Monday, July 27, 2009

The Truth About Detroit's Bankruptcies

Posted on by Stephen Lubben:

The Chrysler and General Motors chapter 11 cases have been vilified in almost every finance-focused media outlet. As a bankruptcy professor, I am confused why this is.

Bankruptcy Code section 363 allows a company to sell its assets before producing a chapter 11 plan. And in the past decade, secured lenders have used this provision, plus the control inherent in being a secured lender, to take charge of chapter 11 cases. The drawn-out, debtor-controlled chapter 11 process of Eastern Airlines and Pan Am is long gone.

The new lenders, who typically have control over all of the debtor's cash and thus have almost complete control over the debtor's fate, are willing to fund a quick sale because section 363 provides a better mechanism for selling assets than state foreclosure law. Chapter 11 now routinely involves a sale early in the case, with the remainder of the case devoted to distributing the proceeds of the sale among the creditors.

The basic structure used to reorganize both GM and Chrysler was not unprecedented. Indeed, it was entirely ordinary. In both cases, the "good" assets were sold to new entities. The consideration for that sale goes to the "old" debtor, and will be distributed according to the absolute priority rule. None of this constitutes a covert reorganization plan or a corruption of the bankruptcy process.

The UAW is getting better treatment than other unsecured creditors. But that better treatment is not coming from the debtor. It is coming from the government, passing through the purchaser of the "good" assets in each case. We can debate whether it is wise for the government to bail out the UAW, but it does not implicate the bankruptcy process.

There is also little to the idea that either case impairs investor rights. GM had $27 billion in secured debt and a liquidation value of at most $9.7 billion. That is, if GM had liquidated, the bondholders would have been entitled to absolutely nothing.

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