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?

One possible answer is that this is all about politics again. The politicians in control of these funds back in Indiana are Republicans and maybe they wanted to pester the Administration. Maybe, but a risky move given that if they had succeeded in derailing the sale, not only would the funds have lost substantially more money, but they would have put several thousand voters in Indiana out of work.

It's the last point -- and White & Case's desire to get into GM -- that makes me think this is a pure holdup play. I don't think the funds ever really wanted to "win" on the merits of their argument, rather they wanted to make themselves enough of a pest that Chrysler (or the Treasury) would pay them to go away. It's not an uncommon move in large chapter 11 cases, and its not new. In 1916 Paul Cravath, in explaining the stages of a railroad reorganization, stated:

You have now reached the stage when the professional obstructor is most likely to appear, if he has not already appeared. I was going to call him the professional striker, but that would hardly be fair, because the small security holder who seeks to obstruct a reorganization is not always a striker, by which I mean a person who seeks by creating a nuisance value for himself to force the payment of an amount wholly disproportionate to his interest in the property as the price of the withdrawal of the nuisance of his presence. 

Sound familiar? There's not anything wrong with this strategy, so long as the attorney does not violate Rule 11, but it should be recognized for what it is.

Comments

[Jared]

I've been wondering this too.

I can't imagine the Indiana Pension funds are actually paying for this, or paying market rate if they are. After all, they estimated their loss at $5,000,000 versus a liquidation -- you can't justify hiring a biglaw firm for that measure of damages. Here are some possible answers:

1) W&C actually took the case on contingency, to get good press for the firm. After all, presumably their initial hedge fund group had already paid for the bulk of the work product that they relied upon in preparation for and at trial. The good publicity for Lauria might be worth the $1 million or so in receivables.

2) Parties anticipate W&C will get paid under a substantial contribution motion after the final consummation of the Plan. This means either W&C gets paid in the first place if this was contingency work, or the Indiana Pensioners get reimbursed.

[Color me confused]

Jared,

I'm curious on what basis you think that W&C might be entitled to a 503(b) administrative expense claim? That is not an easy argument to make and I'm having a difficult time understanding how they advanced the cases or benefited the estates.

[KL]

I know this may sound crazy, but I believe they were acting on a principle of fairness. Whether legally correct, or not, everyone acknowledges that the UST's actions here have favored the UAW over all other stakeholders. That favoritism, literally repaying a 70 yr old political IOU, is disgusting to them.

Moreover, it is likely that throughout the process, the UST has acted in bad faith - the email traffic seems to represent that and conversations I've had with the other lenders (the one's who've claimed they were threatened) seems to support that probability.

[Cletis]

Regardless of what one considers "fair" or how the "principle of fairness" may realate to the Chrysler 363 sale, I doubt that objective comes within the scope of the Indiana state treasurer's obligations to his constituents. In this case, as he reported to the NYT Dealbook on Tuesday, he has spent $2 mil. of their funds (sor far) tilting at this windmill.
http://dealbook.blogs.nytimes.com/2009/06/09/an-interview-with-indianas-treasurer/

[Adam]

Can someone more knowledgeable talk about Mourdock's choices from an ERISA perspective? I think that might help show that the political rationale was really important here:

First of all, if it were economically rationale to buy claims and object in hopes of special treatment, then a private party would have done it.

Second, if there were a real valuation argument to be made, then many more bondholders should have been willing to split the the legal fees.

Third, it seems like if the trustee of a fund with enforceable fiduciary duties (such as an ERISA plan) were going to spend money, she would need some reason to think that there would be a return for the beneficiaries, and at 2M in fees on a 17M investment, she would need a 16% increase just to get the fees *back*.

So that leaves Mourdock. Does anyone know if as the Indiana State Treasurer, he may enjoy sovereign immunity defenses that would keep him from being sued for investment decisions that might be actionable by private retirees or investors?

[Lawrence D. Loeb]

Adam:

I just want to clarify some things in relation to what you said.

The Indiana funds owned pieces of a $10.0 billion first-lien bank loan. By the time of the bankruptcy (and before the pieces were purchased by the funds), $3.1 billion of that loan had been paid down, leaving $6.9 billion.

Unlike GM, there were no bondholders (or bonds), only banks (which were recipients of TARP money) and hedge funds. There were second-lien holders that surrendered any claim (like Daimler) and many unsecured creditors. One unsecured creditor received $10.337 billion of value, the VEBA (which funds benefits for UAW members and retirees).

President Obama's statement announcing the Chrysler bankruptcy effectively treated the funds that hadn't agreed to the offer made prior to the filing ($2.25 billion) as traitors (calling them speculators, etc.).

A group of investors in these bank loans, calling themselves the "Non-TARP Lenders" retained Tom Lauria and White & Case to advise them and assist in negotiations prior to the bankruptcy. Membership in this group dropped over time, after President Obama's specific targeting of them and after Judge Gonzalez required that White & Case disclose the names of the funds he was representing (the funds had wanted to file this information, which is required under Rule 2019, under seal).

When the Indiana funds contacted White & Case on May 19th, the "Non-TARP lenders" were no longer fighting - and stopped funding W&C, but Lauria had done a significant amount of work for them, enabling him to quickly work on the funds' behalf.

The fact that none of the other first-lien lenders joined in the dispute isn't indicative of any consensus on the valuation. It is indicative of the Administration's successful campaign to wipe out dissent against the Chrysler 363(b) sale.

I have written about some of this at http://blog.lawrencedloeb.com/2009/06/could-indiana-pensioners-have-prevailed.html and there was a good piece on TheDeal.com site yesterday at http://www.thedeal.com/newsweekly/community/when-hedge-funds-go-to-bankruptcy-court.php.

I hope this is helpful.

[lmclark]

Mr. Loeb --

I think Steve got it right with his quote from Paul Cravath. Lauria attempted to extract value for his clients by being obstructionist -- and by heating up the rhetoric in the media. That's fine. That's his job. He made the pitch that the government was behaving like outlaws. The conservative media then jumped on that with charges that the administration was trying to turn the U.S. into a socialist (or even communist) workers' paradise.

The Obama administration struck back by calling the holdouts greedy (I don't think he called them traitors, but I could be wrong) and accused them of selfishly putting their own interests ahead of everyone else's interests.

Sounds to me like just some good old fashioned bare-knuckled brawling, trying to use public (and some political) pressure to advance positions. I personally am not surprised. Hard nosed negotiations often take place in the bankruptcy context. We just don't normally see those negotiations on public display -- much less find the media being used as a tool in those negotiations.

But I think you are wrong to pitch it as "the Administration's successful campaign to wipe out dissent." That suggests something far more pernicious than I think the facts warrant. As Prof. Lubben has already pointed out, the real pressure points for the lenders were (1) Chrysler in liquidation was a nightmare scenario for the lenders and (2) credit bidding was their only real legal option -- and they did not want to own Chrysler. The lenders responded to that pressure, just as parties always respond to pressure in negotiations. Recasting that as "wiping out dissent" is both disingenuous and unfair.

[Lawrence D. Loeb]

lmclark:

Actually, I have spent over 20 years in valuation and investment banking. I reviewed the Capstone report (used to support the transaction and the fairness opinion) and found a number of assumptions that would not have withstood criticism. Not only that, but the valuation was prepared on a liquidation basis.

Section 506(a)(1) states "An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under section 553 of this title, is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property, or to the extent of the amount subject to setoff, as the case may be, and is an unsecured claim to the extent that the value of such creditor’s interest or the amount so subject to setoff is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest."

The Supreme Court, in Associates Commercial v. Rash, stated "That actual use, rather than a foreclosure sale that will not take place, is the proper guide under a prescription hinged to the property’s 'disposition or use.'" In that case, they found that a Chapter 13 debtor attempting to cram down a secured lender and use secured property could not use the liquidation value of that property to determine its value (and thus, the amount of the claim that was unsecured). Rather, in that case, the Court, in an 8-1 decision determined that, since the debtor intended to continue to use the asset, the appropriate basis was replacement cost. In Chrysler's Chapter 11 case, that would equate to the use of going concern value as the correct basis for valuing the assets that the first-lien loans are secured against.

Given that the UAW's VEBA received $10.337 billion, attributed to NewChrysler, in exchange for concessions that were not worth anything close to that amount, $2.0 billion was not a good indicator of the value of the secured assets in a going concern.

The Obama Administration, and the Automotive Task Force in particular, engaged in a successful campaign to influence the secured creditors (most of whom were recipients of TARP money) to violate their fiduciary responsibilities to their shareholders/investors and accept the $2.0 billion offer. Given that, I don't believe it is disingenuous or unfair to characterize the Administration's behavior as wiping out dissent. That's what they did. They decided that the ends justified the means, regardless of the law.

We will see if the case goes on to the Supreme Court (the Court only turned down the stay, they didn't rule on certiorari), but it seems unlikely that the creditors will continue that effort unless they intend to assert that the transaction was done without "good faith," and thus can be unwound under 363(m). Otherwise, it is unclear who would pay damages if they were to prevail (Section 363(g) would protect NewChrysler).

Bankruptcy negotiation often involves tough posturing and hard line negotiating, but there has NEVER before been a situation where the creditors were crammed down by the President of the United States.

By the way, I'm not pro or anti Obama. I am, however, pro-business and I was outraged at the President's treatment of this situation.

Luckily, nothing in Judge Gonzalez's opinion creates a troubling precedent. The Administration's behavior in this matter, however, is another thing. We'll see if there is any impact on lender behavior, but it is likely that loans to union employers will be more expensive, if and when they are offered.

There is an excellent analysis of this situation, and its implication for distressed investors, on TheDeal.com site at http://www.thedeal.com/newsweekly/community/when-hedge-funds-go-to-bankruptcy-court.php.

I have written much more about this on my blog. You can find links to the Associates decision and other related items at http://blog.lawrencedloeb.com/2009/06/puzzling-commentary-by-felix-salmon.html. You can find some of my questions about Capstone's valuation at http://blog.lawrencedloeb.com/2009/06/could-indiana-pensioners-have-prevailed.html.