Is the GM section 363 bankruptcy plan really a stealth re-organization plan?
We have just learned that Fiat has successfully completed its deal with Chrysler. This means that the bankrupt ‘Old Chrysler’ will now have far fewer cash and assets available for creditors and that it will be liquidated with large or total losses likely for creditors. Dissident creditors tried to get their case heard by the Supreme Court. But this was rejected, paving the way for the Fiat deal.
Key to why things turned out as they did is the use of section 363 of the bankruptcy code, which allows a company to sell assets without creditor approval and before a re-organization plan can be submitted. The sale produces cash available to creditors in the eventual liquidation of the company. The sold assets can continue to operate as before, but in a re-organized fashion. This is exactly what the Obama Administration wanted for Chrysler. So, in the case of the government versus bondholders count round one to the government.
Now, it’s time to turn to General Motors. This is a very important case because GM is such a big player in so many arenas. Think of Chrysler as a test run of GM, the real US auto emergency. A bankrupt GM that does not receive the same quick section 363 treatment that Chrysler received would be a very nasty shock to the U.S. and global economy.
The problem is that General Motors is a whole different case altogether. And I am not so sure the government is going to be successful here. Here’s why. While the Chrysler deal involved a sale of the principal assets, the GM bankruptcy looks more like a stealth re-organization which violates the spirit of section 363. Back in 2004, Daniel Glosband, a bankruptcy expert at the law firm Goodwin Proctor reflected on this issue at the site FindLaw. (emphasis added below)
Advantages of a Section 363 sale include speed, transfer of assets free and clear of encumbrances and interests, transfer of restricted contracts and avoidance of exposure to claims under fraudulent transfer laws. For a seller, the Section 363 process eliminates director and officer exposure for the sale and limits exposure for breach of representations and warranties. Cosmic balance, however, requires a few clouds to accompany the silver linings.
Traditionally, the sale of a business in chapter 11 was accomplished through a plan of reorganization that identified and dealt with each class of creditors and equity holders. The sale plan was described to the affected creditors and equity holders in a prospectus-like disclosure statement and put to a vote. Bankruptcy law required acceptance of the plan by specified majorities of affected parties, a cumbersome process that lasted for several months and sometimes several years. Initially, courts were skeptical of Section 363 sales that circumvented the protective reorganization plan process. Early cases required the debtor to prove that a sale outside of a reorganization plan was necessary, for example by showing that the debtor’s business had insufficient cash flow to survive the full plan process. Lately, however, the Section 363 sale, which can be completed in as little as two to three months, has become the preferred method for sales of distressed businesses.
Clearly, if the courts decide that the government is trying to circumvent the normal Chapter 11 process by invoking section 363, you are going to have a problem. The Obama people are going to argue that GM is dependent on government monies to exist and that it cannot ‘survive the full plan process.’ But, creditors are going to contest this case and they may have more success than they did at Chrysler.
As for Fiat, the last paragraph of the FindLaw article describes quite well why their stock has popped on the news of a successful Chrysler deal.
The goal of the purchaser at a Section 363 sale is to take advantage of the financial distress of the seller and the power of the Bankruptcy Code to make a safe, profitable investment. While a Section 363 sale is a complex exercise with risks for the unwary, it can be an efficient avenue for a well-prepared buyer to acquire a financially troubled business.