I was talking to an old friend last night about the Chrysler bankruptcy and, in particular, whether Chrysler (and Treasury, and the UAW) will be able to get around the order of priority of creditors in bankruptcy – which ordinarily would favor the senior secured lenders who are trying to block the proposed plan. I thought I would do a little research, but then (again via Calculated Risk) I found Steve Jakubowski’s analysis of precisely this issue, which apparently everyone on the Internet has already been linking to. It’s actually Part 3 of a series; you may want to start with Part 1.
My summary, for those who don’t like reading citations from court opinions: The issue with the “restructuring initiative” agreed-upon by Chrysler, the government, Fiat, and the UAW, is that it only pays the senior secured creditors $2 billion in cash for $6.9 billion in secured debt; since secured creditors’ claims should come first, they argue they would get more from a liquidation. In particular, the VEBA created to fund retiree benefits is owed $8.5 billion; it is getting $4.6 billion debt and 55% of the equity in New Chrysler.
The government’s plan is to get around this by creating a new entity, New Chrysler, and having the existing entity, Old Chrysler, sell its assets to New Chrysler. Technically speaking, Old Chrysler is not being reorganized; it is just selling assets. However, as Jankubowski explains, a bankruptcy court can block such an asset sale if it is effectively a reorganization by another name. The Second Circuit (the appeals court that would hear the appeal of the bankruptcy proceeding) has said that such an asset sale may go ahead if there is a “good business reason” for it – a test that is spelled out, not entirely clearly, in other court opinions.
Behind the legal test, the underlying legal principle at issue, discussed in Part 3, is whether the “absolute priority” rule, which determines the order of claims by creditors in bankruptcy, prevails over the general policy consideration that bankruptcy is intended to enable companies to return to healthy operations. To simplify greatly, Chrysler and the government’’s argument is that without the “asset sale,” the company will simply disintegrate; the creditors’ argument is, or could be, that that doesn’t matter.
If you want to know what corporate law is like, I recommend reading the posts in full.