The Chrysler Sale Motion

I wanted to start with something about the Chrysler sale because commentators whom I respect (see here and here) seem to be somewhat skeptical of the endeavor.

I think these commentators have misunderstood the structure of the sale, no doubt in part because the overall structure of the deal has been somewhat “over-described.”  There are obvious political reasons for this – in particular, the Administration needs to present a complete story of how Chrysler’s employees will keep their jobs when the dust settles.  There is also a general lack of chapter 11 understanding among both politicians and the press.

As I comprehend the sale structure, based on the pleadings filed late Sunday, the debtor will transfer key assets and contracts to a new Delaware LLC in exchange for $2 billion in cash and various cure payments.  As part of the deal, the new owner (the Delaware LLC) will assume some contracts, including the labor agreements.

The last piece of this does technically violate the absolute priority rule, but in a way that is mandated by the Bankruptcy Code.  Contract counterparties always get their prepetition claims paid in full when their contracts are assumed and assigned in a §363 sale.   §365(b)(1).

The sale will be free and clear under §363(f)(3), using the argument that “value” in that provision means economic value.  Reasonable parties can disagree on that point.  But notice that if the dissenting lenders win on the (f)(3) argument it does not necessarily stop the sale, rather it probably just means that the sale price gets lowered (because of the increased risk for the buyer).  Also keep in mind that the objecting creditors would seem to have the burden of proof here.   §363(p)(2).

I don’t see how (a) the new owner’s renegotiation of the labor agreement or (b) the distribution of ownership interests in the new owner are issues for the bankruptcy court to approve.  Financing provided to the new owner also does not seem to a topic for the bankruptcy court to rule on.   This is not an SPM type case where a senior lender is “gifting” its recovery for the benefit of junior claimants – rather the new owner of the assets is providing ownership interests in exchange for new consideration (new financing and labor concessions).

The sale is subject to higher and better offers, despite what has been suggested, but we all know that such an offer is unlikely.

The one real complaint I see here is that the dissenting senior lenders are probably being precluding from credit-biding their claim by the conflicted senior lenders, many of whom have a controlling shareholder that is on both sides of this deal.  (I’m assuming there is a collective action clause in the senior debt that precludes the dissenters from going it alone.)

Of course, there is always some risk that the big banks in a senior debt agreement will dominate the voting.  Nevertheless, I'll pick up on the credit-bid issue in my next post, as I see that as the neglected issue of this argument.

Comments

[Lawrence D. Loeb]

Stephen:

What do you think about the issue of "good faith" issue under 363(m) given that the US Treasury is on all sides of this deal (twisting the arms of the senior lenders, providing the DIP, and setting the price of the deal)?

How about the "sub rosa" issue? Do you think there should be greater discussion of the need for a rapid resolution to get Chrysler's business out of bankruptcy? Shouldn't this be required given the precedent (Lionel, etc.)?

What about the required schedule incorporated into the DIP agreement? Isn't that schedule unusually accelerated for the DIP lender to dictate? Wouldn't most judges view such terms skeptically (if it weren't submitted by Treasury?

As for the "prepetition contract" with the union, would that really apply? The agreement was negotiated as part of the out-of-court restructuring that was not consummated. Would an executable contract contemplate the consideration paid from an entity that doesn't exist and, therefore, couldn't be executed without the out-of-court transaction or the 363(b) sale? I would think that the prospective nature of the consideration would lead to the agreement being considered part of the 363(b) transaction, and not as an assumed contract.

I have also been discussing these issues on my blog (blog.lawrencedloeb.com), but I'm very interested in your thoughts.

What are your thoughts?

Thanks.

[Eric Rasmusen]

Thank you for this good post.

I don't know much bankruptcy law, but I have a question.

Suppose that if all labor contracts vanished, Chrysler's assets would be worth $5B, but the assets plus the existing labor contracts are only worth $1B. There are two ways the law might work:

1. If Chrysler goes bankrupt, the labor union is a creditor with a claim of $4B because its contract was breached.

2. If Chrysler goes bankrupt, the labor union is not a creditor, because Chrysler is not obligated to hire workers any more.

If the law is (1), then it is fair to sell the assets plus contracts for $2B; the lenders actually benefit when Chrysler then goes bankrupt. If the law is (2), then the asset sale is unfair: the lenders lose $3B as a result of it.

Which is the law?

[Stephen Lubben]

Eric -- a good question. The law is closer to your #1, although with some qualifications. When Chrysler enters bankruptcy it is still bound by the union agreement, until it goes through the process for rejecting it (which is somewhat more involved than rejection of a "normal" contract). If the agreement is rejected, the union has a claim for breach and we are in your situation #1. If the agreement is assumed (i.e., reorganized Chrysler will perform -- either because it's a good deal or they can't meet the standards to reject) the estate will have to cure any pre-bankruptcy defaults and provide adequate assurance of future performance.

Bidders on Chrysler's assets could have bought them without the union contracts, but obviously the only bidder in the show here was unlikely to do that since they (New Chrysler -- which is a strange amalgam of governments and Fiat, to be joined by the union post sale) needed the government financing, and the government(s) is/are trying to minimize job losses as a political goal.

[Eric Rasmusen]

Thanks for the answer. That raises the big question of the penalty for breach. Is it a lump sum of money, or can the union somehow get specific performance?

I write law-and-econ articles. This looks like a situation for efficient breach. The union work rules and pay levels are inefficient-- they cost Chrysler more than the benefit to the workers. Thus, the way to maximize the value of the entity is to breach the contract, pay damages, and start over without the union.

So there might be a third possibility to add to my two above:

(3) If Chrysler goes bankrupt, the labor union is a creditor with a claim of $1.5B because its contract was breached. Its damages are only 1.5B, while Chrysler's benefit is 4B because the contract is inefficient.

In case (3), selling the assets plus contract for 2B is worse for the creditors than selling the assets for 5B and paying 1.5B for breach of contract. In this case, though, my guess of 1.5B damages vs. 4B benefits from breach is crucial, and reality might well make the difference so small that assets-plus-contract sale is fair.