Sunday, May 31, 2009

Reflections on Chrysler and the Adjustment of Creditors' Rights

In honor of GM's pending doom, what follows is an email forwarded to me from a friend of my older brother. He's an experienced restructuring expert. It takes a lot of the discussion surrounding the Chrysler "issue" and condensces it quite nicely.

Before we get to that, I will offer the one counterpoint that I've heard to all of this that at least gives me pause. The counterpoint is that, in the end, all of the creditors accepted the re-org voluntarily (defining "voluntary" in the broadest possible sense). Further, while there has been outrage about the UAW receiving 55% of the re-org'd company as a junior creditor, they in fact did not receive 55% as a junior creditor; in essence, the U.S. Treasury received it and chose to give it to the UAW which is completely within their rights.

Anyway, here's the excellent email I was referencing:


I’m not sure if many of you have been closely following the developments in the Chrysler bankruptcy. As a restructuring professional, this is of tremendous interest to me and many others in my general line of work. Much has been made of one of the highest profile bankruptcies in history, especially the recent negative press surrounding a group of hedge funds and other lenders (collectively the Non-TARP lenders) that initially refused to accept the proposed pre-bankruptcy restructuring plan promulgated by Chrysler and the United States Treasury. Despite all the coverage, I fear very few people actually have a reasonable understanding of what is transpiring in the case. To a large degree I think the media is focused on the wrong aspects of this case. In light of that, I felt it was appropriate to share with you my views on this situation. Please keep in mind that these are solely my opinions and not those of my employer.

I believe the outcome in the Chrysler case is a national embarrassment and a major blow to creditor rights in this country. And while I’m sure the topic of “creditor rights” is not something near and dear to your hearts, creditor rights are incredibly important to the everyday mechanics of our economy. Anybody who borrows money to purchase a house or car, or uses a credit card, is impacted by creditor rights. The rights that creditors have against borrowers who cannot pay their debts are the underpinning of lending, and credit is the fuel of our economy.

I cannot understate my personal disappointment with what has happened in this case. While the proposed transaction is presented as a sale of Chrysler’s assets pursuant to Section 363 of the Bankruptcy Code, it is clear to me that this “sale” of Chrysler to “New Chrysler” is no sale at all but instead a sub-rosa plan of reorganization that violates the rule of absolute priority by providing a far lower recovery to secured creditors than they are entitled to under applicable law. Simply put, I believe the law is being subverted.

In terms of distributions of cash from the Chrysler estate, first lien creditors stand to get $2 billion in cash, or approximately a 29% recovery on their claim, while second lien creditors and third lien creditors (most notably the United States Treasury) receive zero recovery. It should be noted that Treasury injected $4 billion of TARP money into Chrysler on January 2, 2009 for that third lien claim. Within five short months, Treasury took a complete loss on that investment in terms of the recovery it will receive from the Chrysler estate.

It should also be noted that while secured creditors are significantly impaired, the Chrysler estate will be making significant levels of payments to a host of unsecured creditors such as vendors and dealerships that rank behind all secured creditors in terms of priority.

In order to consummate the purchase of the Chrysler assets and operate thereafter, New Chrysler will receive $6 billion in funded debt from Treasury in new senior secured debt. Aside from this debt, New Chrysler will also issue a note in an amount of nearly $4.6 billion to a Voluntary Employee Benefit Association (VEBA) of the United Auto Workers. The VEBA will also receive 55% of New Chrysler’s equity. Treasury and the Canadian government will receive 8% and 2% respectively.

While I am not advocating that Chrysler be liquidated, it certainly could be liquidated for more than $2 billion even under the worst assumptions, and generate a higher recovery for the first lien secured lenders. And if for some reason that wasn’t the case and the Chrysler assets are worth something less than $2 billion, then all of the following must also be true:

(i) It makes no economic sense for Treasury loan $6 billion to New Chrysler

(ii) Depending on the priority of the note in New Chrysler’s capital structure, the $4.6 billion note to the UAW’s VEBA may be worthless

(iii) At present, the equity to be held by Treasury and the UAW VEBA in New Chrysler following the sale must also be worthless

But the reality is that Chrysler is worth far more than $2 billion. Unfortunately, because of the way this transaction is being structured, the value of Chrysler that exceeds $2 billion is not being subjected to the typical waterfall of priority, where secured creditors are paid in full (beginning with the first lien lenders) before any significant recovery is provided to unsecured creditors. Instead, the assets of Chrysler are being stripped from the Chrysler estate for a price of only $2 billion, with a significant portion of that excess value flowing to unsecured creditors (most notably the UAW).

The Non-TARP lenders who hold first lien debt objected to this treatment, and in my opinion, rightfully so. In response to their protests, they have been repudiated by various members of the press and several politicians, including, most notably, our President. Rumors are rampant concerning a variety of threats that were levied at the Non-TARP lenders. Meanwhile, the other holders of Chrysler’s first lien debt, many of which received taxpayer money under TARP, have been lauded for consenting to this transaction. It strikes me as backwards to vilify those parties that are standing up for their rights under the law while other financial institutions, buttressed by taxpayer dollars, are so willing to consent to a far worse deal than they are entitled to under the law.

And try as I might, it is impossible for me to ignore the potential political ramifications of this transaction:
- Treasury is a multi-billion dollar secured creditor of Chrysler that will take a complete loss on the capital infusion it made into Chrysler earlier this year.
- Treasury has recently provided a multi-billion debtor-in-possession line of credit to Chrysler.
- Treasury was in the middle of all of the negotiations between Chrysler and the proposed “purchaser”, New Chrysler, and it would appear that Treasury had a significant role in arriving at the $2 billion purchase price paid to the Chrysler estate in return for Chrysler’s assets.
- Treasury is providing several billion in financing to New Chrysler.
- Treasury will have an 8% ownership stake in New Chrysler.

But the UAW, a huge political supporter of the current administration (and an unsecured creditor of Chrysler), somehow gets 55% of New Chrysler. I fail to see a contribution from the UAW that justifies receipt of a $4.6 billion note and 55% of the stock issued by New Chrysler when compared to what Treasury is receiving. However, I do see Treasury on all sides of this transaction with massive potential for conflicts of interest. One would think that with all these potential conflicts that Treasury would be steadfast in ensuring adherence to the law. Unfortunately that does not appear to be the case.

Given the fact pattern, I am inexorably drawn to a few depressing conclusions:

1) Treasury is orchestrating a public taking of the Chrysler assets from the Chrysler bankruptcy estate for far less than those assets are worth and transferring them (and their value) to a new entity which has as a principal stakeholder a union that is politically aligned with those who control Treasury.

2) It is unclear what it means to be a secured creditor if this kind of treatment can occur in bankruptcy.

3) This entire problem could have been easily avoided if Treasury and “New Chrysler” had just decided to pay a fair price for the Chrysler assets from the Chrysler estate and allow those proceeds to follow the applicable waterfall of absolute priority. Relative to the amount of money that has been spent or committed to date by the administration, paying an additional $10-15 billion is essentially a rounding error. One has to be very concerned that the administration would go to this degree of public trouble over an amount that could easily be otherwise swept under the rug. Which means…

4) They will do it again.

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