Bankruptcy Reorganizations and the Troubling Legacy of Chrysler and GM

1. Bankruptcy Reorganizations and the Troubling Legacy of Chrysler and GM By Ralph Brubaker & Charles J. Tabb 2010 U. Illinois L. Review 1375

2. Or, “how scary is the § 363 revolution?” § 363

3. Or, “what is the essence of ‘reorganization’?” “Reorganization” = ???

4. Sea change: Plan 363 sale Chrysler & GM cases are the poster children highlighting the sea change in recent years from the traditional Chapter 11 reorganization model of a duly confirmed “plan” to an all-asset sale under § 363 363 sale Plan

5. The cases • Chrysler: • went through bankruptcy in 41 days • $2 billion “sale” from “Old Chrysler” to “New Chrysler” free & clear of underwater senior secured debt • GM: • went through bankruptcy in 39 days • Credit bid “sale” from “Old GM” to “New GM,” to underwater secured lenders

6. Traditional points of controversy re 363 sales • 1st: all-asset sale under 363, rather than via plan, deprives economic stakeholders of procedural & substantive protections in plan process • 2nd: not really a “sale” at all • But a “reorganization” wolf masquerading in “sale” sheep’s clothing • “Sub Rosa” plan

7. Historic “tests” to ferret out the twin concerns • The “sales are suspect” issue: • “good business reason” (Lionel) • i.e., why can’t we wait for a plan? • The reorganization wolf / sales sheep issue: • No “sub rosa plans” in a sale (Braniff)

8. What is not the problem • Neither the “sales are suspect” nor the “wolf/sheep sub rosa” issue is real concern raised by auto cases • Although the “sub rosa” plan issue, properly understood, is implicated • Problem: the “plan” / “sale” dichotomy is a false one  almost any sale can be effectuated as a plan, and any plan can be structured as a sale • So not helpful for a court to seek guidance on whether to approve a 363 sale in a model of a “true” sale or plan – no such thing!

9. What is the problem So what is our worry?  Boyd risen from the dead Boyd * referring of course to the 1913 Supreme Court ruling in equity receivership case that any “value” in the debtor had to be distributed in accordance with distributional entitlements, notwithstanding a supposed “sale” structure And yet this is precisely what the auto cases – and especially GM – appear to allow

10. Boyd resurrected – and no one noticed • It is bad enough that the reorganization fallacy that the Supreme Court laid to rest in Boyd was resurrected in the auto cases • Even more disturbing is that no one seemed to notice – it happened sub silentio • Which makes it even more likely that reorganization lawyers will be able to circumvent distributional entitlements via a 363 “sale” • Without the real issue even being on the table

11. The central point “Whether reorganization value is captured by “sale” or by “plan” is not the central question, as long as the means chosen preserves and upholds chapter 11’s distributional norms” … Thus, “courts confronting these issues must keep their primary focus on the core need to protect the normative distributional entitlements of stakeholders, whether the reorganization proceeds by sale or plan” (p. 1379)

12. A nod to plans? • Given that central thesis, I might be willing (probably more willing than my coauthor Ralph?) to acknowledge that IF distributional issues are implicated, then a plan may be favored • my basic point is that the plan process makes it easier for the court to monitor the fairness of, and for affected parties to have a meaningful say in, the question of “who gets what” • But it COULD be done via a sale  as long as court was alert to need to enforce distributional norms

13. Our Grades: Chrysler & GM on the real issue Chrysler: passed -- did not contravene stakeholders’ distributional entitlements GM: failed – did violate the rights of stakeholders to share in value of entity according to distributional norms  Acknowledge that our view (esp. on Chrysler) is controversial (but of course correct!)

14. Chrysler sale All assets 35% Fiat [Old] 8% US $2B + debt assumption 2% Canada 55% equity + Senior Secured VEBA ($10B $4.6B) (owed $6.9B) Trade ($5.3B) Warranty, dealer ($4B) Pension ($3.5B) OUT: Jr. secured; Unassumed unsecured; Old equity New Chrsyler

15. GM sale All assets + pref + $6.7 B [Old] 60.8% US Credit bid 11.7% Canada + 10% common stock + pref + $1.3B + debt assumption [eg, warranty, product liability, non-govt secured] US & Canada secured (~ $50B) Unsecured ($117B) 10% Old GM + warrants - Bonds ($27B) - UAW trust ($21B) 17.5% VEBA + warrants + pref + $6.5B New GM

16. 1st principles of reorganization Two distinct issues raised in reorganizations, and implicated in the whole 363 sale debate: 1st: how much? 2nd: to whom? One of the problems muddying the whole 363 debate is that the two issues tend to get conflated  the “sub rosa” plan issue gets confused with the preliminary question of when an all-asset 363 sale should be permitted at all

17. All cash Way to keep the two issues distinct is to posit an all cash 363 sale In effect just converting estate assets into a pot of $ Before sale after sale

18. 1stprinciple: maximize value • One of the core concerns in a bankruptcy reorganization is to maximize estate value • This is a question simply of how BIG a pot of $ we can get • It is in everyone’s interests to get a bigger pot of $ Which prefer?

19. Sale v. plan  agnostic on pie size! This crucial threshold issue of maximizing estate value is NOT really implicated in the “sale v. plan” debate

20. Value max? • No reason can’t get just as big (or bigger!) a pie out of estate assets in a 363 sale as in a plan • Sending out disclosure statements, voting, etc. does not grow the value of the estate • Individual stakeholders don’t enjoy unique & special value maximization insights that can only be captured via the plan direct democracy process • Indeed, give much deference to firm in business decisions • Only concern should be, is the pot of $ as big as it can be?

21. Aggregate vs individual • Note, though, that just because the action proposed may maximize the AGGREGATE value of the estate does not always mean that the value to each INDIVIDUAL stakeholder will be maximized • So do possibly disadvantage some individual stakeholders if we partially disenfranchise them via a sale process, rather than giving them a direct vote under a plan • But, is such a “harm” worthy of protection, if may make the entire pot smaller? • Answer: “no”

22. Big pot ≠ who gets The question of, “is this as big was we can make the pot of $ ?” is totally distinct from the question of “who gets what out of the pot” We should worry more if the “who gets what” issue is decided via a sale OK sale not OK sale

23. Reorganization premise -> capture surplus The whole point of trying to salvage a firm via a bankruptcy reorganization – rather than just liquidating the firm (in or out of bankruptcy) -- is the belief that extra value (the “going concern surplus”) can be captured going concern surplus liquidate reorganize

24. 363 Sale may be ok if get surplus In principle, if our 1st driving concern is to make sure we capture the “surplus” for the benefit of the stakeholders of the firm (viewed in the aggregate), then we should not necessarily object if we can realize that surplus via a 363 sale 363 sale? If realize -> then

25. Judicial test • In theory, then, a 363 sale should be fine if the only issue is whether that sale allows us to maximize aggregate estate value • i.e., are we still capturing the surplus? OR • Judicial test: “good business reason” for 363 sale • Gets at the “getting the surplus?” issue, but indirectly

26. The “lose-by-waiting” OK for sale Could just ask directly in any 363 all-asset sale: “does this maximize the estate value?” Instead, the Lionel “good business reason” test is framed on a “would we lose estate value if we waited for a plan?” and then only approve if answer “yes”: Sale now = Wait for plan =

27. Why require “lose-if-wait” justification? • Query why courts will only approve an immediate 363 all-asset sale if evident would lose $ by waiting? • Deference to the plan process protections (e.g., disclosure, voting, etc.) • As contrasted with the more limited process rights in a sale (notice, opportunity to be heard, etc.) • But do these really matter on the question of how to maximize estate value? • Plan dissent usually is over the “who gets what” issue, not over the “what should we do with the assets” question

28. Could change test • Could change the test to ask only if the sale = max • Even ifwould not lose anything by waiting • Thus, argue no reason not to approve 363 sale if: Sale now = Wait for plan =  it’s going to be the same size pot either way!

29. Applying the “GBR” test in auto cases Even with quibble about whether it really makes sense to use a “good business reason” test for a 363 sale, rather than a “is this really the max” test, was not much of a hurdle for courts to clear on the facts in either Chrysler or in GM Courts in both cases saw the estate value as a “melting ice cube” – i.e., waiting likely would cause enormous loss in aggregate value

30. Call the government’s bluff? One of main reasons the proverbial “ice cube” would melt in the auto cases was the risk that the US and Canadian governments would walk away They were putting up all the $, and said “sale now or forget it” Some critics say should have called their bluff – but would it really have been worth it? No other deals were on the horizon

31. What DO we need a plan for? If a 363 sale (rather than a plan) may be just as –indeed if not more – effective in maximizing aggregate estate value, then one might ask – what role does a plan ever serve? The answer is: determining who gets what, i.e., making decisions on how to DISTRIBUTE estate value to the interested stakeholders

32. Negotiating over the surplus • Premise of the whole plan democracy process is to ensure a fair method of allocating the supposed going concern surplus Surplus: to whom? Plan may be required Liquidation baseline ->

33. Informed suffrage on “who gets what” Idea is that the various stakeholders should have the right to negotiate over, be informed about, and have a formal say (via a vote) as to which of them gets what share of the reorganization surplus, all subject to baseline protective allocation rules And that is what we call a “plan”

34. Sale problems • If try to allocate reorganization value under a 363 sale, lose both (i) process and (ii) substantive protections • Process: disclosure, voting, etc • Cannot really substitute fully for in “sale” under 363. Fatal? • Substantive: best interests, absolute priority, etc. • Court COULD invoke these norms in deciding whether to approve a 363 sale

35. When 363 “sale” is not OK? 363 “sale” usually should NOT be approved when that “sale” directs the distribution of the sale proceeds among various stakeholders Group A 20% Group B 50% 30% Group C

36. Or, at least import distributional norms • As 2nd-best option, if otherwise a quick “sale” does seem necessary (due to exigencies, e.g., auto cases)  the court at the very least should import distributional norms from the plan confirmation rules, including: • Best interests test • Fair and equitable • No unfair discrimination • Class treatment Plan rules import 363 sale

37. “Sub rosa” plan issue • This “distribution-by-sale” problem parades under the rubric of “no sub rosa plans in a 363 sale” • We don’t think the use of the “sub rosa” terminology moves the analytical ball forward –begs questions of “what is a sub rosa plan, and why is that bad?” • better to focus directly on what the real concern is • And that concern is allowing unchecked & unmonitored distribution to stakeholders contrary to rights

38. Chrysler distributional attacks (1) Indiana Pension Funds (a secured Cr) argued sale was an invalid “sub rosa” plan because it gave “value to unsecured creditors (i.e., in the form of the ownership interest in New Chrysler provided to the union benefit funds) without paying off secured debt in full.” (2) Unequal treatment of unsecured creditors -> through the debt assumption of some unsecured claims, but not others

39. Reprise: Chrysler sale All assets 35% Fiat [Old] 8% US $2B + debt assumption2% Canada 55% equity Senior Secured VEBA($10B + 4.6B) (owed $6.9B) Trade ($5.3B) Warranty, dealer ($4B) Pension ($3.5B) OUT: Jr. secured; Unassumed unsecured; Old equity New Chrsyler

40. Secured Cr objection? nay Indiana Pension Funds’ objection to the distribution to the VEBA was properly rejected by Judge Gonzalez – no distributional violation in the sale 1st: IPF’s class consented to the give-up 2nd: even if class had not consented, the “fair and equitable” protection for a secured class is not through absolute priority rule (i.e., cut out jr classes), but through sale of collateral with credit bid right

41. The consent? One main argument that has been leveled agst the “consent” point is that secured CR consent was tainted by conflict of interest, b/c the US govt was dangling TARP $ out to those banks, and effectively forced them to “consent” to Chrysler deal as a condition of getting the TARP $: just say “yes”

42. Sale / plan -> no difference re consent • 1st problem with the “tainted consent” argument is that Judge Gonzalez found no factual evidence to support it • 2nd, and more fundamentally – no reason why judge would have made a different finding on legitimacy of consent if in a plan context • Would challenge to “designate” in a plan • But same factual decision as in sale setting • Purely a judicial call – parties don’t “vote” on consent!

43. Protect Secured via Credit Bid • For class of secured claims, a primary “fair and equitable” distributional protection is the right of secured class to CREDIT BID their claim on a sale • In Chrysler: • sale price = $2 billion • Secured class had claim of $6.9 billion, secured by all assets • If thought $2 billion not enough, senior secured class could have “credit bid” up to $6.9 billion and acquired all assets of Old Chrysler • Did not do so – suggests ok with $2 billion price tag

44. {bracket caveat: Philly Newspapers!} Won’t dwell on it here, but of course you all know of the possible problem wherein secured creditors are denied the right to credit bid in a chapter 11 sale, see, e.g., Philly Newspapers and Pacific Lumber Of course, even there the secured Cr is protected by an “indubitable equivalent” standard, so could be OK if bankruptcy judge does her job right

45. Bigger problem: CR inequality in debt assumption? • Have been considering the distribution-by-sale issue on premise that have a cash-only sale • And suggest there is usually little to worry about there • But what if the sale instead is not all cash, but is for cash PLUS assumption of some debts?

46. risk inequality The sale purchaser’s assumption of some unsecured debts, and not others, raises serious risk of improper distribution-by-sale Some unsecured creditors (those whose debts are assumed) do better than others (those whose aren’t) And occurs as a consequence of the sale itself

47. The distributional norm implicated • Unsecured creditor equality • Implement in plan context through rules governing: • Classification (substantially similar only) • Same treatment in class • Class voting • No “unfair discrimination” if in cramdown

48. Unequal distribution? What about this all-cash sale? NOT approve Obviously group B gets more than C, which gets more than A 100 Unsecured class A sale 20 proceeds Unsecured class B 50 30 Unsecured class C

49. Can reach same result via debt assumption Could restructure sale to reach the same result, with equal distribution of sale proceeds to the unsecured classes, but with a differential debt assumption by the purchaser of the to-be-preferred classes 60+ Assume zero + Assume 30 + Assume 10 Unsecured class A 20 sale Unsecured class B proceeds 20 20 Unsecured class C

50. Economically equivalent • The two structures just described are economically identical in substance: • Purchaser commits to pay 100 • 1. All-cash: pay 100 • 2. Cash + assumption: pay 60, assume 40 = 100 • Creditor benefits total 100, differentially; same totals • 1. All-cash: pay A 20, B 50, C 30 • 2. Cash + assumption: pay A 20; pay B 20+ assume 30 = 50; pay C 20 + assume 10 = 30