Fear and Greed Blog

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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As I noted in a recent post, the Ad Hoc Committee of Bondholders (Oaktree, Whippoorwill Associates, and Solus Alternative Asset Management) withdrew their proposal to provide Dayton Superior with DIP financing after negotiating revisions to GECC's proposal (the filing with the new proposal is included in this document filed yesterday). The Ad Hoc Committee, DK Acquisition Partners and Silver Point Capital also withdrew their objections to the financing. The revisions greatly improved the economic terms offered to Dayton Superior.

The company issued this press release a few minutes ago:

Dayton Superior Amends DIP Credit Facility as Creditors Resolve Material Differences

DAYTON, Ohio--(BUSINESS WIRE)--Dayton Superior Corporation (Pink Sheets: DSUPQ), the leading North American provider of specialized products for the nonresidential concrete construction market, today announced that the U.S. Bankruptcy Court for the District of Delaware in Wilmington has approved an amendment to its $165 million debtor-in-possession (DIP) credit facility provided by GE Capital.

This amendment to the DIP credit facility reduces the interest rate at which the company can borrow money, provides the company additional time to reach key milestones in the chapter 11 process, reduces the required EBITDA milestones and contemplates that holders of the company’s senior subordinated notes will be entitled to participate in a rights offering as part of the company’s reorganization. In connection with this amendment, the holders of the company’s senior subordinated notes and the lenders under the company’s term loan credit facility have withdrawn their objections to the DIP credit facility and have reached an understanding in principle with GE Capital on a plan for the company’s emergence from chapter 11. The company is working quickly to resolve the open issues and hopes to emerge from chapter 11 as soon as possible.

“This amendment to our DIP credit facility and the bondholders’ withdrawal of their objections are critical steps towards smoothly and quickly exiting from chapter 11,” said Rick Zimmerman, Dayton Superior's President and Chief Executive Officer. “We are encouraged that the parties have resolved their material differences and look forward to efficiently finalizing our capital restructuring process.”

As previously announced, Dayton Superior filed a voluntary petition for reorganization under chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware in Wilmington on April 19, 2009. Additional information about the filing for creditors and other parties is available through a link on the Company website, www.daytonsuperior.com.

While the Company is in chapter 11, investments in its securities will be highly speculative. Investors should assume that shares of the Company's common stock have little or no value and will likely be cancelled upon consummation of the Company's reorganization. The outcome of the chapter 11 restructuring case is uncertain and subject to substantial risk. There can be no assurance that the Company will be successful in achieving its financial reorganization.

ABOUT DAYTON SUPERIOR CORPORATION

Dayton Superior is the leading North American provider of specialized products consumed in nonresidential, concrete construction, and we are the largest concrete forming and shoring rental company serving the domestic, nonresidential construction market. Our products can be found on construction sites nationwide and are used in nonresidential construction projects, including: infrastructure projects, such as highways, bridges, airports, power plants and water management projects; institutional projects, such as schools, stadiums, hospitals and government buildings; and commercial projects, such as retail stores, offices and recreational, distribution and manufacturing facilities.

Note: Certain statements made herein concerning anticipated future performance are forward-looking statements. These forward-looking statements are based on estimates, projections, beliefs and assumptions of management and are not guarantees of future performance. Actual future performance, outcomes and results may differ materially from those expressed in forward-looking statements as a result of a number of important factors. Representative examples of these factors include (without limitation):

• Depressed or fluctuating market conditions for the Company's products and services;


• operating restrictions imposed by the Company's existing debt;


• increased raw material costs and operating expenses;


• the ability to increase manufacturing efficiency, leverage purchasing power and broaden the Company's distribution network;


• the competitive nature of the nonresidential construction industry in general, as well as specific market areas;


• the Company's ability to obtain court approval with respect to its motions in the chapter 11 proceedings;


• the ability of the Company to operate pursuant to the terms of the DIP facility;


• the ability of the Company to prosecute, develop and consummate a plan of reorganization with respect to the chapter 11 proceedings;


• risks associated with third-party motions in the chapter 11 proceedings, which may interfere with the Company's ability to develop and consummate a consensual plan of reorganization; and


• the potential adverse effects of the chapter 11 proceedings on the Company's liquidity or results of operations.

This list of factors is not intended to be exhaustive, and additional information concerning relevant risk factors can be found in Dayton Superior's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K filed with the Securities and Exchange Commission.

In drawing conclusions set out in our forward-looking statements above, we have assumed, among other things: the ability of the Company to obtain court approval with respect to its motions in the chapter 11 proceedings; the ability of the Company to operate pursuant to the terms of the DIP facility; the ability of the Company to prosecute, develop and consummate a plan of reorganization with respect to the chapter 11 proceedings; that the Company will be able to manage the risks associated with third party motions in the chapter 11 proceedings and they will not interfere with the Company's ability to develop and consummate a plan of reorganization; and the Company will be able to adequately manage any potential adverse effects of the chapter 11 proceedings on the Company's liquidity or results of operations.


Contacts
Dayton Superior Corporation
Edward J. Puisis, 937-428-7172
Executive Vice President & CFO
Fax: 937-428-9115

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There were a number of filings on the Dayton Superior Docket on June 3rd. Among them were an application by the Official Committee of Unsecured Creditors to retain Conway, Del Genio, Gries & Co., LLC as their financial advisor, the Agenda for Friday's hearing, and GECC's response in relation to the DIP financing matter.

There was news in the GECC response. The response stated that the Ad Hoc Committee of Bondholders has withdrawn their alternative DIP proposal and will be withdrawing their objection to GECC's DIP proposal, as submitted by the Debtor. DK Acquisition Partners and Silver Point Capital also will be withdrawing their objection to the DIP proposal.

Apparently, GECC has agreed to modify the terms of their DIP by:

• Reducing the interest rate from LIBOR plus 12.00% to LIBOR plus 7.50 %;
• Reducing the facility fee cap from $3 million to $1,950,000;
• Eliminating the requirement for a financial advisor; and
• Extending dates for milestones and for a sale.

The Official Committee of Unsecured Creditors has not withdrawn their objection, so there will be further discussion of the matter at Friday's hearing.

I have not yet seen the revised DIP agreement, but according to the Agenda, the Debtor will be submitting a document entitled "Debtor's Supplemental Memorandum of Law in Support of DIP Financing Motion and Amendment #1 to DIP Credit Agreement." I expect that will be filed today.

Given that there is only one remaining proposal for DIP financing, it will be interesting to see if the Judge requires any changes to the modified agreement - particularly since he issued an Interim Order authorizing the DIP under the original agreement.

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In an earlier post, I discussed the situation in the Dayton Superior bankruptcy. At the time, I understood that the matter would be decided in Court on May 11th. I was mistaken.

In order to properly decide this issue, both sides have been engaged in discovery. The parties were to provide a status update to the Court at a hearing today. At present, there have not been any documents relating to the results of that hearing on the public docket. The hearing on the DIP has been moved to June 5th at 9:30 AM.

Currently, GECC has scheduled depositions of DK Acquisition Partners and Silver Point Capital for May 27th and a deposition of the Official Committee of Secured Creditors for May 28th.

The Official Committee Of Unsecured Lenders filed a Preliminary Objection to the DIP Order yesterday (at least that's when it hit the public docket, I do not have access to PACER). This preliminary objection included the following statement:

Discovery, including depositions, is proceeding in this contested matter among the parties-in-interest. During the afternoon of Thursday, May 14, 2009, in the midst of that discovery, the Committee was advised that a tentative resolution (contingent on documentation, among other things), was reached between GECC and Oaktree of certain issues between them with respect to the DIP Motion. The Committee understands that, subject to the terms of that agreement, Oaktree is expected to withdraw its DIP financing proposal to the Debtor and the Ad Hoc Committee's objection to the GECC DIP Facility upon consummation of the resolution with GECC.

If Oaktree and GECC do come to an agreement, the Official Unsecured Committee has changes that they are seeking to have incorporated into the final DIP financing agreement at the June 5th hearing.

An agreement by Oaktree will take the alternative offer of DIP financing off the table as they were one of the three parties participating in that offer (the others being Whippoorwill Associates and Solus Alternative Asset Management).

Dayton Superior appears to be a great example of the state of the DIP market today. The only parties willing to offer DIP financing were the existing lenders. GECC is looking to roll-up their existing loan into a DIP facility which will improve their position from a secured lender to a secured lender with superpriority status. The bondholders were looking to provide only new financing, but only if it they were given pari passu status with GECC on their liens (and thus have a secured administrative priority status for the DIP loan).

The GECC proposal does not provide as much new cash as the bondholders' offer, and it will cost significantly more (higher fees and higher interest rate, to be charged on the entire balance rather than just the new money). The bondholders' offer charges a lower interest rate, a lower fee, and only applies to the new money (and more new money is provided), but the Debtor would have to prove that there was adequate protection for the existing liens before it could offer the pari passu status sought by the bondholders in their offer.

Since there are little, if any, in the way of assets that are not secured by one (or more) of the lenders, no other party was interested in pursuing the opportunity to provide the DIP.

I will keep watching this situation play out.

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Professor Stephen Lubben of Seton Hall has written a post on the Credit Slips blog that provides some justification for the way the Chrysler bankruptcy is proceeding.

I submitted some questions to Professor Lubben in the comments section of the blog.

I am indebted to the Wall Street Journal Bankruptcy Beat Blog for pointing me towards Professor Lubben's comments. I've added both blogs to my Blog Roll on this site.

I am interested in what you think about all of this.

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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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President Obama seems to think so. In a speech on Thursday, the President said:

While many stakeholders made sacrifices and worked constructively, I have to tell you some did not. In particular, a group of investment firms and hedge funds decided to hold out for the prospect of an unjustified taxpayer-funded bailout. They were hoping that everybody else would make sacrifices, and they would have to make none. Some demanded twice the return that other lenders were getting. I don't stand with them. I stand with Chrysler's employees and their families and communities. I stand with Chrysler's management, its dealers, and its suppliers. I stand with the millions of Americans who own and want to buy Chrysler cars. I don't stand with those who held out when everybody else is making sacrifices. And that's why I'm supporting Chrysler's plans to use our bankruptcy laws to clear away its remaining obligations so the company can get back on its feet and onto a path of success.

He further stated "it was unacceptable to let a small group of speculators
endanger Chrysler's future by refusing to sacrifice like everyone else."

Now I know that the general perception of "investors and hedge funds," not to mention "speculators" is that they are close to, if not as bad as, the so-called "robber barons" of yesteryear.

Many people will think these firms deserve to lose money, perhaps all of it. Heck, I'm sure that there are some Americans who would like nothing better than to physically take out their anger at the economy on these "speculators" who let greed get the better of them.

I guess it's smart for the President to frame the issue in populist terms. After all, the workers compromised; Daimler, the former owner, compromised; even the private equity firm, Cerberus, compromised! Although the Cerberus part was somehow was left out of the speech.

The other secured lenders were willing to take the deal offered as well. So what's wrong with these "investment firms and hedge funds." How could they possible think they were going to get away with an "unjustified taxpayer-funded bailout?" Why did they think they could get "twice the return that other lenders were getting?" Are they really so greedy and rapacious that they would rather see poor Chrysler employees on line at soup kitchens and living in Hoovervilles while they gleefully liquidate and American icon?

Well, certainly that seems to be the party line among Chrysler, its well paid advisers, the unions, and the Executive Branch, led by the President himself!

It might make a wonderful movie some day, like "It's a Wonderful Life," but it's a fairy tale. In reality, things aren't so clear cut.

Let's examine what has happened and is happening:

• Chrysler and the President's "Automotive Task Force" tried to arrange a distressed debt exchange. Typically, in such negotiations, the parties know that there is a financial distress and the failure to come to an agreement will lead to a bankruptcy.

Bankruptcy, under Chapter 11, provides companies with protection from their creditors. The company (known as the "Debtor in Possession") doesn't have to pay interest or principal on any debt owed at the start of the case (although, generally, it is necessary to pay some parties to keep the business running) until the end, when the Plan of Reorganization is confirmed.

Bankruptcy also provides the debtor in possession with the opportunity to cancel executable contracts (like leases, long term purchase agreements, etc.).

At the conclusion of the bankruptcy, the pre-petition creditors are given some form of compensation (or nothing, if they are too junior). Compensation can be cash, a future promise to pay cash (in the form of a loan agreement or bond), and/or equity.

One class of creditors that is given special protection under the law is the secured creditors. Under a strict reading of the law, compensation would be paid out based on absolute priority (the priority of payment in a liquidation). Therefore, if the value in the business left at the end of a bankruptcy is less than the secured claims, then the secured creditors receive all the compensation and the unsecured creditors receive nothing.

Secured credit is one of the foundations of American capitalism. Without it, many businesses wouldn't be able to borrow money at all. Other businesses use secured loans to obtain cheaper capital.

If the Chrysler case brought the rights of secured creditors into question, then lending would dry up for some parties and become more expensive for everyone else.

The "investment firms and hedge funds" own a portion of the loans issued under Chrysler's "First Lien Credit Agreement" which was amended and restated on August 3, 2007. The loan under the agreement was initially $10 billion, but has been paid down to the current level of $6.9 billion. This facility (according to the Affidavit of Ronald E. Kolka, Chrysler's CFO) is

(a) secured by a security interest in and first lien on substantially all of Chrysler's assets,including accounts receivable, inventory, equipment, books and records, cash, general intangibles, real property and a pledge of all of the capital stock of each of Chrysler's domestic subsidiaries (other than its charitable subsidiaries) and 65% of all of the capital stock of each of Chrysler's first-tier Foreign Subsidiaries; and (b) guaranteed by certain other Debtors, which guarantees are secured by a first priority lien on substantially all of such Chrysler's respective assets, including a pledge of all of the capital stock of each of its domestic subsidiaries and 65%of all the capital stock of each of its first-tier foreign subsidiaries.

So the owners of those first lien loans should, under absolute priority, be at the front of the line to receive any value from the assets of Chrysler.

• The first lien secured creditors were initially offered $2.0 billion in cash to pay off the $6.9 billion of that secured debt (roughly 29 cents on the Dollar). This was satisfactory to some of the lenders, but not all. The offer was then increased to $2.25 billion in cash (roughly 33 cents on the Dollar). The "investment firms and hedge funds" refused to accept that offer either.

Now most of the banks (probably all) accepted both the 29 cent offer and the 33 cent offer. They own the same loans as the "investment firms and hedge funds," so why were they willing to compromise?

It might have had something to do with the Government's place in the banking world. First, many of these banks had taken TARP money - so the government owns equity in the institution and those banks are under a microscope. In addition, both the TARP banks and the non-TARP banks rely on the Treasury, the Federal Reserve, and the FDIC (among other Government entities) to conduct their business. The President's Automotive Task Force (and, subsequently, the President) made it very clear that they wanted the exchange to get done, with an implied thread to anyone who stood in their way (and Congress has been pushing for a deal as well).

• The "Investment Firms and Hedge Funds" that refused to give in had less to fear from the Government, so they could exercise their fiduciary responsibilities. Even so, they were willing to agree to 60 cents on the Dollar (although there was a story on Bloomberg that they were willing to take $2.5 billion, or 36 cents on the Dollar).

One fact that is often forgotten when discussing "Wall Street" and "Hedge Funds" in particular, is who actually owns the assets that they manage. While the investor base varies, among the largest players are pension funds, insurance companies, and endowments (universities like Yale and Harvard have been active investors in these funds for over a decade). So losses by these funds impacts the public through the financial stability of the institutions supporting their pensions, life insurance, etc.

So, back to the President's argument. Let's look at it one piece at a time:

• The unions compromised - But they were unsecured creditors being offered more than the offer to the first lien secured creditors. They couldn't hope for a better deal.
• Major financial institutions compromised - but, as I discussed above, they were given an offer they couldn't refuse.
• Daimler agreed to give up its stake - They owned equity and had loaned money against a second lien. They weren't getting anything if the first lien was cut to 33 cents! I don't know enough about their liability in relation to the pension plan, but as former owners, there was probably a case against them to fund the pension.

Well, the pressure didn't work on the holdouts (they owned approximately 15 percent of the loan). Chrysler has filed for bankruptcy.

The Chrysler team, led by President Obama, is trying to do a "surgical bankruptcy" from which they hope to emerge in 60 days. The plan is:

(a) Chrysler will transfer substantially all of its operation assets to New Chrysler; and (b) in exchange for those assets,New Chrysler will assume certain liabilities of Chrysler and pay Chrysler $2 billion in cash.Prior to the Closing Date, (a) Fiat will contribute to New Chrysler access to competitive fuel efficient vehicle platforms, certain technology, distribution capabilities in key growth markets and substantial cost saving opportunities; and (b) New Chrysler will issue approximately 55%,8% and 2% of the Membership Interests in New Chrysler to a new VEBA, the U.S. Treasury and the Canadian government, respectively. After the "Fiat Transaction", a subsidiary of Fiat will own 20% of the equity of New Chrysler, with the right to acquire additional 31% of NewChrysler's Membership Interests under certain circumstances.

So the union's pension plan will own 55%, Fiat will own 20%, the US will own 8%, Canada will own 2%, and there's 15% unaccounted for. All that will be left for the creditors will be the $2 billion in cash and whatever assets are left behind (except for any assumed liabilities, which are most likely trade and employee related) - after the lawyers, consultants, and investment bankers are paid out of the estate for their services during the bankruptcy.

To implement this plan, Chrysler will file a motion for a 363(b) sale to New Chrysler, which will be the "stalking horse" bidder in the sale process.

Our friend at the Distressed Debt Investing blog has looked at the documents and provides an interesting analysis - including the observation that the CFO stated an incorrect price in his Affidavit (he said the first tier loan debt is trading at 15 cents on the Dollar - it's actually, according to the blogger, 25.25 bid and 27.25 offer). His two posts are here and here and include links to the documents with an analysis.

Over at the Bankruptcy Litigation Blog, Steve Jakubowski points out that there are several hurdles for a rapid 363(b) sale. He cites a 2002 paper co-written by Chrysler's primary bankruptcy attorney, Corinne Ball discussing these hurdles. Here is an updated version of that article from 2007.

In that article, she states:

The most common justifications for a Section 363 Sale, which is typically much faster than a Plan Sale, are that the value of the assets involved will rapidly deteriorate or that the seller urgently needs the cash from the sale to continue its remaining businesses and avoid a liquidation, which, in either case, will lead to a lower recovery by creditors. See, e.g., In re Trans World Airlines, Inc., et al., No. 01-00056 (PJW), 2001 WL 1820326, at *4 (Bankr. D.Del. Apr. 2, 2001) ("TWA had no other strategic transaction available to it and had no offer for value to which it could turn. Nor could TWA rely on its self-help plan because TWA was unable to procure adequate capital infusion to implement that plan. Its only alternative was a free fall chapter 11 filing with the high likelihood of a piecemeal liquidation of the enterprise.")

Well, they've created an "urgent" need through the terms of the DIP being offered by the Treasury (here is a copy of the Term Sheet - it was part of the Exhibit to the declaration by the advisor from Capstone, Robert Manzo). The DIP loan is partially contingent on the filing of the petition for the 363(b) sale must be filed by Monday May 4th, the hearing on the petition to take place on or before May 9th, all bids related to the auction are to be received by May 20th, the lead bid must be determined by May 29th, the hearing on the motion to approve the sale must be held by June 1st, and the transaction must close by June 27, 2009 (see Schedule 5). Failure to comply with that schedule will constitute a default of the DIP agreement.

We'll get to find out how Judge Gonzalez enjoys having a proverbial gun to his head. To me, this could easily be construed as a sub rosa reorganization, violating the Section 1129(b)(2)(A) since substantially all of the assets are being sold without a full reorganization process (and the value of any operating improvements that could be made under the protection of Chapter 11 will accrue to the owners of NewChrysler, not the pre-petition creditors).

There could also be an argument made as to whether the union, Fiat, the US Treasury, and the Canadian entity are acting in "good faith." This could particularly be argued in connection with the promotion of the VEBA claim above that of the first lien lenders.

I don't know if the DIP lender, particularly the Government, will be given the right to create a crisis situation justifying the sale. If not, getting past the legal precedent of Lionel, Braniff, Iridium, and this case from the Southern District of Texas.

This is going to be a very interesting case, and it starts in 2 3/4 hours!

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One of the themes that I've been discussing in my most recent posts relate to how there have been significant changes in the bankruptcy/restructuring process from previous bankruptcy waves.

The Wall Street Journal has a blog called "Bankruptcy Beat" and in this post they present comments made by the co-head of Jefferies’ restructuring group at a Jefferies' conference last Thursday.

One of the changes that he identified is how the "fulcrum security" has moved up in the capital structure. He stated that now it is typically the first lien lenders (generally the bank debt) that are in that position.

In the past the fulcrum was typically in second lien or unsecured debt.

The "fulcrum security" is the security that ends up controlling the company after a bankruptcy.

Wilbur Ross, at the Wharton Restructuring Conference on February 27th, discussed how the fulcrum security, more and more frequently, is going to be the Debtor in Possession loan.

As I mentioned, in my last post, this could be the result in the Dayton Superior bankruptcy (particularly if the DIP is extended by the bondholders, without the liens that they initially requested).

It also seems that Bill Ackman may be pursuing this strategy in the General Growth bankruptcy.

In the markets, it is generally a good idea to revisit your assumptions when people are saying "this time it's different," but, in this case, it really is - at least for now.

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I promised in an earlier post to discuss why distressed companies are having such difficulty raising Debtor In Possession financings.

I discussed the issue in this comment on the Distressed Debt Investing blog.

Floyd Norris of The New York Times, in this article from yesterday's edition, discusses the recent increase in bank loans from a different perspective (although I believe that his shot at Alan Greenspan is unwarranted; Greenspan knows more about markets than Norris ever will).

I am taking this discussion further to state that the popularity of utilizing bank debt over the last several years has changed the Chapter 11 reorganization process.

The majority of the companies that are filing, or that want to file, to reorganize took advantage of the increased availability of bank debt. Sometimes loans were taken to support an equity sponsor's leveraged buyout (or to finance a dividend payment from the purchased company to the sponsor's fund). Sometimes companies used these loans to expand (and some of those expansions were ill-timed given the current economic conditions).

In the past, if companies were looking to borrow these types of funds, they issued bonds - most of which were unsecured. Because of this, in the past, there were uncollateralized assets that were available as security to support a DIP financing if the business became financially distressed.

Bank debt, on the other hand, is usually collateralized. Banks offered first lien, second lien, and even third lien debt as the market became more and more exuberant. This was possible because of the tremendous market demand for securitized products like CDOs and CLOs. The banks were able to make loans, collect fees, sell the loans, and then repeat the process. It was very attractive to the banks and the low yields in the fixed income market made the securitized products look very attractive (particularly with the ratings they were given by the ratings agencies), which fed the exuberance.

Companies were attracted by the cheap cost of these loans and were even able to negotiate for attractive terms like minimal covenants (which provide the banks with power, outside of a bankruptcy, when a company's financial ratios indicate the company is becoming distressed) and features like Payment-In-Kind toggle (where the company, at its discretion, can pay interest due by increasing the size of the loan in the amount due instead of paying in cash).

Since bank debt is typically priced at a premium over a reference rate (like LIBOR), the banks were willing to lend at initial rates that were lower than those available in the bond market (inflation risk was minimized by the floating rate, and there was lower repayment since the loans were secured by the borrowers' assets).

Now, when these companies are looking for DIP financing, they are usually at the mercy of their existing secured creditors. Other potential lenders are less interested in offering DIP financing because there are no assets to secure the DIP. Without security, and given the difficult market for exit financing (loans to the post petition company that can be used to pay off the DIP, often at a lower interest rate than the DIP), even the administrative priority status (or, often super-priority status) offered to DIP financiers is not attractive enough for lenders to actively compete in the DIP market.

Consequently, a significant number of the DIP financings currently taking place are funded by existing secured lenders and include a roll-up of some, or all, of the existing secured debt (with the end result that the administrative priority applies not only to the new funds, but to the existing "rolled-up" loans). The terms for these DIPs provide the lenders with attractive interest rates (applying to the entire DIP, not just the new money, which means the lenders receive higher interest rates on their prepetition debt) and fees for arranging the DIP. The lenders are also able to impose numerous loan covenants that can provide them with significant power in the restructuring process.

In the Dayton Superior case that I was commenting on, the DIP is a hotly contested issue. The Court provided an interim ruling in favor of Dayton Superior's motion to accept the DIP facility offered by GECC. The economic terms of this offer are significantly inferior to the DIP offer by the bondholders, but the bondholders, who are not secured, are seeking to collateralize the DIP with the same assets currently collateralizing GECC's prepetition debt (on pari passu terms). If Dayton Superior accepted this "priming" of GECC's loans, the bondholder DIP would be contested by GECC.

Section 364(d)(1)(B) of the Bankruptcy Code states the Trustee (or Debtor) must prove there is "adequate protection of the holder of the lien on the property of the estate on which such ... equal lien is proposed to be granted."

The Court is having a final hearing on the DIP motion on May 11th. At that hearing, the bondholders will have to provide sufficient evidence that there is adequate protection for GECC's prepetition debt with the bondholders' DIP facility sharing the collateral. Dayton Superior's advisers seem to have concluded this would not be the case, which may be the reason they recommended GECC's offer over the offer made by Oaktree (and now the bondholders).

If the bondholders were willing to give up their requirement for collateral, they could pursue a strategy that would put them in a position of controlling the company after it emerges from bankruptcy.

Dayton Hudson is just one example of the how changes in financing structures have changed the dynamics of the reorganization process under Chapter 11 as opposed to previous recessions.

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Weil, Gotshal & Manges LLP has posted a good article on DIP financing.

If you are interested in learning about, or participating in this market, I recommend reading it.

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Today's edition of Toronto's The Globe and Mail had an interesting article about what's going on in the Debtor in Possession financing market today. Please click on the link below (I've pasted the article, in case the link breaks, but the pasted version lacks a picture and price chart on Abitibi).

http://www.theglobeandmail.com/servlet/story/RTGAM.20090421.wlawmain0421/BNStory/robLawPage/home

Lenders jockey for pole position

Jacquie McNish
Globe and Mail

April 21, 2009 at 5:47 PM EDT

AbitibiBowater Inc. [ABH-T] had every reason to believe it was one of the lucky ones.

Strapped for cash to pay $6-billion (U.S.) of debts in a sputtering newsprint market, the crippled giant still had what it took to win the attentions of one of the world's most prominent lenders. Earlier this month, GE Capital was so convinced of AbitibiBowater's long-term future that it was finalizing a $600-million emergency infusion, known as a debtor-in-possession or DIP loan, to sustain a company headed for bankruptcy proceedings.

If signed, AbitibiBowater would have landed a rare major DIP loan at a time when conventional lenders have all but disappeared from corporate bailouts.

But it wasn't to be. Two weeks ago, with no warning, GE Capital pulled the loan off the table and faded away like ink on a newspaper. The abrupt retreat left AbitibiBowater with little choice but to cede what it described in court documents as “extraordinary” rights to a set of replacement DIP lenders. The generous terms are the latest in a series of power grabs by bankruptcy lenders that have triggered a handful of messy and time-consuming creditor battles.

“He who controls the DIP controls the process these days,” said Aubrey Kauffman, a restructuring specialist with Fasken Martineau DuMoulin LLP.

AbitibiBowater lost virtually all of its negotiating leverage with potential DIP lenders when GE Capital left it stranded.

“That jolted everybody,” said one person close to AbitibiBowater.

After what sources described as five frantic days and nights of talks with potential lenders including Goldman Sachs & Co., AbitibiBowater and its legal team at Stikeman Elliott LLP and Paul Weiss Rifkind Wharton & Garrison LLP were unable to strike a replacement deal with conventional lenders.

Instead, it was forced to tap two of its major investors – Fairfax Financial Holdings Ltd. and Avenue Capital Group – and the Quebec government for a total of about $300-million in DIP loans. If certain conditions are met, the company can borrow as much as $700-million.

A voluminous 252-page credit agreement negotiated by Fairfax's lawyers at Torys LLP and Shearman Sterling LLP and Avenue Capital's New York firm Kramer Levin Naftalis & Frankel LLP essentially vaulted the two investors from a lowly perch as largely unsecured creditors to high-ranking lenders with the right to effectively veto most major decisions, such as asset sales.

Restructuring loans have been a lucrative business for decades for adventurous lenders such as GE Capital and CIT Group. DIP lending pays high interest rates, rich fees and, typically, the loans rank ahead of most other debts.

Defaults are rare on DIP loans, but lenders have largely pulled away from the market because of fears that losses will rise as the global recession deepens. Moody's Investors Service has become so concerned about DIP loans that it recently started to rate them to reflect the risks of possible defaults.

Against this backdrop, most companies don't have much choice but to swallow tough terms demanded by those willing to wager a DIP loan.

These days, most troubled companies can raise DIP loans only from a short list of affiliated companies, existing investors and, in some cases, governments that are willing to protect their existing investments or political interests by lending emergency funds.

“The only people who are willing to come forward are people who already have a vested stake in the company and want to preserve their interests through a DIP loan,” said Robert Chadwick, a Goodmans LLP lawyer who represents a number of AbitibiBowater bondholders.

These loans don't always sit well with other creditors, some of whom are pushing back against what they call overgenerous loans. The result is heightened tension between creditors, and delays for managers who are racing against the clock to right their corporate ships in turbulent waters.

Dutch-based petrochemical giant LyondellBasell Industries found itself in the middle of an international bank shoving match when it negotiated a record $8-billion (U.S.) DIP loan with a syndicate of banks in January to tide it through bankruptcy court proceedings. At least one bank, ABN Amro, was so infuriated that it threatened to walk away from the bailout because it argued that the big DIP loan weakened its claim to company assets set aside as collateral for its $3.4-billion loan.

Other unsecured creditors were so angered that some made moves to claim assets from LyondellBasell affiliates that were operating outside court protection. The mess has kept LyondellBasell and its lawyers busy in a variety of courts seeking orders to stop the creditor raids.

Creditors of the company that owns the Philadelphia Inquirer started complaining when they read the fine print in a $25-million (U.S.) DIP loan and discovered that the lender, a real estate developer, protected the job and pay raise of the company's chief executive officer, Brian Tierney. Shortly after the company won protection under Chapter 11 of the U.S. Bankruptcy Code, Mr. Tierney agreed to give up his raise.

Creditors of Circuit City's Canadian chain, The Source, found themselves in a cross-border tug of war about the terms of a $1.3-billion DIP loan that was arranged for the U.S.-based retailer by a syndicate of its existing banks led by Bank of America. When The Source's Canadian creditors began to read the small print, “the plot thickened,” said Fasken's Mr. Kauffman, who represents one of the subsidiary's suppliers.

What the creditors discovered was that the U.S. parent had agreed to hand the DIP lenders the right to seize most the assets of the healthy Canadian unit. The arrangement earned a rare rebuke from a court-appointed monitor and an Ontario judge set aside a portion of Canadian assets to protect local creditors.

Orestes Pasparakis, an Ogilvy Renault LLP lawyer who represented Bank of America in the Circuit City filing, defended the terms of the U.S. DIP as the necessary price of a loan that was urgently needed to keep a troubled retailer operating. In the end, the U.S. parent was forced to liquidate, but he said the DIP loan, which has been fully repaid, allowed the healthier Canadian unit to keep paying its bills while it restructured. “The Canadian stores would not have had the luxury of exploring its options had it not been for that loan,” he said.

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