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Chrysler & Credit Bidding

posted by Stephen Lubben

As I made clear in my prior post, I think that many of the arguments advanced against the Chrysler sale motion are largely noise, generated by confusion over the structure of the deal.  But I also mentioned that one real problem I see here turns on the dissenting lenders’ apparent inability to credit bid.

The Bankruptcy Code expressly recognizes the right of a secured creditor to “credit bid” its claim in a §363 sale, just as a home lender can bid the value of its mortgage in a state foreclosure sale.  § 363(k).

Thus, if the debtor moves to sell its assets worth $100 in a 363 sale, the bank with a $40 lien on the assets can bid “$40” and offset its secured claim against the bid, meaning that the bank only has to pay cash for the debtor’s assets if the auction price goes above $40.

Thus, if Chrysler were a typical chapter 11 case, the senior lending group would be able to credit bid up to $6.9 billion for the debtor’s assets.  If the lenders won the auction, they could then sell the assets to Fiat or anyone else.

Here the lenders (as a group) decided to forgo their right to credit bid and instead accept $2 billion in cash.  The offer was at one point raised to $2.2 billion, but that has apparently been taken off the table since Chrysler entered chapter 11.

Normally I’d say that the lenders’ decision to take the $2 billion was a strong indication that they expected Chrysler’s assets to sell for a price less than or equal to that amount, mooting their need to credit bid.  But in this case the decision to take the $2 billion offer is being driven by the largest lenders, all of whom are to some degree under the control of the Treasury Department.

More on this, after the jump.

I think we have to concede that this control, and the conflict it creates, and the President’s decision to publicly scold the dissenting senior lenders has tainted this process, making it unlike a normal chapter 11 case.  The decision to scold the dissenting lenders – perhaps driven by the lenders somewhat juvenile press release – is perplexing, since it seems to blame them for a chapter 11 case that I believe would have happened anyway.  Moreover, holdouts are a fact of life in workouts and chapter 11 cases – the trick is to figure out how to deal with them, and publicly shaming them is probably not going to help that process.  However politics sometimes produces silliness, even among those who should know better.

The real issue is how much do we believe all this has tainted the process.  In this case, you could argue that the Fiat price would be so low without the union agreement that the secureds are getting the same or even a higher recovery on an absolute basis.  But we'll never know for sure and in that sense the process is tainted, and I think this is not harmless.  Future hedge funds may pay lower prices to buy distressed debt in large companies like Chrysler and future secured lenders may therefore require higher interest rates from borrowers.  Moreover, the global story that we tell about the benefits of having a system like chapter 11 is diminished by this case.

Ideally the entire GM and Chrysler situation would have moved to bankruptcy court much earlier, where the process could have been conducted more like a normal chapter 11 case.  As I’ve written, too much of the decision to avoid chapter 11 in the recent crisis has been driven by unwarranted fear of chapter 11, driven by either a serious misunderstanding of what modern chapter 11 practice entails, or an intentional effort to create fear and panic about chapter 11, to support the case for a bailout.

How does this influence the pending sale hearing?  Probably not very much.  A bankruptcy judge simply takes the case as it comes, and can't spend too much time worrying about the backstory.

(And for those of you wondering about §363(m), keep in mind that the "entity" that will purchase the debtor's assets probably doesn't have a good faith problem -- see also §§101(15), (41) -- unless we engage in some viel piercing).

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Comments

Stephen:

I agree with you that Chapter 11 should have been used in a more conventional way for Chrysler (and perhaps GM). I wonder what you think about the use of 363(b) to transfer the business out of bankruptcy rather than utilizing the protections offered by the process to make the necessary changes to contracts (such as dealerships) and other aspects of the business.

In that case, of course, the existing lenders would benefit from the increased value of the business from the operational restructuring, while bearing the (not insignificant) costs of the bankruptcy process.

Chrysler does have some aspect of a financial distress situation (bad balance sheet), but they also have operational issues. There is a real question as to whether they can profitably make the products that will sell in the current market. Minivans and other gas guzzlers have offered great margins, but we're back to smaller cars where the current structure offers little, if any, marginal profit.

As to the childishness of the public letter issued by the Non-TARP lenders, I believe you are being too harsh. They were being pressured both publicly (although without names) and privately by the Administration. There were rumors questioning whether the Non-TARP lenders had protected themselves with credit default swaps, and thus wanted bankruptcy. Other rumors made their way to the media claiming that the holdouts were not willing to give anything up.

I don't believe it is unreasonable for those funds to get their story out. Clearly their co-lenders were acting partially based on their acceptance of TARP funds (you can argue whether TARP was being used as a carrot or stick by the Administration).

They wanted the world to know that they were willing to take less than 100 cents on the Dollar. They had offered to take a 40 percent haircut. They also wanted to point out the conflicts of their co-lenders, which explained (at least partially) why they would hold out for a better offer.

While I suspect that you are not an expert in valuation, I am. I don't have enough information on this private company to perform a detailed valuation, but we do have some information that provides a basis for analysis.

I do feel comfortable saying that it is unlikely that the assets, which the first lien holders should receive first payment from, are worth significantly more than $2 billion. I base that on the fact, as disclosed in the CFO's Affidavit, that the book value of those assets is $39.3 billion. In addition, the UAW has disclosed that they were told that the VEBA's 55 percent equity share in the NewCo was worth $4.25 billion, giving NewCo an equity value of $7.73 billion. NewCo is also assuming the $4.587 billion note due to the VEBA. The Enterprise Value of NewCo, at inception, then is $12.3 billion. Even if you say that Fiat's contribution of technology is worth 51% of NewCo's equity (for simplicity, let's just assume that they meet all the conditions necessary to reach that), that leaves $3.788 billion of equity value plus the $4.587 billion of assumed debt that should be considered the value of old Chrysler's contribution (or $8.375 billion).

The proposal, therefore, is to eliminate $6.9 billion of first lien loans in exchange for $2 billion when the Chrysler assets being contributed to NewCo (which only includes the "good assets") have an implied value of $8.375 billion.

That doesn't trouble you at all?

LDL: Don't you have to subtract off the value of the government subsidy (i.e. the DIP loan that no one expects to be repaid) in your calculations -- and perhaps even the possibility that this subsidy may increase the value over time of the company?

Anon:

I'm not sure what you are saying.

The First Lien holders are ahead of the Government, both for the TARP money (invested prior to the bankruptcy) and the DIP because of their security interest in substantially all of the assets of Chrysler. When the Government made their prepetition loan, they knew that they were subordinate to the First Lien, and they expressly concede it in their DIP Agreement.

The First Lien lenders are not being offered anything other than a 29 cents on the Dollar cash payment, so they have no opportunity to benefit from any increase in the value of the company over time. The only parties that will own equity under the proposed plan are the VEBA, Fiat, and the US and Canadian governments.

Under the plan, the First Lien debt would be settled - apparently by the cash (although this isn't entirely clear - they may retain the right to the proceeds of the sale of the assets left behind in the creation of NewChrysler) while a portion of the DIP is going to NewChrysler, an entity that is not subject to the First Lien lenders' rights. Any repayment of the DIP will come from NewChrysler (although, if the First Lien settles for the $2 billion in cash, then the DIP could be paid from the proceeds of the sale of the non-NewChrysler asset), so it is possible that the DIP will be repaid (and the Government is taking 8% of New Chrysler, which is valued at $618 million (at least before any dilution for Fiat's increased ownership).

Lawrence and Steve (and anon too),

Fascinating exchange. Thanks.

I think your link to Felix's blog is very revealing. The "silliness" he references there concerns "vulture funds" on the international scene. Felix sees it as such, but doesn't see that some of the efforts to publicly shame Chrysler's creditors to which he has lent his approval are quite analogous, domestic though they be.

I think there are several issues, I have not seen properly addressed. First, what about 363(f), I think there are a lot of problems under that sub-section. Second, isn't there law to the effect that a sale that is tantamount to a plan of reorganization is not properly considered under 363? Third, many groups of unsecured creditors (discontinued dealers, tort claimants, lemon-law claimants) will receive nothing, while the UAW gets 55% of newco. It seems to me that they should be quite unhappy. Fourth, shouldn't a proper motion to convert to 7 have been granted?

"Fat Man":

1. Section 363(f) has been interpreted to mean that the property can't be sold for less than it is worth, not the value of the loan that the property is liened against. The debtor in possession's position is that the assets being transferred are worth no more than $2 billion (of course, all of Chrysler's assets - including those left behind - have a book value of $39.3 billion, but who's counting).

2. There is significant case law about when it is appropriate to allow a 363(b) sale that might otherwise be viewed as a "sub rosa" plan. I suggest reading this post by Steve Jakubowski on the Bankruptcy Litigation blog (http://www.bankruptcylitigationblog.com/archives/bankruptcy-in-the-news-chrysler-files-bankruptcy-part-ii-testing-the-limits-of-section-363-sales.html).

3. There is an Unsecured Creditors Committee that will seek to obtain whatever value they can from the assets left behind in "old Chrysler."

4. Why would a Chapter 7 motion be made or accepted? The company filed a Chapter 11. I believe they are given an opportunity to provide a plan of reorganization. As for the liquidation of the remaining assets, it's my understanding that such a liquidation could be done under Chapter 11.

How's that for a non-lawyer! :-)


Thank you Mr. Loeb:

As to your item 1. 363(f) provides:

(f) The trustee may sell property ... free and clear of any interest in such property ... ,only if (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property;

I am skeptical about your view of the case law, although I am, as I said, unfamiliar with it. There is a meaningful difference between the value of a lien and the value of the collateral securing the lien. In this case, where there are many items of collateral, each securing the entire lien, the value of any single item of collateral must be less than the value of the lien. your interpretation would render the restriction fairly meaningless.

As to the third item, I find it hard to believe that there will be anything left for the unsecureds given the more than 4 G$ deficiency in the payment to the secured creditors. Surely, the disparate treatment of one unsecured (the UAW) must rankle.

A motion to convert should be made to drop the pretense that a reorganization is possible. A 7 should be cheaper. Actually, if the secureds do completely trump the remaining unsecureds, they should make a motion to abandon the remaining collateral, whereupon the proceeding could be terminated as no assets.

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