Indiana and the Chrysler Bankruptcy

Some of my fellow Hoosier bloggers (h/t Abdul and Josh Claybourn) have been following the Chrysler bankruptcy, particularly with respect to Indiana’s unexpectedly prominent role in the matter. Josh, in particular, has strong feelings on the issue, calling the proposed reorganization (presumably with some degree of hyperbole “The End of Capitalism as We Know It.”)

For those who haven’t been following the matter, Indiana Treasurer Richard Mourdock has been spearheading objections to the reorganization plan because of its affect on approximately $42 million nominally owed to the Indiana State Teachers Retirement Fund, the Indiana State Pension Trust and the Indiana Major Moves Construction Fund for investments these funds made in Chrysler. This represents about 0.6% of the $6.9 billion in first priority liens against Chrysler’s assets. However, despite Indiana’s very minor position among this class of creditors, it is the one raising the biggest stink and trying the hardest to derail the process. Chrysler smells politics. So do I. Under the proposed plan, Indiana will receive a return of about 29%.

This is an issue that journalists and Indiana politicians should probably be familiar with going forward. Maybe I’m wrong, but this has the smell of Mourdock and, potentially, Gov. Daniels trying to set themselves up politically as champions of the marketplace and defenders against Obama’s nefarious economic plots. If the bankruptcy court’s description (pdf) of the evidence presented bears any resemblance to what was actually presented, Indiana’s pursuit of these claims looks like a waste of taxpayer money – first there is no apparent alternative that would yield more money to the Indiana funds than the one being approved by the court; and second Indiana invested in Chrysler subject to an agreement that requires the Indiana funds to go along with the decisions of fellow investors that control a vastly greater share of the funds invested. Those creditors have consented to the deal with Fiat for a New Chrysler.

Much more after the jump.

The nut of Indiana (and Josh’s) objection is that, under the plan, lesser priority claims will receive value while Indiana’s (and other) first-priority claims will not be made whole. Under a liquidation scenario, typically you sell everything off and then, from that pool of money you pay the first class of creditors (e.g. first priority lien holders). Once they are paid in full, you move on to the second class of creditors (e.g. unsecured lenders). When you reach a class of creditors whose claims exceed the remaining pool of money, you pay those creditors a pro rata share of what’s left. Any remaining classes of creditors get nothing. The important point is that you don’t pay the second class creditors anything until the first class creditors have been paid in full.

Here is the problem with Indiana (and Josh’s) analysis: the restructuring plan under which the government and the UAW and other lesser creditors receive value also provides more money to the first lien creditors than they would get from a liquidation.

Josh mentioned that the intricacies of bankruptcy law are too boring and not very conducive to concise sound bites. Living, as I do, to serve, I have read the 47 page opinion (pdf) of the bankruptcy judge which addresses Indiana’s objections.

Josh says:

Simply put, political convenience is being placed ahead of long standing laws and capitalist foundations . . . on an enormous scale.

Earlier, he said, more ominously:

Thousands upon thousands of people are getting steamrolled by this outrageous affront to the credit system, but only Indiana has objected, and its efforts appear to be fruitless thus far. I fear that President Obama’s actions in the Chrysler bankruptcy signal the dawn of a new era in which powerful political interests trump capitalism and the sanctity of contracts. May God have mercy on us all.

The judge’s decision, though somewhat long, is pretty straight forward and, my conclusion is that God’s mercy can be reserved for other contexts.

Judge Gonzalez summarizes Indiana’s objections (at page 11) as being that collateral is being stripped and transferred to New Chrysler where it would be worth significantly more than the money paid to the First Lien Lenders; unsecured deficiency claims will not be paid while unsecured trade debt would be paid in full; senior claims such as those of the Indiana funds would be impaired while junior lenders such as the Governmental Entities, VEBA (the retiree health care fund), and the UAW, as unsecured creditors will receive value; and Fiat will get a stake in New Chrysler for contributing access to technology but not any actual cash.

The court ultimately rejected these objections. The court relied on evidence with which it was presented at a hearing on the value that could be expected to be realized if Chrysler’s assets were liquidated — Option #1. At the time of the hearing, that value was about $800 million. This was down from $0 to $1.2 billion about three weeks before and an initial estimate of $2.6 billion. All indications are that Chrysler is a wasting asset.

Option #2 is a Fiat organized “New Chrysler” which would pay $2 billion for certain assets and contracts of old Chrysler. In addition, if this transaction is completed quickly, the U.S. Government will contribute $4.96 billion in financing costs for the transaction and an additional $6 billion secured financing for operating costs for the New Chrysler. In return, it will get a stake of about 12.36% in the New Chrysler. Similarly, the UAW and VEBA are willing to make concessions on contracts with and claims against the New Chrysler which will be of benefit to the new company. In return VEBA will receive a 67% stake in the new company. And Fiat’s contribution will yield a 20% stake in the new company. What is important to consider for Option #2 is that these entities get a stake not by virtue of their junior, pre-bankruptcy petition claims against the old Chrysler — claims for which they will receive nothing — but rather for the new value they are providing to the new company and based on new agreements with that entity.

The court determined that, because Option #2 yields greater value to the creditors than would be realized under Option #1, the creditors suffer no harm and receive a benefit from moving forward under Option #2. This is probably the most important point: Indiana can’t point to an available scenario where the Indiana funds get more money. The best they can do is to suggest that, if the U.S. Government’s bluff was called, it would offer transaction funding and funding for the New Chrysler on terms that were more beneficial to Indiana as a creditor of the old company. Judge Gonzalez reasoned that he didn’t have the authority or inclination to gamble away the bankruptcy estate’s money based on that sort of speculation.

Procedurally, however, the easier nail in the coffin of the Indiana funds’ claims is that they have waived those claims. The Indiana funds were invested subject to an investment agreement called the First Lien Credit Agreement. That Agreement designates an administrative agent by whose actions the investors agreed to be bound. That agent, based on the consent of creditors representing 92.5% of the dollars owed to the First Lien Creditors, agreed to the New Chrysler transaction to which Indiana now objects. The court held that Indiana is bound by the consent of its agent under the First Lien Credit Agreement.

Indiana claims that this consent given by its agent should be nullified because the other creditors are influenced by obligations to the U.S. Government. The court, in the first place, questioned its jurisdiction over what is, in effect, an inter-creditor dispute — Indiana’s dispute with its fellow creditors under the First Lien Credit Agreement. In any event, the court found that Indiana’s allegations that the other creditors are breaching their fiduciary duties was speculation without evidence presented. Regardless, Indiana has waived its right to act inconsistently with the determination of the “Required Lenders” under the First Lien Credit Agreement. If it didn’t like that obligation, it shouldn’t have invested in an investment with such restrictions.

The options for first priority lenders were a) liquidation; b) negotiate with other sources of funding; or c) provide funding themselves. Indiana’s fellow creditors went with “option b” — where liquidation, “option a,” resulted in less money and where the U.S. Government was the lender of last resort after Chrysler had tried doggedly (and failed) to obtain funding from other sources. The court observed that the U.S. Government’s demands were no more coercive, and in some instances less coercive, than one would find from other lenders of last resort in the rough and tumble world of the marketplace. Because the lender of last resort can simply withhold funding for the new operation, it can set the terms on which that new funding will be provided. If creditors of the old operation can get more value from liquidation (or funding from other sources on better terms), they are free to do so. But, in this case, alternate funding was not available and liquidation would have resulted in less money. That being the case, the first priority lenders of the old Chrysler decided to agree to the Fiat deal as the higher value option on the terms largely set by the U.S. Government as the lender of last resort for the New Chrysler.

Footnote 23 at page 35 of the opinion is interesting. In it, the court addresses some of Indiana’s contentions, particularly with respect to the use of TARP funds. The judge notes that the Indiana funds contention that they were looking for a safe investment vehicle with a low interest rate is inconsistent with the facts at the time of the investment. The funds paid $0.43 on the dollar for the investment. Because interest was paid at the face value of the investment, Indiana’s interest rate was effectively double the nominal rate. Indiana continued receiving interest on its investment because of the TARP funds that were invested. It failed to object to the legality of the source of funds at that point. Furthermore, Indiana’s argument for rejecting the proposed deal effectively relies on holding out for more TARP funds. Indiana’s position seems to boil down to “TARP money shouldn’t go to New Chrysler, rather, more TARP money should go to the Indiana funds.”

It looks as if the bankruptcy court has decided that appeals should be expedited. Accordingly, it has authorized the appeal to skip the District Court — which would ordinarily be the next step — and proceed directly to the Second Circuit Court of Appeals.