Chrysler & 363 Sales, Again

Two leading bankruptcy professors are out with new critiques of the pending Chrysler sale motion. Todd Zywicki argues that the President has violated the rule of law by promoting a plan that violates the absolute priority rule, because the union will recover more of its claim than the senior lenders. Mark Roe, whose position on Chrysler I discussed before, makes a more nuanced point that the sale procedures in place all but preclude competitive bids for Chrysler’s assets.

I’m somewhat in agreement with the Roe argument, but I have little sympathy for the Zywicki argument. The absolute priority point with regard to the union’s recovery strikes me as a red herring, in this case wrapped up in some overheated language that compares the President to Hugo Chávez. Whatever.

The union and its trust are not being paid by the debtor, but rather are receiving their recovery from the new owner of Chrysler’s assets, so there is no absolute priority violation. Sure the new owner is getting the funds from the government, but I’m not sure how that matters.

The key question is whether the senior lenders might have obtained more than $2 billion in some alternative bankruptcy, which brings us back to the Roe argument. Essentially he argues that the sale procedures have so locked-up the process that competitive bids will never surface, and we’ll never have a true market check on the value the government (through the new owner of the assets) is paying the senior lenders. I agree.

But the lack of competitive bidding is not unique to this bankruptcy case. A few years back TWA entered chapter 11 (for the third time) with a DIP loan from American Airlines. Guess who won TWA’s assets at the 363 sale.  Most 363 sales involve one bidder.  And even when an alternative bidder emerges, they are often not credible alternates to the "stalking horse."  For example, the bidder may offer more for a particular plant, but refuse to buy as many plants as the stalking horse.

If Roe intends to join Lynn LoPucki in a general critique of 363 sales, I guess I can get onboard with that. However, I do think that critics of modern 363 sale practice often overstate the depth of the markets for these assets. How much value do we really think there is in Chrysler’s assets when GM is about to dump an even bigger amount of similar assets onto the market and potential industry buyers are currently retrenching?  Locking up an asset sale does not really matter if the market is thin and you know that competing bids are unlikely to materialize.  In short, a quick and somewhat uncompetitive 363 sale may be the only option for some firms.

As I’ve said before, I do worry about the way in which the government – through the TARP program and the criticism of creditors exercising their rights – has handcuffed the senior lenders in this case. Credit bidding is a key check on a debtor’s incentives to mismanage an asset sale to the determent of secured creditors, and the government has not been sufficiently sensitive to the ways in which it has undercut this in the Chrysler case.

Comments

[Jeffrey D. Sternklar]

The absolute priority rule issue is not so simply dismissed. I don't presume to have researched the issue, but see the Second Circuit's Iridium decision for reasons why the absolute priority rule may be critical.

[Lord]

No, it takes a judge to do it, but you are right Stephan, the absolute priority argument only makes sense if $2 billion was too small. It hurts to have to sell during a credit crisis when no one wants to buy but that is the hazard of investing in cyclical industries. They should feel lucky to have gotten what they did. They certainly offered no alternative.