Credit Slips

California

I just gave an interview with a reporter from Santiago, Chile on the situation in California. My assessment of the situation, which may be of interest to Credit Slips readers, follows:

The key problem in California is that the state budget is comprised of many fixed expenses. Many of these were put in place by voter initiatives. That leaves a relatively small part of the budget (welfare programs and the Universities are two of the larger ones) that can be adjusted down when tax revenues fall, such as they have been, because people's incomes have fallen.

So California faces a tough choice of radically cutting its budget -- which may have collateral economic consequences, for example, cutting welfare will dramatically cut spending by the poor -- or finding some other source of "plugging" the hole in its budget. One possible solution would be to borrow money from the federal government. The federal government might consider doing this if it believes that the austerity measures required to balance California's budget would have knock-on effects for the national economy. Given that California's economy is the biggest single part of the national economy -- California's GDP is comparable to France or Canada -- this would not be an unreasonable assumption.

On the other hand, the politics are quite complex. The Republicans in California hold a blocking position (by virtue of rules that require a 2/3 majority in the legislature to pass a tax increase), and generally hope to use the present situation to achieve the kind of minimalist state government they have always desired. And the Obama Administration has to fear that Republicans in Washington, including some from California, will criticize any further government involvement in the economy, particularly involvement that increases the federal debt load.

Thoughts? Did I miss anything?

GM Update

Another appeal has been filed, while the District Court has denied the ad hoc committee's request for a stay pending appeal.  All signs point to a quick closing either late today or early tomorrow.  Then we can expect the debtors to move to dismiss the appeals on the basis of §363(m) and mootness.  I expect the appellants to counter that the sale can proceed without §363(f) protection, but I remain doubtful that an appellate court could change such an important "deal term" after the sale has closed.

Certification Denied

The bankruptcy court has denied the motion to certify the GM appeals to the 2d Circuit.  (And the request for the stay too).

UPDATE:  The court's decision can be found here.

Not so fast (says GM)

The debtors have filed an objection to the motions to expedite the appeal to the 2d Circuit. In short, the debtors argue

The issues that the Movants wish to raise on appeal do not rise to matters of public importance.  Rather, the interests that they wish to champion are their own (in the Individual Accident Litigants’ words, “[c]ertifying the . . . appeal will materially advance the . . . determination of their rights against the Purchaser”):  that is, the Movants want certification as to claims of a handful of individual tort litigants who assert, but have not yet even prevailed on, alleged prepetition claims that can and will be addressed in the administration of the chapter 11 cases.

The debtors also argue against a stay pending appeal, and argue that if the court does grant such a stay it should be conditioned on the posting of a substantial bond.  The bankruptcy court hearing on these motions is scheduled to begin right now.

I do think the debtors are right to highlight the extent to which the appellants seem to be pursuing an appeal for the sake of legal clarity -- the federal courts, unlike some state courts (e.g., New Hampshire), have strong rules against issuing "advisory opinions" that clarify the law without influencing the outcome of the pending case.

GM Appeals (update)

A second appeal has been filed, this one by the "Ad Hoc Committee of Asbestos Personal Injury Claimants." The Ad Hoc Committee -- whose standing to appeal I doubt (although the members could appeal, so perhaps I'm being pedantic) -- has moved for a stay pending appeal.  Both appellants have moved to certify the case directly to the 2d Circuit. A hearing before the bankruptcy court is scheduled for tomorrow night, to be followed, no doubt, by activity Wednesday morning at either the District or Court of Appeals, as appropriate.

Absent a stay, the appellants will have to deal with the inevitable mootness and 363(m) arguments -- something they appear ready to address.  As for the direct appeal to the 2d Circuit, I wonder if there is much reason for such an appeal in this instance -- the panel that heard the Chrysler appeal did address the §363(f) issue already, so the appeal in this case is essentially a request for an en banc review of that decision. Of course, for that very reason having the case proceed first to the District Court seems to be an exercise in extreme futility, but I don't see a "waste of time" clause in 28 U.S.C. §158(d)(2).

I'm Confused (California Edition)

On the day that California's credit rating has dropped through the floor, the FT has an article noting that traders are looking to buy the IOUs that California has been issuing to pay daily obligations, quoting one buyer who "would like" to purchase the IOUs for 50% of face.  But the same article goes on to note that key banks in California are accepting the IOUs as deposits -- so if I can sell my IOU to Wells Fargo for 100, why exactly would I sell it to the random trader in Ohio for 50? 

Another example of the "float a wacky idea to get in the paper" phenomenon, I suspect. 

UPDATE:  Or perhaps not.  The banks are apparently reconsidering.

GM Sale Approved

The opinion and order have been posted.  And the first appeal has also been filed.

GM and §363(f)

As I noted in a recent post, "new GM" has agreed to "assume all products liability claims arising from accidents or other discrete incidents arising from the operation of GM vehicles occurring subsequent to the Closing of the 363 Transaction." (Debtors' response to objections, paragraph 62). The purchasing entity has also agreed to be responsible for "lemon law" claims.

This suggests that current tort claims will continue to be subject to Chrysler-like treatment, meaning that the gains in speed at the GM sale hearing may be somewhat less than I suggested in my prior post.  On the other hand, from a strategic perspective, this move would be consistent with the settlement GM made with its bondholders on the eve of filing. That settlement had the effect of fracturing the dissenting bondholders and removing the most effective sale objectors, and I have previously argued that the extension of §363(f) to future claims is the weakest part of the automakers' successor liability argument, because doing so would seem to violate due process.

GM Sale Objections

I have not covered the GM objections with the same intensity as I did in Chrysler, in part because the vast bulk of the objections raise the very same issues. For example, I'm sure most Credit Slips readers know how I feel about the old sub rosa plan argument. But for those of you looking for information on how the sale hearing will proceed, a good place to start is the Debtors' response to the objections. Even if you don't agree with the debtors' arguments, they provide a helpful service by organizing the objections and providing docket numbers for each one.

GM decides speed is better

GM has decided not to fight the §363(f) issue and will not attempt to "cleanse" its assets of tort claims when transfered to "New GM." I have previously argued that §363(f) should be read to apply to tort claims, subject to the overriding limits of due process that would temper 363(f) as applied to future claims. (Unless somebody wants to argue that Katz overcomes other Amendments too -- as explained by the majority, the Bankruptcy Clause does appear more powerful than previously understood).

Nevertheless, the issue is not a simple one and would have likely bogged down the sale hearing for a few days -- especially given that the litigants are better prepared than they were in Chrysler, and GM's case, which does not involve even the semblance of an outside bidder (vs. Fiat in Chrysler), is somewhat weaker. Accordingly, GM made the understandable choice to keep its case moving.

Transnational Bankruptcy

At the final day of the INSOL conference in Vancouver, I attended a fascinating panel on the issues that arise when a multinational corporate group seeks to reorganize. The panel was staffed by judges from Canada, the UK, Korea, and Germany -- and  deftly chaired by a U.S. judge who managed to resist drawing the discussion back to the U.S. For those of us from the U.S., I think the discourse was particularly enlightening. While the panel began with lots of optimism about the new tools for cross-border coordination, by the end it became plain that only Canada would consider a joint reorganization case. In the other jurisdictions, it was clear that the vision of a cross-border case was actually a series of parallel cases within the several jurisdictions, aimed at reaching a common point.

The distinction is important, and a point that is often lost in the good-feeling surrounding the adoption of chapter-15-like procedures. In a joint reorganization case, creditors are apt to be treated equally, based on the value of the unified enterprise. In the case of parallel proceedings, creditors in those jurisdictions that happen to have readily "realizable" assets are going to have significant holdup power, especially if the assets remain "local" as part of a separate bankruptcy proceeding. For local secured creditors, that may be a fair result, but for unsecured creditors who likely relied on the value of the overall enterprise, this sort of jurisdictional fragmentation is likely to produce very arbitrary (and likely inefficient) results.

The Current Paradox

I'm spending the week at the INSOL conference in Vancouver. I think it is important for academics to interact with the "real world" on occasion, to make sure that one's scholarship does not become too ivory tower. And the INSOL events are especially good since they provide a chance to interact with the global insolvency community.

But I have noticed that many of the panels could benefit from an "outside voice." In particular, during one panel I attended today two points were made:  (1) government intervention in the restructuring process increases uncertainty and makes life difficult for senior lenders in particular (lots of agreeing nods) and (2) because of "deleveraging," banks are essentially not making loans to distressed companies (more nods here).  Well, given point 2, either you are going to have government intervention or you are going to have corporate failure on a massive scale. Given the social dislocation associated with the latter option, politicians have strong incentives to embrace intervention (especially those in the majority, who will face the blame for said dislocation).

Making the GM sale hearing a bit more contentious?

I'm still thinking about the Supreme Court's opinion today, which held that the terms of the 1986 Manville plan are binding even if they exceeded the bankruptcy court's jurisdiction, but my initial take is that this makes the fight over selling the GM assets "free and clear" more important, because the tort creditors can't count on being able to challenge the order after the fact.  Of course, I've already argued that current tort claims probably are subject to §363(f), but plainly the tort claimants (and perhaps others) don't agree.

A Further Thought on Securitization Regulation

As I noted in my earlier treatise post, the Administration has proposed requiring all originators to keep a stake in each asset securitization, to ensure that they have "skin in the game."  In particular, the Administration proposes requiring retention of a 5% stake, and would further mandate that the stake remain unhedged.

The last bit troubles Felix Salmon, who seems to think that makes CFOs life difficult.  Perhaps, but should we care?  In particular, there clearly is some tension between this proposal and traditional risk management.  But at present, originators can use CDS to give themselves a zero or even negative stake in the outcome of the securitization.  In such a world -- and that's the world we'll return to if we simply restart the securitization market without change -- the downward spiral of asset quality I described in my prior post in essentially unstoppable.

Sure investors will be "smart" now, and they won't buy low quality assets with the same mania, but individual investor moderation does only little to address the systemic issues that come from excessive securitization.  Only an unhedged originator stake can correctly align incentives.  I doubt 5% is a sufficiently large stake; but it's a start, indeed any number greater than zero is a move in the right direction.

When Is a Market Too Big?

The emerging details of the Administration's securitization regulations have got me to thinking about an issue I first began to consider with regard to CDS. Namely, at what point do apparently useful tools allow a market to become "too big," in the sense that the market begins to generate systemic risks. And what can be done about it?

In the case of CDS (credit default swaps, see here and here), the existence of CDS allows for a magnification of the underlying debt market in ways that may create systemic risks. For example, although I have generally argued that GM would have been better off filing for chapter 11 a few years ago, doing so would have have had the potential to result in several collateral failures of financial institutions, because of the massive amount of then-outstanding CDS in which GM was the "reference entity." Indeed, a simple downgrade of GM's rating during this period almost completely unhinged the CDS market. In this respect, GM's slow glide into bankruptcy court was actually helpful, in that it allowed the market to "burn off" a lot of outstanding CDS, which simply expired before the bankruptcy.

California and Default

As I noted previously, a default by California would have serious repercussions for the larger national and even global economy. Extreme budget cuts in California to avoid such a default could also have serious effects on the larger economy, given California is such a big part of the U.S. economy.

Given this conundrum, the one obvious way out of the problem would be for the federal government to loan California the money it needs to balance it budget without radical program cuts. But I have previously noted that the Administration has political reasons to avoid getting further entangled in "bailouts," particularly when doing so will aid a Republican governor who is likely to have little ability to "call off" the members of his party in Congress.

Thus, it is perhaps unsurprising that the Washington Post reports that the Administration has denied California's request for federal aid. But this bears watching, as I suspect -- baring a truly marvelous economic recovery -- the Administration will be forced to revisit this issue again.

California is, after all, facing a $24 billion budget shortfall. It is going to be very hard for the State to close this gap without some serious effects on the broader economy. For example, the Governor has proposed ending the State's welfare program, all financial aid for college students, and its program that provides medical insurance to children of low-income parents. I'm sure my personal-bankruptcy savvy co-bloggers can anticipate what effects that might have on consumer spending, and bankruptcy rates, in California.

Yet another reason not to pack up the stimulus program just yet.

So Maybe Chrysler Was Only Worth $2 Billion After All

The WSJ has the details on what the lenders who supported the deal were looking at.  In short, the "analysis suggests that the $2 billion that the Treasury Department agreed to pay to Chrysler’s largest lenders, including J.P. Morgan Chase, Citigroup and Morgan Stanley, to settle a total of $6.9 billion first-lien debt may have been the best deal those lenders could have gotten."

I told you this wasn't a big deal, despite what all those editorial writers kept say -- I'm going off to be smug now.

The Growing, Unseen Chapter 11 Wave

Over the weekend, Six Flags -- the owner of Magic Mountain in Los Angeles and other amusement parks -- filed a chapter 11 petition in Delaware. This morning, the Extended Stay hotel chain filed a chapter 11 petition in New York.  All of this is part of an increasing wave of large corporate chapter 11 cases that has been obscured by GM, Chrysler, and Lehman Brothers. Magic Mountain lost its appeal once I left my teens (never did get there) and I'm not sure I've ever stayed at an Extended Stay hotel, but both of these debtors have billions of dollars in assets and thousands of employees. That is, these companies have serious implications for the future of chapter 11 and the larger economy.

Indeed, according to bankrutpcydata.com, already there have been thirty-five chapter 11 cases filed by debtors with assets of more than $1 billion this year. In 2008 there were not that many large cases in the entire year. Chapter 11 cases of this size can be expected to continue to develop throughout the year and into next year, as we continue to work through a "bulge" in senior debt that newly moderate lenders will refuse to refinance and a series of problems in private equity. And the "tail" of this chapter 11 boom can be expect to persist for at least a couple of years past the petition date -- that is, into 2012.

Congress will probably never hold hearings on whether these companies should be allowed to use §365, but I think we can expect that the collective, collateral effect of these cases on trade creditors, landlords, and employees will equal, if not exceed, the effects of the better-known cases. This will in turn create a ripple of small business bankruptcy cases that will be completely unseen by the financial press and most academics, including myself.

Illustration from "Editor," all rights reserved.

GM Retention Applications

The key retention applications were filed on Friday, and by the morning we can expect the inevitable gasping story about how Harvey Miller bills at $950 an hour.  The press keeps doing this, and the big firms have no reason to stop them, given that most of the cost of a case comes from the middle of the billing structure.

Reviewing the Weil application, I was struck by how dreadfully dull retention applications really are. I mean, the Weil GM application is essentially the same basic application that Weil/Skadden/etc. have been filing for at least 15 years now -- I have the binders in my office to prove it.

Why hasn't this been reduced to one page ("We want to retain Weil Arps & Ellis to do the typical things that debtors' counsel does in big chapter 11 cases. They charge a lot, but we think they're worth it. As shown by the attached, they meet the requirements of §327(a).") with an attached declaration that has the case-specific (i.e., interesting) information?

Claim or Interest -- part 2

In my prior post on this topic, I examined and rejected the argument that reference to §1141 helps us understand §363(f), inasmuch as the term "interest" is used in different ways in the two sections.

But what about the core argument that the tort claimants have made, namely, that "interests" means "liens" in §363(f), and thus it is impermissible for the bankruptcy courts to allow the sale of automaker assets free of successor liability claims, which are clearly not liens. Recall the objection filed by the "tort claimants and consumer organizations," where it was argued that §1141:

is much broader than that of Section 363(f) by including “claims”, not just “interests in property,” i.e. liens.

earlier in the same objection, the argument is even more plain:

the language of Section 363(f), read in conjunction with other provisions of the Bankruptcy Code, is clear.  It establishes that “interests in property” which can be foreclosed under Section 363(f) are liens, mortgages, money judgments, writs of garnishment and attachment, and the like, and cannot encompass unliquidated successor liability claims.

The strongest argument against equating "interests" with liens in §363(f) comes from subpart (f)(3), which applies if "such interest is a lien." If we adopt the tort claimants' argument, this provision nonsensically states if "such lien is a lien." I submit that a more plausible reading of §363(f)(3) would suggest that "interest" as used in §363(f) includes liens, but it is not limited to liens. This reading is also buttressed by §362(d)(4), which speaks of recording "interests or liens" in real property.

But the second quote from the tort claimants does recognize a somewhat broader reading of "interests" in §363(f), while rejecting the inclusion of "unliquidated successor liability claims."  Of course, the right to assert a successor liability claim is not an "unliquidated successor liability claim" from the debtor's perspective. Unliquidated or not, it is not even a claim against the estate -- rather, it is only properly termed a claim against the buyer of the debtor's assets. From the perspective of the debtor's bankruptcy estate, a successor liability cause of action is a right that certain creditors hold, but it is not a right or claim against the debtor.  Correctly conceptualizing the right to bring a successor liability claim not only further undermines the analogy to §1141, but also properly focuses us on the issue of whether this right could be an "interest in property."

Claim or Interest -- part 1

One of the key disputes in both the GM and Chrysler cases has been the use of §363(f) to sell the assets "free and clear" of successor liability claims.  The normal rule is that a corporation that buys another corporation's assets does not buy its liabilities, unless it expressly contracts to do so.  In this context, successor liability typically refers to the "product line" exceptions developed by the California and Michigan Supreme Courts, that allow the assertion of product liability claims against the buyer, notwithstanding the normal rule.

The primary argument against the debtor's ability to sell its assets free of the plaintiff's ability to assert a successor liability claim against the buyer is that §363(f) refers to sales free of an "interest in such property," while §1141, the chapter 11 discharge, relieves the debtor of "claims and interests."  For example, in the objection to the Chrysler sale filed by the "tort claimants and consumer organizations," it was argued:

Moreover, the language of Section 1141 of the Bankruptcy Code confirms the propriety of a narrow reading of Section 363(f).  Section 1141, which governs the disposition of estate property in a plan of reorganization, broadly states that property dealt with in a plan is free and clear of all “claims and interests of creditors.” 11 U.S.C. § 1141(c). This language is much broader than that of Section 363(f) by including “claims”, not just “interests in property,” i.e. liens.

I do not find the comparison of these two provisions particularly helpful, because it seems clear that the word "interest" is used very differently in the two sections.  Indeed, the Bankruptcy Code uses the word "interest" or variations thereof (e.g., disinterested) more than 300 times, often in very different contexts. The most obvious example being interest paid on a debt, e.g., §362(d)(3)(B), a use which would seem to be of little relevance to this discussion.

A Final Thought on the Chrysler Sale

A recent exchange with a commenter on the blog lead me to this conclusion: doesn't the argument that the consideration going to the Unions should have instead gone into the estate, for the benefit of the secured lenders, amount to little more than an argument that the buyer of the Chrysler assets (backed by the government) should have overpaid for the assets?

Another Chrysler Appeal

This time a dealership, appealing from the bankruptcy court's order authorizing the rejection of the dealership agreement. I don't get the fight these dealers are putting up -- once the sale closed, staying with "old Chrysler" does not strike me as an attractive alternative.

But perhaps the appeal is to clarify the effect of the rejection on the dealers state-law remedies. Nonetheless, might be time for some cost-benefit analysis -- and keep in mind every appeal means more professional expenses for the debtor and less chance of any recovery for the unsecured creditors. 

UPDATE:  Another appeal from a different group of dealers.

Those wacky members of Congress

I assume the Automobile Dealer Economic Rights Restoration Act of 2009 (H.R. 2743) is going nowwhere fast, but I do appreciate that a few members of the House were kind enough to provide this bankruptcy professor with some interesting reading on a rainy Thursday afternoon in Newark.

Section 3(a) of the bill provides that "[i]n order to protect assets of the Federal Government and better assure the viability of automobile manufacturers in which the Federal Government has an ownership interest" said manufacturers "may not deprive an automobile dealer of its economic rights and shall honor those rights as they existed" on the eve of a manufacturer's bankruptcy case.

Now the bill does not actually reference § 365, and one could easily question the premise of the opening clause, but I assume that this is intended to "unreject" Chrysler's unwanted dealership agreements, and thwart GM's expected move reject some of its own dealership agreements.

The thing that makes this amusing is that section 3(c) of the bill expressly states that if enacted it will have no effect on the sale orders in either chapter 11 case. In short, the dealers who are "saved" by this bill will have the dubious privilege of being dealers for liquidating corporations that no longer manufacture cars. That is, the bill does not to alter the reality that the dealers' contracts are with "old" GM and Chrysler and they are being left behind. As the dealers will say when they realize this -- "swell," or words to that effect.

Finally, there is a part of me that hesitates to point out this flaw, because, as I have argued, chapter 11 already suffers from excessive Congressional tinkering that has made it increasingly difficult to actually reorganize companies under the Code. I would also think that any attempt to do what Congress seems to want to do here might run afoul of due process and separation of powers, particularly as applied to Chrysler -- although I'm getting myself pretty far out on the constitutional law limb here and will retreat to the wonderfulness of the Bankruptcy Code at once.

UPDATE:  One way around the statutory problem I identify is to read this as an attempt to create some sort of successor liability in the reorganized companies for these contracts, essentially assigning them without using §365.  The constitutional law issues, whatever their merit, would still remain.  And I think Fiat (and maybe the Canadians) might have some problems with this -- it amounts to changing the deal after it's been closed.

Oakland = GM?

Where have I heard this before:

Oakland City Council members may have privately bandied about the possibility of the city filing for bankruptcy, an unusually rare event in U.S. history. But none says it's likely, and Mayor Ron Dellums virtually ruled it out Tuesday.

"Bankruptcy is not a strategy that has been seriously considered, nor is it being pursued at this point," he said in a statement.

Full story here.  At least the mayor qualifies his answer, unlike GM's prior management.

What Did the Indiana Funds Want?

Felix Salmon wonders about this editorial and why anyone would pay White & Case lots of money to contest either the Chrysler or GM deals.  The editorial is easily dispatched as the usual jumble from people who can't be bothered to understand the actual deal structure. 

The question of what the Indiana funds were up to and why anyone might want to hire White & Case to do the same thing in GM, where the dissenting creditors have an even weaker position, is less obvious. 

The Indiana funds apparently paid $17 million for a stake in Chrysler's secured loan that had a face value of $43 million. That is, from inception they were investors in distressed debt and presumably understood the risk associated with that. Today they received $15 million as their share of the sale proceeds. That's exactly what they would have received on the first day of the case, but along the way the Indiana funds thought it might be nice to run up a bill with White & Case that must easily top $1 million, pursuing some arguments of dubious merit. Why do it?

GM's Bondholders

The "Unofficial Committee of Family & Dissident GM Bondholders" -- a group comprised of 3 individuals who hold 0.0085% of the outstanding GM bonds -- has moved to become an official committee.  I have never seen a case where a single security has been subdivided into multiple committees (the bonds are already represented on the general committee).

Among the issues the F&D folks raise is the possibility that some of the bondholders who agreed to support the revised deal with GM might have CDS protection (sometimes referred to as a "basis trade"). This is an issue I discussed in my article on CDS and chapter 11 -- the possibility that hedged creditors might support different plans than "normal" creditors, given their downside protection -- and it will be interesting to see if at the sale hearing the bankruptcy court wants to know more about the bondholders who are supporting the sale.

California and the Argentine Option

As a person who still considers Los Angeles home, I often find myself reading the Los Angeles Times webpage.  Yesterday I saw that Los Angeles County's recent note offering got a lower than expected credit-rating, in part because of the State's financial problems.  A county official quoted in the article explained that S&P had based the rating on a "worst case scenario."  My initial response was, are they doing that now?

Several people have asked me whether California might not follow GM into bankruptcy court.  The easy answer to that is "no," since states, unlike cities and counties, can't file under the federal Bankruptcy Code.

But the financial press has also picked up on the issue and noted that California might be forced to default at some point this year if it becomes impossible to continually refinance its outstanding debt. In a recent Bloomberg column, Kevin Hassett breathlessly proclaims that "California leads nation to bond default abyss." He goes on to trace the problem to California's high corporate and personal income taxes, and then makes the entirely predictable argument that this shows that federal taxes should not be raised either.

Of course this ignores the fact that California has high corporate and personal taxes because its property taxes are extremely low. Proposition 13 instituted a kind of rent control scheme for property taxes in the late 1970s that caps increases in property taxes save for when the property is sold.  In a state like California where property values increased much more rapidly than inflation over the past few decades, and the state population has been rapidly increasing, this provided a windfall to generally older, long-time homeowners, that the legislature made up by increases in other taxes.

But what about the basic question of a California default. Could it happen? Certainly. It has happened before.

42 Days and Out

The Chrysler sale has closed.

Now the rejected dealers, underpaid secured lenders, and other unsecured creditors can file their proofs of claim and wait to see if there is anything left in "old Chrysler" to make any sort of a distribution.  If there is not some hope of value in the near term, we may be looking at a conversion to chapter 7.

My own research shows that liquidation in chapter 11 is highly preferable for the unsecured creditors, as the mean and median distribution in chapter 7 is 0%.  Of course, that option is only available if there are funds to pay for it -- Jones Day is not going to work for free.

In Other Chrysler news

The bankruptcy court entered an order today that allows the debtor to reject more than 700 dealership agreements, effective today. The order includes the following slightly odd finding:

To the extent that any Dealer Laws conflict with the terms of this Order or the impact of the rejection of the Rejected Agreements under the Bankruptcy Code and applicable case law, such laws are preempted by the Bankruptcy Code, pursuant to the Supremacy Clause of the United States Constitution.

Essentially this is a restatement of the law of preemption.  A broad restatement. Not really a finding. More relevant to the dealers, the bankruptcy court retains jurisdiction over "all matters relating to the implementation, enforcement and interpretation of this Order." That is, don't even try to go to state court on this.

The order indicates that the court will issue an opinion on this in the near future. Just in case some other debtor wants to cite it.

Chrysler Appeal -- Let the Closing Commence

The Supreme Court has lifted the stay.

The Absolute Priority Rule?

Part of the debate about the GM and Chrysler cases has turned on the putative violation of the Absolute Priority Rule. I've previously argued that the actual deal structure in both cases contains no such violation, because the value going to the unions is not the debtors' and the senior lenders have no claim on it.

But there is also a good deal of unreality in the notion that the Absolute Priority Rule is a hard and fast rule, never to be violated. Professor Epstein snidely notes that President Obama is "no bankruptcy lawyer." Well neither is Professor Epstein, and one of the key problems with much of the debate about these cases is that the most vocal commentators have failed to acknowledge that the Absolute Priority Rule is routinely violated in modern chapter 11 practice.

Nevermind that stuff our CEO said

Fiat notes that the Chrysler deal, by its terms, automatically expires on June 15th if not closed.  Lyle at SCOTUSblog has more on the responses to the Indiana Funds' filing this morning.

GM, Chrysler, and Future Tort Claims

Steve Jakubowski continues his interesting ruminations over the Chyrlser sale, noting that he doubts that Justice Ginsburg is "losing sleep over whether the sale is a sub rosa plan or whether the absolute priority rule was violated."  I agree, although clearly lots of other chapter 11 professors do not.

Steve goes on to state that the big issue in the appeal is the treatment of tort creditors -- noting that even Credit Slips wild man Professor Lubben agrees with regard to future tort claimants (gasp!).

Well, I do agree that future tort claimants have the strongest argument of all the appellants (and strangely, they are receiving the least press attention), which is why I was very interested to see that there has been a motion to appoint a future asbestos claims representative in GM.

It might well be in GM's interest to agree to this motion, since the presence of such a representative might increase its ability to address these claims in the sale order. On the other hand, there is an argument to be made that the tort plaintiffs might have been better off not filing this motion, since it will make it harder for them to assert successor liability claims against "new GM," an entity that might actually be able to pay such claims.

That Wasn't So Smart

Fiat's CEO flushes his company's leverage, saying Fiat won't walk away from the deal even if it goes past June 15, potentially complicating things for Chrysler's attorneys, who have argued that any delay will "kill the sale."  The Obama Administration can't be too pleased either, since they may be forced to play the heavy, again.

Chrysler Appeal -- Stay Edition

Justice Ginsburg has entered a temporary stay that essentially extends the 4pm deadline, without telling us more.

UPDATE:  My friends at SOTUSblog (whom I've never met) have more on the order. They describe the order as having "no legal significance."

Why It Will Be Good To Be a Bankruptcy Lawyer . . . .

. . . . or at least a chapter 11 lawyer, even after the Chrysler and GM sales close.  Assuming, of course, the Supreme Court does not outlaw 363 sales.

Chrysler Sale Order Appeal -- U.S. Weighs In

The Solicitor General's memorandum urging Justice Ginsburg to deny the request for a stay is here.  The pleading highlights the difficulties the appellants will have overcoming the bankruptcy court's findings of fact.

The pleading also rejects my suggested interpretation of Iridium, arguing instead that the 2d Circuit embraced Braniff in that opinion. The Solicitor General then goes on to argue that the bankruptcy court court found that this was not a sub rosa plan, and that finding is correct. This is a reasonable interpretation of Iridium, and avoids the creation of a circuit split, which might lead to Supreme Court review.

The Politics of GM and Chrysler

There is no doubt that both GM and Chrysler are highly political bankruptcy cases, and the Politico blog has a new story that examines the Republican party's efforts to use GM to attack the President.  In part this ability to use these cases for political ends reflects GM's long history of saying the right things while doing the same old things, a point I have made before.  It also reflects the degree to which GM, unlike most other debtors, has managed to alienate a few generations of consumers with the products it put out in the late 1970s and throughout much of the 1980s.  For people who don't rely on GM or Chrysler for their jobs, these companies should have long ago been brushed aside by the invisible hand.  Saving them is therefore bound to be controversial, since support for the automakers has been concentrated into a narrow region of the country.  The automakers can blame themselves for creating this situation.

But most importantly, the political nature of these chapter 11 cases also flows from the reality that no politician would have allowed companies of this economic magnitude to fail during a severe economic crisis.  And I do believe that these cases, in this economic context, were inevitably bound to have significant political involvement, and if the Republicans had won the White House last year, it would be the Democratic party who would now be complaining about "corporate welfare" while President McCain bailed out GM (perhaps favoring dealers instead of the unions).

Yet another reason why it would have been preferable for the automakers to have addressed their problems a few years ago.  Of course, there was no stakeholder interested in compelling such a result at that time.  In short, there was a kind of market failure, perhaps caused by the shear size of these debtors.

 . . . there goes my invite to next year's ALEA conference.

What's Going On?

Throughout the Chrysler case, the Indiana Pension Funds have asserted that they hold $42 million of the senior debt.  But in their application last night (at page 6), asking the Supreme Court for a stay, they assert they hold $100 million of the senior debt.

Have they been buying debt? To what end?

Chrysler's Sale Order & Filene's Basement

At pages 20-21 of their application for a stay of the bankruptcy court and 2d Circuit's rulings, the appellants state that the Supreme Court will want to consider their appeal because:

This matter also raises an important issue of first impression: whether, and to what extent, section 363 of the Bankruptcy Code may be construed to permit a debtor, even under exigent circumstances, to deal with substantially all of its assets and liabilities without complying with the Congressionally-mandated procedural and substantive protections specified in sections 1122-1129 of the Bankruptcy Code for such transactions.

As I noted yesterday, the appellants have become increasingly open about the broad implications of their challenge to the Chrysler sale. And for this I'm glad, as I have also indicated my impatience with those who pretend that the use of a 363 to shorten a chapter 11 case is some sort of novelty.

But consider the implications of this appeal for a truly ordinary chapter 11 case, like that of Filene's Basement. Last week Filene's Basement sold most of its assets to a bidder backed by Men's Warehouse, after entering chapter 11 in May.

The timeline is essentially the same as in Chrysler, and the winning bidder intends to keep most of the stores operating -- which leads to the very same issues of preferring some creditors (those needed for ongoing operations) while others are "left behind" in old Filene's Basement.

If the Supreme Court were to adopt strict rules against 363 sales, many, many large chapter 11 cases would become chapter 7 cases. The entire chapter 11 bar has a big stake in the outcome of this appeal.

Chrysler Sale Order Appeal -- Supreme Court Edition

The appellants have asked Justice Ginsburg to stay the closing of the 363 sale so that the Supreme Court can consider the issues in the appeal.  The SOCTUSBlog has good coverage of the various pleadings. I have previously indicated that the appellants bankruptcy-law arguments are not particularly compelling, save for perhaps the issue of barring future tort claims.

Interestingly, the appellants rely on several op-ed pieces to support their application for a stay.  I have questioned the analysis in some of these op-eds here.

In a large part the bankruptcy part of the appeal to the Supreme Court is based on the old sub rosa plan argument. I believe it was Judge Sack who noted, in Friday's arguments before the 2d Circuit, that using the term "sub rosa" really does not add much to the analysis. Essentially, the key question is whether a 363 sale becomes so much like a plan that the there should have been voting and a disclosure statement.

The TARP issues strike me as the issues more likely to interest the Supreme Court.  On the other hand, these issues may be the most fragile ones in the appeal because it is not clear that the appellants have standing. Moreover, as the 2d Cir. seemed to recognize on Friday, there is a sense in which the TARP issues are kind of "tacked on" to the appellants arguments. The Canadian funding of this case is plainly not subject to this challenge, and even if the challenge were successful, it's not clear what role this would have in the bankruptcy case. Indeed, a "win" on this issue would arguably harm the appellants more than losing this appeal could. A withdrawal of Treasury funding would bring a quick end to Chrysler's chapter 11 case -- and leave a chapter 7 trustee with a daunting task.

The 2d Circuit

As you have no doubt have heard by now, and as I had long expected, the 2d Circuit affirmed the bankruptcy court's decision in Chrysler, essentially incorporating the Bankruptcy Judge's opinion by reference.  The courtroom was packed -- at least 300 people in attendance -- and there was notable surprise when the panel announced at the end of argument that they would take a ten minute recess and return.

Clearly this not only helps Chrysler -- assuming the appeal to the Supreme Court is unsuccessful, as I expect it will be -- but also GM, which is following the same basic template.

One of the most interesting parts of the hearing, from my perspective, occurred when the attorney for the Indiana Funds seemed to argue for Lionel to be overturned and for the appellate court to reduce the bankruptcy court's discretion in the area of 363 sales. Although the court clearly did not accept his invitation, that moment was the closest the appellants got to acknowledging just how significantly they needed to change chapter 11 practice if they were to win.

Shocked, Shocked

Steve Jakubowski has a great new post up summarizing the bankruptcy court's decision in Chrysler, and in it he makes plain an argument that I've only referred to obliquely. In particular, in both GM and Chrysler many of the banks, hedge funds, and other institutional creditors are getting a taste of their own medicine, and they hate it.

In the past decade lenders have learned how to play the chapter 11 game.  They lock up all of the debtors assets with security interests and make strong demands, like quick 363 sales and "roll overs" of pre-petition debt into post-petition credit lines, as the price for allowing a reorganization case to even happen. In this way, the Treasury is simply playing the institutional lenders' game -- exerting a lot of control over the chapter 11 process as the result of the DIP financing it is providing.

Thus, when I see these same institutional investors acting like Captain Renault, I'm skeptical.  And when I see the financial press suddenly expressing shock at these practices, I say "where have you been?"

Federalist 44

As others have noted, the Indiana Pension Funds invoke the founding fathers in support of their claim that the government is rolling over their rights as creditors.  This part of the brief particularly stands out:

As James Madison wrote long ago in language that is still markedly salient today: “laws impairing the obligation of contract are contrary to the first principles of the social compact, and to every principle of sound legislation.”  The FEDERALIST No. 44 (James Madison).

I'm not a constitutional law expert, but this quote seems out of context to me.  Federalist 44 deals with the Contract Clause, the prohibition on the States passing laws impairing contractual obligations. Congress' power under the Bankruptcy Clause is not subject to this limitation. The Supreme Court, under Chief Justice Marshall, explained the relationship between the two clauses in 1819 in Sturges v. Crowninshield:

Without entering further into the delicate inquiry respecting the precise limitations which the several grants of power to congress, contained in the constitution, may impose on the state legislatures, than is necessary for the decision of the question before the court, it is sufficient to say, that, until the power to pass uniform laws on the subject of bankruptcies be exercised by congress, the States are not forbidden to pass a bankrupt law, provided it contain no principle which violates the 10th section of the first article of the constitution of the United States [the Contract Clause].

Indeed, it is arguable that a Bankruptcy Code would be unworkable, or at least of limited value, it if could not impair the obligations of preexisting contracts.  And similarly, seen from the perspective of those founding fathers who saw debtor-creditor law as an important part of the national economy, it makes perfect sense that the States' ability to atomize debt collection law would be restricted.

Chrysler Briefs (copies)

By popular demand, below are some of the key briefs in the Chrysler appeal.  There are about a dozen total briefs in this appeal, but reading these will give you the core arguments.

Download Debtor Brief

Download US Brief

Download Ind Brief

The Chrysler Briefs

Tomorrow at 2pm a panel of the 2d Circuit (09-2311) will hear arguments in the expedited appeal of the Chrysler sale order.  I hope to attend the hearing.

In preparation, I've been slogging through as many of the briefs as possible, and my initial take-away is that there is not much new here. There are essentially two core issues on appeal:

First:  Did the bankruptcy court err in approving the sale?  Subsumed within this issue are the claims that the Chrysler sale was a sub rosa, that the plan violated the absolute priority rule, and that the debtors' assets can't be sold "free and clear" of tort claims under §363(f).

If you've been reading my posts, you know that I believe the sub rosa plan and absolute priority rule issues to be based on either a misunderstanding of the deal structure, and or intentional attempt to confuse the issue. The sale order does not dictate how the the post-sale debtor should proceed with its case, and unless these appellants are attempting to upend typical 363 practice in the SDNY and Delaware, this deal is unremarkable.

For the last ten years chapter 11 cases, particularly in New York and Delaware, have increasingly turned on quick 363 sales, at the demand of senior lenders, with the remainder of the case devoted to handing out the proceeds.  Congress could decide that this is bad bankruptcy policy, but it would be quite a shock to the bankruptcy bar if the 2d Circuit chose this case to suddenly change all that, especially given the predictably dire results of doing so.

The absolute priority rule is also not violated because the value going to the unions is not coming from the debtor.  A purchaser of assets can do whatever it wants post sale, and just because the senior lenders are jealous does not make it a violation of the Bankruptcy Code.  

On the "free and clear" issue, I tend to think that the 2d Circuit will follow the 3d Circuit's reasoning in TWA.

GM & Opel

On the day GM filed, the Times ran a story noting that GM's European division – Opel/Vauxhall – had been “spared” going into bankruptcy by the deal with Magna and some Russian investors.

Are we so certain they were spared?  Sure in the short term European employees and others who rely on GM will avoid some pain, but what about the long term?  The domestic part of GM is talking about dropping over 2,000 dealers, rewriting its labor contracts, massively reducing its debt load and shuttering several plants, all in about a month.  Will Opel’s new owners be able to achieve a similar degree of restructuring in anything close to that timeframe?  It may be my American chauvinism, but my impression is that it will be even harder to obtain a comprehensive restructuring of Opel outside of a bankruptcy process, as the European jurisdictions have much stricter laws regarding the termination of employees, shuttering plants, etc.

As GM and its stakeholders are now learning, sometimes avoiding bankruptcy simply makes the pain worse when it comes.  GM's chapter 11 case would have been much simpler (relatively) two years ago, when the credit markets were open and people where still buying cars.

(I invite the European readers to comment or correct me in the comments or via email.)

Let the Canadians Run It

The Financial Times mentions that Senator Alexander has proposed distributing the U.S. Treasury's stake in reorganized GM to taxpayers. After we all receive our 0.0000003% stake in GM (talk about separation of ownership and control), the Canadians and the UAW will be the controlling shareholders.

I'm not sure the Senator has thought this all the way through.

(and, yes, I know that not every American is a "taxpayer," but you get the point).

Chrysler Appeal

The 2d Circuit is holding a hearing on Friday.  No word in the article on whether they'll stay the closing, which can happen any time after noon on Friday.  Unfortunately the Circuit's PACER page is not as useful as the bankruptcy court's.

Update:  The hearing is at 2pm on Friday.  There is a stay in place pending the hearing; briefs are due tomorrow by noon.  The orders are below.

Download ChryslerAppealGrant

Download ChryslerStayArgumentGrant