Editorial: Chrysler Zombie Watch 6: Bankruptcy Prof. Condemns Chrysler C11
David A. Skeel Jr. is the S. Samuel Arsht Professor of Corporate Law at the University of Pennsylvania Law School and author of “Icarus in the Boardroom” (Oxford University Press, 2005) and “Debt’s Dominion: A History of Bankruptcy Law in America” (Princeton University Press, 2001). In an article in the free market American Enterprise Institute’s house organ, The American, Skeel says that while the Obama administration avowedly patterns itself after FDR’s New Deal, the deal that the President’s task force on autos has cooked up for Chrysler would actually “make a true New Dealer turn over in his grave.”
Prof. Skeel points out that a major aspect of the New Deal was reform of bankruptcy laws that permitted sham sales called “equity receiverships” to bondholders and other creditors.
New Dealers hated the process, which they saw as opaque and designed to foist a deal crafted by the insiders on everyone else. Jerome Frank, a lawyer who later headed an important New Deal agency and became a federal judge, complained in 1933 that the judicial sale in these cases “was a mockery and a sham.” He said, “A sale at which there can be only one bidder, is a sale in name only.”
In 1938, thanks to the handiwork of another prominent New Dealer, future Supreme Court Justice and then-SEC Chairman William Douglas, Congress dramatically altered the bankruptcy laws, eliminating the former practice.
The Obama administration blueprint for Chrysler’s bankruptcy looks startlingly like the artificial sales that the New Dealers so abhorred. Unlike a traditional reorganization, in which the parties negotiate the terms of a restructuring that is then voted on by each class of creditors and shareholders, the administration plans to quickly sell Chrysler’s most important assets to a new entity “New Chrysler” whose stock will be owned by Chrysler’s employees and Fiat.
The senior lenders who objected to the government’s offer (which amounted to little more than 30 percent of their claims) will not have any vote on the sale. Their only option is the one they have pursued: objecting to the sale, and praying that bankruptcy judge Arthur Gonzalez takes a hard look at its terms even while the government is breathing down his neck and saying in a sense, he better approve or else.
The dissident bondholders made Judge Gonzalez’ job a little easier today when they folded after two of the remaining five holdouts withdrew from litigation. Still, Gonzalez has to approve the sale of whatever worthwhile remains among the dross of Chrysler.
What makes the Chrysler plan unique, and makes it similar to the receiverships of the New Dealers’ era, is that it is not really a sale at all. It is a pretend sale and its main purpose is to eliminate the pesky creditors who might otherwise interfere with the government’s plans. It also seems to flout bankruptcy’s priority rules by giving Chrysler’s employees (who are general creditors) a big stake in New Chrysler while forcing senior lenders to take a major haircut. The usual rule is that senior creditors must be paid in full before lower priority creditors are entitled to anything.
Skeel says that the judge can do two things to make sure the sale is appropriate. The first is to get an independent determination of the value of Chrysler. So far all the parties involved in valuing the assets have an interest in exaggerating or lowballing the company’s valuation. The second is to require a complete accounting of the deal so it’s absolutely transparent in terms of who is participating and who’s getting the shortest haircut.
Though much of the criticism of the Obama administration’s plans for Chrysler and GM has centered around government excesses, threats to the capital markets and the rule of law, it’s interesting that Prof. Skeel worries more for what it may portend in terms of bankruptcies in general.
The Chrysler sale looks like the latest of a series of government interventions that have run roughshod over ordinary legal rules, and it appears to be paving the way for a similar strategy in a General Motors bankruptcy. Much of what the government is doing allowing Chrysler to file for bankruptcy, promising to guarantee its warranty obligations is admirable. But the use of a sham sale of the sort the New Dealers thought they had forever eliminated will cause mischief in future bankruptcy cases.
Not only may the government go back to this well, but in the future private parties will conclude that sham sales are a legitimate tool in their own cases.
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