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Last week, Bankruptcy Judge Arthur Gonzalez denied a request by Indiana governmental pension and capital funds (the State Police fund, Teachers' Retirement Fund, and the Major Moves road construction fund) to delay the sale of Chrysler to Fiat (OTCPK:FIATY) while the funds sought review of the Chrysler/Fiat deal from a federal district court. All three funds hold secured creditor debt which will effectively be subordinated if the Chrysler/Fiat deal closes. Typically, secured creditors get "first dibs" on the assets of a company in bankruptcy while unsecured creditor get the remains. The arrangement created by Pres. Obama's administration, however, would place unsecured creditors (namely, Chrysler's union) in a better position than Chrysler's secured creditors. As an attorney, I can tell you that I have never seen such a thing done, though bankruptcy is not my specialty.

Now, the Indiana funds--administered by Indiana Treasurer Richard Mourdock--have requested that a federal district court take jurisdiction over the Chrysler case. The request is based on a variety of reasons, but the most serious claim is that by forcing secured creditors into a position behind unsecured creditors, the government is executing a "taking" without due process and, therefore, violating the 5th Amendment to the U.S. Constitution. The argument boils down to the following steps:

1. The Chrysler deal has the federal government's fingerprints all over it, so the deal is tantamount to an action by the federal government itself

2. By placing Chrysler's secured creditors behind unsecured creditors, the federal government diminished the value of the funds' assets (the current "deal" will result in the funds' receiving only about 29 cents on each dollar they invested). Such an action is equivalent to "taking" the pensioners' property without due process of law.

3. The remedy requested is for the District Court to order a halt to the sale, place Chrysler under a trustee, and work on a deal that will "cure" the civil rights violation alleged.

The funds' attorneys argued the case before federal district court Judge Thomas Griesa Tuesday morning in New York. What will happen? I don't know. If Judge Griesa halts the Chrysler/Fiat deal, then it appears that the company is doomed and may be liquidated. This may give Judge Griesa pause. If he accedes to the government's actions, however, then he is essentially allowing brute force to dictate the outcomes in the bankruptcy process. His is not a position I envy.

Disclosure: No position in Chrysler or Fiat

Source: Will the Chrysler Deal Be Delayed?