Zywicki on the Chrysler Bankruptcy: Whither the Rule of Law?
Todd Zywicki, the University Foundation Professor of Law at George Mason University's School of Law, has been a friend to me and this blog since very early in my blogging career back in 2005 when his first of many links to one of my posts on the Volokh Conspiracy blog multiplied my puny site visits by ten-fold. His justification? Polish bankruptcy lawyers always stand together!
Todd takes some pretty unorthodox views now and then, exhibiting what Professor Lawless called "cognitive dissonance" in testimony before Congress when he extolled the newly-enacted BAPCPA bill as "perfect" and "well-calibrated." You did have to wonder though whether Todd was arguing simply because he really likes to argue!
While his backing of BAPCPA may not have been one of his shining moments, his passionate op-ed piece in yesterday's Wall Street Journal entitled Chrysler and the Rule of Law is. In it, he articulates what has disturbed a lot of people in the business and financial community about the heavy-handed manner in which the Chrysler sale was jammed down the senior lenders by the Obama administration (as this phenomenal piece of journalism by the WSJ's Jeff McCracken and Neil King proves). Todd wrote:
The Obama administration's behavior in the Chrysler bankruptcy is a profound challenge to the rule of law. Secured creditors -- entitled to first priority payment under the "absolute priority rule" -- have been browbeaten by an American president into accepting only 30 cents on the dollar of their claims. Meanwhile, the United Auto Workers union, holding junior creditor claims, will get about 50 cents on the dollar.
The absolute priority rule is a linchpin of bankruptcy law. By preserving the substantive property and contract rights of creditors, it ensures that bankruptcy is used primarily as a procedural mechanism for the efficient resolution of financial distress. Chapter 11 promotes economic efficiency by reorganizing viable but financially distressed firms, i.e., firms that are worth more alive than dead. Violating absolute priority undermines this commitment by introducing questions of redistribution into the process. It enables the rights of senior creditors to be plundered in order to benefit the rights of junior creditors.
The U.S. government also wants to rush through what amounts to a sham sale of all of Chrysler's assets to Fiat. While speedy bankruptcy sales are not unheard of, they are usually reserved for situations involving a wasting or perishable asset (think of a truck of oranges) where delay might be fatal to the asset's, or in this case the company's, value. That's hardly the case with Chrysler. But in a Chapter 11 reorganization, creditors have the right to vote to approve or reject the plan. The Obama administration's asset-sale plan implements a de facto reorganization but denies to creditors the opportunity to vote on it.
By stepping over the bright line between the rule of law and the arbitrary behavior of men, President Obama may have created a thousand new failing businesses. That is, businesses that might have received financing before but that now will not, since lenders face the potential of future government confiscation. In other words, Mr. Obama may have helped save the jobs of thousands of union workers whose dues, in part, engineered his election. But what about the untold number of job losses in the future caused by trampling the sanctity of contracts today?
My earlier posts on Chrysler examined whether the Chrysler sale is tantamount to an illegal "sub rosa" plan or whether the "absolute priority rule" will kill the Chrysler sale, but with nowhere near Todd's passion. His views are resonating with many, including Jack and Suzy Welch, who are far from "speculators" or "Obama-bashers." In their column last week in Business Week entited, A Bad Week for Business, they wrote:
Look, we don't know how the Washington-Detroit negotiations played out. But the ease with which the large bank lenders appeared to cave to a pennies-on-the-dollar deal might suggest that TARP was involved; the government was wielding a big stick, and it wielded it in favor of the unions over the conventions of bankruptcy law. Is such a radical upending of the economic system good for business confidence and capital formation? It's hard to imagine how.
And so, we are beginning to feel afraid—very afraid. We believe America needs to be more competitive than ever to get out of this recession.
It looks like not everyone agrees.
And so, with GM moving inexorably towards the Chrysler model of bankruptcy justice, as reported here, we bankruptcy professionals--lawyers, judges, and consultants alike--have to wonder, "whither the rule of law?" Who knows, maybe there was something to that Thracymacus guy's view that "might is right" and justice is "the interest of the stronger," and that because "in a state the Government is the strongest, it will try to get--and it will get--whatever it wants for itself."
6/05/09 Update: See my analysis of the Chrysler Sale Opinion (Part I) here.
© Steve Jakubowski 2009
So I can understand some people not liking the strings that the government attached to it's debtor in possession funding because of the way the creditors ended up having their priority order in line swapped. However where is the outrage on the ruling of the judge allowing the asset sale? Apparently this judge looked at the existing case law and all the relevant facts and determined no "rule of law" had been broken. Has his ruling been released and does it include details on his reasoning? It would be nice to see criticisms of his specific reasoning.
[Ed. Note: The sale hearing is at the end of the month. I think everyone agrees that with no opposition from the senior lenders to the plan, there will be nothing for the judge to issue an opinion on and the sale will be approved.]
I continue with my view in prior posts that the Chrysler sale in bankruptcy does not violate the absolute priority rule and that "rule of law" is safe and sound.
Bankruptcy cases are full of concessions and compromises. The absolute priority rule does not trump all other competing claims. What is clear is that no one is contesting that $2 billion is a fair price for these distressed assets. Also, none of this amount is paid to the UAW. The debtor pays nothing to the UAW. Ultimately, an auction where anyone is free to bid will determine value of the sale assets
Two of the op-ed's main points are in error, IMHO:
1. The op-ed is critical of a quick sale, stating:
While speedy bankruptcy sales are not unheard of, they are usually reserved for situations involving a wasting or perishable asset (think of a truck of oranges) where delay might be fatal to the asset's, or in this case the company's, value. That's hardly the case with Chrysler.
However, Chrysler has no cash to continue operations. I think a Chrysler that is "operating" is worth much more than one that has been shuttered for six months to a year during plan negotiations. No commercial lender would provide a DIP Loan to Chrysler. In this case a speedy sale is needed. Keep in mind that the Government's DIP Financing has no chance of being paid back and is essence a "gift". It is not terribly unusual for a DIP Lender to set terms regarding the pace of the bankruptcy case. Chrysler is a wasting asset.
2. Earlier in the op-ed piece is this statement:
Secured creditors -- entitled to first priority payment under the "absolute priority rule" -- have been browbeaten by an American president into accepting only 30 cents on the dollar of their claims. Meanwhile, the United Auto workers union, holding junior creditor claims, will get about 50 cents on the dollar.
However, this statement does not account for who is paying each claim and what is the type of payment.
The secured creditors are getting $2 billion in cash, plus they keep their lien on the remaining assets of the debtor which includes a number of plants and its real estate. The UAW is getting for the VEBA Trust a 55% equity interest in New-Chrysler that is NOT publicly traded and a $4.587 billion promissory note from New-Chrylser that is paid over 13 years. The UAW gets no cash, merely a paper stake that is entirely dependent on the success of New-Chrysler. I don't know if that was taken into account when 50 cent on the dollar was calculated.
More important, the debtor pays nothing to the UAW. The purchaser made a deal with the UAW for labor peace going forward. I do not think a buyer would want to buy an operation as dependent on labor as an automaker without negotiating an agreement with the union. Putting it another way, Chrysler's assets are worth $2 billion in cash if and only if labor peace is part of the bargain.
Note also that under section 1113 of the Bankruptcy Code, a debtor reorganizing under chapter 11 is not free to unilaterally reject labor agreements. Any modifications to labor agreements must be necessary to the reorganization. I don't know how the VEBA Trust obligations fit under that section. However, it seems clear that labor agreements are entitled to special protections that may trump the absolute priority rule. This is not discussed in the financial or popular press.
That UAW is a convenient whipping boy in this debate. When Obama guaranteed all warranty claims, that too violated the absolute priority rule. Warranty claims are unsecured claims but are assured a recovery of 100 cents on the dollar because of Obama. No one complained. Most agree that such payments are necessary to insure that Chrysler is a viable entity going forward, even though perhaps a violation of the absolute priority rule. Similarly, labor peace is important for New-Chrysler to be viable. The absolute priority rule is not the only consideration in US bankruptcies
Finally, no secured lender is saying $2 billion is a bad price. The argument is in the abstract, citing the absolute priority rule and now, the rule of law. The only people putting up cash are the US and Canadian governments, including the US DIP loan that will never be repaid. Chrysler has been "for sale"Â for months. No one has made an offer to buy. A bankruptcy auction will be held soon. Others are free to come and bid. If no one bids, then the free market has spoken regarding the value of these assets.
Oh, and by the way, it seems that the reason no secured lender is saying $2
billion is a bad price is due to pressure from the government. It is
unlikely that they agree that $2 billion is sufficient (particularly since they couldn't come to agreement prior to the filing, even with a $2.25 billion offer - the lowest offered by the Non-TARP lenders implied a valuation of $4.14 billion).
If you read the fairness opinion (see Docket 173), Greenhill's logic is:
1. Without additional funding, Chrysler would have to liquidate.
2. The liquidation value should be between $900 million and $3.2 billion.
3. Therefore the $2 billion price is fair.
Greenhill specifically states in their presentation material (supporting the Declaration by the Managing Director leading the project) that they relied on Capstone's valuation and that they did not perform any valuations as part of their engagement.
Capstone's analysis (Docket 52) states that they such a liquidation is unprecedented and they lay out their liquidation assumptions. It is unclear to me that these assumptions would be found reasonable if challenged.
Further, the rules of the 363(b) sale Order restrict the form of any bids to be consistent with the NewChrysler bid. No other party can bid for specific assets (purchase some brands and plants, while leaving others) and there is little time for a group of bidders to coordinate a sale in the form required.
Also, the Non-TARP lenders have been prohibited from credit bidding for the assets (apparently as part of the loan agreement, the holders of the first lien loans must vote together on such a bid, or there would have to be a waiver - which in the current environment is not going to happen).
I don't agree that "the free market has spoken regarding the value of these assets."
I believe that the UAW Agreement distracts from the real problems inherent in Chrysler's expedited 363(b) sale. While Chrysler did make the Agreement with the UAW to compensate the VEBA in a restructured Chrysler and this Agreement is being assumed by NewChrysler; any purchaser would have to come to an agreement with the UAW.
As I argued in my blog
y-right.html), it would have been better to simply announce that the parties making the bid intend to make the same Agreement with the UAW upon purchase while excluding them from the bid process.
I believe that, even given the issue of form, the reality is that priority isn't being violated.
To me, the real issue is the acceleration of the sale and how the secured creditors have been forced (apparently) to accept a deal that they otherwise would have vehemently contested.
Since the only objections to the process are currently from small creditors for whom, presumably, adequate protection can be structured, Judge Gonzalez will not have to opine on whether there is an adequate business reason for the accelerated sale in a 363(b) instead of as part of the Plan (it seems unlikely that he will raise the issue from the bench, particularly given the specifics of the situation).
By the way, as I pointed out in another blog post (http://blog.lawrencedloeb.com/2009/04/why-doesnt-anybody-want-to-take-dip.
html), the lack of available DIP financing is due more to the lack of assets available to secure a DIP. Chrysler's plan effectively states that the assets supporting the $6.9 billion of existing loans (which represent substantially all the assets, per the Affidavit of the CFO) are worth only
$2 billion (plus whatever value resides in the assets excluded from the
sale) so there aren't enough assets to provide the adequate protection of existing lenders as required under Section 364. Any DIP lender, therefore, would not be able to prime the existing first lien lenders and would have to rely on their super-priority administrative status, hoping for some realization beyond the $6.9 billion!
Specifically, the CFO stated "Chrysler's obligations under the First Lien Credit Agreement are (a) secured by a security interest in and first lien on substantially all of Chrysler's assets, including accounts receivable, inventory, equipment, books and records, cash, general intangibles, real property and a pledge of all of the capital stock of each of Chrysler's domestic subsidiaries (other than its charitable subsidiaries) and 65% of all of the capital stock of each of Chrysler's first-tier Foreign Subsidiaries; and (b) guaranteed by certain other Debtors, which guarantees are secured by a first priority lien on substantially all of such Chrysler's respective assets, including a pledge of all of the capital stock of each of its domestic subsidiaries and 65% of all the capital stock of each of its first-tier foreign subsidiaries."