Obstacles to a Quick Chrysler Bankruptcy

Editor’s Note: This post is based on an op-ed piece by Professor Mark Roe in today’s Wall Street Journal.

Yesterday, Chrysler filed for Chapter 11 bankruptcy protection in preparation for a partnership with Italy’s Fiat. President Barack Obama says he hopes the bankruptcy proceeding will be quick and efficient, done in 30-60 days. I hope so too. But a Chrysler bankruptcy has many moving parts — and with Chrysler unable to make money selling cars, it just doesn’t have enough nongovernment cash to grease those moving parts to facilitate a smooth bankruptcy. Chrysler is in worse shape than GM. And remember, Fiat has yet to offer a penny for its 20% share in Chrysler.

This could get messy and easily last longer than the 30-60 days now advertised. First off, in a bankruptcy any single creditor is entitled to get the liquidation value of its claim, under 1129(a)(7) of the Bankruptcy Code and the bankruptcy judge cannot approve a plan of reorganization that fails to comply with 1129(a)(7). So any creditor can assert that what it would get if Chrysler sold its factories quickly would be more than the 32 cents per dollar that Treasury had guaranteed Chrysler’s secured creditors before the government deal fell apart this week.

Valuation proceedings are notoriously difficult in Chapter 11. Although the judge doesn’t actually need to liquidate Chrysler, the judge must determine what it would have gone for if there were a liquidation. Some creditors appeared ready to bring that case to the bankruptcy judge. While the judge may in the end conclude that Chrysler’s liquidation value is less than the 32 cents the creditors would receive, with public estimates now varying substantially, a valuation hearing if brought, and if not suppressed with a quick estimate from the judge, is not likely to allow the proceeding to close within 30-60 days.

On top of liquidation value, the whole class of secured creditors is entitled to the fair value of their claims for any deficiency portion not satisfied by the value of the security. Usually that value is greater than liquidation value, though Chrysler may be an exception.

The government thinks the additional value issue will be resolved easily. That’s because in a bankruptcy proceeding the creditors whose claims amount to two-thirds of the total amount of debt can bind the rest to take the deal. Indeed, the judge doesn’t have to figure out whether value is fair, if the class of creditors votes in favor. And since two-thirds have already raised their hands in favor of 32 cents on the dollar, it seems to be a done deal.

But this time it might not be so easy. Not all of those who’ve already raised their hands in favor prior to bankruptcy, especially the smaller investors, will still be raising their hands inside Chapter 11. They can change their mind, and some just didn’t want any negative publicity before the bankruptcy.

Worse, there could be a legal fight over whether the vote of Citibank and the other “big four” creditors — J.P. Morgan Chase, Morgan Stanley and Goldman Sachs, who together hold 70% of Chrysler’s debt — should be counted toward the two-thirds threshold that would bind the company’s other 42 creditors. The Bankruptcy Code requires that the votes of creditors be given in “good faith.” It won’t be hard for the smaller creditors to argue that Citibank and other TARP recipients’ votes aren’t in full good faith. In agreeing to Treasury’s offer of 32 cents for each $1 of their debt, the objectors would say, Citibank and some others were influenced by the fact that Treasury was keeping them afloat with federal subsidies. If this type of litigation begins, it won’t be easily resolved.

Meanwhile, Fiat will want to rationalize Chrysler’s bloated dealership network. Indeed, this once seemed a core aspect of any effort to reconstruct Chrysler, so the last day’s focus on a few secured creditors seems misplaced. If the dealer network had to be downsized to reflect Chrysler’s declining sales, and if that downsizing could realistically be done only in bankruptcy, then the recent media focus on the hold-out creditors might have been a bit of a diversion. But, regardless, we shouldn’t expect terminated dealers to go quietly. They’ll argue that their contracts can’t be easily rejected by a bankruptcy judge because they’re protected by state franchise laws. And in any event, they are entitled to some form of payment (reduced or otherwise) as damages if Chrysler terminates their dealership contracts. The damages would be paid in reduced bankruptcy dollars, because the terminated dealers would be just general unsecured creditors, but if there’s value in Chrysler beyond the secured facilities, this could itself be more than a 30-60 day problem.

If the bankruptcy court could sell Chrysler’s core operations intact, many of these bankruptcy frictions could be left behind. That would be the best operational outcome, but it’s not clear that there’s any real buyer right now in the plan — Fiat is prepared to take a major stock position in a reorganized Chrysler, but it doesn’t seem ready to pay any cash for it. Sales of divisions of a bankrupt firm are common in bankruptcy and often the best solution. But these kinds of sales typically are done via an auction, where other players can outbid Fiat. If Fiat isn’t paying anything, then it may be easy to outbid. The question then would become whether the judge would be willing this time to forego a real auction. Moreover, there’s a residual question of whether a 363 sale that precludes 1129 determinations such as creditor consent, bargaining, or judicial cram-down if a bargain isn’t reached is a proper use of 363. That kind of preclusive effect might be in play by a sale that allows only one result, such as, say, with the government’s $2 billion flowing into to a shell of the old Chrysler without an auction, with there being no other significant assets or liabilities in the old shell, because everything else moved over into the new company. Some courts have said now that it must be a real sale that doesn’t determine the rest of the reorganization. A pure sale of Chrysler’s operations for cash or similar consideration would typically not be preclusive. How much more the parties can add on to a straight sale and still keep the sale a valid one under 363 is potentially a substantial issue.

Perhaps a Chrysler bankruptcy would be different, and none of these issues will emerge. They might not emerge because of the weight of the US government in influencing key players, including the bankruptcy court accommodating national policy. But if it were otherwise, and if questions of federal economic and political policy were not in play, these issues would be real and, if they emerged, couldn’t readily be resolved in a 30-60 day bankruptcy.

If Chrysler could make cars that more people wanted to buy, bankruptcy would be much easier — and possibly not necessary. But that’s not the case, so figuring out who will bear what amount of the losses will take place in a bankruptcy court, where too many players have leverage under the law, and where the reality of Chrysler’s weak operational prospects makes a fast and easy resolution unlikely if the company’s operations can’t be quickly sold intact.

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One Comment

  1. Doug Park
    Posted Tuesday, May 5, 2009 at 12:27 am | Permalink

    I would like to expand on a few of Professor Roe’s points.

    1. Fiat has not offered a penny for a 20% share in Chrysler.

    There is no guarantee that Fiat will make an offer for a stake for Chrysler. Fiat is strongly considering buying a large stake in, if not all of, GM’s Opel. In many ways, Opel may fit better with Fiat because Opel’s main market is Europe, as is Fiat’s. There may be fewer post-acquisition integration issues in a Fiat/Opel partnership than in a Fiat/Chrysler deal. Fiat could easily decide that taking a stake in Chrysler does not make sense. No other buyer has expressed an interest in Chrysler.

    2. Chrysler does not make cars that people want to buy.

    This is the underlying problem for Chrysler. Chrysler has been going down this road for at least 10 years. As a recent Harvard Business Publishing piece argues, the best business model is to make insanely great stuff. http://bit.ly/SqjVA . Unfortunately, it’s been a long time since Chrysler has made great cars. Bankruptcy may ease Chrysler’s debt obligations, but it won’t make Chrysler’s cars any better.