Sunday, May 03, 2009

Chrysler Seeks the Ultimate 363 Sale as the Treasury Department Dictates the Pace

Chrysler, LLC filed for chapter 11 bankruptcy on April 30 with the United States Treasury firmly in the driver’s seat (pun intended). In its first day filings, Chrysler announced that it would be seeking $4.5 billion in DIP financing from the Treasury and that it intended to affect a sale of substantially all of its assets to a newly created entity within 60 days. The U.S. Treasury filed a statement concurring in the filing and noting that its commitment to provide DIP financing was conditioned on timely filing and approval of the motion for sale of assets free and clear of liens.

Chrysler’s Woes

According to Chrysler’s filings, it is “one of the most agile and innovative car manufacturers in the world” whose name is “synonymous with innovative engineering” and whose liquidation “would have significant adverse impacts on the nation’s economy.” However, the filings also show (or at least imply) that the company took on too much debt in a leveraged buyout, failed to keep up with technology and mortgaged its future to payment of employee benefits.

While Chrysler bills itself as “the quintessential American automobile company,” its present difficulties as well as its plan for recovery arise from European alliances. In 1998, Chrysler merged with German automaker Daimler-Benz. At the time, the company was healthy and had cash reserves of $7.5 billion. The German alliance didn’t work out and Chrysler went private in a leveraged buyout in 2007. As part of this transaction, Chrysler incurred $10 billion in first lien debt (which has been paid down to $7 billion). According to Chrysler, this first lien debt is now trading at 15 cents on the dollar. It also incurred $2 billion in second lien debt from affiliates of its shareholders, including $1.5 billion from Daimler Financial. When Chrysler encountered financial difficulty last year, it received $4 billion in TARP funds from the U.S. Treasury, which are secured by a third lien. In addition to these secured debts, Chrysler owes $5.4 billion in trade debt, $1 million on its Amex cards and is required to spend $6.7 billion for settlement of claims relating to employee health care benefits. As will be discussed later, Chrysler's exit strategy in this case involves an alliance with Fiat.

Beginning in February 2007, the company began paring down its offerings to those which had the best sales and margins. Three of those identified in this class were the Jeep Grand Cherokee, the Dodge Ram truck and the Chrysler Town & Country minivan. All of these were large and not very fuel efficient. The implication is that Chrysler doesn't do so well in the market for fuel efficient cars, an impression reinforced by Chrysler's statements about the benefits of obtaining small car technology from Fiat.

According to Chrysler, it was hit hard by the financial crisis in the fall of 2008. When the market for securitizations imploded, there was no longer a means to sell auto loans to obtain new capital. Additionally, with the economy in free fall, people stopped buying vehicles. Chrysler points to sales in January to March of 2009, which were 35-37% below sales during the same months in 2008. In December 2008, Chrysler idled its plants for one month (with some staying closed longer).

One requirement of accepting the TARP money (which Chrysler notes that “many other large corporate pillars of the economy” requested), was that Chrysler had to submit a Viability Plan to the government and show its progress in meeting certain benchmarks. The government told Chrysler that it would support its working capital needs up through April 30 and required it to negotiate agreements with its creditors, the UAW and its proposed partner Fiat within this time. Chrysler reports that it reached the required agreements with almost all constituencies and filed bankruptcy on April 30 to implement the plan.

The Proposed Sale

While Chrysler paints a glowing picture of the progress it has made in negotiating with stakeholders, the U.S. Treasury has indicated that it is holding a gun to the company’s head and requires a sale to be approved and closed within 60 days. According to a statement released on behalf of Acting U.S. Attorney for the Southern District of New York Lev Dassin:

The President has made clear that the United States cannot commit to fund Chrysler if the company’s restructuring lacks a realistic probability of success. Treasury cannot and will not make an open-ended commitment to Chrysler for billions of dollars more, especially in light of the myriad other meritorious, competing demands for the public’s resources; its commitment to fund Chrysler’s bankruptcy must be contingent on Chrysler achieving the milestones necessary to close a sale in sixty days. Simply put, this time period for a sale is a necessary and critical condition to government funding.

Statement of the United States Department of the Treasury in Support of the Commencement of Chrysler, LLC’s Chapter 11 Case, p. 5.

As a condition of providing DIP financing, the government has required that Chrysler adhere to the following schedule in selling its assets:

May 4: File 363 motion
May 9: Hearing to approve sales procedures
May 10: Have final and non-appealable order entered
May 20: Receive bids
May 29: In court auction
June 1: Hearing to approve sale
June 15: Entry of final and non-appealable order approving sale
June 27: Close the 363 sale.

If Chrysler fails to meet this timeline, the Treasury reserves the right to cut off funding and drive the company into liquidation.

The United States Treasury, in addition to being a pre-petition lender and post-petition lender is also a proposed equity holder in the stalking horse bidder. Under the proposed 363 motion, Chrysler’s operating assets will be transferred to New Chrysler of which the United States will be an 8% interest holder.

The proposed transaction consists of the following elements:

1. Chrysler will transfer substantially all of its operating assets to New Chrysler.
2. New Chrysler will assume” certain liabilities” of Chrysler and pay $2 billion in cash to Chrysler.

3. Fiat will contribute “to New Chrysler access to competitive fuel-efficient vehicle platforms, certain technology, distribution capabilities in key growth markets and substantial cost saving opportunities” (whatever that means).

4. New Chrysler will be owned 55% by a Voluntary Employees Beneficiary Association, 8% by the United States, 2% by Canada and 20% by Fiat (with the right to increase its stake to 51%).

Although $2 billion is to be paid to Chrysler, it states that it anticipates that no cash will remain in the company. Instead, the company will be left with eight manufacturing plants which are not being transferred.

The documents filed so far are somewhat vague about which “certain liabilities” will be assumed. However, Chrysler’s declaration does state that the company’s largest first lien creditors, JP Morgan Chase, Goldman Sachs, Morgan Stanley and Citigroup, have agreed to write off 70% of their debt and that the $2 billion in second lien debt owed to Chrysler’s shareholders, Daimler Financial and Cerberus Capital, will be forgiven. The shareholders will also be required to fund hundreds of millions of dollars in pension liabilities. It does not expressly say what will happen to the U.S. government's third lien debt or the company's trade debt.


This is certainly an unprecedented case. However, the extent to which the United States is directing the outcome of the proceeding raises some major issues.

First, is this a sub rosa plan? The Second Circuit has held that sub rosa plans cannot be part of a Section 363 sale. In re Iridium Operating, LLC, 478 F.3d 452 (2nd Cir. 2007) (“The trustee is prohibited from such use, sale or lease if it would amount to a sub rosa plan of reorganization. The reason sub rosa plans are prohibited is based on a fear that a debtor-in-possession will enter into transactions that will, in effect, "short circuit the requirements of Chapter 11 for confirmation of a reorganization plan.").

The proposed sale transaction looks like it is rearranging the priorities of creditors, which would be a clear sign of a sub rosa plan. Based on what has been disclosed so far, first lien holders will receive only 28% of their claims and second lien holders will receive nothing. However, nothing is said about the third lien held by the United States or the trade creditor claims. Allowing junior claims to participate without payment in full of senior claims is a clear violation of the absolute priority rule unless the parties vote in favor of the plan. Since there is no voting on a sale, how can this consent take place?

Additionally, the sale motion essentially dictates the post-reorganization ownership of New Chrysler, allocating it between employee benefits, the United States and Canadian governments and Fiat. Dictating who will own the reorganized debtor is another sure sign of a sub rosa plan. Some clever lawyering was used to try to avoid this problem. The 363 motion will not dictate that the company is sold to New Chrysler, only that it will be the stalking horse bidder. However, given the extremely short time frame dictated by the U.S. Treasury, there is no meaningful opportunity for outsiders to bid.

There are also some very interesting separations of power issues. Typically, a bankruptcy judge would not allow a DIP lender to dictate that all of the company’s assets be sold within 60 days. However, in this case, the President of the United States, acting through the Treasury Department is the one dictating the result. Should the judicial branch defer to the executive branch in this instance or should the court be free to say no to the President. This one is easily answered. The Bankruptcy Judge can veto the Treasury Department’s terms for post-petition lending, but cannot force the Treasury Department to lend. Thus, the Judge must decide whether he is willing to take the responsibility for killing Chrysler. While this is an unfair burden to place on a judge, he is still free to act.

The other interesting question is how the U.S. Trustee can be an effective watchdog for the case when the President and the Treasury Department are potentially overstepping their bounds in directing how the case will proceed. Technically, there are separate lines of authority, since the Treasury Department is appearing through the U.S. Attorney and the U.S. Trustee is part of the Justice Department. However, they are both part of the United States executive branch with the President at the top. In a lower profile case, this might not be a problem. However, in a case of this magnitude, it seems like the U.S. Trustee is placed in a no win situation. However, I am not aware of any provision which allows someone outside of the executive branch to step in for the U.S. Trustee in the event of a conflict.

It will be interesting to see how Judge Gonzales and the U.S. Trustee navigate this minefield.


Anonymous said...

Very nifty analysis..keep up the good work

Anonymous said...

I don't know whether this will affect the analysis of the 363 sale, but the financial analysis in Chrysler's business plan prepared by Capstone assumes that the Treasury's pre-petition loan and the DIP financing will be forgiven. (Exhibit D, Declaration of Robert Manzo.)

Anonymous said...

"Potentially" overstepping their bounds? You're being generous.

Anonymous said...

hmmm, it's almost... almost as if the presiding bankruptcy judge was appointed in 1995... remind me... how long are they appointed for?

14 years?

nothing to see here. move along.

Anonymous said...

Thanks for the helpful blog.