Chrysler’s Greedy Hedge Fund Holdouts Get It Right

Date: Thursday, May 7, 2009
Author: Ann Woolner, Bloomberg.com

You can call the plan to merge Chrysler and Fiat good for the economy. You can think it creative.

You can say it’s the start of “a vibrant new company,” as Chrysler LLC Chairman Robert Nardelli did last week.

But there’s one word that you can’t call the Chrysler bankruptcy package: legal.

The plan would overturn basic rules of bankruptcy by setting up a sort-of sale to sidestep pesky legal requirements. It would bulldoze well-established rights of secured creditors, property rights the U.S. Constitution guarantees.

So if U.S. Bankruptcy Judge Arthur Gonzalez follows the law, the Chrysler rescue plan dies. If he blinks and approves it, secured creditors everywhere should feel a shiver of unease, and quick sales of insolvent companies to avoid court scrutiny would multiply.

The other option is a settlement, and that might well be where this is headed.

I hate to say it, but the dissident Chrysler lenders are right, the ones President Barack Obama described as greedy hedge funds selfishly blocking Chrysler’s survival.

The president’s fist-waving looks a lot like the posturing lawyers use to scare an adversary into surrender, never mind the law. In fact, several are giving up the cause.

At the heart of the plan, and at the heart of the plan’s problem, is the idea that Chrysler would sell itself quickly rather than go through months or years of court-supervised reorganization.

Within 60 Days

Called a 363 sale for the relevant section of the bankruptcy code, it can close within 60 days and unload all or part of the company. The sale to Barclays of a piece of Lehman Brothers Holdings Inc. took about a day.

A 363 sale is perfectly legal when a sound business reason demands it and when it isn’t reorganization in disguise.

But if it’s aimed at resolving creditors’ claims, that is what reorganization is for. Bankruptcy reorganization promises secured creditors at least the same payout they would get if the company liquidated, and Chrysler’s proposed sale looks like a way around that.

Figuring what creditors have coming to them requires lots of paperwork and hearings. That’s why it takes so long.

Drawn-Out Bankruptcy

And that is what Chrysler is trying to avoid. In fact, it must avoid a long, drawn-out bankruptcy if it is to survive.

But with a 363 sale, there is no chance to figure the value of Chrysler’s assets if sold piecemeal, much less what each creditor should get.

The secured creditors who are complaining about this helped save Chrysler the last time it almost went under, in 2007 after the marriage to Daimler AG soured. How much of a haircut should they be forced to take?

The dissidents say the sale is nothing more than what bankruptcy law calls a sub rosa reorganization, a secret reordering dressed up to look like a sale, which the law forbids.

Plus, would it even be a true sale?

In public statements Chrysler says a United Auto Workers health benefits trust would get 55 percent of the shares of New Chrysler and a $4.6 billion note to satisfy some of the group’s unsecured claims against the company.

Paying nothing but offering its fuel-efficiency expertise, Fiat SpA would own 20 percent initially and could increase its stake by another 15 percent. The U.S. and Canadian governments, which are providing billions in interim financing, would own the rest.

Phony Sale

Chrysler is essentially selling itself to itself, says Lynn LoPucki, a law professor at the University of California, Los Angeles. He teaches secured transactions and maintains a database of major bankruptcies.

So, if the “sale” isn’t a true sale, and if it dictates payout to secured creditors, isn’t that a sub rosa reorganization?

If it favors junior creditors over senior creditors, doesn’t it violate the very basics of bankruptcy law? Senior creditors can volunteer to give up some of what’s due them but they can’t be forced to by a bankruptcy court.

“Those are property rights, and they are protected by the Constitution,” says Daniel Glosband, a partner in Boston’s Goodwin Procter. “You can’t just take them away.”

And yet, it could happen.

‘Enormous Momentum’

“There’s an enormous momentum in favor of the government plan,” says Jay Westbrook, who teaches bankruptcy law at the University of Texas.

It’s naïve to assume bankruptcy judges feel compelled to follow the law, says LoPucki.

He argues that bankruptcy courts across the country compete for the big cases by giving lawyers for major companies what they want.

“According to the law, this plan should not be approved,” LoPucki says.

Yet he predicts Gonzalez will do it anyway to persuade other companies (General Motors Corp. comes to mind) to pick Manhattan’s bankruptcy court over, say Detroit’s.

Already the Chrysler case is one for the books. You have the federal government sending a company into bankruptcy court, financing its reorganization, deciding who will get what, setting a strict timetable and urging a judge to blink at the law.

If the argument that Chrysler’s welfare is so critical to the national interest that longstanding laws can be ignored, what’s next?

Some future president will find a way to justify blatantly illegal conduct. Such as torture.

(Ann Woolner is a columnist for Bloomberg News. The opinions expressed are her own.)

To contact the writer of this column: Ann Woolner in Atlanta at awoolner@bloomberg.net.