Tuesday, June 9, 2009

The absolute priority rule?

Posted on Credit Slips by Stephen Lubben:

Part of the debate about the GM and Chrysler cases has turned on the putative violation of the Absolute Priority Rule. I've previously argued that the actual deal structure in both cases contains no such violation, because the value going to the unions is not the debtors' and the senior lenders have no claim on it.

But there is also a good deal of unreality in the notion that the Absolute Priority Rule is a hard and fast rule, never to be violated. Professor Epstein snidely notes that President Obama is "no bankruptcy lawyer." Well neither is Professor Epstein, and one of the key problems with much of the debate about these cases is that the most vocal commentators have failed to acknowledge that the Absolute Priority Rule is routinely violated in modern chapter 11 practice.

Quite frankly, it would be impossible to keep most businesses operating in chapter 11 without some violations of absolute priority. Virtually every first day paper filed in a large chapter 11 case asks for permission to violate absolute priority -- either by paying pre-petition claims of critical trade vendors, or paying certain claims in the "ordinary course" (i.e., as though the bankruptcy didn't happen), or by paying employees even if they don't technically fit into the requirements for priority or the debtor has so much secured debt that priority claims might not actually be "in the money."

Chrysler would seem to be an example of the latter case. Maybe GM too. Yet all of the ire is focused on the Unions, when it is not even clear that their stakes in the reorganized automakers is a violation of absolute priority.

Senior lenders routinely violate absolute priority when they demand a "rollover" of their prepetition debt into a post-petition DIP loan that often has even more liens and greater protection for the lenders than the pre-petition loan did. The lenders also get fees for their violation of the "rule."

And buyers of assets routinely "pick and choose" which contracts and agreements they want, and which they don't. Those creditors lucky enough to be chosen are happy, the others not so much. This is not new (see here too -- note the dates on both), yet commentators continue to pretend, either intentionally or because they don't know better, that until these two automotive cases it was somehow unheard of.

I get that these cases are political, yet not every political disagreement is a violation of bankruptcy law. It would be helpful if the "experts" stopped confusing their readers by confounding the two.

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