Chrysler's Bankruptcy Sale Opinion - Part I: Proving "What Goes Around, Comes Around"
[6/9/09 Update: See Part II of my analysis of Judge Gonzalez's sale opinion here.]
Well it's official, and really no surprise: Judge Gonzalez in this opinion (WL) approved the sale of Chrysler's assets in the Fiat Transaction "free and clear of liens, claims, interests and encumbrances."
Part I of my quick take on the opinion focuses on the most discussed elements of the case that have caused so much unnecessary heartburn (some caused, I admit, by my own three previous posts). Here's my thoughts on a few of the key issues in the opinion that I touched upon in prior posts:
- Was it a sub rosa plan (as questioned here)? The Court said no. And I actually agree. It's hard to argue something circumvents the chapter 11 plan process when the debtor wouldn't have survived long enough to be able to propose a plan in the first place. Arguments that a sale is a sub rosa plan make sense when the debtor can survive to confirmation; they are irrelevant where the debtor can't.
- Was the absolute priority rule violated (as questioned here)? The Court danced around this issue pretty well, taking the position, well stated in this Credit Slips blog post, that "the allocation of ownership interests in the new enterprise is irrelevant to the estates' economic interests" and that "in addition, the UAW, VEBA, and the Treasury are not receiving distributions on account of their prepetition claims ... [but] under separately-negotiated agreements with New Chrysler ... [that are] not value which would otherwise inure to the benefit of the Debtors' estates."
Everyone cares about the retirees' medical claims under VEBA, but it's hard to see why this group should get any consideration from the New Chrysler since they will provide no value to the new enterprise. Moreover, it's quite common in bankruptcy cases (see In re UAL, discussed here) for the current employees to leave the retirees hanging out to dry precisely because they'll provide no value to the new enterprise and the existing employees want to retain whatever benefits they can eke out for themselves. To this limited extent, therefore, perhaps the flow of consideration does violate the absolute priority rule. The auto workers union is obviously a tighter and more cohesive group, however, and they refused to do what their comrades in the pilots union did to the retiree pilots, thus enabling the Court here to find that the "unprecedented modifications to the collective bargaining agreement, including a six-year no-strike clause" were sufficient to justify New Chrysler's assumption of obligations to all VEBA claimants, as demanded by the union.
- What are the rules of the game for "last-resort" lenders? One thing I said in my 10 minute interview with Anthony Mason that didn't make it on TV was that "what goes around, comes around" (as the apparently not so old saying goes) and that here, the secured lenders were getting a taste of their own medicine, so it was hard to feel too sorry for them. After all, in most bankruptcy cases, the existing secured lender is the lender of last resort, and it is the existing secured lender that takes the hard-line, "take it or leave it" position described by Judge Gonzalez that leaves everyone else gasping for air as it stuffs its demands down everyone's throat, including the court's. Such practices, Judge Gonzalez tells us, are "troubling to some, but such is the harsh reality of the marketplace." Further, as I was quoted in my 7 seconds of fame, "the [governments'] providing the money, and they're the ones who are ultimately going to decide how that money's going to be spent." And that's pretty much what Judge Gonzalez said, though far more articulately:
The absence of other entities coming forward to fund any transaction highlights the risk presented to distressed companies that are situated similarly to Chrysler. Accompanying that risk is the lender's ability to dictate many of the key terms upon which any funding will occur. The hard-fought "take it or leave it" approach that often drives the outcome of this type of negotiation is troubling to some, but such is the harsh reality of the marketplace. Here, the Governmental Entities, as lenders of last resort, are dictating the terms upon which they will fund the transaction, thereby leaving the Debtors with few options. Nevertheless, the usual marketplace dynamics play out and the Court applies the same bankruptcy law analysis. Moreover, the Debtors' CEO testified that the demands from the Governmental Entities were not greater than that presented by other lenders, and in some aspects were not as onerous....
[T]he ordinary marketplace dynamic played out with respect to the lenders and whatever ability they had to dictate terms. The fact that the lenders of last resort happened to be Governmental Entities did not alter that dynamic. The Governmental Entities did not preclude other entities from participating or negotiating, they merely set forth the terms that they required to provide financing and the parties were either amenable to them or not. Finally, as noted, the Governmental Entities had no obligation to fund the transaction and Chrysler and Fiat were free to walk away from the negotiations.
- Has the "Rule of Law" Been Withered (as questioned here)? Maybe, as I'll discuss later in Part II, but not for the reasons the Indiana Pension Funds are arguing on appeal. In fact, if anything, the following well-worn rules have been affirmed in this case:
1. You can't circumvent chapter 11's plan process when you can't even fund next week's payroll.
2. You can't violate the absolute priority rule if junior creditors necessary to the new enterprise get something out of the deal.
3. Lenders of last resort owe no duty to anyone but themselves and can dictate the terms of a plan or sale so long as the terms aren't unconscionable, which they aren't here.
More to follow, and thanks as always for reading!
© Steve Jakubowski 2009
The Judge's analysis is wrong, because the essential premise, that the government is just like any other lender providing DIP financing, is wrong. The government is qualitatively unique from other lenders of last resort. The distinctions being that the government has unlimitedly deep pockets, no other creditor can outbid the government and most importantly; and one can't say no to the government when they make you an offer. So, no, the usual marketplace dynamics don't play out and the Court should not apply the same bankruptcy law analysis. When the usual marketplace dynamics play out, Chapter 7 Liquidation lingers in the back of everyones' mind. The government made it clear that Chrysler would not be allowed to fail and that they would provide whatever funding the transaction required. Chapter 7 was never an option, though it should have been and should still be.The statement that "the Governmental Entities had no obligation to fund the transaction and Chrysler and Fiat were free to walk away from the negotiations." is mendacious, to say the least.
A couple of comments:
1. I'm a little confused by your last three points. It appeared to me that the Chrysler opinion, as you analyzed it, said that you CAN circumvent Chapter 11 through a 363(b) if the other choice is liquidation; you CAN violate absolute priority (aggregiously) if the junior creditors are necessary to the continuation of the business; but that Lenders of last resort CAN dictate (consistent with what you said, but I'm confused by the two negatives and one positive).
2. The idea that the secureds got their own medicine is a little off. There were numerous holders of the first lien debt who never participate in the DIP financing process. In addition, even the Non-TARP lenders were willing to accept a 60% payout. That would have been a fairer result, while still inflicting the pain implied by your "comes around/goes around" comment.
3. The idea that any last resort lender can dictate terms because they're the money SHOULD BE LIMITED to where they aren't using the court to shelter fraudulent conveyance. The premise that the $2 billion is fair, while not challenged by the Indiana Pensioners was highly questionable (as I discuss on my blog at http://blog.lawrencedloeb.com/2009/06/could-indiana-pensioners-have-prevailed.html). The money dictates in most deals, but that is usually limited by the alternatives to the deal. In my opinion, that wasn't the case in this transaction.
4. I think your analysis of the sub rosa issue is interesting.
Thanks for your analysis. I look forward to Part II (and III?).
Yea, agree with other commenters. it seems very clear that you do not grasp the logic, or the explicit rule of the law. Your assertions seem to rely upon the notion that the bankrupt company must be kept alive and a going concern. Since when are secured creditors under a duty of care to maintain jobs and keep a money-losing entity afloat?
The bare assertion you state fails to address this obvious flaw.
Should the Indiana pension funds have used a valuation argument instead? It seems that railroading assets toward a predetermined buyer is not achieving the maximum value for all parties.
So incompetent is Indiana's claim that one suspects it may be bogus - a sham claim designed to litigate the issues to ensure appellate defeat in order to dissuade other or later claims.
The questions posed by Indiana's claims ask essentially Will the Indiana Funds suffer a concrete and particularized injury stemming from either
1. The proposed sale transaction by which a substantial part of the assets of Old Chrysler are being sold for $2 billion and where those assets secure $6.9 billion in first lien loans including those owned by the Indiana funds.
2. The use by the government of TARP monies to provide funding to New Chrysler for the purchase in 1 above and where such use appears to stretch the Treasury mandate further than Congressional intent because Treasury in providing this funding is treating new Chrysler as a "financial Institution" as such term is defined by the EESA Act which may be an illegal interpretation.
3. Whether the sale constitutes an illegal 'sub Rosa' plan of reorganization since it was secretive and involved a lack of good faith or integrity by a highly politically motivated government during the course of the sale proceedings and negotiations and as such provided evidence, if not of outright fraud then at least of collusion between the purchaser and other bidders and the trustee as well as an attempt to take unfair advantage of the lien holders by rushing through such sale solely in order to preserve government interests rather than to maximize the extraction of the value of the collateral for the benefit of Indiana.
As for 1. the government argues that to the contrary, as a result of the GovernmentÃƒÆ’Ã‚Â¢ÃƒÂ¢Ã¢â‚¬Å¡Ã‚Â¬ÃƒÂ¢Ã¢â‚¬Å¾Ã‚Â¢s 'largesse', the Indiana funds will receive value "well in excess of the liquidation value of their collateral." Since the Indiana Funds are therefore suffering no injury in fact from the contemplated sale of Chrysler assets to New Chrysler, they are without standing to raise any challenge to the Sale Order on that basis.
The government uses the "going concern" valuation report by their distressed asset expert Robert Manzo of Capstone Advisory Group (formerly co-head of the largest restructuring practice in North America, FTI Consulting,) to justify that position and quotes Manzo as saying that in a forced liquidation the first lien holders would receive only between $654 million and $2.6 billion or between 9% and 38% of their claims.
As for 2 the government argues that Indiana lacks standing to make such a claim and anyway Treasury is correct in its interpretation that New Chrysler is indeed a 'financial institution' as defined by EESA.
As for 3 the government argues that negotiations were entirely at arms length, were fair and in good faith, there were no other bidders and further that Indiana lacks standing to make such claim. With reference to the resultant apparant inappropriate priority to VEBA and others which liabilities total over 26 billion are being assumed by New Chrysler, since such 'priority' through the assumption is entirely an indirect result and therefore a matter solely between the government and UAW and as such is unrelated to the proposed asset sale to New Chrysler and so without bearing on Indiana.
With regard to 1 a careful reading of the Manzo report (see http://www.scribd.com/doc/14955009/Report-of-Robert-Manzo ) makes clear that the government's position is untenable: Indiana is indeed correct and Old Chrysler is being offered significantly less than fair value for the collateral which backs the loans.
With regard to this, whilst Manzo states that absent such a sale then, as a going concern in a Chapter 7 liquidation, the first Lien holders would receive only between 9% and 38% of their claims, however that estimate assumes that the first lien holders would bear the 'going concern' costs of up to 6 months of liquidation costs including up to 6 months of employee expenses under collective bargaining agreements AND would have to satisfy Debtor in Possession (DIP) financing. The Government's own position is that the costs are $100 million a day, Manzo's (para 91) is that the liquidation costs would be $2 billion if manufacturing is ceased (spread over 3 years) or $2.3 billion a month if manufacturing continues (Para 97).
However the 'going concern' formula simply ignores the possibility of a simple purchase of cherry picked assets, including cash, by the creditors, in satisfaction of their lien as could be achieved itself immediately under 363 were the creditors themselves to offer to purchase the assets. In such a transfer it is conceivable that the first lien holders could indeed receive at least 50% of their claims instead of less than 30 cents on the dollar.
Indeed Manzo points to the assets having a value of between $2.3 and $3.8 billion without going concern costs deducted: however a close reading of these figures suggests Manzo outrageously reduces the values below reasonable figures: he is assuming for instance (Para 65) that the $5.6 billion in brand new Chrysler cars and trucks in inventory (at book cost) could be sold at less than 20% of their manufacture costs or only about 10% to 15% of their normal retail cost. This is patently absurd. A fire sale of Chrysler new cars could likely sell these in a matter of months at 50% of book cost or even higher.
This also ignores potential recovery on Chrysler's nearly $40 to $50 billion in assets (Para 78) of which available for such immediate transfer under 363 are, (at recent book cost):
$5.6 billion in new cars and trucks in inventory (Para 65)
$11.9 billion in plant, equipment and machinery (para 48)
$6.9 billion in equipment operating leases (vehicle leases to 3rd parties.) (para 74)
$8.7 billion in manufacturing assets including land and buildings ($1.9 billion) and equipment ($6.8 billion) (Para 69)
$1.4 billion in liquid assets.
Whilst Manzo (who was hardly impartial being indirectly employed by the Treasury's Auto Task Force albeit through Chrysler AND whose $10 million fee is contingent on the New Chrysler sale closing) states in his report that as a going concern "Chrysler would be a stronger operational and financial enterprise with the Fiat alliance". Manzo's assumption concerning that value of New Chrysler is based solely on new Chrysler as a going concern having significant new capital from the government which therefore creates a company with total assets of $28.5 billion at book value and a valuable alliance with Fiat.
This is entirely different to the issue of the value of the assets NOT on a going concern basis which is a more reliable comparison especially since once sold to New Chrysler then Old Chrysler will cease to be a going concern. The value of the assets being sold to new Chrysler valued NOT with the going concern costs deducted would be significantly higher than $2 billion and certainly in this respect Manzo does not contradict Indiana's claims that the value of the collateral securing the first lien holders' loans is worth much more than the $2 billion dollars they are being offered.
With regard to point 2, the legitimacy of the financing of the offer for the purchase by New Chrysler of the assets of Old Chrysler is clearly a valid matter for judicial consideration in the process and if a 'False Claims Act' filing or motion for injunction were to prevent TARP Funds being used to fund New Chrysler on the potentially valid grounds that New Chrysler is NOT a ÃƒÆ’Ã‚Â¢ÃƒÂ¢Ã¢â‚¬Å¡Ã‚Â¬Ãƒâ€¦Ã¢â‚¬Å“financial institutionÃƒÆ’Ã‚Â¢ÃƒÂ¢Ã¢â‚¬Å¡Ã‚Â¬ÃƒÂ¯Ã‚Â¿Ã‚Â½ within the meaning and Congressional intent of the EESA statute, then the New Chrysler concept would be threatened. This does indeed injure Indiana since it calls into question the legality AND ability of the offer by New Chrysler to purchase the assets of Old Chrysler and is therefore clearly a legitimate issue for the court. Indiana could indeed prevail on this issue under judicial estoppel since both the government and Chrysler imposed terms on potential bidders requiring them to demonstrate, concurrent with their bids, the integrity of their financing.
With regard to point 3, this clearly appears to be a jury matter: press reports such as those by the New York Times at http://www.nytimes.com/2009/03/30/business/30auto.html "U.S. Lays Down Terms for Auto Bailout" clearly demonstrate a massive conflict of interest between The Presidential Task Force (politically motivated by the threat of a cascading bankruptcy and consequent additional 500,000 unemployment), Treasury and Social Security (financially motivated by up to $55 billion in claims or lost tax revenue which a Chapter 7 would create), UAW (one of Obama's biggest backers) - anxious to maintain its jugular grip on the US auto industry and so on. Indeed it seems likely to me that the bankruptcy court judge himself was deeply involved in the government's shenanigans given the obvious extent of the preparatory work by the court prior to filing and therefore should therefore have properly recused himself on this issue. The fact that New Chrysler is assuming, without any obligation whatsoever to do so, $26 billion in Old Chrysler liabilities (Para 49 of Manzo) is alone enough to provide evidence for this. In fact it calls into question whether there is in fact a 363 sale at all when all that is happening is that the first lien holders are simply being surgically removed from the Enterprise. The entire matter appears ripe for a False Claims Act filing.
However in the absence of another bid it appears Indiana's best chance of achieving fair value would be to offer to purchase 'cherry picked' assets for $3 billion through a 363 and achieve nearly 50% satisfaction on its loans whilst retaining 100% of New Chrysler. It could easily sell the $5.6 billion of the new cars and trucks in inventory over the next year for at least $1 billion, it could easily sell Jeep as a line for $250 million to the Chinese, it could easily sell the Canadian operations to EDC for $500 million and it could easily sell the remainder of Chrysler, now entirely debt free for $1.25 billion to Fiat.
From Judge Gonzalez' order:
"Here, the Debtors have established a good business reason for the sale of their assets at the early stages of these cases. Notwithstanding the highly publicized and extensive efforts that have been expended in the last two years to seek various alliances for Chrysler, the Fiat Transaction is the only option that is currently viable. The only other alternative is the immediate liquidation of the company. Further, the whole enterprise may be worth more than the sum of its parts because of the synergy between Chrysler, which provides its network of dealerships, its productions of larger cars, and Fiat, which provides the smaller car technology, and the access to certain international markets."
OK for starters, it's bass ackwards. If a sale to Fiat is "currently the only option available", that's a reason to delay the sale, not rush it. Polaroid's creditors just got a quick sale thrown out because there was no bidding process. Maybe Chrysler shopped itself to every carmaker in the world, but the Judge doesn't say so. Only a vague "In that regard, no bidder other than Fiat came forward."
"Network of dealerships" is weak. The old dealership model is dead. Most Mercedes buyers already or will soon order direct from the factory. Access to international markets for big Chryslers? Didn't do much for Daimler. The Chinese already have their Hummers (unless their regulators nix it, which is likely).
"Moreover, the Debtors were forced to cease operations in order to conserve resources.
That action, however, was done with a view towards ensuring that the facilities were prepared to
resume normal production quickly after any sale, and that consumers were not impacted. Any
material delay would result in substantial costs in several areas, including the amounts required
to restart the operations, loss of skilled workers, loss of suppliers and dealers who could be forced to go out of business in the interim, and the erosion of consumer confidence. In addition,
delay may vitiate several vital agreements negotiated amongst the Debtors and various constituents. Thus, approval of the Debtors proposed sale of assets is necessary to preserves some portion of the going concern value of the Chrysler business and to maximize the value of the Debtor estates."
"loss of suppliers and dealers who could be
forced to go out of business in the interim,"
Might be a good thing. Let them reorganize and make better deals with New Supplier and New Dealer.
There are no numbers given for the extra costs from delay so there's no way to evaluate the Judge's arguments. A quick sale to get production running again doesn't give me confidence as a consumer. I'm buying a $20,000+ item which can kill. Take your time, get it right.
The special considerations for quick sales come from rotting fish on the docks cases.
Quick sales of big car companies pushed by the government smell fishy.
"Here, the Governmental Entities, as lenders of last resort, are dictating the terms upon which they will fund the transaction, thereby leaving the Debtors with few options. Nevertheless, the usual marketplace dynamics play out and the Court applies the same bankruptcy law analysis. Moreover, the Debtors' CEO testified that the demands from the Governmental Entities were not greater than that presented by other lenders, and in some aspects were not as onerous.... "
Yeah that's the problem Judge, they're playing with TARP taxpayer money. Courts should take extra care to make sure bidding processes are respected and not rushed, given the potential corruption.
1. If I can buy a dollar for 47 cents and I don't foresee a risk to that dollar I am quite naive. If Indiana thought the claims were so secured, why the deep discount?
2. I disagree with first comment by jardiner01 completely. The government does not have bottomless pockets, it doesn't even have the money to do this. What it has is the power of being the law and therefore rendering sub rosa moot. Implicit eminent domain.
The rule of law is the rule of the bankruptcy code which explicitly allows for a 363 sale which alters in effect the absolute priority rule, depending on how the Judge after reviewing the facts, can answer the question: Would liquidation be better for the creditors as a whole (or for the secured or any particular lender, if you like) than the 363 Sale?
You can disagree with some of the facts or the conclusions drawn from those facts, but you cannot argue that the rule of law dictates a result in favor of the secured claimants.
Although I agree that this one pushes the envelope, should anyone be surprised that a judge who is a level above an ALJ would rule in favor of a sale advocated by the President of the United States, financed by the United States itself, and perceived by most Americans as good for the United States? It is, to borrow from Obama, above his pay grade. Let the Supremes figure it out. And don't be the least bit surprised if they let it happen while drawing distinctions that make it virtually non-precedential.
Regarding Chrysler, I offer a few comments. First, in Chapter 11, context is everything. Notice that just yesterday, a Delphi sale did not go through. Why? Because it was different in scale than Chrysler. Context is everything -- Chrysler had to be approved; Delphi did not. It all is a Utilitarian scheme; at some point, the injury to a few is outweighed by the perceived greater benefit. Even the "Absolute" priority rule is not so absolute. Just as in the old riddle, when is a door not a door -- when it is ajar, a plan does not violate the absolute priority rule and the rule does not apply, when a subrosa plan is executed through a 363 sale and without a 9019 motion (where some courts consider the APR).
One evidentiary issue I did not see answered in my review of the Chrysler 363 motion is whether the 2nd tier secured lenders were "in the money." Under 506, was there value to their collateral? Again, context is everything. I suspect that in the context of the alternatives to the Fiat sale, the first position lenders were undersecured, particularly when junior to the government priming loans. As a result, compared to the alternatives on the table or brought to the table, the 2nd tier lenders would receive nothing.
Another context question that is not directly relevant, but I find indirectly relevant is this: when did the bond holders come into the game? My suspicion, not backed up by any facts, is that all but the unions have come to the Chrsyler table relatively recently. I suspect that outside the unions, the vast majority of stakeholders, including those who now are disgruntled, came to the table as volunteers, relatively recently, certainly at a time when Chrysler was known to be at risk.