The Chrysler Bankruptcy

Earlier this week, I wrote an article which provided some basic education on the topics of capital structure and bankruptcy. This may have been overly simple for some readers, but one goal here is to provide education so that our readers can better decipher the news. With these basic financial principles, we can explore the Chrysler bankruptcy in more detail.

By the middle of 2008, the so-called Big 3 (GM, Ford and Chrysler) were already in suspect financial condition. When the economy began to really flounder in September, it only served to push the already weak companies to the edge of the economic abyss. At the end of September, Congress passed legislation which would provide $25B in loan guarantees to the automobile industry. In November, the circus intensified in the height of bailout fever, when the three CEOs came to Washington to beg for money. Legislation was crafted and passed in the House to provide direct loans to the Big 3; it did not make it out of the Senate. In a legally and constitutionally questionable move, the White House dedicated TARP funds to provide loans to Chrysler and GM. Chrysler received $4B. The Obama adminstration created an auto Task Force which would review restructuring plans provided by the automakers. The Chrysler plan was not enough and they prepared for bankruptcy.

Chrysler is (was) a privately owned company with Cerberus Capital Management owning an 80.1% share of the company and the remaining equity held by Daimler AG. Daimler wrote off their ownership (i.e. determined that the value was equal to zero) in October of 2008. Besides the money which has lent/given by the U.S. and Canadian governments, Chrysler had $6.9B in outstanding senior secured debt. There is another $2B in junior debt held by Daimler and Cerberus; and, of course, there are the TARP loans which are even more junior on the majority of Chrysler's collateral. Additionally, the UAW had set up a Voluntary Employee Benefits Association (VEBA) which holds an unsecured claim against Chrysler. The VEBA was set up to take the responsiblity of health care benefits from the Big 3. Chrysler was obligated to pay $9B to the fund. (More detail on the VEBA can be found in this article.)

Since Chrysler was unable to fund its obligations to bondholders or find investors willing to save them from bankruptcy, they had to proceed with their filing on April 30. Throughout the month of May, the Bankruptcy Court of the Southern District of New York heard the case. The case proceeded with the intent to facilitate a "363 Sale" in reference to Section 363 of the Bankruptcy Code. This allows for a sale of selected assets and transfer to selected debts and obligations to be made while the remainder are either liquidated or restructured. The U.S. Tresuary has indicated that it will provide debtor-in-possesion (DIP) financing to Chrysler to continue operations while in bankruptcy only if a 363 sale could be executed in a "surgical bankruptcy". Enter Fiat.

Fiat, the Italian automaker, has offered "access to competitive fuel-efficient vehicle platforms, distribution capabilities in key growth markets and substantial cost-savings opportunities." A new corporation, New CarCo Acquisition LLC, was set up to be the purchasers of the selected parts of Chrysler in the 363 sale. Fiat has partnered with the VEBA, the U.S. government, and the Canadian government in the form of Export Development Canada as the owners of the "New Chrysler" with a 55% stake going to the VEBA, 8% to the U.S Treasury, 2% to Export Development Canada, and 20% to Fiat. Fiat will quickly receive a 35% share as the deal is finalized with rights to own as much as 51% after the government loans have been repaid. New Chrysler will pay $2B to "Old Chrysler" as part of the sale.

Now, there are objections to this plan. The most notable objection has been made by three Indiana pension funds: the Indiana State Teachers Retirement Fund, the Indiana State Police Pension Trust, and Indiana Major Moves Construction. These three funds purchased $42M of Chrysler debt at 43 cents on the dollar. Additionally, some consumer advocate groups, a group of dealers who will have their franchise agreements terminated, and others have all attempted to block the 363 sale. Last Monday, Judge Arthur Gonzalez denied all objections and approved the sale. His 47 page opinion can be read here. (I have read the whole thing in an effort to understand the details which has been the reason this article is as delayed as it is.)

With the Old Chrysler receiving $2B from the New Chrysler, and essentially no assets remaining in the Old Chrysler of any value, the creditors (bondholders) stand to receive the $2B for the $6.9B in secured debt. This equates to about 29 cents on the dollar. There is a trust which had been established to serve the interests of the senior secured creditors who agreed to this deal in near unanimity. It has been the Indiana Funds who have opposed this most vocally. The U.S. Appeals Court dismissed their objections as well late last week. However, today, the Supreme Court of the U.S. issued a stay on the sale. This stay puts everything on hold until further notice.

My reading of the Gonzalez opinion initially leads me to believe that the sale will go through. I am not a lawyer, so I have no expertise. However, my understanding of the 363 sale allows for the purchasing entity, the New Chrysler in this example, to pick and choose the terms of the sale. This is apparently legal provided that the negotiations are done in good faith (which has received objections from the Indiana Funds and others by claiming the sale was "sub rosa") and provides the best option available for all parties. Expert testimony which was not disputed in a timely manner indicated that the creditors receipt of 29 cents on the dollar would be better than what a liquidation would provide. Further, the court has determined that if the Fiat deal is not consummated, that liquidation is the only other option.

The Indiana Funds have also questioned the constitutionality of the U.S. Treasury using TARP funds to provide financing to Chrysler (both Old and New). This question may or may not be reviewed by the Supreme Court. Both the bankruptcy court and the appeals court have denied reviewing the question because they have determined that the Indiana Funds lack standing. This means that the use of TARP funds has not harmed them so they cannot challenge the action.

You can follow the progress with the Supreme Court at SCOTUS Blog.

Some very interesting analysis of dealer closures can be reviewed here.

This article is more about GM than Chrysler, but is relevant nonetheless. It is a rare occurrence where I tend to agree with Robert Reich.

For more history and context on one of the Indiana Funds, the Indiana State Teachers Retirement Fund, who is having its own issues, you can read the following: ISTA sues the state over school funding, the court's opinion, their website, and a report on the NEA taking over the ISTA.