Bidders Reimbursed For Auction Which Never Occurred: The Fifth Circuit's ASARCO Opinion

The Fifth Circuit has ruled that, under the facts of the specific case, that bidders could recover their costs without a showing of direct benefit to the estate. Matter of ASARCO LLC, No. 10-40930 (5th Cir. 8/16/11). The specific holding was that reimbursement of costs incurred in submitting a bid were governed by the business judgment standard under 11 U.S.C. Sec. 363(b) rather than the benefit to the estate standard under 11 U.S.C. Sec. 503(b). You can find the opinion here.



A Billion Dollar Judgment And An Auction That Wasn't



This was a case about a big judgment and a unique procedure to auction off that judgment. In 1999, Grupo Mexico S.A.B. de C.V. (Grupo Mexico) purchased ASARCO. ASARCO owned 260 million shares of Southern Peru Copper Company (SCC). Through a series of transfers, the SCC shares were transferred from ASARCO to a subsidiary of Grupo Mexico. After ASARCO filed for chapter 11 relief in 2005, it sued the transferee, which was a subsidiary of Grupo Mexico. ASARCO won big. It obtained a judgment for actual fraudulent transfer, aiding and abetting a breach of fiduciary duty and conspiracy. ASARCO LLC v. Americas Mining Corp., 396 B.R. 278 (S.D. Tex. 2008). Not only did it get the shares back, but it also recovered a judgment for $1.4 billion. ASARCO LLC v. Americas Mining Corp., 404 B.R. 150 (S.D. Tex. 2009). (I have included the citations here because they are informative opinions for fraudulent transfer litigation).



Having a valuable asset in hand, ASARCO proposed a plan of reorganization. Its plan was to be funded in part by selling the SCC Judgment. It proposed a two-stage bid solicitation process. In the first stage, its financial adviser identified potential bidders for the judgment. In a variant on the typical auction process, ASARCO invited a select group of bidders to proceed to the second phase of the process. In order to entice the bidders to perform the expensive legal due diligence necessary to evaluate the asset, ASARCO sought and obtained an order from the Bankruptcy Court authorizing it to reimburse qualified bidders for their due diligence expenses. The Bankruptcy Court granted the motion finding that ASARCO had demonstrated a "compelling and sound business justification" for the order.



Grupo Mexico appealed the reimbursement order which was stayed. Meanwhile Grupo Mexico confirmed a plan of reorganization which paid all creditors in full, released the judgment and gave it control of ASARCO. Since Grupo Mexico now controlled ASARCO, ASARCO was not interested in defending the appeal. However, two of the bidders were granted leave to intervene and defend the order.







The Appeal



On appeal, the Appellants argued that because the sale was never concluded, there was not a benefit to the estate and the bidders expenses could not be reimbursed under Sec. 503(b). The bidders argued that the Bankruptcy Court could authorize the payment under the business judgment standard of Sec. 363(b). The business judgment test was a lower bar since it looked at whether the order was reasonable at the time it was sought; on the other hand, the benefit to the estate standard would have analyzed the benefit in hindsight.



The Fifth Circuit distinguished two Third Circuit cases which had disallowed break-up fees. While the Third Circuit had rejected break-up fees on the ground that they chilled the bidding, here the Fifth Circuit found that the reimbursement order sought to increase competition and was offered to all bidders invited to the second round. The Fifth Circuit also distinguished the break-up fee cases on the basis that the auction involved a "very unique and very valuable but possibly worthless asset."



The Ruling

In upholding the order, the Fifth Circuit wrote:

On this record, we conclude that the business judgment standard is the better fit for assessing ASARCO’s reimbursement motion. Section 363 addresses the debtor’s use of the estate property, and in its motion ASARCO sought authorization to make discretionary use of the estate’s funds. Section 503, in contrast, generally applies to third parties that have already incurred expenses in connection to the debtor’s estate. The unsuccessful bidders in O’Brien and Reliant Energy sought payment for expenses incurred without the court’s preapproval for reimbursement, and thus section 503 was the proper channel for requesting payment. In ASARCO’s case, however, the bankruptcy court issued the Reimbursement Order before any potential qualified bidders, including the Intervenors, had incurred due diligence and work fees. In this context, application of the business judgment standard is appropriate.

Opinion, pp. 11-12. Having concluded that the business judgment standard applied, the court had no difficulty finding that the standard had been satisfied.



In a final footnote, the Court hinted that it would have upheld the award under the benefit to the estate standard as well, noting that the District Court had found that the auction process "was perhaps the final impetus needed to encourage the Parent to file its plan which pays creditors in full."

Why It Matters

This case is important for two reasons. One is that large bankruptcy cases are increasingly being resolved by Sec. 363 sales. There are not many circuit level opinions on 363 sales, since most appeals are rendered moot by the sale closing. As a result, any opinion which explains the Sec. 363 process is useful.



Second, this particular opinion, while very fact specific, provides some useful pointers. First, reimbursement orders should be obtained before any due diligence expenses are incurred. Second, the complexity of the asset will influence the advisability of reimbursing due diligence costs. There is a big difference between a tract of raw land and a billion dollar judgment. Finally, and perhaps most importantly, reimbursement orders are justifiable when they will increase competition. In the typical case, a stalking horse bidder is granted reimbursement if it is outbid. This encourages the stalking horse to invest in the due diligence necessary to submit a bid. Conversely, it can be used to tilt the auction procedures in favor of the stalking horse. Here, the unique aspect of the process was that all bidders invited to the second round were granted a right of reimbursement. Thus, the process was even-handed and fostered competition rather than inhibiting it.

Highlights from the National Conference of Bankruptcy Judges Day 1

I am attending the National Conference of Bankruptcy Judges meeting in New Orleans this week. Here are some highlights.

Lawrence P. King Award

The Commercial Law League of America presented the Lawrence P. King Award to Judge Burton Lifland from the Southern District of New York. In his acceptance speech, he stated that he has some concerns about the most recent phenomenon that has overtaken bankruptcy practice. According to judge Lifland, bankruptcy is becoming nothing more than a marketplace and that rehabilitation is on the back burner. He regretted that the pendulum has swung too far.

Philadelphia Newspapers and Credit Bidding

The topic du jour was credit bidding and inter-creditor agreements. Three out of six panels that I attended discussed some combination of these issues. There is another panel on Philadelphia Newspapers scheduled for Friday. (Note to planning committee: try to avoid duplication).

There was a lot of discussion of the Third Circuit opinion in In re Philadelphia Newspapers, 2010 U.S. App. LEXIS 5805 (3rd Cir. 2010), including a presentation from debtor’s counsel. In that case, the Third Circuit held that a sale pursuant to a plan of reorganization could eliminate the lender’s right to credit bid. Under 11 U.S.C. Sec. 1129(b)(2)(A), there are three alternatives for dealing with a secured claim separated by the word “or.” Option (iii) allows the realization of the “indubitable equivalent” of the lender’s collateral. The majority opinion held that a sale without the right to credit bid could provide the “indubitable equivalent.” The dissent argued that the more specific provision, which allowed credit bidding, should control.

I think the dissent had the better argument, but the more intriguing question is why it would be advantageous to avoid credit bidding. Lawrence McMichael, who represented the debtor, said that the rationale (apart from “torturing the lenders”) was to encourage bidders who would want to operate the newspaper, rather than simply sell it. The specter of a bidder with an unlimited right to credit bid was thought to be a deterrent to third party bidders. After the sale was allowed without credit bidding, the number of bidders who signed confidentiality agreements increased from three to thirty and the sale price went from the stalking horse bid of $30 million to $105 million. However, the winning bidder was still members of the bank group who had put together a cash bid.

The counter argument to eliminating credit bidding was that bank group relationships have grown so complex that a cash bid may be difficult to prepare. While the indenture trustee can make a credit bid on behalf of the group, it cannot require the members to advance new capital. Individual members of the group may be deterred from making a cash offer out of concerns about liability to the non-participating members.

An interesting side note is that section 363(k) allows the court to eliminate a right to credit bidding “for cause.” If there are compelling reasons for eliminating credit bidding, it seems more intellectually honest to do it directly.

International Insolvency

The panel on international insolvency included E. Bruce Leonard from Canada, Bankruptcy Judge Charles Case from Phoenix, Michael Crystal from England, Thomas Felsberg from Brazil and Prof. Jay Westbrook from the University of Texas Law School. They provided a good primer on chapter 15.

The purpose of chapter 15 is to allow an ancillary proceeding to be opened in the United States in support of a main proceeding in another country. Chapter 15 consists of two stages: recognition and relief. Recognition of a foreign proceeding is intended to be easy to obtain, although Prof. Westbrook pointed out the problem of haven countries, which incorporate companies but have no economic activity there.

The relief portion is highly discretionary and can include “any other relief than can be granted to a trustee” other than avoidance actions under the Bankruptcy Code. Judge Case stressed the importance of making a record to support the court in exercising its discretion. Any interesting example offered was a case where the chapter 15 proceeding sought to pursue fraudulent transfers under Nevis law. The Fifth Circuit ruled that only avoidance actions under the United States Bankruptcy Code were prohibited.

Individual Chapter 11s

The panel on individual chapter 11 cases included Judge Mary Diehl, Peter Lively, Sally Neely and Riley Walter. They approached the problem from the perspective of chapter 13 lawyers having to learn chapter 11 concepts and chapter 11 lawyers having to learn chapter 13 concepts which apply in individual chapter 11 cases.

They raised several interesting issues.

1. Can the same lawyer represent the debtor and the debtor in possession? What happens when a creditor files an objection to exemptions? Can the debtor’s lawyer defend the objection and get paid for it? In chapter 7 and chapter 11, the trustee may employ professionals, but the debtor may not. Can the attorney for the debtor in possession perform services for the benefit of the individual debtor? In re Dixon, 2010 Bankr. LEXIS 3305 (Bankr. N.D. Cal. 2010) was discussed as an extreme case, which held that not only could the attorneys not be compensated for defending the objection, but that they placed all of their fees at risk by taking a course of action adverse to the estate. Intellectually it is possible to connect the dots, but it is a terrible result practically. It would mean that an individual chapter 11 debtor would be required to hire one lawyer to represent the estate and a second attorney, who could not be paid from estate property, to represent him individually.

A better approach would be to recognize that the debtor in possession is a flesh and blood person with a right to claim exempt property. Once a creditor objects to the claim of exempt property, both the individual debtor and the debtor in possession have an interest in determining whether the property is exempt or not. My personal view is that if there is a conflict, it is one built into the structure of the Bankruptcy Code. An attorney has a duty to zealously represent his client which extends to both roles of the human being. Any other result means that a creditor could hold the debtor hostage by filing frivolous objections to exemptions or complaints to determine dischargeability, knowing that the debtor will be hamstrung in responding.

2. Is there an absolute priority rule for individual chapter 11 debtors? Three cases say no, holding that section 1129(a)(15)’s requirement to pay projected disposable income for five years overrides the absolute priority rule. In re Shat, 2010 WL 702443 (Bankr. D. Nev. 2010); In re Rodemeier, 374 B.R. 264 (Bankr. D. Kan. 2007); In re Tegeder, 369 B.R. 477 (Bankr. D. Neb. 2007). However, four cases have found that the absolute priority rule does apply. In re Gelin, 2010 Bankr. LEXIS 3217 (Bankr. M.D. Fl. 2010); In re Gbadeo, 431 B.R. 222 (Bankr. N.D. Cal. 2010); In re Mullins, 2010 Bankr. LEXIS 2826 (Bankr. W.D. Va. 2010); In re Steedley, 2010 Bankr. LEXIS 3113 (Bankr. S.D. Ga. 2010). Three of the cases finding that the absolute priority rule applies are so new that they came out after the materials were prepared.

3. How do you calculate “projected disposable income” under section 1129(a)(15)? The section says to look to section 1325(b)(2). However, section 1325(b)(2) defines defines “disposable income” as “current monthly income” less expenses reasonably necessary. “Current monthly income” is based on the means test form. However, the expense portion of the means test is contained in section 1325(b)(3), which is not incorporated. Both Collier on Bankruptcy and the Bankruptcy Forms take the position that the expense calculation under the means test is not incorporated so that the court retains discretion to determine which expenses are “reasonably necessary.”

4. Can you close the case prior to discharge to avoid paying U.S. Trustee fees? The panel stated that an increasing number of courts are allowing this practice. However, they cautioned that the automatic stay goes away when the case is closed and the discharge injunction does not apply until discharge is granted at the end of the plan. They recommended including an injunction in the closing order.

Random Thoughts from the National Conference of Bankruptcy Judges--Day 1

I am in Las Vegas for the National Conference of Bankruptcy Judges. The conference promises 2 1/2 days of events combining leading speakers and some frivolity.

I started off Monday by attending the Commercial Law League of America's breakfast with Paul Begala. Begala attended the University of Texas Law School around the same time that I did, but went on to work in the Clinton White House shortly thereafter. He is speaking on the topic Politics in America Today: Too Important to Be Left to the Politicians. However, it should have been titled Will Obama Crash and Burn. One of his central points was that presidents enter office with high expectations and high approval ratings, but inevitably run into scandals and reality which drag their approval ratings down. Some, like Presidents Reagan and Clinton recover, while others, like Jimmy Carter and George H.W. Bush do not. Begala's thesis is that some presidents succeed despite the unpopularity of their foibles. While Americans did not like Iran-Contra and the Monica Lewinsky affair, they liked Ronald Reagan and Bill Clinton. The key, according to Begala, is a belief in American Exceptionalism, the conviction that America is a place which, as de Tocqueville reported early on, contains unlimited opportunities. Reagan (morning in America) and Clinton (the Man from Hope) got this. Begala believes that Obama gets this also. As a matter of fact, his point is how can anyone go from being the grandson of a Kenyan goatherder whose father deserted him to president of the United States without believing in the promise and the magic of America. He contrasts this with a conversation he had with his haughty French brother in law who became suddenly silent when asked when France would elect a President of Algerian or Moroccan descent.

Upon entering the main hall, my first thought is that I am in a cavern. The speakers are way off in the distance. Most of the audience crowds around the back, leaving plenty of room up front for this willing to walk half a mile or so.

Barbara Houser, the incoming president of the NCBJ, gives a preview of next year's conference in New Orleans. When I think of Judge Houser, I think of serious, sober analysis. However, the promotional video shows the wild side of Judge Houser, speeding around New Orleans in what looks like a go cart, wearing a Saints jersey, eating beignets and wandering down Bourbon street in a feathery Mardi Gras mask. It is nice to know that even judges can have fun. (I will try to get the video for a future blog).

From there, the next topic is Obamanomics and the Future of Bankruptcy. Of course, as the panel later makes clear, Obama's key policies regarding economic stimulus and recovery are largely a continuation of the Bush administration's. First up is former Sen. Gordon Smith, who paints a picture of dire consequences when the demographic Tsunami of entitlements hits. If I heard him correctly, he said that at some point in the future, the gap between tax revenues and entitlement payments will equal the gross national product. He posits that the federal government will shift costs down to the states which will not have the ability to print money or engage in endless deficit spending. He wonders aloud whether the bankruptcy code will need to be amended to allow states to file for bankruptcy.

The panel which follows discusses the meaning of the Chrysler and GM cases. The economist on the panel argues that reorganization should be faster, more like a sale. The panel asks whether the current practice is a signal that the chapter 11 process is no longer viable.

Another panelist makes the point that BAPCPA has caused bankruptcies to fall and defaults to rise, which will lead to bankruptcies increasing. Currently 3% of prime mortgages and 14% of subprime mortgages are in default.

The economist addresses the problem of home foreclosures. She posits that lenders foreclose too often because they only consider their own costs and not the larger costs to society (kids having to change schools, vacant homes, property values crashing). Of course, like any good economist, she has a on the one hand this and one the other hand that approach. The current program of relying on voluntary modifications leads to too few modifications, while allowing cram-down in chapter 13 would lead to too many (i.e., people who could have paid their loans given a little time will be able to modify when they don't really need to).

Later in the day, I learn about the different types of recessions. Apprently, there are bathtub recessions, V recessions and hockey stick recessions. We are in a bathtub recession, which involves a steep slide followed by a long trough and a steep recovery. According to the speaker, we have reached the bottom of the bathtub and will stay there for at least three years.

The panel on chapter 11 bemoaned the fact that while we are seeing an uptick in chapter 11s, we are not seeing true reorganizations. Reorganizations today consist of 363 sales, orderly liquidations and cases with significant litigation which will pay off in a short period of time. Another change is that bankruptcy is now part of the process, rather than the focus of the process. In other words, bankruptcy is a tool used to implement a strategy developed ahead of time, rather than the means where the strategy is developed.

Another change is that almost every case of consequence runs the risk of administrative insolvency due to high amounts of leverage leading to the need for a speedy resolution.

One of the speakers argued that we have shifted from a rehabilitation process to a retribution process. Where there is risk, there is failure. He argued that we should give debtors a chance to reorganize after failure rather than penalizing them.

I learned a new term: fulcrum security. These are the secured creditors who stand to win or lose big time depending on the sucess of the reorganization. They are either first lenders who are undersecured or junior lenders. They are more like equity than secured creditors in that they are willing to take greater risks to try to achieve greater rewards. Some creditors in this category go into the case with a loan to own mentality.

Another View on Chrysler

The Chrysler deal has now closed, proving that it is possible to do a multi-billion dollar asset sale on an expedited timetable when the U.S. government is your DIP lender and is directing the pace. I am still scratching my head at the ease with which this deal went through. In the realm where I practice, an attempt to sell the debtor's assets to a purchaser selected by management for a small fraction of the secured debt would not only be denied, but would likely be followed by a motion for sanctions. However, when you are dealing with a debtor whose failure could send nuclear shock waves across the economy, it may be that the strict legalities give way to more pragmatic considerations.

Here is a pragmatic analysis from guest-blogger Steve Roberts.

How about this.

If the government did not step in, Chrysler would shut down and go into liquidation and the senior lenders with $6.9 billion in debt would be paid less than the $2 billion or 29 cents on the dollar the government is offering them.

So the government is using your and my money to bail out the lenders along with everyone else. But holdouts among the lenders are screaming that their constitutional and statutory rights are being violated because inferior claims are getting more.


Lets look at that. Who do we, the taxpayers, need if there is any chance for us to get our money back? The the supply chain and the workers. Without them there is no bailout and the senior lenders would get less. So New Chrysler cuts the unions into the deal and assumes the supply contracts with the suppliers to maintain the supply chain.

The Indiana pension funds, who are the last holdouts among the senior lenders, say that the government is hurting the teachers and state employees of Indiana with this bailout, so let's examine that. The fund managers for these funds bought Chrysler debt in or after 2007 and paid 43 cents on the dollar for it, betting that Chrysler would survive. They were wrong. They did not lose money because the government stepped in. They lost money because they lost on the risk they took.

These fund managers have said publicly in this case that they will settle for 50 cents on the dollar, a neat 7 cent profit. And since the government will not use your and my money to bail these fund managers out for their miscalculation, they are appealing the approval of the sale to the 2nd Circuit on an emergency basis.

They must be betting that the government will pay them more if they win and are willing to take the risk that the government will not let the bailout fail.

Since Steve wrote this analysis, both the Second Circuit and the Supreme Court refused to block the sale and it has now closed.

However, I think it highlights what an unusual case this is. Chrysler was not a meaningful player in its own bankruptcy. Instead, the case tested how much the treasury was willing to pay to avoid the collateral damage from a Chrysler failure. The senior lenders (or at least the holdouts) were not banks which had lent money directly to the debtor, but rather speculators who had bought the debt in the hopes of making of a profit. As Steve correctly points out, the objecting creditors, having seen that the government was in the bailout business, wanted a bailout of their own investment decision. The government stood firm and was backed up by the courts.

What I really want to know is how can I use this precedent in my next single asset real estate case?

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.

Implications

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.