Fear and Greed Blog

As I mentioned, in my last post, Mr. Leo C. Donofrio, who writes on the Natural Born Citizen Blog, has made an argument about the reason that the Supreme Court in its order of December 14, 2009 instructed the United States Court of Appeals for the Second Circuit to dismiss the appeal as moot.

Mr. Donofrio was kind enough to post a discussion of my post on his blog. He was also quite complimentary of my discussions about the Chrysler case earlier this year.

In addition, Mr. Donofrio posted two comments on this blog. I responded to his first comment, which also referred to his blog commentary, in the comments section of my post. Unfortunately, he found my response lacking, leading him to add comments on his blog post and to leave a second comment to my post.

Rather than continue this discussion in the comments section of the last post (the comments section is rather limiting), I decided to respond in this post, as follows:

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First, let me thank you for recognizing me, in your original post, as a bankruptcy expert.

I'm disappointed that our discussion has led you to question my expertise AND that you don't permit comments on your blog (thus requiring me to respond here).

I'm also disappointed that you are not impressed with my last response.

Let me state my case in a clearer manner:

1. The Bankruptcy Court is a Federal Court.


2. The Court of Appeals is a Federal Court that is two levels above the Bankruptcy Court in the judicial hierarchy. The Court of Appeals can overrule any ruling by a Bankruptcy Judge at its discretion (or any judge at any level subordinate to them, which would be pretty much every court except the Supreme Court).


3. On June 2, 2009 the United States Court of Appeal for the Second Circuit "granted a motion for a stay and for expedited appeal directly to the Court of Appeals pursuant to 28 U.S.C. § 158(d)(2)." That is a direct quote from the opinion issued by the United States Court of Appeals for the Second Circuit on August 5, 2009.


4. Article III, Section 1 of The Constitution of the United States of America, states: "The judicial Power of the United States, shall be vested in one supreme Court." The Supreme Court, therefore, can over-rule any ruling by the Courts of Appeal - and certainly the Bankruptcy Courts.


5. Justice Ginsburg, in her role as a Justice of the Supreme Court, has the authority and right to stay the ruling of any court in the United States of America - for any matter before them, including bankruptcy.

I don't understand why you would make a statement that "Justice Ginsberg apparently erred by extending the stay and the new SCOTUS order effectively vacates her extension." That simply isn't true. In fact, the Supreme Court issued a Per Curium decision on June 9, 2009 vacating Justice Ginsburg's order.

This whole discussion has been about why the Supreme Court said that the appeal of the Chrysler asset sale was moot.

Your argument stands on Judge Gonzalez's order, which, as I discussed above, was over-ruled as to the stay. An argument that Judge Gonzalez has the power to limit the actions of the courts above the Bankruptcy Court would seem to be in violation of, among other things, The Constitution.

The only argument that makes sense to me as to why the Supreme Court would order the Second Circuit Court of Appeals to dismiss the appeal as moot, is Section 363(m) of the Bankruptcy Code, which states "The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal."

I believe you are using the same subsection of The Code for your argument, but focusing, for some reason, on the stay.

My argument is that the sale can't be unwound since there is no dispute as to the good faith of the parties.

In either case, under 363(m), the sale can't be unwound. There is, therefore, no way to compensate the appellant. As a result, there is no reason to hear the case.

I'm sorry if I was unclear in the way that I stated my opinion about the SCOTUS ruling. Since we were discussing our opinions, I thought that was clear. I use quotes when I'm quoting someone and those statements were not in quotes. I never intended it to be a trick, neat or not.

I don't know why you are suggesting that I "fail to confront the facts of the case and the facts of the order."

The facts of the case aren't even being discussed; only an interpretation of a ruling.

The ruling was one paragraph. You and I are both interpreting it.

Here, in full, is the final ruling by SCOTUS:

IN POLICE PENSION TRUST, ET AL. V. CHRYSLER LLC, ET AL.
The motion of Washington Legal Foundation, et al. for leave
to file a brief as amici curiae is granted. The petition for a
writ of certiorari is granted. The judgment is vacated, and the
case is remanded to the United States Court of Appeals for the
Second Circuit with instructions to dismiss the appeal as moot.
See United States v. Munsingwear, Inc., 340 U.S. 36 (1950).

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There are two other blogs that I've reviewed that have commented on SCOTUS's decision on Chrysler, The Bankruptcy Litigation Blog and Natural Born Citizen. Both are written by attorneys, each of whom has a stake in either, or both, of GM and Chrysler. They have, therefore, unsurprisingly cut back on posting to their blogs.

Given all the speeches, articles, and thought advanced about the significance and game-changing nature of the Chrysler [case], it's amazing how two simple sentences from the highest court in the land can turn the bankruptcy world on its head.

Leo Donofrio's post, on the other hand, concluded that SCOTUS determined the 2nd Circuit opinion moot because Judge Gonzalez did not issue the stay for the 2nd Circuit hearing - it was issued by the 2nd Circuit. Since Judge Gonzalez ruled on the sale and didn't issue a stay; and since there were no issues relative to Section 363(m), any decision by the 2nd Circuit was moot in any event. Specifically, he states:

After proper briefing on the issue and time to study the law, SCOTUS correctly determined that in order for an appeal such as this to not be moot under 363(m) – absent a bad faith purchaser – the court issuing authorization for the sale would have been required to also stay their own sale authorization at the time such authorization was issued, which did not happen here. Judge Gonzalez did not order the sale stayed pending appeal on June 1st.

Mr. Donofrio's analysis is interesting, but I think it's a poor (if not slanted) reading of the law. Section 363(m) states:

The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.

Not only that, but it seems his analysis is based on a poor interpretation of the facts of the case. Specifically, Judge Gonzalez's Sale Order (Docket 3232 corrections made in Errata Order Docket 3239), dated June 1, 2009, specifically delays the closing of the transaction to allow for an appeal. The Order states:

57. As provided by Bankruptcy Rules 6004(h) and 6006(d), this Sale Order shall not be stayed for ten days after its entry and shall be effective as of 12:00 noon, Eastern Time, on Friday June 5, 2009, and the Debtors and the Purchaser are authorized to close the Sale Transaction on or after 12:00 noon, Eastern Time, on Friday June 5, 2009.4 Any party objecting to this Sale Order must exercise due diligence in filing an appeal and pursuing a stay or risk its appeal being foreclosed as moot in the event Purchaser and the Debtors elect to close prior to this Sale Order becoming a Final Order.

In addition, on June 2, 2009, Judge Gonzalez issued an "Order Certifying Sale Order for Immediate Appeal to United States Court of Appeals, Pursuant to 28 U.S.C. § 158(d)(2)" (Docket 3237) which approved the appeal. Since the stay was already in place under the Sale Order, there was no need to extend it.

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The Supreme Court of the United States announced a decision on the Indiana Pensioners v. Chrysler on Monday.

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7/8/09 1:30 PM Update

After 24 hours, my comment has been posted.

From what I understand, many people that are involved with DealBook are on vacation. I guess my comment, and several others, fell through the cracks.

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I don't know.

I grew up with The New York Times asserting itself as THE newspaper of record. And even though a decision was made to reduce the scope of "All the News That's Fit to Print," I continue to have great respect for the paper (and I've been a daily subscriber for longer than I can remember).

I was quite surprised, when they published an article last night (later picked by Felix Salmon), a version of which was also posted on their DealBook blog that discussed some of the specifics of Judge Gerber's GM decision, but referred to the wrong Lionel bankruptcy (Lionel, LLC).

As many readers know, the case that Judge Gerber was referring to involved Lionel Corporation, not Lionel, LLC. In re Lionel Corp. is the seminal case in relation to Section 363(b) sales (see page 3 of Section 363 Issues–Acquiring Troubled Companies and Assets (Part 1) from the American Law Institute / American Bar Association site for Continuing Legal Education and page 1651 [15th page in the pdf file] of AN EFFICIENCY MODEL OF SECTION 363(b) SALES from the Virginia Law Review). That Lionel case was decided in 1983.

Lionel has been discussed on many of the blogs discussing the appropriateness of using Section 363(b) for both Chrysler and GM. I mentioned it in this blog. Steve Jakubowski (who is representing five accident victims in GM) wrote in great detail on all the legal issues on his Bankruptcy Litigation Blog, including Lionel, in a series of posts here, here, and here (the second post discusses Lionel).

The case cited by the NY Times (I am pasting a copy of the original article at the bottom of this post) was from 2008.

I notified Michael de la Merced (whose Twitter commentary on the hearings was great reading) about the mistake after I read the article online at approximately 12:00 AM on Tuesday morning. Mr. de la Merced was listed as a contributor to the article. He wrote back (around 9:00 AM Tuesday morning) "Yikes! Apologies for that, Larry. Thanks for the link to your post." Unfortunately, he apparently was unable to correct the error (by the way, I strongly recommend reading his pieces in the paper and on DealBook).

When I saw that there was no update to the story, I wrote a comment on the DealBook blog. That comment, which I submitted at 11:58 AM, is still "awaiting moderation" at 11:08 PM (I think 11 plus hours to moderate a comment on the blog of a major publication is a bit long - at least five of those hours were during the business day). Here is what I wrote:

YOUR COMMMENT IS AWAITING MODERATION.

This post refers to the wrong Lionel case (as does the article in today’s paper).

The Lionel case that Judge Gerber referred to in his decision is In re Lionel Corporation, 722 F.2d 1063 (2d Cir.1983), (you can see the case at: http://bulk.resource.org/courts.gov/c/F2/722/722.F2d.1063.83-5060.517.html).

The analysis in this case has defined almost all 363(b) sales (of substantially all of a business) since it was published.

I discussed much of this in relation to the Chrysler case on my blog (blog.lawrencedloeb.com).

— Lawrence D. Loeb

Here is the article from the July 7th edition of The New York Times, with the reference to Lionel in bold:

July 7, 2009
Automakers’ Swift Cases in Bankruptcy Shock Experts
By MICHELINE MAYNARD
DETROIT — That didn’t take long.

In fewer than 45 days each, General Motors and Chrysler swept through government-sponsored sales in bankruptcy court — quick tours that most people in the legal community thought impossible not long ago.

The swift action has riveted bankruptcy lawyers and law professors, who say the cases will be widely studied this fall when law students return.

“It is remarkable,” said James J. White, a professor at the University of Michigan Law School in Ann Arbor, who is planning a three-day seminar on the cases in his bankruptcy class.

Judge Robert E. Gerber of United States Bankruptcy Court in New York approved the G.M. sale late Sunday, although he issued a four-day stay that blocks final action until Thursday.

The sales, handled under Section 363 of the federal bankruptcy code, raised the profile of a tactic once used primarily to shed failing plants or unneeded equipment, and was not considered until a few years ago as a substitute for a complete restructuring.

“Twenty years ago, you would not have been able to do a 363 sale of an entire company,” said Mary Joanne Dowd, a partner in the financial and bankruptcy restructuring practice at Arent Fox in Washington.

While the cases are not likely to bring about the end of old-style restructurings, the sheer scope of G.M. and Chrysler show a Section 363 sale can apply to companies of any size, lawyers say.

For businesses that follow similar legal strategies, the G.M. and Chrysler cases could pave the way for a faster trip through court. For creditors, it could mean less time to reach a deal, especially in situations where companies face strict deadlines from lenders, as the two carmakers did with the government.

In such cases where the government plays a major role, lawyers are likely to feel they have less control than in traditional bankruptcies.

“I don’t think the government pressures judges as much as it pressures everybody,” said Professor White.

In fact, a government-imposed deadline for concluding the G.M. case by the end of this week helped the court work through 850 objections in three days of hearings last week. Normally, such issues could take weeks.

The haste drew skepticism from Michael P. Richman, a lawyer who represents three dissident G.M. bondholders.

At last week’s hearings, he urged Judge Gerber to “call the bluff” of the government deadline and take a more deliberate pace. (On Monday, Mr. Richman said his clients would likely not challenge the sale approval, citing the “enormous costs” that an appeal would incur.)

Obama administration officials say the legal community need not expect a wholesale shift in bankruptcy law. The G.M. and Chrysler cases were unique situations, they note, in which the president wanted to make sure that a crucial American industry survived.

Under the terms of the deal, G.M. would sell its most desirable assets, including the Chevrolet and Cadillac brands, to a new company owned largely by the American and Canadian governments and a health care trust for the United Automobile Workers union.

Over the last decade, Professor White said, companies already have been shifting toward a broader use of Section 363 sales as a quicker approach for restructuring than the usual Chapter 11 process.

In his order approving the G.M. sale late Sunday night, Judge Gerber cited instances involving Lionel, the maker of toy trains, which emerged from bankruptcy last year; Trans World Airlines, which was absorbed by American Airlines in 2001, and other similar cases as justification for his decision.

But none involved government financing, and thus moved far less quickly. The most recent Lionel case took three and half years; a case involving United Airlines took just over three years, and the case of the Delphi Corporation, G.M.’s former parts supplier, has been in court since 2005.

By contrast, G.M. and Chrysler sales beat even the government’s aggressive timetable.

The Treasury Department initially said it expected the Chrysler sale, which required 42 days, including an appeal to the Supreme Court, to be approved in 60 days. It said the G.M. sale would require 60 to 90 days of deliberations; as of Monday, the case has been in court for 36 days.

The speed is even more remarkable given that as recently as mid-March, when the Treasury’s auto task force retained bankruptcy counsel, it was not clear the cases would wind up in bankruptcy court, a senior administration official said Monday.

At that time, G.M. was still resisting a bankruptcy filing and a case did not seem likely at Chrysler, which had Fiat standing by, prepared to assume management control. Fiat officials eventually signed on to the need for a quick bankruptcy filing, which helped Chrysler shed plants, dealers and suppliers.

By mid-April, G.M. came around to the idea of a conventional prepackaged bankruptcy case, which still could have taken months, the official said.

Treasury officials pointedly told G.M. executives that the government, which was financing the company’s stay in bankruptcy, did not have the patience or resources for a long case, and would only provide financing under a Section 363 sale.

The administration official also said that G.M.’s case moved so quickly in part because it had the benefit of an “icebreaker” from Chrysler’s quick tour through bankruptcy.

In his 95-page opinion Sunday, for example, Judge Gerber repeatedly cited the discussion of issues from the opinion by Judge Arthur J. Gonzalez, who approved the Chrysler sale last month.

Professor White said the Supreme Court’s ruling against pensioners from Indiana, who sought to block the Chrysler sale, also was likely to deter similar actions in the G.M. case.

In fact, so far only one lawyer has challenged Judge Gerber’s approval of the sale: Steve Jakubowski, who represents five accident victims. And even he will not ask to delay the closing of the G.M. sale, unlike the Indiana state funds that objected to Chrysler’s turnaround plan.

“I personally didn’t have any problem with the speed of it,” he said of the two cases. “The fact is, the companies were dead.”

Michael J. de la Merced contributed reporting from New York.

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Over the last two to three months, I have written extensively about the Chrysler bankruptcy. Now that the operating company has been purchased by Chrysler Group, LLC, I would like to summarize my thoughts about the case, and clear up any misconceptions that I may have created through my comments.

I may have given the wrong impression about some of the parties to this matter, and let me first clear those up:

Capstone / Robert Manzo

I believe that Robert Manzo and his colleagues at Capstone performed professionally and prepared a report that clearly set out their methodology and included appropriate caveats. They noted in their report that they were preparing a valuation based upon an orderly liquidation of Chrysler’s assets. They provided qualifications in their “Basis of Presentation,” including:

5. This analysis is hypothetical and subject to material variations which may arise during the course of the sale or liquidation of the 31 assembly and manufacturing plants. In an industry suffering from severe volume contraction, shifting consumer demands, tightening consumer finance and liquidity constraints, coupled with other large automobile manufacture[s] potentially disposing of similar assets simultaneously with the liquidation of Chrysler, actual recovery values may be significantly lower than the hypothetical values estimated herein.

and “General Assumptions” including:

4. This would be the first liquidation of a domestic OEM [Original Equipment Manufacturer] and there are likely significant risks that have not yet been identified or quantified. Additionally, the current state of the automotive market is unique and there is no historical reference to look to in assigning hypothetical liquidation values.

and:

9. Proceeds from asset sales are assumed to be depressed due to:

1. Limited potential buyers – domestic OEMs have limited resources and potential foreign buyers (TATA) have no dealer network in place.


2. The industry is plagued with overcapacity – the need for additional capacity doesn’t exist.


3. Re-launch could take 12 – 24 months – lost market share would likely require significant marketing and advertising expenditures to re-invigorate the brands.

In addition, the assumptions used to value each individual asset were clearly stated in the report. The documentation, thus, was clear and well presented.

In my comments on this blog, and elsewhere, I voiced my opinion that the findings reported by Robert Manzo and Capstone might well understate the actual values. I tried to make clear, in my comments, that it was difficult to come to any alternative conclusion from the available information. My belief is, and was, that certain of the stated assumptions in Capstone’s report may not stand up to scrutiny from another expert.

I cannot state, with any degree of certainty, that the valuation would not have withstood challenge.

As Judge Gonzalez noted in his opinion, the valuation prepared by Capstone was not challenged and, therefore, informed his judgment on the fairness of the compensation being proposed in the 363(b) transaction.

Robert Manzo, and his colleagues at Capstone, provided an analysis as requested by their client and they served their client well.

Greenhill

Greenhill provided a fairness opinion to Chrysler for the transaction that was included in the report. I pointed out that they specifically noted that they did not conduct any valuation work in connection with their engagement and that they specifically relied on the Capstone report in coming to their conclusions.

My comments in this regard were highlighting my belief that the investment bankers were not entirely comfortable opining on the liquidation value of Chrysler. They specified that their logic was that, given that the alternative was liquidation and that the proposed compensation was within the range of the potential liquidation values, the proposed transaction was fair.

You can argue with the legal interpretation used in coming to the conclusion (it would appear to be inconsistent with the findings in Associates Commercial v. Rash), but Greenhill is not a law firm.

From an investment banking point of view, their explanation and logic make perfect sense.

Judge Gonzalez

While I disagree with the Judge’s finding, the logic he used to arrive at his opinion makes sense. He relied on uncontested arguments from the debtor on valuation and, apparently, on the matter of who is paying the UAW VEBA.

Perhaps the Judge might have run his court differently under different circumstances, questioning matters from the bench. I do not believe that such actions are expected or required of a bankruptcy judge.

As I've noted, my disagreement stems from the valuation (which was uncontested) and the finding that NewChrysler was paying the $10.337 billion to the VEBA (apparently not contested).

Indiana Pensioners / Indiana Treasurer of State, Richard E. Mourdock

After the Non-TARP lenders withdrew their involvement in the case, the Indiana Pensioners were at a great disadvantage. Not only were they a tiny minority within the group of secured lenders (the others having accepted the proposed transaction), but they could not be expected to bear the significant costs of objecting by themselves (according to some sources, just the cost of retaining White & Case as legal counsel cost $2.0 million, and they had only invested $17 million to purchase their position!).

Without the budget to also retain a financial expert to contest Capstone’s findings; and given the limited time that they had (they did not retain White & Case until May 19th), they were limited to making legal arguments.

The argument, used in bankruptcy court, to oppose the valuation was based on trying to convince Judge Gonzalez that Robert Manzo, and Capstone, were biased by the compensation included in their retention agreement that provided for a $17 million bonus when the deal was completed. Judge Gonzalez, reasonably in my view, rejected this argument since the motion to retain Capstone (Docket 174) was uncontested.

Unfortunately for the Indiana Pensioners, legal arguments alone were not sufficient to derail the momentum of the 363(b) sale.

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The President’s speech, demonizing hedge funds and other investors for opposing the sale was the catalyst for my writing about this case.

I am greatly troubled by how the Executive Branch used populism to bully secured lenders into giving up their contractual rights.

If this ends up being, as many have stated, an isolated and unusual case that will not be repeated; then there should be no long term impact from this behavior. If, however, this situation recurs, there will be a clear need for financial market participants (banks, institutional investors, etc.) to increase the cost of lending and limit the availability of credit (shutting off credit to other potential beneficiaries of Executive interference, such as companies with union work forces).

I wish the new company the best of luck and hope that it prospers, and I hope that this is not a prelude to more government interference in business.

It is one thing for the Government to step into the breach as a last source of funding for, what many believe is, a critical participant in the economy. It is another to attempt to force an outcome inconsistent with the rule of law (which I believe happened in this case).

The rule of law is the basis for the success of capitalism. Any behavior by the Government that attempts to override the law could have a catastrophic long term impact on the markets and the economy.

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Felix Salmon posted this piece on his blog, which had a number of statements that I found puzzling. He seems to be suggesting that Tom Lauria's clients got more than they deserved based on this piece from The Wall Street Journal that relied entirely on (ultimately) Capstone's final report.

He is questioning this editorial from The Detroit News, which suggests that the Chrysler bankruptcy may make it harder for companies borrow; a point that I had made here (quoting a piece from The Wall Street Journal, coincidentally).

Here is my reply (which is currently awaiting moderation) - I have cleaned up the links here - that functionality did not appear available to commenters to Mr. Salmon's blog:

Felix:

Have you read the valuation reports prepared by Capstone (available at http://www.chryslerrestructuring.com/, Docket 52 - later version at Docket 1573)? Did you read Greenhill’s fairness opinion (Docket 173 - which specifically states that they did NO VALUATION WORK in arriving at their conclusions)?

The valuation of Chrysler in liquidation was based on a report that never had to withstand real scrutiny (but Greenhill’s CYA statement should give you an idea that they weren’t ready to comment on it - typically investment banks PERFORM valuations to come to support their opinion).

Furthermore, as pointed out in Lauria’s application to the Supreme Court, the appropriate basis for valuation of secured assets under the Bankruptcy Code is based on how the assets will be employed post-bankruptcy (citing Justice Ginsburg’s opinion in Associates Commercial v. Rash). The assets here are to be used as part of a going concern, so liquidation is NOT the basis that should be used in valuing the secured assets (rather, it should be based on their going concern value - which was never established).

I don’t understand the logic of your statement “The fact that unsecured creditors (the UAW) are getting some recovery from the Chrysler bankruptcy even though secured creditors are taking a haircut is actually good for the secured creditors: it means they’re getting more than they otherwise would be able to salvage out of a liquidation.”

Secured creditors are supposed to be paid off completely, to the value of the assets they are secured against, before unsecureds receive ANYTHING. Furthermore, to the extent that the secured loan exceeds the value of the assets securing it, the loan becomes unsecured and shares pari passu with the other unsecureds.

I don’t know how it’s good for the secured lenders to take a haircut while the unsecureds receive more than the secureds.

In this case, the VEBA is receiving consideration valued at $10.337 billion (Judge Gonzalez decided that this was a payment by NewChrysler, unrelated to the $10.5 billion the Estate owed to the VEBA, but NewChrysler is getting nothing of value in return for the payment) while the first-lien lenders are receiving $2.0 billion on a $6.9 billion secured loan.

It is highly likely that, had this case proceeded at a less frantic pace, the valuation would have been contested and the result quite different.

Of course, it is easy to speculate on what might have been, but there WAS a case to be made for the secured creditors. It didn’t help that the other holders of the first-lien loans were beneficiaries of TARP (and then there are the, unproven, charges of threats against the original group of “Non-TARP” lenders).

There is an excellent article at The Deal on some of these issues.

I wrote a fair amount about the case on my blog as well, including my thoughts on how the Pensioners could have prevailed.

- Posted by Lawrence D. Loeb Your comment is awaiting moderation.

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The Deal has an outstanding piece today discussing, in general, how hedge funds can do better at meeting their objectives when investing in distressed situations - specifically, when the debtor is in bankruptcy.

The writer, Eric B. Fisher of Butzel Long, suggests that it is important for hedge fund managers to be conscious of the bankruptcy judges' point of view. He states that they "aspire to create a forum premised upon transparency and equal access to information" and that the "bankruptcy judge's perspective is long term, focusing on the rehabilitation of ailing companies."

He discusses his thesis in relation to the Chrysler case, and identifies three basic tenets to help shape strategy:

1. "There is strength in numbers." He discusses how the secured lenders opposing the plan in Chrysler shrunk due to the strategies of the Obama Administration, reducing the credibility of the remaining opponents, the Indiana Pensioners.


2. "Articulate a vision larger than 'return on investment.'" He points out that the Pensioners tried to do this by pointing to the retirees who were the beneficiaries of the investment. He says, however, that "Ultimately, however, the party that the bankruptcy judge cares about the most is the debtor." He says that "committees should strive to speak meaningfully to the issues faced by the debtor and offer a competing vision of the case."


3. "Use disclosure to enhance credibility." He says that the natural inclination of hedge funds to keep information private can work against them with the Court.

I recommend reading the article.

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The Chrysler deal was closed today. The new company will operate as Chrysler Group LLC. The Wall Street Journal article is here. Bloomberg gives a more detailed report of the new company here. The New York Times weighs in with some different details here.

There is a profile of Tom Lauria, the White & Case attorney who led the legal team for the Indiana Pensioners in today's edition of The Wall Street Journal here.

I haven't seen any stories, except this note from the SCOTUSBlog, on whether there will be any consideration of the Chrysler transaction after the stay decision was announced (the Court ruled on whether they would stay the transaction, not on any of the legal points being argued in the case).

Even if the Supreme Court did agree to hear the case, I'm not sure how the Indiana Pensioners would benefit, unless there was a finding of a lack of "good faith" in the transaction, since that is the measure required by Section 363(m) to unwind the transaction. Absent that, I'm not sure what entity would be liable for damages suffered by the Indiana Pensioners (again, assuming they ultimately prevailed). Chrysler Group, LLC would appear to be protected under Section 363(g).

In fact, given some of the language from In re Gucci, it isn't clear to me that a challenge to the transaction can be argued absent a lack of good faith finding.

Here is Section 363(g):

Notwithstanding subsection (f) of this section, the trustee may sell property under subsection (b) or (c) of this section free and clear of any vested or contingent right in the nature of dower or curtesy.

And here is Section 363(m):

The reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and such sale or lease were stayed pending appeal.

If any lawyers want to weigh in, I would appreciate it.

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The Supreme Court has lifted its stay on the Chrysler transaction. I don't know if that means that the case will not be heard, but it certainly means that the sale will take place.

There may still be avenues that the Indiana Pensioners can pursue, including challenging the transaction under 363(m) - if they feel they can show lack of "good faith" in the negotiation of the transaction. They could also pursue remedies against the collateral agent.

This is good news for Chrysler's employees and suppliers (and advisers - as far as they might have had their testimony challenged), as well as Fiat. The Administration should be pleased as well.

Personally, I believe the compensation is lower than the value of the assets being transferred, but as I pointed out previously, the valuation was not challenged directly in Court. In that posting I pointed out approaches that, I believe, might have been more successful. The Indiana Pensioners were limited in their ability to take those approaches by time (and budget?).

As I have noted previously, I don't believe that the case itself sets precedent. On the other hand, it may encourage the Administration to take further actions against the long term benefit of the economy.

Through their actions, the Administration seems to have forced the lead banks in Chrysler to fail their fiduciary responsibility to their shareholders in order to avoid problems with their preferred shareholder - and regulator. THAT IS TERRIBLE PRECEDENT.

This would seem to clear a path for GM. We'll see how that case proceeds, but it doesn't have the same issues (the secured holders in GM are getting 100 cents on the Dollar - the $6 billion in secured loans was clearly less than the assets they were secured against).

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Over at SCOTUSBlog, they report on increased sabre rattling from Chrysler, the Solicitor General, and Fiat on the need for resolution of the Chrysler transaction by June 15th.

As they point out, this is in response to the Indiana Pensioners' brief this morning, which pointed out that Fiat's CEO stated that Fiat will "never" walk away from its deal with Chrysler.

While some seem to believe that the CEO made a strategic mistake, I think it was the smart move. His statement provides comfort to suppliers and employees that, whatever happens in the process, he plans to go forward with the deal (and thus the company will continue to operate). His comment, while encouraging the Indiana Pensioners to tell the Supreme Court that urgency isn't as great as the Debtor has claimed, also makes it clear to those Pensioners that their negotiating position doesn't improve with a delay (if Fiat didn't say this, the Indiana Pensioners might believe that they could force a better out of court resolution while the Court debates certiorari - which could preclude other negotiations).

This reminds me of a closing dinner we had after a very contentious transaction (restructuring and cash raise). We gave the client's general counsel a toy sabre for him to rattle (he had done a good job of being threatening during the negotiations).

Fiat has every incentive to stay with the deal (they get 20% to 35% of Chrysler for knowledge - and they get access to the American markets through an established dealer network) and no reason to walk away.

Arguably, rushing the Supreme Court will work to the Debtor's disadvantage since it could lead the Court towards granting certiorari (if they are on the fence, they could feel the necessity to make a decision - and default to hearing the case).

I guess the lawyers need to try to keep up appearances, but I'm really not sure who they think they're bluffing.

It's got to be nerve wracking for Chrysler's employees and suppliers, but it's interesting for us disinterested parties.

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I'd like to thank a friend, who'd rather remain anonymous, for bringing this to my attention.

In the Indiana Pensioners' Application to the Supreme Court, they use one of the arguments that I've discussed (but I didn't use legal precedent) to argue against the value in the plan being rushed by the Debtor.

Specifically, they refer to an opinion written by Justice Ginsburg, in an 8-1 decision, for Associates Commercial Corp. v. Rash Et Ux. in which a Chapter 13 Debtor attempted to cram down their secured creditor and apply a liquidation value as the basis for the value of the secured claim. The Court held that the value for a secured property that is being used, as opposed to liquidated, is the replacement cost. This is based on the second sentence of §506(a), which read (at the time) "Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest" By the way, the second paragraph was added in 2005, after the 1997 decision (and clarifying the matter for individual debtors).

The argument is that the Debtor is claiming that the creditors are only due a payment (originally based on liquidation value) calculated using one methodology, while those same assets are effectively being valued in another manner as part of NewChrysler. The case argues for the use of the going concern value of the property if that property is to be used in a going concern.

Section 506(a) in its entirety is:

(1) An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under section 553 if this title, is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property, or to the extent of the amount subject to setoff, as the case may be, and is an unsecured claim to the extent that the value of such creditor’s interest or the amount so subject to setoff is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.

(2) If the debtor is an individual in a case under chapter 7 or 13, such value with respect to personal property securing an allowed claim shall be determined based on the replacement value of such property as of the date of the filing of the petition without deduction for costs of sale or marketing. With respect to property acquired for personal, family, or household purposes, replacement value shall mean the price a retail merchant would charge for property of that kind considering the age and condition of the property at the time value is determined.

Here is the case:

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There have been a number of good articles and blog posts relating to the appeal by the Indiana Pensioners to the Supreme Court. The Wall Street Journal had a good article, and a lively comment section that I participated in.

The revelations about the email exchanges prior to the bankruptcy filing are interesting, and disturbing. The Journal provided an excellent article on the subject.

Zero Hedge has been providing some interesting analyses and discussions on the subject, including this post (where I also participated in the comments section).

Of course, the Steve Jacubowski at the Bankruptcy Litigation Blog and Professor Stephen Lubben of the Credit Slips Blog (and Seton Hall) have provided interesting legal analyses and dug up interesting points buried in the Court filings.

The SCOTUSblog (covering the Supreme Court of the United States) has provided interesting information as well.

So much to read. So little time.

We wait to see what Justice Ginsburg does tomorrow in relation to the stay. If that is approved, then we will wait to see if the Court grants certiorari.

The Chrysler case. Seldom boring.

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You can read it here.

I think some of the arguments from the Debtor's side were ill advised, but it doesn't appear to have hurt them.

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As I have mentioned in my recent posts, it was unlikely that the Circuit Court of Appeals would overturn Judge Gonzalez's ruling on Chrysler (and I discussed how I think they could have been more successful).

Unsurprisingly, the Court of Appeals has rejected the Pensioners arguments, but stayed the deal until Monday to allow an appeal to the Supreme Court.

I don't know if they will grant certiorari, although this certainly is a high profile case involving the Federal Government. We'll see.

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As I write this, the United States Court of Appeals for the Second Circuit is hearing the appeal of the Indiana Pensioners to Judge Gonzalez's ruling to allow for the 363(b) sale of substantially all of Chrysler's assets to NewChrysler.

As I mentioned in an earlier post, I believe the logic laid out in Judge Gonzalez's opinion was well reasoned, but I believe the conclusion is wrong, but the Judge could only rule on the evidence presented to him.

Now, I'm not saying that Judge Gonzalez should have concluded differently, but it would have required him to ask the parties to come back with more information.

Judge Gonzalez's opinion relied on three key assumptions, both of which, I believe, could have been challenged if the Indiana Pensioners had brought in additional experts. The three assumptions that I am referring to are:

1. That Chrysler is a wasting asset;


2. That the value being paid by NewChrysler for substantially all of the Estate's assets is fair ; and


3. That the consideration being provided to the Union through the VEBA is being paid by NewChrysler and, thus, didn't violate the priority of claims against the estate.

Let me discuss how these key assumptions could have been challenged (I have not seen anything indicating that these arguments were used):

Chrysler as a Wasting Asset

It was imperative for the parties favoring the sale to convince the Judge that Chrysler is a wasting asset in bankruptcy and that it was urgent that the business be sold immediately to maximize the value to the Debtor's estate. The Lionel case stated that "The rule we adopt requires that a judge determining a Sec. 363(b) application expressly find from the evidence presented before him at the hearing a good business reason to grant such an application."

Further, the Lionel opinion stated:

In fashioning its findings, a bankruptcy judge must not blindly follow the hue and cry of the most vocal special interest groups; rather, he should consider all salient factors pertaining to the proceeding and, accordingly, act to further the diverse interests of the debtor, creditors and equity holders, alike. He might, for example, look to such relevant factors as the proportionate value of the asset to the estate as a whole, the amount of elapsed time since the filing, the likelihood that a plan of reorganization will be proposed and confirmed in the near future, the effect of the proposed disposition on future plans of reorganization, the proceeds to be obtained from the disposition vis-a-vis any appraisals of the property, which of the alternatives of use, sale or lease the proposal envisions and, most importantly perhaps, whether the asset is increasing or decreasing in value. This list is not intended to be exclusive, but merely to provide guidance to the bankruptcy judge.

The Court stated that "a debtor applying under Sec. 363(b) carries the burden of demonstrating that a use, sale or lease out of the ordinary course of business will aid the debtor's reorganization" but that an objecting party "is required to produce some evidence respecting its objections."

I am not aware of any real challenge to the Debtor's position (other than the inclusion of some of the articles showing that Chrysler was actually performing reasonably well while in bankruptcy included in some of the objections filed by the dealers, and which I pointed out here and here).

I believe that the Indiana Pensioners could have engaged an expert who could have, at least, created doubt about the Debtor's assertion that there was a "good business reason" to rush through the 363(b) process because:

• There is no evidence that consumers would be unwilling to purchase a vehicle from a company undergoing reorganization through bankruptcy - and the President's promise to support warranties and to fund a successful exit was sufficient to insure that Chrysler's sales would not be impaired by the process (in fact, Chrysler's sales in May seem to have been little effected by the bankruptcy - there have been increased liquidation sales by dealers who are being dropped, but production has been shut down, limiting the availability of specific vehicles in particular markets).


• The shut down of Chrysler's facilities was partly due to a need to balance inventories. It seems that there was also a desire to provide the appearance that, without the close of the planned transaction, those plants would not be restarted. Since the funding for the running of those facilities would be provided by the DIP, the Judge would have to determine whether the coercive elements of the DIP proposal were in the best interests of the Estate.


• Fiat's deadline of June 15th was clear, however, given that they were obtaining, initially, 20%, and eventually 35% of NewCo (and access to Chrysler's dealer network) without any expenditure of cash - but simply for the contribution of know-how, it seems unlikely that Fiat would walk away from the transaction if it were properly managed.

Fairness of Compensation

The Debtor engaged Greenhill & Co., LLC to opine on the fairness of the transaction. Greenhill based its opinion on the premise that, without the transaction (remember, the Government stated that it wouldn't continue to provide funds to Chrysler unless it was to support an approved plan), Chrysler would have to liquidate; and the $2 billion was within the range that Capstone estimated could be realized in a liquidation. Greenhill specifically stated:

We have not made any independent valuation or appraisal of the assets or the liabilities of the Company, or concerning the solvency or fair value of the Company, nor have we been furnished with any appraisals, except for the Liquidation Proceeds Analysis. In particular, we do not express any opinion as to the value of any asset of the Company, whether at current prices or in the future.

I am unaware of any other circumstance where an investment bank issued a fairness opinion in which it did not perform its own valuation analysis. That doesn't mean that it never happens; I've just never seen it.

The Liquidation Proceeds Analysis was prepared by Capstone and is presented in the Declaration of the witness from Capstone, Robert Manzo and the associated exhibit. This analysis stated that the proceeds to the First-Lien Lenders in a liquidation of the assets ranged from $763 million to $2.947 billion (which were, for some reason, discounted to a present value of between $654 million and $2.605 billion).

Mr. Manzo provided a revised Declaration on May 20th to support his testimony (and a further Declaration on May 26th to clarify some issues) that concluded the recoveries to the First-Lien Lenders in a liquidation had declined since his initial analysis to between negative $407 million and $1.378 billion (which, again for some reason, were discounted to a range of N/A to $1.218 billion).

Judge Gonzalez specifically noted that "This testimony, which is unrebutted, is that the $2 billion NewChrysler is paying for the Debtors’ assets exceeds the value that the First-Lien Lenders could recover in an immediate liquidation."

Had the Indiana Pensioners employed a valuation expert, I KNOW that doubt could have been raised about Capstone's estimates based on MY expert opinion and review of the caveats of the Capstone report. Since Chrysler is a private company, I was (and am) unable to perform an independent analysis of Chrysler's value, my opinion is based on the following:

• The Affidavit of the CFO stated that the book value of Chrysler's assets at December 31, 2008 was $39.3 billion. It seems unlikely to me that the assets would only be worth 5% of book value;


• The valuation appears to have the costs of an orderly liquidation, while the values for some of the assets appear to be based on forced liquidation. For example, finished vehicles are estimated to provide recoveries of only 25% to 35% of cost. To put that in perspective, if you assume that Chrysler's gross margins are 10% (they are probably greater than that given that their EBITDA was effectively $0 in 2008 - per Exhibit A to Manzo's declaration) and the dealer margin assumed in the Manufacturer's Suggested Retail Price ("MSRP"), this means that a vehicle costing $18,000 to manufacture, with an MSRP of $22,222 would be liquidated for values ranging from $4,500 to $6,300 (discounts from MSRP of 71.65% to 79.75% - a very good deal, right?). The low value is explained as being due to the lack of warranties (although a property/casualty insurer would probably sell the Estate a 5 year 50,000 mile warranty for each car in the fleet of inventory at much less than $10k per car). There are other such assumptions that could be challenged by an expert;


• The value that would be fair to the First Lien Lenders would only START at the liquidation value of the assets they were secured against. The proposed transaction values the 55% of equity (fully diluted) allocated to the VEBA at $4.25 billion (they are also receiving a note with a value of $4.587 billion and $1.5 billion in cash). Now the structure of the VEBA's position is complicated by the implied call option held by the Treasury Department on any valuation realized above $4.25 billion (increasing at 9% annually), however, this short call option would mean that 55% of the equity would be worth more than $4.25 billion. The implied value for the entire equity of NewChrysler is, therefore, $7.73 billion. Assuming that Fiat's know how is worth the implied $2.7 billion associated with their 35% (assuming the requirements associated with increasing their initial 20% position occur) , that the assumed debt and the equity of the US and Canada are supported by cash or other assets (although the assets transferred from Chrysler are the only other assets in NewChrysler), and the $1.5 billion paid to the VEBA is somehow outside NewChrysler - That would leave $6.837 billion of value not accounted for on the asset side of NewChrysler's balance sheet. The Debtor's plan, therefore, itself values the transferred assets at least $4.25 billion (or 99.1% of the First Lien debt - that is being paid only 28.9%).

In my opinion, that raises serious doubt as to the fairness of the $2.0 billion in compensation.

Priority of Claims

Judge Gonzalez states in his opinion that the $10.337 billion ($4.25 billion value of the equity stake, loan to NewCo valued at $4.587 billion, and $1.5 billion of cash) paid to the VEBA is a deal negotiated, effectively, by NewChrysler and, thus, does not violate priority.

I had argued that Chrysler should have taken this position in this post.

An extremely powerful argument could be made against this position, however. The basis of that argument is "what value does NewChrysler get for the $10.337 billion?"

Hiring a work force in place has SOME value, but not anywhere near $10 billion! There were changes in work rules, and the Union gave up their right to strike for five years, but what is that worth? Heck, the work rules in the Union contract were written in a different era and have no business in the 21st century, yet a worker can still have six unexcused absences before the company can even START the process of firing them. To put that in perspective, I've never had (or heard of any friends who had) a job where they could skip work with no excuse for one day, PERIOD! Certainly, if I had to have an unexcused absence, I wouldn't necessarily be fired, but my employer would have the option.

In fact, the $10.337 billion is a settlement of a liability owed by the Estate. Even if the Union failed to forgive their claim against the Estate, that claim is made worthless by the low payment for Chrysler's assets.

The payment to the VEBA is clearly a violation of priority. Now it is not unusual for the final resolution of a case to provide compensation in a manner inconsistent with absolute priority, but the SCALE of this violation is beyond absurd.

White & Case apparently challenged the Manzo violation only by bringing up his personal compensation (and, thus, his stake in coming up with the result he did - by the way, according to the testimony, Capstone will receive a $17 million success fee and Manzo's allocation will be $10 million). The Judge countered this argument by pointing out that nobody contested the hiring of Capstone, and their compensation arrangement was disclosed prior to the order allowing for their retention.

White & Case is an excellent law firm. I suspect the only reason that no experts were engaged was for lack of resources. The Indiana Pensioners had less than $25 million invested in their position and may not have been willing to risk the costs of employing an expert (which could be expensive).

Had experts been employed, I believe the sale would have been delayed, a more reasonable deal would have been negotiated and Chrysler would have emerged.

One nagging question is "why were the secured lenders in Chrysler targeted, but not the General Motors secured lenders (who are unimpaired under that plan)?"

Maybe we'll know someday.

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On Sunday night, Judge Gonzalez published his opinion allowing the Chrysler sale to go through (pending an appeal to the Second U.S. Circuit Court of Appeals in New York, with oral arguments to start Friday June 5th).

After reading his opinion, my conclusion is NO, the case will not have an impact on distressed investing.

The Government's heavy involvement in the case (and the impact of that involvement) are unprecedented, but unlikely to occur again. I believe that involvement will have limited (if any) impact on lending or distressed investing.

The likelihood of any attempt to repeat this involvement is de minimis; and the lack of any judicial review (at least yet) of the Government's behavior means that any future attempts may not be successful (if the opinion had touched on the Government's role, other than the passing discussion in the opinion, then THAT would have been very troubling).

The specific circumstances of this case are so unusual that, I believe, banks and investors will consider them to be the equivalent of being struck by lightning (you can't live your life ducking a lightning strike that is almost certain to never come).

I was pleasantly surprised that, even thought the Judge decided to allow the sale, the opinion didn't address the issues that I believed could have negatively impacted credit markets, particularly the distressed investing and secured lending markets (I will address this in another post).

The Judge, based on the arguments presented, concluded:

• there are exigent circumstances, providing a good business reason for the sale of substantially all the assets in a 363(b) sale (as required by Lionel);



• the planned 363(b) sale was not a sub rosa plan because "The Debtors are receiving fair value for the assets being sold. Not one penny of value of the Debtors' assets is going to anyone other than the First-Lien Lenders." He relied on the Capstone testimony WHICH WAS NOT REBUTTED;



• the collateral securing the first lien was worth $2.0 billion (so there was no violation of 363(f); and



• the transaction is fair, as supported by the extensive sale process and no better offer.

The Judge stated that "the First-Lien Lenders will receive a greater return under the proposed sale, which reflects the going concern value, than under a piecemeal liquidation."

This conclusion is, in my opinion, well reasoned. I think the conclusion is wrong, but the Judge could only rule on the evidence presented to him.

I will present my thoughts on this in a separate post.

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Here is an interesting piece from the Automotive News on the second day of hearings.

Worth a read. They kept focus, and left the terrorist comment out when they quoted from it.

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I found the allusion to Heart of Darkness (or Apocalypse Now, if you prefer) in this article from the Automotive News a little over the top, but amusing nonetheless. It provides an interesting discussion of the first day's arguments in the Chrysler sale hearing.

Then, we have the overuse of the term terrorist in the email evidence (as described in this post). I guess we should be glad they didn't bring out Hitler or the Nazis.

If this guy was anywhere near New York or DC on 9/11, he needs his head examined!

As a point of comparison, football analysts toned down the military terms often used in football (blitz, shot, etc.) after 9/11 to recognize that, generally, in football nobody dies. Football announcers are not known to be particularly empathetic, but this guy from Wilkie makes them seem like innocent kindergartners.

Meanwhile, the sale hearing goes into day 3 at 9:00 AM Friday morning.

The end result seems preordained, but Judge Gonzalez is making sure that there is an excellent record for the expected appeal.

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If you have a twitter account, you can follow the postings at http://twitter.com/DealZone.

You can see the web version on Reuters at http://blogs.reuters.com/reuters-dealzone/2009/05/27/liveblogging-chrysler-in-bankruptcy-court/.

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Over the last two hours approximately 73 documents have been added to Chrysler's docket (and they're apparently still in court!).

I say "apparently still in court" because the Indiana Pensioners have filed a Motion for a Continuance of the Sale Hearing together with a Proposed Order for the Judge, should he allow the motion. Failing that, the Indiana Pensioners have filed a Motion to Strike the Last Minute Declarations together with a Proposed Order.

The motion for continuance is interesting reading. Apparently the Indiana Pensioners have been conducting an incredibly ambitious discovery process, having:

• taken 23 depositions between May 23rd and May 26th, most within 48 hours of the sale hearing;
• received over 87,000 documents totaling 385,000 pages from 39 separate discovery requests; and
• took two additional depositions on May 26th based on an incomplete review of the documents.

As of late Monday evening, May 25th, 2,308 documents totaling 26,000 pages had not yet been entered into the electronic database (which significantly increases the efficiency of the discovery process).

Interestingly:

• The Supplemental Declaration of Robert Manzo was not filed until after 10 PM on May 26th;
• The Declaration of James N. Chapman was filed between 12:30 AM and 3:00 AM on May 27th; and
• The Supplemental Declaration of Robert J. Nardelli was not filed until after 1:00 AM on May 27th.

The Indiana Pensioner's motion for a continuance is based on the incredibly tight timeframe imposed by the Court for discovery and that the Debtor was continuing to provide information even as the motion for Continuance was being prepared.

The motion to strike is based on the lack of time that the Indiana Pensioners had to review the late declarations.

Here is the Declaration of Owen C. Pell that supports both motions by the Pensioners.

On the other side, here is the opening statement by Corinne Ball on behalf of the Debtors in relation to the sale hearing. You will note that she continues to claim that the business enterprise value of Chrysler is melting away as these proceedings continue. This claim, the debtors assert, provides a good business reason to proceed with the 363(b) sale.

Apparently, the value of Chrysler is like an ice cube, and bankruptcy proceedings for Chrysler are like putting that ice cube in the middle of the Sahara Desert at noon!

I wonder if she was aware of the statements made by Chrysler personnel about how well Chrysler cars are continuing to sell (see here and here).

I don't envy Judge Gonzalez. He has had to read thousands (possibly tens of thousands) of pages of motions, declarations, contracts, etc. in relation to all aspects of the Chrysler bankruptcy - and many related to today's sales hearing. All of this is happening in a 27 day period!

We'll see what happens, but I doubt the continuance motion will be approved (particularly since I didn't see anything about a continuance in a search I did at 1:30 PM on Google's News search).

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