Thursday, May 14, 2009
A Little Bit of Chrysler
Many comments have crossed the blogosphere with regard to the violation of contract law and bankruptcy law which I think, to be honest, are a little bit off base and perhaps more than a trifle partisan. In particular, they argue that the Obama Administration bullied certain creditors into accepting a proposal which somehow violated contract law, etc, etc, etc.
Frankly, that's not right. While I may not like the fact that the US government is funding the auto industry, how the Company or industry is getting restructured per se isn't violating the law. And without government money, Chrysler very likely would have entered a Chapter 7 bankruptcy liquidation process, with pennies on the dollar for all parties.
First, Chrysler is simply no longer able to meet its contractual obligations - let's start with that. And second, in order to sustain itself, Chrysler had no private funding alternative. It did not receive funding proposals from banks. It only got one from the government.
Now in bankruptcies that require new money to fund operating losses - and I don't mean DIP loans, which are typically senior loans made to companies post a bankruptcy filing to ensure a business has operational liquidity though it has positive operating cash flow - but the money which effectively owns the Company because it funds pre-interest losses, the rules get set by the new money. If the creditors don't like those rules, hey, let them put up new money. The notion that the taxpayers put up a bunch of money to prop up the senior or subordinated creditors is no more satisfying than doing it for the unions. By the way, if the creditors felt wronged and wanted to go to bankruptcy court to sort it out, they certainly could do that. The President said so. The problem, I suspect, related to the ongoing funding of the Company. If Chrysler continued to require money to fund its operating losses (and it clearly would), and the only lender to be found was Uncle Sam, then those lenders were going to be bludgeoned (economically, that is) far more unsparingly than what the most current proposal suggested was the case. When I act as a private party in those situations, I usually get called names too. Bully is polite, to be honest.
I would make one final observation - none of the reported holdouts (Perella Weinberg and Oppenheimer, to name two) are known as investment firms with distressed-to-control expertise. I think they simply screwed up here. They made a bad investment, and didn't appreciate how much new money Chrysler required; and they certainly didn't have the legs to fund it on their own. So they got hosed down - not because they were ripped off; but because Chrysler was a disastrous credit.
This is one place where the legal expertise, I'm afraid, gets trumped by commercial reality.
If we want to take issue with the Chrysler situation (and GM, no doubt), it relates to whether we believe the government should have funded these 2 horrible companies at all. The point was only to preserve jobs. And that may have been a mistake in any event. There is, after all, an argument that says by preserving 3 weak companies, we doom them to further shrinkage and long term malaise. By contrast, what if the government had allowed Chrysler to have been liquidated in an orderly fashion? Would this have made Ford and GM more competitive? Could they then have sought private funding for their own restructurings, whether in or out of court? That, to me, is the more interesting public policy question. And since the government funding has happened under 2 administrations of different political affiliation, I would say this isn't such a partisan question. And, by the way, it's not an easy call. Letting Lehman go bust hurt a lot of people; letting Chrysler go wouldn't have been pretty either.
16 Comments:
By 
, at
Thu May 14, 05:01:00 PM:
Are you saying the new money sets the rules without the consent of the old money? That doesn't seem right, I thought that the new money has to cajole/convince/bully the old money into believing that the new money's offer is better than what they'd get in liquidation. If the old money says "no", into chapter 7 they go, where they new money can bid for the assets like anybody else.
By 
Cardinalpark, at
Thu May 14, 05:17:00 PM:
No, in the end, the old money does need to agree. Outside of court, you need 100% consent. Inside of Chapter 11, you need 51% of the lender and 67% of the money. That's why it's relatively unusual to have these restructurings agreed outside of court. Who gets 100%? But, as a practical matter, the new money can usually convince 51/67 to come along. But it's never pleasant, let's say. There is always the threat of liquidation and associated liability. It's messy.
But the plan design is invariably created by the new money in companies running operating losses.
By , at
Thu May 14, 05:58:00 PM:
I agree in part, both with your post and your comment. In my experience new money wins in a chapter proceeding 100% of the time if the only old money is junior (unsecured, subordinated and/or equity) or if there is only one deal on the table. In this instance the government made the only offer, so they would probably have won anyway later on, after lots of negotiating with the senior money.
Courts do love to keep companies alive and if someone shows up willing to make payroll it takes a powerful argument to stop that from happening. For the junior capital, it's "Welcome to your cram-down" time, but senior, secured lenders get a decent deal generally.
In the Chrysler instance the government won because they were new money and they won quickly because the banks were thoroughly browbeaten-- by the government. So, I disagree with you on that point. The bnaks were senior, fully secured, and yet they walked away from without even trying to negotiate for better terms, leaving Peralla and Oppenheimer swinging in the wind, and I've never seen banks cave so quickly. I believe there is only one explanation for their unprecedented behavior, and that could only be because their TARP investor told them to. Having negotiated with government creditors more than once in a bankruptcy I have no doubt at all that the discussion was short and crystal clear to all lenders.
My experience is different in this respect than yours, I guess.
It's true that now is a bad time to be auctioning off auto plants, and just possibly one could argue that there might be appraisals coming in showing that the security would therefore not cover the senior debt outstanding (no one cares one whit generally about the unsecured or junior debt, unless they are willing to come up with new money). But I would point out that in this case the appraisals were never done, since the lenders caved in record time. Was there even time to organize creditor committees, or identify members of the various classes? I don't think so. This has "beaten up by the government" written all over it. Moreover, it wasn't just Peralla and Oppenheimer complaining, it was the head of the bankruptcy practice at White and Case, a pretty good firm and one we used to use frequently in our leveraged buyout business years ago.
By Escort81, at
Thu May 14, 08:39:00 PM:
Cardinalpark -
I will defer to your experience, which is deeper, broader and more recent than my own, but when I blogged about it after reading one of Meagan McArdle's pieces in The Atlantic, I tried to put myself in the shoes of Chrysler's senior secured creditors, and speculate on why they would have turned down the transaction that Rattner offered, and opted for the bankruptcy process instead. I did note that junior creditors can leap ahead in line in certain distressed situations outside of bankruptcy, as long as everyone signs off, as you also indicate in your comment above.
I agree with what I understand your general point to be -- purchasers of distressed debt are like other speculative investors: you put down your money, you take your chances. Anyone who purchased Chrysler debt over the last nine months probably understood (or should have) that the cram down scenario was a possibility, given the likelihood of an Obama victory since about the end of last summer. Knowing it can happen in advance doesn't necessarily make it feel any better when it occurs.
It would have been nice if President Obama hadn't singled out the senior creditors for specific criticism. I am not sure that I understand what the point of that rather unnecessary and gratuitous comment was on the part of the POTUS (especially when it's our job to make unnecessary and gratuitous comments), unless it was to send a message to GM creditors to play ball. Why pick on a niche investor? It might have been better if he hadn't commented on that aspect of the Chrysler situation.
We haven't heard much from Lauria since his radio interview, which I linked to. I wouldn't mind reading what Leon Black's take on all of this is (or anyone else at Apollo, for that matter), since he is one of the more successful debt-to-control investors over the last couple of decades.
I am not sure any of this will matter in 3 to 5 years, if at that time there is no Chrysler. It might be that the Obama administration is simply trying to kick the can down the road and postpone what they think will ultimately be a liquidation, hoping it occurs after November 2012.
By , at
Thu May 14, 10:42:00 PM:
Anyone who purchased Chrysler debt over the last nine months probably understood (or should have) that the cram down scenario was a possibilityBut we're talking about senior debt here. Cramdown shouldn't have affected them at all without wiping out junior debtors first.
By davod, at
Thu May 14, 11:10:00 PM:
How did the union get so much control of Chrysler? How does this help Chrysler?
By MainStreet, at
Fri May 15, 01:03:00 AM:
All but davod seems to have missed the point. It wasn't so much that the senior debt holders got screwed, it was that a most junior holder (union) got so much political payback. It is well known that the union contracts are unsustainable and no one is foolish enough to think the unions could run any legitimate business. Politics is all it is and at the cost of all American taxpayers.
By Andrewdb, at
Fri May 15, 02:50:00 AM:
Our BK guy at The Firm (we are not involved in any of the auto stuff) tells me that the last of the objectors withdrew their objections when the judge refused permission to file their objections under seal - after the ones that became publicly known received death threats.
Maybe I am a goodie two shoes transaction wonk, but death threats (that appear at least condoned by the government - look at the POTUS' comments) do not seem to kosher to me - there is some "tough bargaining" that is not or should not be tolerated.
By , at
Fri May 15, 06:04:00 AM:
I agree with Anonymous that the protections for secured lenders under the law are strong enough that the senior lenders would not have caved here without strong government interference. My understanding through the grapevine was that JP Morgan was adamantly against the government offer until "they were shown the light" by their government watchers.
CardinalPark: Without substantial TARP lender backing for turning the priority rules upside down in this case, I don't see how a judge could have crammed the result down: (1) The case violates basic tenets of absolute priority, (2) The secured lenders are not getting "adequate protection", and (3) The case does not establish that claimants are getting at least as good a deal as they would in a liquidation.
I think that relying on who provided the new money is a bit of a weak reed because the government had already committed to DIP-style lending back in the Fall of 2008, obviating the incentives for anyone else to participate. I don't think that means you can for that reason trash secured lenders' rights.
By , at
Fri May 15, 08:02:00 AM:
By the way, CP, you seem to think Chrysler isn't now going to go bankrupt. Maybe the government will keep pumping money in so Fiat can make payroll, but these jobs are already lost and gone- we just don't yet know when exactly that'll happen.
By , at
Fri May 15, 08:10:00 AM:
The bondholders who were secured are probably fiduciaries in this instance, in that they represent individual investors. Average people got screwed here by the government, just to make a useless political pay-off to the UAW. It is that stark, and these managers are wide open to lawsuits I would imagine. And, as ugly as the position must have been, "the government threatened my livelihood and even my life" isn't going to be much of a defense.
By Cardinalpark, at
Fri May 15, 08:47:00 AM:
In then end, all of us are speculating to some extent because we don't know what would have happened in an alternative, private restructuring. The fact is that senior secured creditors are being bullied, as we speak, by private parties providing new money into agreeing to significant writedowns. And in those same circumstances, people with no apparent economic value are being paid off for their "nuisance value" having nothing to do with strict priority. The US bankruptcy process often sees junior creditors wind up with more equity than senior creditors; they've just taken a larger % writedown and/or received less cash.
The assessment lenders had to make was simple -- will I do better in court in a protracted battle? And I think the commercial reality is, in all likelihood, no. Between more new funding standing first in line and setting new rules, and a continued poor economic/car sales enviroment, the net value achievable by the holdouts was probably just going down. And, to be honest, the reason they weren't being liquidated outright for pennies was thanks to Uncle Sam.
Lauria, the White and Case bankruptcy guy, is flamboyant and likes to get attention. But it is not clear to me that he has an economic clue. Lawyers are meant to give legal advice, not give investment or commercial advice. That's somebody else's responsibility, and I think in this case it was abdicated.
The fact Apollo didn't touch this should tell you something.
By , at
Fri May 15, 09:19:00 AM:
The assessment lenders had to make was simple -- will I do better in court in a protracted battle? And I think the commercial reality is, in all likelihood, no.You might well be right. But it's never going to be known because the senior creditors never did the work they are obligated to do- no appraisals, no negotiating, no working to seek a better deal from some other party. The speed with which this happened is without precedent, and made it impossible to have done that work. Your speculation about what the values that might have resulted in some hypothetical future liquidation may be correct, but what we know with certainty is that the senior, secured lenders walked away from their position without a fight, and seemingly without doing even the simplest assessment of liquidation values. In doing so it appears to an outside observer that they ignored their basic responsibility to their investors to maximize recovery.
No fiduciary does that lightly, or at all if they can avoid it. When they are sued by their investors I look forward to hearing the explanation.
By Cardinalpark, at
Fri May 15, 11:33:00 AM:
Anon - I don't know this to be the case but I suspect the senior secureds were "primed" by the goverment loans. That's what a DIP lender would do. Which is to say, that the government money was senior to the senior secureds and trumped their historical security. They agreed to that because they were unwilling to provide liquidity, as they might have in other bankruptcy situations, because of the enormity of the hole here.
So I don't think the senior lenders were as irresponsible or as dumb as they might appear....at least not for walking away. You can question mightily what the hell they were thinking about when they lent to the Cerberus LBO of Chrysler. That might go down as the business brainfart of all time. But cutting your losses by not throwing good money after bad and avoiding an outright liquidation? I wouldn't question that judgment.
By , at
Fri May 15, 11:46:00 AM:
Now, I think you are getting to the crux of the matter. I looked for evidence of government negotiations with senior secured creditors before the government put any money into Chrysler and GM, since that's exactly what a smart person would have done, and I haven't found any.
What I think happened is that the bond holders and the banks sat quietly while the government made payroll after payroll at these two companies, and they were never approached to subordinate their claims in favor of the new, government supplied money. If there is any evidence to the contrary CP I'd love to see it; it would renew my faith in the intelligence of the Treasury Department.
By , at
Sat May 16, 10:56:00 AM:
Let's see if marginal credits in union dominated industries can get secured loans going forward. This absolutely critical source of financing, for many capital intensive industries, may just have been shut down. Thuggish intimidation of firms and threats to the physical safety of individual fund managers, all to further the President's political aims, is unbelievable.
If we had a free and inquiring press, we wouldn't be in this fix.
