien value should be determined under 506(a) as the economic value and not the face value.
Other courts say the cram down provisions of the Code satisfies #5.
[Ed Note: I have also have a long post under "Litigation Lore" on Judge Markell's decision in the PW/Clearchannel case that's worth looking at in this context. Thanks to you and Norm for input.]
Excellent posts. Thanks very much for your insight.
If the dissident creditors prevail in court, the government can simply strip their winnings away from them with a 100% excise tax, which Congress may gladly pass. However, another poster made a good point. Why didn't the government simply use eminent domain to buy out existing bondholders at the current (tiny) value of their bonds? Might the problem be credit default swaps that the government, through its subsidiary AIG, would be obligated to pay? The need for Congressional approval of eminent domain? Maybe they just didn't think of it?
Maybe they will learn and do GM differently, through eminent domain.
Now if we can cancel contracts with UAW, we can get somewhere. Otherwise a fake bankruptcy. Also, I would like to declare BK and get rid off all my debts and keep my money. Where do I go?
Fake bankruptcies, fake car companies, fake banks, all make me ill. REAL bankruptcies start soon, minus 100's billions of taxpayers money.---STUPID STUPID STUPID