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GM, Chrysler and Ideologically Selective Bankruptcy Formalism

posted by Adam Levitin

James Sherk and Todd Zywicki have an op-ed in the Wall Street Journal that kvetches about the unfairness of the Chrysler and GM bankruptcies.  As one might expect, their complaint centers upon the contention that the senior lienholders in Chrysler get 29 cents on the dollar, while the UAW VEBA received a superior treatment despite holding a general unsecured claim.  They also allege that the UAW didn't make serious concessions in the bankruptcies, and that GM unnecessarily assumed the UAW pension obligations of its major supplier and former subsidiary Delphi. All of this, Sherk and Zywicki calculate, cost taxpayers $23 billion unnecessarily.  

There are two problems with Sherk and Zywicki's argument. First, it plays fast and loose with the facts, and second, it makes a number of heroic assumptions.

The Chrysler Distribution:  the Facts

Let's start with the facts. You would never know from reading Sherk and Zywicki, but the UAW got nothing, zilch, nada in the Chrysler bankruptcy. There was no distribution whatsoever to the UAW in the old Chrysler liquidation. That means that there was no "preferential treatment" of the UAW in the bankruptcy.  Absolute priority was observed to a punctilio of honor the most sensitive.

Sherk and Zywicki Look Outside of Bankruptcy...Selectively.

Sherk and Zywicki's argument is instead based on the fact that the UAW VEBA was given an ownership share in the New Chrsyler entity that purchase the good Chrsyler assets as well as an unsecured medium term note for a few billion. The value of this ownership share and note are uncertain, but they are certainly value. But it is not value that was given in the bankruptcy and it was not taken from the Chrysler lienholders. It is value that was given outside of the bankruptcy by Fiat and the US and Canadian governments as part of a labor deal with the UAW that brought Chrysler's labor expenses into line with the rest of the industry (with 50% compensation reductions for new hires...). Sherk and Zywicki may not like that deal, but it is hardly apparent that it was an unreasonable deal for Fiat and the US and Canadian governments to make. In any case, since when did the Wall Street Journal op-ed page publish heretical articles questioning business judgment or the working of the free market (for that is what the Chrysler deal was)? 

Now, readers might reasonably object that I'm being unduly formalistic in separating the UAW VEBA transaction with New Chrysler from the bankruptcy; after all, the only reason New Chrsyler was formed was to acquire assets in the bankruptcy. That's fair. But if we're going to set formalism aside, then we need to take a holistic view of the Chrysler restructuring, in which bankruptcy was just the final chapter. In 2007, the UAW negotiated a deal with Chrysler in which Chrsyler agreed to fund a VEBA in exchange for being released from pension and retiree benefits. The UAW took a 40% haircut in the deal. Surely that needs to be part of the calculus. 

So too should be the fact that some of the senior lienholders bought their claims in the secondary market at a discount--something close to the 29 cents they received. And we should also note that the senior lienholders supported the asset sale to New Chrsyler. The objecting Indiana pension fund (a secondary market purchaser) failed to abide by the majority vote of the loan syndicate into which it had purchased. In short, the only folks who seem agrieved by the Chrysler bankruptcy are those with an ideological ax to grind against labor unions.

Unless Sherk and Zywicki are making the heroic assumption that there was another deal possible than the ones reached in Chrysler and GM, it's pretty hard to complain about the deals that were reached. There were no other bidders and the liquidation alternative would have been pretty horrific, as discussed below. There's a reason that the GM and Chrysler senior creditors supported the deals and that the bankruptcy courts approved them. 

Sherk and Zywicki Ignore the UAW's Pre-Bankruptcy Concessions

Sherk and Zywicki are upset that the UAW didn't make the major concessions in the bankruptcy. They'd like to see the union take a bigger hit. But they completely ignore the UAW's pre-bankruptcy concessions. It surely cannot be a serious compliant that the UAW's concessions (which were quite major) occurred before bankruptcy, rather than during bankruptcy. That's basically arguing that the UAW should have forced the companies into bankruptcy.  The bankruptcies were simply the last step in a restructuring; the legal procedure was simply being used to shed the legacy assets and deal with bondholders, tort, and tax claimants who can't be disposed of so easily out of court. A bankruptcy prof like Zywicki surely knows that bankruptcy is only one tool in the debt restructuring toolbox and often the final step in a larger process. 

It Makes a Lot of Sense for GM to Assuem Delphi UAW Pension Obligations If That Keeps Delphi in Business

I can't address the assumption of Delphi's UAW pension obligations with certainty, but keep in mind that Delphi is GM's main supplier. There is a co-dependent relationship between GM and Delphi. As far as I can tell, the asset sale in Delphi's bankruptcy occured subsequent to GM's assumption of the UAW pension obligation. If so, it may well have been a necessary precondition for the Delphi asset sale, which was the key final piece of the Delphi restructuring. In other words, GM may have assumed the Delphi UAW pensions to ensure that Delphi would continue to exist and supply it. Auto parts are not quickly or easily resourced, so ensuring the continued viability of a key supplier seems like a pretty reasonable business move, rather than some nefarious crony deal. 

$23 Billion Was a Reasonable Price to Pay for Peace of Mind

Finally, this sort of hindsight second-guessing is pretty ridiculous. The Obama (and Bush) Administrations could certainly have done some things better in the automanufacturers' bankruptcies. (The sale procedures, for example, had unnecessary but almost assuredly benign restrictions, for example, that have only given ammo to ideological critics of the bankruptcies. And Chrysler should have made provision for future claimants.) But they were working in conditions where it was better to be safe than sorry. And if that meant being a little too generous to ensure that the deal went through, then that's the price we have had to pay to have peace of mind that there is something still left to America's industrial base. For remember, the failure of either GM or Chrysler would not have been contained to just that company. The failure of either would likely have resulted in the failure of the other, as well as Ford because of shared single-sourced suppliers that would have failed without business from one of the big three. And that in turn would have triggered a cascade of failures up and down the auto manufacturing industry, both among part suppliers and among other OEMs. Nissan, I'm told, was extremely concerned of the impact of a Chrysler liquidation on its ability to manufacture cars in the US. Would Sherk and Zywicki really have wanted to gamble on the fate of the US industrial base? Or is this just ex-post ideological posturing? 

Comments

I am sure Professor Zywicki would not change one word of his article . . . no matter how wrong it was.

Your point about the transfer occurring outside the Chrysler chapter 11 is important. It is perhaps to be expected that the same crowd who often argues that contractually complex structures must be respected on issues such as collapsing LBOs in fraudulent transfer obligations or substantive consolidation suddenly insist on looking past the contractual formalities when it suits their conclusion.

I agree with what you have written as a description of those bankruptcies. The supposedly injured creditors had a right to top and chose not to. So whatever bid was out there to keep the enterprise alive won, warts and all.

I wish to point out that these facets are utterly representative of 363 sales generally. For that reason, I don't think the government violated any of the prevailing norms of large-scale chapter 11 practice. But also, I hope you will recognize that and see the implicatins of what you just wrote vs your position on 363's, which I think is fairly described, to borrow your own words, as "bankruptcy formalism". Right? You're not making any arguments about no formal disclosure, no formal vote, etc.

363s are an excellent tool for preserving going concerns fast and at fair market value and should be recognized as such.

Bob and AMT are both exactly right, but what do you honestly expect from Heritage and George Mason? John Q. Taxpayer is the backstop for these busted pensions anyway; how can transferring any part of the liability anywhere else not be seen as a positive for John Q.?

mt--I'm not opposed to 363 sales. I think the next major bankruptcy law overhaul will need to better reconcile 363 procedures with 1129 plan confirmation procedures. How is another issue.

The other thing to note about 363 is that not all 363s are the same. Some are quick and fast and happen shortly after filing. Others (like Delphi's) only occur years after filing, which makes the speed point less salient.

"In the following days, the lenders began to realize their leverage was small and dwindling. Only the government had the ability or willingness to finance a bankruptcy reorganization of Chrysler, while also supporting its warranties and suppliers and recapitalizing Chrysler Financial. None of the lenders, some of which had consumer operations in the Midwest near Chrysler plants, had any desire to take over and liquidate the company."
(quote from linked cite)
http://epicureandealmaker.blogspot.com/2009/05/more-of-kickin-sitcheyation.html

The secured lenders are LUCKY to be getting their .29$ on the dollar, since without the government, GM & Chrysler would have been liquidated since these secured lenders were not going to finance the ongoing operations.

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