May 01, 2009
Yesterday, Chrysler filed for Chapter 11 bankruptcy protection in preparation for a partnership with Italy's Fiat. President Barack Obama says he hopes the bankruptcy proceeding will be quick and efficient, and that the Fiat deal "will give Chrysler a chance not only to survive, but to thrive in a global auto industry."
I hope so too. But a Chrysler bankruptcy has many moving parts -- and with Chrysler unable to make money selling cars, it just doesn't have enough nongovernment cash to grease those moving parts to facilitate a smooth bankruptcy. Chrysler is in worse shape than GM. And remember, Fiat has yet to offer a penny for its 20% share in Chrysler. Thus far, it's only offering access to its fuel-efficient technology.
This could get messy. First off, in a bankruptcy any single creditor is entitled to get the liquidation value of its claim. So any creditor can assert that what it would get if Chrysler sold its factories quickly would be more than the 32 cents per dollar that Treasury had guaranteed Chrysler's secured creditors before the government deal fell apart this week.
Valuation proceedings are notoriously difficult in Chapter 11. Although the judge doesn't actually need to liquidate Chrysler, the judge must determine what it would have gone for if there were a liquidation. Some creditors appeared ready to bring that case to the bankruptcy judge.
On top of liquidation value, the whole class of secured creditors is entitled to the "fair value" of their claims. Usually fair value -- the money that can be obtained from operations -- is greater than liquidation value, though Chrysler may be an exception.
The government thinks the fair value issue will be resolved easily. That's because in a bankruptcy proceeding the creditors whose claims amount to two-thirds of the total amount of debt can bind the rest to take the deal. Indeed, the judge doesn't have to figure out whether value is fair, if the class of creditors votes in favor. And since two-thirds have already raised their hands in favor of 32 cents on the dollar, it seems to be a done deal.
But this time it might not be so easy. Not all of those who've already raised their hands in favor prior to bankruptcy, especially the smaller investors, will still be raising their hands inside Chapter 11. They can change their mind, and some just didn't want any negative publicity before the bankruptcy.
Worse, there could be a legal fight over whether the vote of Citibank and the other "big four" creditors -- J.P. Morgan Chase, Morgan Stanley and Goldman Sachs, who together hold 70% of Chrysler's debt -- should be counted toward the two-thirds threshold that would bind the company's other 42 creditors. The Bankruptcy Code requires that the votes of creditors be given in "good faith." It won't be hard for the smaller creditors to argue that Citibank and other TARP recipient's votes aren't in full good faith. In agreeing to Treasury's offer of 32 cents for each $1 of their debt, the objectors would say, Citibank and some others were influenced by the fact that Treasury was keeping them afloat with federal subsidies. If this type of litigation begins, it won't be easily resolved.
Meanwhile, Fiat will want to rationalize Chrysler's bloated dealership network. Indeed, this once seemed a core aspect of any effort to reconstruct Chrysler, so the last day's focus on a few secured creditors seems misplaced. But terminated dealers won't go quietly. They'll argue that their contracts can't be easily rejected by a bankruptcy judge because they're protected by state franchise laws. And in any event, they are entitled to some form of payment (reduced or otherwise) from a bankrupt Chrysler if their dealerships are terminated.
If the bankruptcy court could sell Chrysler's core operations intact, many of these bankruptcy frictions could be left behind. That would be the best operational outcome, but it's not clear that there's any real buyer -- Fiat is prepared to take a major stock position in a reorganized Chrysler, but it doesn't seem ready to pay any cash for it. Sales of divisions of a bankrupt firm are common in bankruptcy and often the best solution. But these kinds of sales typically are done via an auction, where other players can outbid Fiat. If Fiat isn't paying anything, then it may be easy to outbid. The question then would become whether the judge would be willing this time to forego a real auction.
If Chrysler could make cars that more people wanted to buy, bankruptcy would be much easier -- and probably not necessary. But that's not the case, so figuring out who will bear what amount of the losses will take place in a bankruptcy court, where too many players have leverage under the law, and where the reality of Chrysler's weak operational prospects makes a fast and easy resolution unlikely if the company can't be quickly sold.
Mr. Roe is a professor at Harvard Law School, where he teaches bankruptcy and corporate governance.