But some eras are better than others. Interestingly, Skeel has a new piece up at The American arguing that, at least on this front, the New Dealers improved bankruptcy--and that the administration's recent actions represent a throwback to a less happy era:
In the early 20th century, large troubled corporations did not file for Chapter 11 like they do today. They used a process known as "equity receivership," which involved an artificial "sale" of the company to a new entity set up by the debtor and the investment banks who represented its bondholders and stockholders. The new entity was the only bidder at the sale, and creditors who were unhappy with the terms of the reorganization had very little opportunity to interfere.
New Dealers hated the process, which they saw as opaque and designed to foist a deal crafted by the insiders on everyone else. Jerome Frank, a lawyer who later headed an important New Deal agency and became a federal judge, complained in 1933 that the judicial sale in these cases "was a mockery and a sham." He said, "A sale at which there can be only one bidder, is a sale in name only." In 1938, thanks to the handiwork of another prominent New Dealer, future Supreme Court Justice and then-SEC Chairman William Douglas, Congress dramatically altered the bankruptcy laws, eliminating the former practice.
'A sale at which there can be only one bidder, is a sale in name only.'The Obama administration blueprint for Chrysler's bankruptcy looks startlingly like the artificial sales that the New Dealers so abhorred. Unlike a traditional reorganization, in which the parties negotiate the terms of a restructuring that is then voted on by each class of creditors and shareholders, the administration plans to quickly sell Chrysler's most important assets to a new entity--"New Chrysler"--whose stock will be owned by Chrysler's employees and Fiat. The senior lenders who objected to the government's offer (which amounted to little more than 30 percent of their claims) will not have any vote on the sale. Their only option is the one they have pursued: objecting to the sale, and praying that bankruptcy judge Arthur Gonzalez takes a hard look at its terms even while the government is breathing down his neck and saying in a sense, he better approve or else.
What makes the Chrysler plan unique is that it is a pretend sale and its main purpose is to eliminate the pesky creditors who might otherwise interfere with the government's plans.
As the administration has pointed out in defense of its plan to commandeer the bankruptcy process, asset sales (known as 363 sales, based on the relevant provision) have become a common feature of Chapter 11 cases in the last 20 years. What makes the Chrysler plan unique, and makes it similar to the receiverships of the New Dealers' era, is that it is not really a sale at all. It is a pretend sale and its main purpose is to eliminate the pesky creditors who might otherwise interfere with the government's plans. It also seems to flout bankruptcy's priority rules by giving Chrysler's employees (who are general creditors) a big stake in New Chrysler while forcing senior lenders to take a major haircut. The usual rule is that senior creditors must be paid in full before lower priority creditors are entitled to anything.
I've interviewed Skeel for several articles, and he can't plausibly be termed a right-wing lunatic axe to grind; he has flexible and nuanced views of the bankruptcy process with a healthy respect for the benefits of a debtor-generous system, as you'll discover if you read his book. If he thinks this is rather dangerous precedent, it probably is.
Bankruptcy is often portrayed as a question of creditors v. debtors, and of course that's not a ridiculous frame. But just as important is the tension between insiders and outsiders. This conflict has existed for as long as we've had insolvency, and it doesn't match up to the creditor/debtor divide. In fact, you might think of it as another axis, with four quadrants.
I suspect Obama views his administration's actions as moving along the X axis towards a more debtor-friendly system. But in fact, Chrysler, not the UAW, is the debtor, and it's not likely the company would have ended up in liquidation. The administration's actions weren't debtor-friendly, they were insider friendly. This was classic collusion among creditors, and it's why the parts of the bankruptcy law that deal with Section 363 sales spend so much time talking about the importance of avoiding sham transactions. Cutting back on that sort of abuse was at least as important an achievement as giving debtors a fresh start.
There are, of course, changes that both benefit outsiders and debtors. Britain's recent move away from letting senior secured creditors appoint their own receivers increased total recovery from the enterprise (though, to be fair, it also increased administrative costs.) On the other hand, France's new debtor-friendly bankruptcy law has apparently made it nearly impossible for creditors to get insolvent companies to the table--nice for the companies, but bad for the creditors, and probably bad for anyone who would like to borrow money in the future. American bankruptcy works so well precisely because it provides an orderly process that everyone has to participate in, where no one group's interests are paramount.
Update: Weirdness fixed, I think.
You've got an odd duplication of this post.
Britain's recent move away from letting senior secured creditors increased total recovery from the enterprise (though, to be fair, it also increased administrative costs.)
I think you're missing one or more words after creditors, because I cannot make heads nor tails out of that sentence.
And in news of another bankrupt entity, Fannie Mae announced that it LOST 23 BILLION BUCKS in the last quarter - making the losses at car companies look like chicken feed.
http://www.businessinsider.com/why-the-media-ignores-the-400-billion-fannie-and-freddie-bailout-2009-5
Media Still Covering Up The $400 Billion Fannie And Freddie Scandal (FNM, FRE)
"This morning, Fannie Mae (FNM) announced that it had lost another $23 billion in the quarter, and would have to call down $19 billion more in taxpayer support. It also said that it would face losses as far as the eye can see.
Do you know how much we've committed to backstopping Fannie and its partner-in-crime Freddie Mac (FRE)? $400 BILLION! Back in February that was doubled from the original $200 billion.
But the news of the quarterly loss is getting hardly any attention. Nothing here at the NYT business section, for example. Nothing at the blogs that were going nuts when AIG was revealed to have paid out bonuses back in March.
The problem is that the Fannie and Freddie disasters don't fit into any conventional media narrative. At AIG you had Joe Cassano, lurking in the shadows, turning AIGFP into his own personal casino, while taking home gargantuan pay."
Judge Gonzalez put the company up for open bid as I understand it. If somebody wants to pay more than the $2 billion that the Government is offering for Chrysler then it's theirs presumably. Politically, this might have to be mediated by a non US entity.
That is my understanding, too, but the compressed time schedule is going to make it very unlikely anyone puts forward a real bid for the simple reason that no one is going to have the time to examine and analyze the financial condition of Chrysler, and that is assuming they would even get real cooperation from those now managing the company.
However, this is still an improvement over what the Administration was attempting to do, and the holdouts, if they wish to continue contesting this, can still appeal. Personally, I have doubted they could recover more from a liquidation or a competitive bid- there is simply no way that this piece of shit could ever be profitable again. The government has just committed itself to continuous payments to the Big Three (Ford will be there, too- you can count on it).
Personally, I have doubted they could recover more from a liquidation or a competitive bid- there is simply no way that this PoS could ever be profitable again.
What does that have to do with the senior secured debtor's recovery? IIUC, there are unsecured creditors getting money / assets out of this, ahead of the senior creditors. the only fix that's needed is to take that money / those assets away from the unsecured creditors, and give them to the senior ones.
IOW, the only reason that President Obama's desires are being substituted for the law is that that is what President Obama wants, and various people and institutions that should be protecting the rule of law, are instead rolling over for him.
What do you know differently?
The unsecured creditors are not getting money ahead of the secured creditors. The bidder willing to pay the highest price to the secured creditors also - for entirely uneconomic reasons - wants to give additional money to the unsecured. The secured creditors are receiving the best deal they can, and if another party was willing to come in and offer more to them than what the government is offering, they could knock the government out.
I'm not trying to defend the entire transaction - it's certainly a give-away by the government to the Unions, and we're kidding ourselves if we think that Chrysler II won't be back at the public teat again soon - but the rights of the secured creditors and the law are being respected.
Vermando,
I'm sorry, but that makes no sense. Here's why:
Assume I'm a 2nd bidder for Chrysler. My bid is 1% higher for the secured creidtors, and absolutely nothing for the unsecured creditors. Will my bid beat the Obama Administration's bid?
If yes, then you're fine. but if no, the Obama bid is "higher", then it's because the money going to the unsecured creditors is considered part of the bid.
And if it's part of the bid, then the secured creditors are supposed to be first in line/
I thought the company was being sold to Fiat, not the Government. No?
So is the Obama Administration buying Chrysler, then giving it to Fiat?
Yes, Fiat isn't putting up any money, only the promise to manage the enterprise, provide their technology/ product as it might fit with Chrysler's potential offerings and dealerships. An odd factoid is that the last time Fiat was in the US, ~ 1970-77, it was FDR, Jr who controlled the US operation or its Northeast states segment.
Thanks for following up on the Chrysler bankruptcy case. I find it disturbing that this case has not got much attention that it deserves. I agree with you that the process is the issue here. Without government intervention Chrysler will be liquidated (which is probably the best outcome for all around except UAW and the lenders) so the government is in the position to dictate terms. However it should have dictated it in favor of the taxpayers and negotiate with lenders on commercial terms. Afterward it can transfer the negotiated interest to the UAW if it so desires but that would be a political process. Now in the name of expediency it is mixing the political step (transfer to UAW) with the commercial one (negotiating with lenders) and creating an image of favoring junior creditors over senior lenders.
So who does this hurt the most? Ford, of course. For one Ford will have a limping competitor with reduced debt load and government financing. If that is not enough, the bankruptcy process has got to make Ford lenders (who are all secured as Ford mortgaged everything) think twice about the security of their collateral. When time comes for renegotiating their credit facility (if Ford can last that long) some (at least the non Tarp ones) will have to think hard about renewing their commitment.
Cui Bono? That's easy - the lawyers. I once had a friend who worked as a receptionist for Drexel. Ten years after liquidation they were still feeding off the corpse.
I like the post. The only reason I'm hopeful this won't be a trend is because this transaction is peculiarly special for two reasons:
1) It's collusion amongst the creditors, but with one creditor - the government - willing to act with complete economic irrationality. The secured creditors are still likely receiving the best deal they can, but the preferred insiders are getting such a good deal because the government is willing to take such a bath. I don't think that many other creditors will be this generous.
2) Reason 1 is not so comforting if one believes that the government is going to be doing this a lot, but fortunately this is not the first time that the government has taken such action for the car industry, and their benevolence has always in the past remained limited. If this industry were playing by the same rules as everyone else all of the companies would have been bankrupt a long time ago. The government has helped them stay afloat, not just through near-bankruptcy subsidies, as with Chrysler years ago, but by strong-arming lower-cost importers in trade wars. It's disgusting and a good lesson about what happens to an industry when it receives such protection, but as of yet these maneuvers have remained auto industry exceptionalism and have not spread to the broader economy.
3) This only works, in part, because of the financial crisis. The administration may have preempted a more generous Fiat bid, though that seems unlikely given that they're not putting up a dime, but otherwise, the whole deal falls apart if someone could come forward and purchase the thing. As has been pointed out, Jeep alone is likely worth ~$4 billion in a good market, so this would normally not be that unlikely. However, the global car industry is reeling, so the value of all makers is depressed - especially given that Jeep and Chrysler aren't even the only lines desperately shopping right now - and few buyers who might normally be interested are in a position to make a bid. Likewise, private shops are having trouble getting credit right now. So, I would hope that in a normal economy this type of deal would not be possible since the bidding requirements - which are generally being complied with here - would prevent it.
Those are my reasons to hope that this remains a single act and does not become a precedent. If it spreads, then I think your post is entirely accurate in identifying some of the many problems which arise.
"The secured creditors are still likely receiving the best deal they can,..."
Shouldn't that be for them to decide?
Under bankruptcy law, no, it's not. The protections of this portion of the bankruptcy law are procedural - the fair bidding process - not substantive.
This portion of the bankruptcy code was created in part to handle exactly this type of situation - a small group of creditors with, from a voting perspective, a blocking position holding out to gain a better deal for themselves in a way that harms the creditors and enterprise as a whole. Yes, we want senior creditors to pursue their legal rights, but we don't want them doing it in a way that allows them to use the threat of destroying a large mountain of wealth to gain a bigger piece of the pile for themselves. Getting around them is not a breach of the rule of law or an usurpation of their rights - it is the purpose and proper functioning of this portion of the bankruptcy code.
The troubling aspect of the deal is not the use of the bankruptcy code but the government's involvement - if Fiat had been willing to offer the secured creditors a better deal, then the government effectively usurped their right by stepping in as a partner. There is no indication that this happened - and the fact that no other company ever expressed a peep of interest in making a bid, even before the government stepped, indicates that there likely was no such bid in the market - but we don't know for sure, so injustice still could have been done through that mechanism.
Otherwise, there is no violation of the rule of law here, nor, from what I can tell, is there a subversion of the bankruptcy code itself or the rights of the secured creditors.
You seem to suggest that the majority of the secured debt holders are just pleased as punch with the deal, and that the holdouts are a bunch of cranks who are just standing in the way.
If this had proceded in a normal bankruptcy, sans govt involvement, I believe most of them would be saying the same thing as the 'crank' minority.
let's try a nice counter-example:
A company is going bankrupt, to the point that the employees haven't been paid for their last six weeks of work. Along come a bidder. He wants the equipment and buildings, some of the managers, and the good will of some of the previous owners. But he couldn't care less about the current employees. So the bidder offers to pay enough so that, if it all went to the employees, it would pay all their back wages. However, the bidder structures the offer so that 30% goes to pay for the buildings and equipment (this gets split among the employees), and the rest is a gift he's giving "for entirely uneconomic reasons" to the employees he cares about, and the former owners.
Think a bankruptcy court will let him get away with it?
Vermando,
You post is consistent with the proposition that this violation of the law - and violation of the rule of law - won't happen again, unless the reigning political administration decides to do it again. The political class has not risen up in protest, and neither has the media or the legal culture.
No, I'm saying that:
1) This is not a violation of the law and
2) This is exceedingly unlikely to happen again.
On the first point, how is this a violation of the rule of law vis-a-vis the secured creditors? The complaint is that the government is paying monies to the less senior creditors that it could pay to the more senior, but there is nothing illegal about that.
Think of it like this - suppose that instead of this route they had decided to sell off assets of the company. And suppose somebody had made a $2.5 billion bid for Jeep. Swell. Now, suppose that bidder realized that he would need the cooperation of certain less senior creditors in the future. So, in addition to his $2.5 billion bid he also announced that he's going to pay $1 billion extra, one third to creditors who would go bust if he didn't make them whole, one third to powerful creditors whose cooperation he thought he would need in the future, and one third to employees so that they did not leave the business and to buy some good will for the next round of labor negotiations.
That is completely legal.
Now, you could complain if there was another bidder willing to pay $3.0 billion for the company straight up. It would be wrong for the original bidder to count his extra billion in his bid price, and you could argue that the company, on behalf of the senior creditors, would have to accept the $3 billion in place of the $2.5 billion + $1 billion.
But that's not what's happening here. There is no other bidder. Nobody else is willing to pay for this company right now. The government is the $2.5 billion bidder. It is the high bidder. If the company would say that it could not pay the extra $1 billion the way it wants, it would walk.
A high bidder that buys an asset can do with it what it pleases, including making creditors that it wants to please for the future whole, so long as it is the high bidder. It is not illegal. We are wrong to say it is.
When AIG was bailed out, the Fed arbitrarily took a majority stake which gave it both the controlling interest in the company's affairs, and a means of liquidating that stake to return the money once the economic situation has stabilized. The TARP money came to the banks with specific application requirements that could reasonably be expected to address the situation at hand, plus executive compensation limits. If a bailout is truly necessary, that kind of behavior is at least credible, and is probably best outcome for a bad situation.
The Chrysler deal, meanwhile, apparently has neither of these features. If the shell of Chrysler has a viable business or valuable assets inside that cannot be sold at a plausible market rate due to a perfect economic storm, then let the administration behave as per the above precedents. If not, then a liquidation bankruptcy is unavoidable and overdue. The continued governmental dumping of billions into the company, and the unnaturally favorable terms to the UAW, has every appearance of Obama playing money fairy to a favored constituency with a taxpayer-backed checkbook.
You're wrong. This is a sub rosa plan that does an end run around the absolute priority rule. http://www.bankruptcylitigationblog.com/archives/bankruptcy-in-the-news-chrysler-bankruptcy-analysis-part-iii-will-the-absolute-priority-rule-kill-the-sale.html
downfall, as I read the bankruptcy litigation blog, I momentarily sniff a Democratic target when I read of the Eastern Airlines bankruptcy where a union coddling judge led to a reduction of the value of the assets by prolonging the time to termination of the entity. I think you have to imagine some inverse process here where continuing the entity in it's present form with government assistance might get the creditors to a better deal. What bothers me more is the USSRization of the process where the 'speculators,' formerly known as kulaks, are told to shut up lest you get in touch with your 'inner polar bear' in Siberia as those who know what is good for them are working on production. This doesn't encourage other kulaks/ bankers who need not to be found in fault on some rule to 'kick the tires' and make a bid, a reticence which may find repeated applicability. This situation as a deal is like the parable of the workers in the vineyard where those who started working at break of day get paid the same as the late hired. Frankly, like Ed points I think it's hard to know what massive commitment of 'full faith and credit' of the treasury is most worrisome. Where are our principles of triage?
Vermando,
If you were to declare bankruptcy, and before you did it you preferentially paid off some of your creditors, the other creditors could challenge those payments in bankruptcy court, and get the money redirected to themselves.
how is your claimed situation any different than that?
Why is this a surprise to anybody? I learned years ago that liberals don't really care about equality and fairness, they only care about who is imposing the inequities. If it is private individuals making choices in a private market, they are against it. If it is Governemnt, they are for it. It does no good trying to reason with them. You can demostrate far greater inequities under Government and they still won't change their minds. Doubt me, look at the public school system. Any attempt at improving the educational quality of poor people through semi free market solutions, are squashed. The liberal would rather maintain the inequalitiy rather than entertain the idea of decreasing government control. Government is their religion. They sleep better at night knowing that Big Government is watching over them.
The right's love affair with big govt resides in the pentagon, which is just "govt for non-usa zones" - and let's not forget that conservatives and liberals in the usa (as represented by the Democrat and Republican parties ) are both at the centre, with not much difference between them - on another note, has anyone in the usa made the observation that the auto bailout amounts (substantially) to a regional bailout (michigan/ohio/pennsylvania/etc.) by the usa central govt - this is what drives me nuts in canada when i see it, and i wonder why i don't see similar objections in the usa media