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Some critics say the automakers are structuring their bankruptcies as sales in an improper way.
Alix Stuart, CFO.com | US
June 9, 2009
After years of speculation and months of high drama, automakers Chrysler and General Motors finally declared bankruptcy. Or at least that's what they want you to think. According to some bankruptcy experts, the process the car companies are using to shed their debt runs afoul of the law and could potentially further worsen the credit crunch. In light of Supreme Court Justice Ruth Bader Ginsburg's ruling yesterday to delay indefinitely the sale of Chrysler's assets to Fiat, their arguments may have added weight.
The government is "end-running the Chapter 11 process" by structuring the bankruptcies as sales, says Lynn LoPucki, a law professor at both UCLA and Harvard law schools. Both Chrysler and General Motors are invoking Section 363 of the bankruptcy code, through which they can sell off their companies without getting approval from all of their creditors, to rid themselves of obligations. One of the chief benefits of the approach is that it should get them out of bankruptcy fast - likely within 30 to 90 days - but "it's improper, because creditors are not getting the legal procedure allowed to them by Congress," says LoPucki.
And that could scare off lenders in a wide variety of future situations, say some experts. "The reason America has always been the most welcoming place for loans is because everyone knows what their downside is, since we have the most well-established set of bankruptcy codes," said Peter Kaufman, president and head of restructuring and distressed M&A for the investment bank Gordian Group, in a recent teleconference sponsored by the American Bankruptcy Institute. "Now all that has been turned on its ear."
In a classic bankruptcy filing, a struggling company submits a plan of reorganization to a bankruptcy court for approval. The court then generally solicits input from creditors and lenders, so that divvying up the company's available assets is a negotiated process. Pre-packaged bankruptcies follow the same process, but the company gets the necessary approvals before submitting the plan to a judge, speeding up the timeframe. In a 363 sale, however, a company does not need to submit a plan to the court, but rather sells assets to a buyer in an expedited process that does not require buy-in from any of its debtors.
Such 363 sales are not unusual, say experts. But the fact that in the two auto bankruptcies, the "buyer," or at least a major creditor, is in fact the government, is what makes them different and potentially "sub rosa," or unfair. A group of Indiana pension funds that had purchased secured debt last year is currently challenging the Chrysler sale on those grounds, since the funds would stand to get less from the deal than junior unsecured debtors, including the United Auto Workers union. On Monday, Justice Ginsburg ordered the sale of Chrysler assets to Fiat to be put on hold indefinitely, while the Supreme Court considers the funds' challenge.
To be sure, some experts view the Chrysler and GM bankruptcies as giant exceptions to the rule that stemmed from extraordinary circumstances that are unlikely to be repeated. "To view these as precedent for anything else is overstating the case," said Schuyler G. Carroll, partner in the bankruptcy and financial restructuring group at law firm Arent Fox LLP, in the ABI teleconference.
But the very fact that the government has gotten involved in the automaker deals may scare some lenders off from future deals with any similarities, Kaufman said. The GM situation - in which unions are also being preferred to bondholders - is "going to make lenders incredibly wary of putting their money in when there's a union or potential policy concern involved. It's only a special case until the next time it happens."
On the flip side, companies already on the brink of bankruptcy may benefit from the Chrysler and GM situations, assuming the sales proceed. Nearly any corporate reorganization can in theory be viewed as a sale, according to LoPucki, a fact that more companies are likely to seize upon in the wake of the automaker filings. Gordian Group's Kaufman, for one, says the structure will be among the options he advises directors and officers of distressed companies to consider. "If you're trying to encourage capital providers, [the 363 sales are] a disturbing trend, but if it's there, I'd like to take advantage of it," he says. "We're certainly going to see how far we can push that envelope."
For now, it's unclear how the bankruptcy courts will rule in other cases, when the government isn't the major creditor. As a longtime critic of the bankruptcy courts, though, LoPucki expects judges to rubberstamp this 363 approach freely, to the detriment of other creditors and lenders. "I'd be surprised it if didn't happen," he says.