Thursday, May 7, 2009

Chrysler & Credit Bidding

Posted on Credit Slips by Stephen Lubben:

As I made clear in my prior post, I think that many of the arguments advanced against the Chrysler sale motion are largely noise, generated by confusion over the structure of the deal. But I also mentioned that one real problem I see here turns on the dissenting lenders’ apparent inability to credit bid.

The Bankruptcy Code expressly recognizes the right of a secured creditor to “credit bid” its claim in a §363 sale, just as a home lender can bid the value of its mortgage in a state foreclosure sale. § 363(k).

Thus, if the debtor moves to sell its assets worth $100 in a 363 sale, the bank with a $40 lien on the assets can bid “$40” and offset its secured claim against the bid, meaning that the bank only has to pay cash for the debtor’s assets if the auction price goes above $40.

Thus, if Chrysler were a typical chapter 11 case, the senior lending group would be able to credit bid up to $6.9 billion for the debtor’s assets. If the lenders won the auction, they could then sell the assets to Fiat or anyone else.

Here the lenders (as a group) decided to forgo their right to credit bid and instead accept $2 billion in cash. The offer was at one point raised to $2.2 billion, but that has apparently been taken off the table since Chrysler entered chapter 11.

Normally I’d say that the lenders’ decision to take the $2 billion was a strong indication that they expected Chrysler’s assets to sell for a price less than or equal to that amount, mooting their need to credit bid. But in this case the decision to take the $2 billion offer is being driven by the largest lenders, all of whom are to some degree under the control of the Treasury Department.

More on this, after the jump.

I think we have to concede that this control, and the conflict it creates, and the President’s decision to publicly scold the dissenting senior lenders has tainted this process, making it unlike a normal chapter 11 case. The decision to scold the dissenting lenders – perhaps driven by the lenders somewhat juvenile press release – is perplexing, since it seems to blame them for a chapter 11 case that I believe would have happened anyway. Moreover, holdouts are a fact of life in workouts and chapter 11 cases – the trick is to figure out how to deal with them, and publicly shaming them is probably not going to help that process. However politics sometimes produces silliness, even among those who should know better.

The real issue is how much do we believe all this has tainted the process. In this case, you could argue that the Fiat price would be so low without the union agreement that the secureds are getting the same or even a higher recovery on an absolute basis. But we'll never know for sure and in that sense the process is tainted, and I think this is not harmless. Future hedge funds may pay lower prices to buy distressed debt in large companies like Chrysler and future secured lenders may therefore require higher interest rates from borrowers. Moreover, the global story that we tell about the benefits of having a system like chapter 11 is diminished by this case.

Ideally the entire GM and Chrysler situation would have moved to bankruptcy court much earlier, where the process could have been conducted more like a normal chapter 11 case. As I’ve written, too much of the decision to avoid chapter 11 in the recent crisis has been driven by unwarranted fear of chapter 11, driven by either a serious misunderstanding of what modern chapter 11 practice entails, or an intentional effort to create fear and panic about chapter 11, to support the case for a bailout.

How does this influence the pending sale hearing? Probably not very much. A bankruptcy judge simply takes the case as it comes, and can't spend too much time worrying about the backstory.

(And for those of you wondering about §363(m), keep in mind that the "entity" that will purchase the debtor's assets probably doesn't have a good faith problem -- see also §§101(15), (41) -- unless we engage in some viel piercing).

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