Bankruptcy judge Arthur Gonzalez has permitted an appeal by Indiana pension funds to the Second Circuit on his ruling allowing a sale of the company to Fiat. According to the NYT:
The judge, Arthur J. Gonzalez, said that an appeal that sought to block the sale to Fiat could be heard directly by the United States Court of Appeals for the Second Circuit, a move that the American carmaker had wanted. Normally, appeals to bankruptcy court decisions are heard in federal district court, which sits directly above bankruptcy court in the judicial hierarchy. But cases may be moved directly to the appeals court if a judge finds it necessary.
"This case involves a matter of public importance, and an immediate appeal may materially advance the progress of this case," Judge Gonzalez wrote in his order.
The appeal was filed by lawyers for a group of Indiana pension funds, which objected to the sale because they were seeking more compensation for the Chrysler secured debt they hold.
The WSJ reports today that the Second Circuit will apparently hear the appeal on Friday:
Chrysler LLC's exit from bankruptcy could hit a speed bump Friday when a federal appeals court is scheduled to hear from a group of Indiana state pension and investment funds objecting to the auto maker's reorganization.
The funds are trying to block the sales of most of Chrysler's assets to Fiat SpA, contending the deal's terms regarding secured lenders are unconstitutional.
The sale was approved on Sunday by the U.S. Bankruptcy Court in Manhattan, but the funds filed an appeal. The U.S. Court of Appeals for the Second Circuit will hear the case on Friday.
Perhaps Co-Blogger Zywicki can explain what all this means for bankruptcy proceedings and likely outcomes. It seems to me unlikely, but I defer to bankruptcy experts, that lenders will win the appeal. The WSJ article talks with a bankruptcy expert:
A lot is riding on the outcome. The Obama administration is hoping a speedy restructuring of Chrysler through bankruptcy will signal the road ahead will be smooth for General Motors Corp., which the Treasury ushered into bankruptcy protection on Monday. Moreover, Fiat can back out of the deal if bankruptcy proceedings go beyond June 15.
"You can't take away from the fact that this is a huge case. There's a huge amount of public interest," said Earle Erman, a bankruptcy attorney with Erman, Teicher, Miller, Zucker & Freedman, a Southfield, MI based firm. "This is obviously an unusually large case."
A ruling in the lenders favor appears unlikely given the bankruptcy code primarily requires they get a fair repayment on their investment, Mr. Erman said. He declined to speculate on a separate argument they are making challenging the legality of providing a manufacturer like Chrysler money from TARP, which was designed for financial institutions.
People close to the case say that if the pension funds lose their appeal, their chief lawyer, Thomas Lauria of White & Case, may try to take the matter to the Supreme Court, a move that could impose a significant delay on Chrysler's reorganization.
I wanted to note, further to an earlier post, that at issue are rights of the secured/senior creditors. They argue that the effect of the reorganization plan is to benefit the junior creditors, and the union especially, at the expense of the seniors:
The Indiana pension funds — the Indiana State Teachers Retirement Fund, the Indiana State Pension Trust and the Indiana Major Moves Construction Fund — own just $42 million of Chrysler's $6.9 billion in secured debt, and the other secured lenders have already agreed to accept a settlement paying them about 29 cents on the dollar.
The Indiana funds bought Chrysler's debt a year ago for 43 cents on the dollar, and are arguing the restructuring plan is unfair because U.S. law normally puts secured lenders at the front of the line for repayment. They say junior creditors are being put ahead of senior secured lenders in the plan.
There are two questions here. One is whether it is in fact true that the reorganization plan (the same basic issue arises for the GM bankruptcy) benefits junior creditors, starting with the UAW, at the expense of the senior creditors. The second is whether the senior creditors have in fact been dealt with unfairly, given that they could, in principle, go to court — and as the Indiana pension funds have done. Although I would welcome hearing anything that Todd might want to say, the answers seems to me pretty clearly, yes and yes.
In both Chrysler and GM, the junior creditor UAW wound up with far more equity — that is, whatever it is, however, speculative, that the parties thought might be of value in the future — than the senior creditors did. It doesn't really help to say that absent the government bailout, they would have done even worse. Bankruptcy, as I understand it on this matter, is about the relative claims of the parties, relative to each other, seniors and juniors. In fact, although a number of commenters raised it in a post of mine yesterday, I don't see many financial commentators disputing that at all (although, to be sure, I won't rule out confirmation bias!).
This leads directly to the second question — why, consistent among other things with fiduciary duty, didn't the senior creditors, or more of them, contest this reorganization and assert their rights? I said yesterday that they were "strong-armed" by the administration which, after all, has extended financing to many of them and so altered their incentives with regards to asserting legal rights. Mirabile dictu, today's Washington Post editorial on the GM bankruptcy says (emphasis added):
Also worrisome was the strong-arming of the company's bondholders, who got far less equity in return for their money than the UAW, the president's political ally. The administration wants to spin GM back to the private sector as soon as possible. But private investors may have been durably scared by the union's display of clout. Indeed, the UAW boasted to its members that it blocked a plan to build GM cars in China and "negotiated new opportunities for UAW involvement in future business decisions."
The retort says, look, the seniors could have exercised their rights and gone to court, but they didn't. If it's because they received government money and so have to dance to the government's tune, that is in the interests of the taxpayers, who are otherwise going to lose as value is transferred first to the creditors in bailing them out, and then to creditors when they take money that would otherwise go to fixing Detroit.
The counter-response is that the problem is not so much one of junior and senior creditors, it is, as David Skeel has noted, a problem of politically favored insiders and politically disfavored outsiders. It is highly unlikely to be efficient, either in the allocation of credit in the economy or in the making of cars, for the government to be naming winners and losers not even on the basis of its (likely dubious) estimations of efficiency, but instead on the basis of the UAW insiders and creditor-fiduciary outsiders.
My experience negotiating lending deals in the developing world suggests that the most important characteristic is not creditor-debtor, but insider-outsider when it comes to efficiency when a government is somehow involved. In the areas I am familiar with, independent media, government involvement comes in the form of broadcast licenses, newsprint monopolies, government agency advertising, all sorts of ways. Crony capitalism in one way or another, rent-seeking, as Megan McArdle explains:
Bankruptcy is often portrayed as a question of creditors v. debtors, and of course that's not a ridiculous frame. But just as important is the tension between insiders and outsiders. This conflict has existed for as long as we've had insolvency, and it doesn't match up to the creditor/debtor divide .... I suspect Obama views his administration's actions as moving along the X axis towards a more debtor-friendly system. But in fact, Chrysler, not the UAW, is the debtor, and it's not likely the company would have ended up in liquidation. The administration's actions weren't debtor-friendly, they were insider friendly. This was classic collusion among creditors, and it's why the parts of the bankruptcy law that deal with Section 363 sales spend so much time talking about the importance of avoiding sham transactions. Cutting back on that sort of abuse was at least as important an achievement as giving debtors a fresh start.
It is far from mad to point out, as McArdle does, that the current Detroit policies are far less about the rights of creditors than they are about the privileges of political insiders. Yet the frame against which the Second Circuit will consider this will be one of creditors versus creditors versus debtors, in the context of something approved by a bankruptcy judge who notes that 90% plus of the senior/secured creditors have approved. The "strong-arming" that caused them not to enforce their legal rights — the frame of favored insiders and disfavored outsiders — will not be on the table. In my estimation, that's to be regretted because, yes and with all due respect to everyone, it does remind me slightly too much of deals in Skopje and Belgrade.