Business Law Prof Blog

363 Sales in Bankrutpcy

The Chrysler bankruptcy and now the GM bankruptcy feature 363 sales.  I have written briefly on this before,  This deserves the careful attention of more than a few blog entries.  Chapter 11 features, features, a well tested "plan approval" procedure.  First, managers, and it that fails, then groups of investors, propose a "plan" for the reorganization of the bankrupt company.  The plan compromises the claims of the lower tranches of debt (usually turning debt into equity and giving shareholders a token residual equity position for their shares) so that the company becomes solvent (the operating profit now can pay the remaining debt obligations on time).  The bankruptcy judge must be convinced the plan is viable (or he will send the company into Chapter 7, a liquidation) and divides the investors into classes. Those classes whose claims are "impaired" by the plain -- they are not receiving full payment on their obligations -- vote by class on the plan (the vote seeks two majorities, one by number of creditors voting and one by the amount of the claims being voted).  Some secured creditors, with high priority, may not vote because they are not impaired.  If enough classes vote in favor, the judge has the option of "cramming down" the plan on those classes that do not.  If the plan "passes," the company emerges from Chapter 11.  A 363 sale is an emergency sale of the company, proposed by management and approved by the judge, before any plan has been proposed, let alone passed.  A 363 sale can be an end run around the entire Chapter 11 procedure.  Once the company is sold, the Chapter 11 turns into an Chapter 7 -- the proceeds of the deal are the only thing left to do for the court.  Over twenty years ago, the Circuit Courts recognized that a 363 sale was a method of avoiding Chapter 11 procedures and thus they restricted the process with a threshold -- the assets must be time sensitive (like vegetables in a railroad car).  Here we see the government doing the same thing -- they are avoiding the Chapter 11 procedure, to avoid the claims of those pesky creditors that are not going along with the government's version of the a workout, by selling the companies first and quickly in 363 sales. The argument is that the companies must move quickly or lose all their customer. Yet last month was both companies best sales month in several months -- after the bankruptcies were either announced or known.  These 363 sales are, in essence, total cram downs without a vote.  The danger?  Managers sell the company cheap to reward themselves and their go along creditor buddies (read, the UAW and the government as debt holder here).  Bankruptcy judges, eager to avoid a year of hearings and decisions, and eager to "save" jobs of employees by keeping the company doors open, have a strong incentive to go alone.  In these cases, first Fiat and now a Chinese company (and the government itself in buying the "new GM") are getting too sweet a deal in these 363 sales.  In the government's case, the sweet deal is an avoidance of the difficult question of whether the "new GM" will survive - whether it should be thrown into a Chapter 7.  Taxpayers and unsecured, non-union creditors are taking the hit.  The bankruptcies should go through the full plan process.  Old time test procedures work -- new emergency reasons to avoid them are -- well, trouble in river city.  

GM Numbers: New Plan Does Not Make Economic Sense

GM has $90 B in assets and $170 B in debts.  The government plans to put in another $30 B, for loans.  the new company will be a shell of its former self, employing 40 to 50 thousand or so workers once all the plants are closed.  GM has 225,000 workers worldwide and, until today, 90,000 here.  Why spent so much on a shell of a company with a very questionable future?  Given even optimistic estimates for selling new cars, GM is likely not to show a profit for many, many years.  It is likely to go into bankruptcy again, soon.  This is a major government investment for 40 to 50 thousand jobs (less than half the seats in Ohio State Stadium). 

Morevoer, under the new plan, much of the overhanding debt is cancelled in exchange for equity in the new company.  Yet the amount of equity doled out to the various debt holders is very suspicious.  The standard is equality -- all unsecured debtholders with cancelled debt get an equal amounts of equity relative to the debt cancelled.  This equality standard has been, as many commentators have noted, trashed.  Workers unsecured claims get four times the value of the unsecured claims of all other creditors.  Taxpayers as current debtors get less, ceding much of the value ot their equity claims to the UAW.   In essence, taxpayer and bondholder money has been shuffled into the UAW.  

The new structure establishes severe conflicts of interest.  To whom does the CEO report?  The government?  Canada?  The UAW?  The government has a conflict -- it is both regulator and owner. As a regulator it reports to environmental constituencies, labor unions, and others.  Taxpayers lose in this. The UAW, on the other hand, supports American -only jobs (members pay dues).  The union does not care for GM cars imported from abroad (where some of its best small cars are manufactured);  it will willingly ssacrifice GM profit for job guarantees. In sum, this is a political payoff from a new Democratic government to one of its longest and most faithful supporters, the UAW.  The government is saving jobs that should not be saved to save a union.  The government will be protectionist (selling Opel on the condition that Opel not import into the United States, for example) and will subsidize the jobs to subsidize the union. 

A Chapter 11 reorganization, many months ago, without government interference and money, was the best route, but government interference cost GM the opportunity for a normal restructuring.  The past iinvolvement of the government, sacrificing the opportunity for a Chapter 11, now means the best decision going forward is a Chapter 7, liquidation.  Sell the $90 B in assets and divide the cash among the debtors.  

The history of government bailouts of auto companies worldwide is abysmal.  Why can we do better?  This goverment controlled Chapter 11 is either a very, very reckless path born of hubris or a calculated political payoff with long-term economic costs.  You pick.         

Setting Up a Scapegoat for GM

The NYTs today is gushing over a 31 year old who interrupted law school to "run" General Motors in the bankruptcy announced today. He has no formal economic training and no business training. His dad is a "green" engineer.  He is a scapegoat.  Obama's high ranking economic advisors haveset this kid up to take the fall of an inevitable failure of a government effort to run an automotive company.  They are not going to be front and center on this. They know that it is highly likely that GM will emerge from bankruptcy a mess.  It's future will pprobably be a second bankruptcy (similar to many of the struggling airline companies). 

Yesterday I took my son to a barber and we tested Buffett's advice: "Never ask a barber whether you need a haircut."  We asked the barber: "What to you tell people who ask you whether they need a haircut?"  He responded: "I always say yes, of course."  Obama has the same problem with his "experts."  When you ask and "expert" for advice th modern expert, educated at Harvard or Yale always will tell you they can fix the problem; they never say "I don't know" or  " We should stay out."  Obama and his experts think they can run a car company, reluctantly, of course, but they have "no choice, but to fix the problem."  Where is the humility? Not taught in school by experts; not held by experts.

Sotomayor on Business Cases

Business law academics, pouring over, Judge Sotomayor's cases business law, authored as a district court judge and as the writing judge for a Second Circuit panel of three judge, can find no discern able "leanings" or "theories" that would either favor or disfavor those who run businesses in the United States. 

I have commented that I was surprised on her high rate of reversal by the Supreme Court, most of which are in business related cases.  She has lost 3 of 5 appeals from the circuit court and lost her only appeal on a business related decision of a district court opinion.  Most agree that she will lose the Ricci case as well, which is pending, putting her at 5 of 7 reversals in cases taken by the Supreme Court.  This is high for an individual judge (even though the supreme court does reverse in 70 percent of all cases), parparticularly for a circuit judge not in the Ninth Circuit (which suffers, by far, the highest reversal rate) and particularly for a circuit judge in the Second Circuit (which does not not get reversed as much as other circuits).  Moreover, one of  her opinions that the Supreme Court affirmed was done so on alternative grounds with a backhand comment on her reasoning -- I would put it in the reversed category (that makes it 6 of 7).  Only one of the reversals was close (a 5-4 decision) and one was unanimous (8-0), a particularly tough reversal (the number of 8-0 reversals from the Court that are not from the Ninth Circuit is small, indeed). 

In any event, the reversal rate will not affect her confirmation, which will go smoothly.  More of interest is her new role on the court in business cases. Her is my take: The Supreme Court, after the retirement of Justice Powell and until the appointment of Justice Roberts, was woefully short on business expertise. The number of business cases accepted declined significantly and those who wrote the cases that were accepted did so with a remarkable lack of enthusiasm and, more critically, with a fundamental misunderstanding the effect of many of the opinions on market incentives and market planning produced by the opinions themselves.  This tin ear to the effect of an opinion on future business practice and structure was due to training, or the lackof it, in business culture and market structures.  When judges lack market based training and experience and lawyers argue that opinions will affect markets in negative ways, most judge turn literal and conservative and stay close to the rules (let agencies or legislatures establish the market based incentives). A few judges do not care for arguments that imply necessarily that a judge has limited economic expertise and, to help the little guy (or some other guy), just let it rip and damn the consequences (it looks good at the retirement dinner).   Does Judge Sotomayor show market training or market sensitivity (for history or economics) in her many decisions? No [Not a surprise: During her education she focused on federalism and civil rights questions (often relating to Puerto Rico); her pratice was as a governement criminal lawyer and, later, as an intellectual property enforcer; her talks and classes given as a judge are not related to business matters]. Will she be literal or let it rip?  So far, she has be literal in business cases (although sometime literally wrong), but put a Justice's robe on someone and things can change.

Sotomayor on Business Cases

I was reviewing Judge Sotomayor's record on business cases and the same word kept coming up, reversed.   There is little to be said of a consistent record learning one way or the other on the business cases except the high frequency of reversals by the Supreme Court whenever one of her cases goes up on appeal.  There is one case she wrote that I do not like at all and that is her opinion several years back giving the NYSE immunity from investor actions questioning the manipulative activities of NYSE floor brokers and specialists.  The NYSE has change enough to moot the opinion, but at the time it I found it poorly reasoned and of questionable policy to boot. 

The New SEC Rule on Shareholder Voting: Make it Discretionary

The new SEC rule on shareholder voting may be good policy for individual firms, but is it a good mandatory rule for all publicly traded firms.  No.  The better rule is one that asks all publicly traded firms to vote periodically on their shareholder voting procedure; do the shareholders want the SEC rule or not.

The Bond Rating of the United States

The rating companies have announced officially the first step of a bond rating downgrade for the United Kingdom.  Are we far behind?  There are rumors that the United States is next due to this years ridiculous budget deficit and increased national debt as a result.  This is a shock; CEOs get fired for this.

Indiana Steps Up

The zany deal in the Chrysler bankruptcy finally has a serious opponent that willl be hard to for Obama to publicly belittle -- the three Indiana state pension funds (led by the state Treasurer Richard Mourdock).  They are carrying the water for the rest of the country.  In a statement that fortells the state's view of its prospects, however, Mourdock also announced publicly what many other will do privately -- a refusal to invest any funds in the debt of any bailout company or any company that may be bailed out.  As noted here many weeks ago -- the government will be the only financer now for many trouble companies -- just the opposite of what a healthy recovery needs.  Now is it up to the bankruptcy trustee -- I hope he steps up too. 

SEC Proposal on Board Nominations

The SEC is proposing a new rule on board nominations for large publicly-traded companies.  Shareholders, or groups of shareholders that control over 1% (3% for mid-sized companies and 5% for small) of the company's voting shares can nominate directors to corporate boards in the company's proxy materials.  The proposal, similar to the Schumer bill, was the inevitable result of a confluence of three events:  a rescission,  Democratic control of Congress and the Presidency, and the failure of Delaware courts to set up to the plate in Disney and other cases of fidiciary abuse.  The feds are going to reshape corporate governance in the United States.

Buchheit and Skeel on Bankruptcy in the NYTs

Burchheit and Skeet have proposed a "modified" bankruptcy proceeding for large financial institutions in today's NYTs.  The government will "guarantee" all trading obligations for 60 to 90 days to enable companies to "prepare" for a Chapter 11.  It is loony, of course.  First, the government's decisions (or decisions as it considers whether to "role" the guarantee") are discretionary, political (talk to the ethanol supporters), and volatile.  The uncertainty will incentivize delay by the private section until the government declares (and changes its mind and re declares and so on).  Second, how does such a "guarantee" work?  If I were the company I would default on everything (counter parties cannot claim default but the company itself could declare that it could not pay, take government money, as much as I could, and then work out a deal.  Without government controls, the companies would game the government -- which means we must put government officials on boards and such -- conservator ship.  Conservator ships are a much better mechanism that this proposal, even though they have many, many flaws as well (see the Fannie and Freddie).  Another set of aacademics with a government based solution that is inferior to the processes we already have in place.