Tuesday, May 5, 2009

Chrysler Can’t Even Get Bankruptcy Right!

As I’ve mentioned in an earlier post, if the current plan proposed by Chrysler and the Government is successful, lenders would question their rights when extending loans. They would, quite reasonably, question the value of a lien (secured lending) if the borrower were to become insolvent and the Government decided to be involved (because of unions or any other reason).

This issue could have wide ranging consequences, potentially leading to higher rates and less available financing - particularly for borrowers that employ union workers.

The current proposal from Chrysler and the Government is to force a sale to a new company (let’s call that “NewCo”) with an ownership distribution of 55% to the Voluntary Employee Beneficiary Association, 8% by the US Government, 2% by the Canadian Government, and 20% by Fiat – who may acquire up to 31% more under certain conditions (there’s a missing 15% in that distribution, but let’s ignore that). The first lien lenders, in the initial proposals were to receive only $2.0 billion (later raised to $2.25 billion).

Under this plan, the unions, who are unsecured, receive benefits valued at $10.3 billion (the VEBA would receive a $1.5 billion cash contribution to the VEBA, a $4.587 billion note bearing interest at 9%, and 55% of NewCo - valued at $4.25 billion).

Since the unsecured creditors normally are not entitled to anything until the secured lenders are paid (that's in a Chapter 7 liquidation). In Chapter 11, it is not unusual to provide consideration to claimants differently from the absolute priorities in the code, the deviation in this case would seem to be unprecedented.

The terms of the UAW deal (based on the 9 page memo sent to Chrysler’s UAW members that I obtained from The Detroit News site, although this Detroit News article said the memo was 12 pages long) are that the United Auto Workers will give up certain rights under their contract (including the suspension of the cost of living allowance, Christmas bonuses in 2009 and 2010, etc.). In exchange, the Union obtains the following:

  • 55% of NewCo’s stock will be owned by the VEBA together with the right to designate one member of NewCo’s Board, with that appointment subject to the UAW’s approval. If the NewCo stock is sold for more than $4.25 billion – increasing at 9% each year – the excess will go to the US Government as payment towards the $6 billion in loans to NewCo/Chrysler;

  • A transfer of the VEBA assets currently maintained at Chrysler of $1.5 billion on January 1, 2010;

  • NewCo will issue a $4.587 billion note to the VEBA to be paid (like a mortgage) as follows:
  1. 2010-2011: $300 million per year;
  2. 2012: $400 million;
  3. 2013: $600 million in 2013;
  4. 2014-2017: $650 million per year; and
  5. 2019-2023: $823 million per year;
The effective interest rate on this $4.587 billion note is approximately 9%; and
    • The VEBA will be an independent fund governed by an 11-member Committee, including 5 members appointed by the UAW and 6 independent members.
    These terms were agreed to prior to the bankruptcy and were supposed to be the basis for an out of court restructuring (they probably would have needed to file for Chapter 11 anyway to deal with their dealer issues, but they don’t want to mention that).

    Had the Governments (US and Canada) announced:

    • They were going to provide $4.1 billion of Debtor in Possession financing;

    • The financing was to be subject to an accelerated timetable to sell specific assets to NewCo (using the same time table as the existing proposal);

    • $2 billion was to finance the purchase of NewCo's assets from Chrysler and that Newco would be 80% owned by the Governments and 20% by Fiat (potentially increasing to 51% under certain conditions); and

    • That, while the unions were not part of this deal, the owners of NewCo intended to negotiate an agreement with the UAW that was substantially the same as the terms agreed to as part of the April 28th agreement and, as part of the agreement, the UAW would surrender any claims against Chrysler (the $1.5 billion cash contribution to the plan would be paid either as part of the $4.1 billion, or separately by the Governments).
    Under this scenario, the Non-TARP lenders might try to claim that the UAW deal was substantially being paid by the Chrysler estate (among the assets being transferred to NewCo) and, therefore, the union agreement should be considered part of the 363(b) sale. Furthermore, they might argue, as they do now, that as unsecured creditors, the compensation to the unions meant that their first lien rights were being violated by the payment to an unsecured party (particularly given the orders of magnitude).

    However, the Government could probably moot that argument by stating, quite correctly, that NewCo would be worthless without the union employees and that, to avoid a strike due to Chrysler’s failure to live up to part of their obligations in the 2007 agreement (or simply that, since the Government wasn’t buying the legal entity, but only the assets and that they needed to negotiate a deal with the workers for NewCo to be a going concern), such an agreement would be necessary. Therefore, the agreement with the UAW was not based on their unsecured claim. In addition, as the DIP lender, it was in the Government’s interest to see the union's claim against Chrysler erased; but, alternatively, NewCo could make the UAW agreement without requiring the union to drop their claims against Chrysler – those claims would be behind the other creditors (thus worthless) anyway.

    That would then leave the issue of whether or not the accelerated sale under 363(b) was a sub rosa plan. To deal with that question, the Debtor in Possession could argue (as they have been for quite some time) that consumers wouldn’t purchase a car from a bankrupt company and, therefore, there is an urgent business reason to expedite the sale.

    Personally, I think it makes sense to give the first lien creditors the missing 15% in NewCo (currently valued at $1.16 billion based on the Union statement) towards their $6.9 billion loan, leaving them to recover any additional amounts towards their remaining $5.3 billion claim from the liquidation of the estate.

    This solution would avoid dealing with the issue that we currently have in which the DIP lender (the Governments of the US and Canada) are creating the need for an expedited sale through their required timetable. It would also eliminate the issue of violating the rights of the secured creditors.

    Then the argument becomes one of valuation.

    I would appreciate any comments you might have.

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