Fascinating Showdown Ahead for U.S., Chrysler and Fiat

With Chrysler now in bankruptcy, our attention will turn to whether Obama’s promise of a short and surgical bankruptcy, coupled with an alliance agreement with Fiat (FIATY.PK), will ultimately be realized. Steve Jakubowski has presented some interesting legal analysis of the Chrysler bankruptcy (see Assessing the Financial Carnage and Testing the Limits of 363 - ht CalculatedRisk).

Although Steve analyzes the bankruptcy from a legal perspective, there are some interesting strategic dilemmas that emerge. For example, Steve went through the legal filings to piece together Chrysler’s balance sheet and financial standing. He points out:

• The claims of the top 50 unsecured creditors total $730 million, with total trade at about $1.5 billion.
• The claims of the senior secured lenders total $6.9 billion.
• The USA is owed $4 billion, secured by a third priority lien.
• Cerberus and Damiler AG are owed $2 billion secured by a second priority lien.
• An additional approximately $8.5 billion is owed to the VEBA funds that were designed to cover the costs of unionized retiree health benefits.

This raises an interesting set of questions. For example, why would the secured lenders be willing to take $2 billion to settle their claims? After all, they are technically first in line (after the DIP financier). Moreover, they feel that the federal government tried to cram down a Fiat deal in which unsecured creditors have been unduly favored over secured creditors. They argue that in liquidation they might be better off trying to recoup their money. Assuming Chrysler’s assets still have some value (which the truck, minivan, and Jeep lines probably do), they might be right. So to a certain extent I cannot blame them for not backing down.

By contrast, Chrysler’s representatives maintain that the secured creditors are likely to recover very little in the event of liquidation. As Steve points out:

In the end, however, the matter will be determined by the opinion testimony elicited from the parties’ opposing experts (with Houlihan Lokey’s Eric Siegert representing the dissenting lenders and Capstone Advisory Group’s Robert Manzo, who prepared this 166 page first day affidavit / expert report, representing Chrysler). Notably, Manzo concludes in his affidavit (pp. 26-27) that:

Based on the Liquidation Analysis, the First Lien holders are expected to recover between 9% and 38% of their claims, on a net present value basis, [which] translates into a range of between $654 million and $2.6 billion. It is my professional opinion that given the market developments subsequent to this analysis, coupled with the limited success of other OEM effort to move individual car lines, the First Lien holders would likely recover at the low end of this range as part of any liquidation of the Company. The U.S. Treasury is only expected to recover between 3% and 6% of its claims.

Since Chrysler obviously favors the Fiat deal, it is not a surprise that they “believe” that the first lien holders are making a mistake. I am not so sure I agree with that position, as again, I think there might be a bit more value in Chrysler’s products and brands.

Another interesting point that comes out of Steve’s analysis is that the US government is third in line, after the bank lenders and Cerberus/Daimler. Therefore, in liquidation, it is unclear that the taxpayer would receive much in return. But that begs the question: Is it better to get nothing in return for a $4 Billion loan, or lend invest an additional $6 Billion to support a Fiat deal (putting the taxpayer $10 Billion in the hole) with the prospect of still getting nothing in return? And under the Fiat scenario, the federal government’s claim would only be in equity, meaning that in the event of future bankruptcy, the taxpayer will be among the first to get wiped out. So again, it’s unclear to me that the Fiat deal is in the best interests of the taxpayer.

Now I am not a legal expert, but Steve makes some interesting points with respect to the role of the judge in cases such as these. He writes:

In concluding that the debtor…should be sold outside of the context of a reorganization plan, he [the judge] asks:

• Is there evidence of a need for speed?
• What is the business justification?
• Is the case sufficiently mature to assure due process?
• Is the proposed APA sufficiently straightforward to facilitate competitive bids or is the purchaser the only potential interested party?
• Have the assets been aggressively marketed in an active market?
• Are the fiduciaries that control the debtor truly disinterested?
• Does the proposed sale include all of a debtor’s assets and does it include the “crown jewel” (noting that “the likelihood of approval of the § 363 sale is inversely proportional to the percentage of the value of the debtor’s assets that are to be sold”)?
• What extraordinary protections does the purchaser want?
• How burdensome would it be to propose the sale as part of confirmation of a Chapter 11 plan?
• Who will benefit from the sale?
• Are special adequate protection measures necessary and possible?
• Was the hearing a true adversary presentation? Is the integrity of the bankruptcy process protected?
• What other factors apply to the case at hand that tip the balance or that overweigh the evaluative factors set forth above?

The most interesting question to me is the one about “are the fiduciaries that control the debtor truly disinterested?” In this case the fiduciary that controls the debtor is the federal government, since it is my understanding that it will act as a the trustee. On that basis, since the government is both creditor and trustee, how can it be disinterested??

Also, another interesting consideration is whether the Fiat deal unduly favors the auto union, and Chrysler’s retirees, vis-a-vis secured creditors. Again, I am not a legal expert, so it is not entirely crystal clear to me which claims comes first in bankruptcy (secured creditor claims or VEBA claims), although if I am not mistaken, the claims of the auto union should be unsecured claims and therefore junior to secured creditors. Either way, a 55% ownership stake in Chrysler for the union seemed a bit rich to me.

Steve concludes by reminding readers:

Never forget that in litigation, nothing is guaranteed. Indeed, much depends on the judge drawn. The judge overseeing this case is Judge Arthur Gonzalez, who proved… that he will adhere to what he believes the law requires, even if the financial markets turn upside down because of it.

So, who will win? Really, only the true speculator and/or holder of Chrysler credit default swaps will (and perhaps Fiat if they–unlike their predecessors–can make it work), as my first post on the financial carnage at Chrysler demonstrates.

My guess is that after much briefing, discovery, and expedited litigation over the next 60 days, Judge Gonzalez will show enough angst to worry both sides that they stand to lose, thus resulting in a compromise that settles the matter and allows the transaction to go forward. But with all Chrysler plants and operations now idled pending a final sale, the pressure to get the deal consummated and return people to work will be so overwhelming that it’s hard to imagine Judge Gonzalez not approving the transaction in some form that’s acceptable to everyone (except perhaps the dissenting lenders).

Steve claims that there is chance that Fiat might be a winner if they can make this deal work. As I’ve written before, I view Fiat’s chances of success as a low probability event (see Fiasco for Fiat or Now Introducing Fiat/Chrysler).

Irrespective of the outcome, one thing is certain: This is going to be a fascinating showdown - one that is extremely complex from both a legal and strategic perspective.

Disclosure: No Positions

Comments

[Jasper M:]

GOOD article.
The point about conflict of interest, as the us is trustee and creditor, was a particularly good catch.
Ultimately, I suspect Chrysler's biggest problem is Chrysler's management, which leads me to believe their assets likely Will have better value without them. SOMEbody will buy Jeep, for example.

While I am relieved to hear the the presiding judge is one who will stick to the law, I am genuinely curious to see if the administration attempt some sort of pressure or end-around him.
Personally, I am sort of rooting for the disenting lenders, as I get the impression the others are acting as stooges for the administration, manipulated by their dependence on TARP.

May 02 06:41 PM

[User 383211:]

I believe Fiat's chance of success are in fact extremely high. The US are currently considering a car scrappage scheme, which in Europe is linked to CO2 emission levels. And Fiat are the masters of low emissions having taken the European record for 2 years in a row now. Obama has also signalled a different US position on Kyoto and higher petrol prices, petrol taxes and/or CO2-based taxes (which exist throughout Europe except Germany) shouldn't be too far down the line. Furthermore Fiat can beat the Japanese in EVERY motor technology today: having invented the common rail engine, they are now at the fourth generation with the Multijet2, the incredible Multiair engines will go on sale in September, they are the largest producers of CNG vehicles, and they have developed a hybrid platform which is tiny compared with the Japanese Prius or Insight (and the Japanese are the masters of miniaturisation!). The only real problem here, in my opinion, is the legal uncertainty Chrysler are in now.

May 02 08:42 PM

[OldSouth:]

Excellent analysis, Mr. Saloman, raising the correct questions.

At bottom, the problems with this 'bankruptcy' are ethical:

1. The senior secured lenders are, by law, entitled to stand first in line. There are assets to liquidate (or reorganize and turn into money-makers) to settle their claims. Chrysler certainly holds the rights to thousands of design patents on vehicles, parts, and manufacturing processes. For instance, the mini-van is a very serviceable configuration--millions of moms with kids around the country can't be that wrong. The Dodge pickups, if marketed well, can give the Ford F-150/250/350 lines a real run for their money. Why can't two smaller(NON-UNION!) firms be organized to manufacture and distribute these vehicle lines? Without the horrendous per-vehicle expense added by the UAW's health/pension/work rules/featherbedding, these can be delivered to market profitably. We will always have mommies, farmers, ranchers, building contractors and hunting/fishing enthusiasts who will buy these vehicles. Add in the patents on parts and processes, available to sell or license, and Chrysler looks like a cash orchard awaiting harvest.

2. Why the **&&@@@@!!!! is the UAW being offered 55% of Chrysler? These clowns are in great part responsible for this train wreck. Remember how they would call a strike on one of the Big Three in order to force it to knuckle under, and then pick off the other two in succession? The only upside is that a majority stake might force them to act like adults for the first time in history. They can't 'stick it to The Man' if they themselves are 'The Man'. But after seven decades of wanton childishness, how optimistically should we await this 'conversion experience', this epiphany, this Damascus Road change of heart?

3. We the taxpayers have been dragged involuntarily, and under false pretenses, into this mess. We can kiss almost every penny shoveled in Chrysler's direction goodbye. Until today, I didn't know that we were protected by a third priority lien, which means we finish about twenty lengths behind the UAW, which is the defacto holder of the first lien. Those promises made to UAW were premised on the expectation that Chrysler would make profit, from which the health and pension bennies would be paid. No profit, no bennies; and it's not up to us to cough up just because profit wasn't made.

So, when is a senior secured debt not a senior secured debt?

When the UAW is in the room? When the White House(of either party) decides that a bankrupt enterprise is 'too big to fail'?

And, next time, when a pension fund manager looks at buying senior secured debt issued by Corporation Q....(remembering of course that the manager bears fiduciary responsibility for his actions)???

Personally, I hope the senior debt holders raise unshirted Cain in court, and tie up the process for months. There's enough Chrysler inventory out there to keep purchasers happy, so the plants can stay closed into next year, no problem.

This isn't about the survival of Chrysler.

It is about the survival of the rule of law.

It is a question of ethics.

May 02 10:02 PM

[Jasper M:]

Oldsouth:
Just to play devil's advocate . . .
I think the justification for the huge pay off to the UAW is the various pension and other obligations owed to them. It's a pretty huge sum - instrumental in strangling Chrysler, and the rest of industry.

Here's the important part for taxpayers: if the pension obligations Don't get covered, the taxpayer is on the hook for them.

May 03 12:26 AM

[dspg:]

Sort of irritating isn't it that the government is backing one party in this one. I think that if this is a union owned company, no-one will buy their products and they will simply fail again. I would prefer that the government not squander my taxes such.

May 03 04:22 PM

[woodsey:]

This retired auto worker and STILL UAW member agrees: Yes it IS about ethics.

May 03 04:45 PM