Tracking new cases: New test of Chrysler deal

By Lyle Denniston
on Sep 12, 2009 at 7:32 am

NOTE: From time to time, the blog will examine significant new cases filed at the Supreme Court.  This post is one in that series.  Some of these cases very likely will appear later in the blog’s Petitions to Watch feature when the Court is ready to consider them.

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Without trying to unravel all of the deal that saved automaker Chrysler, three trust funds from Indiana have asked the Supreme Court to rule that the arrangement violated federal bankrupty law.  As a remedy, the funds argued in a new petition that the United Auto Workers and the retired UAW members’ benefit plan should have to surrender their stock in the surviving company and hand over $4.6 billion in another asset they received in the package. Those assets should then be distribited to holders of debt owed by the “old Chrysler,” the funds argued in Indiana State Police Pension Trust, et al., v. Chrysler LLC, et al. (docket 09-285, filed on Sept. 4).

The legal issue at the center of the case is the power of a bankruptcy court to allow a failing company to sell all of its assets while its case is in court, without going through the reorganization process that protects creditors.  That issue arises under a section of Chapter 11 (section 363) that permits a banrkuptcy trustee to make a quick sale of the firm’s property before final arrangements are made to reorganize the firm to keep it alive.   The Indiana trust funds argued that this was used in the Chrysler case to accomplish an “end-around” Chapter 11.  “On its face,” the petition asserted, “this deal smacks of the sort of insider favoritism that the Bankruptcy C ode was designed to prevent.”

The Chrysler sale, carried out in June, was arranged by the Obama Administration in a move to save the company from threatened, even imminent collapse as the automaker was losing sales and hemorrhaging cash.  Practically all of its assets were sold to Fiat, the Italian automaker, in a package deal that was financed by the U.S. and Canadian governments. 

 The Supreme Court has been involved with the deal once before: on June 9, it turned down a series of pleas to block the sale until its legality could be tested.  The Court’s action, however, did not pass upon the legal issues involved.

A bankruptcy judge in New York had approved the sale after a quick proceedng, and the Second Circuit Court upheld that ruling, but did not explain its action until issuing an opinion on Aug. 5 — nearly two months after the deal had been wrapped up.  A key part of that ruling is now at issue in the case filed with the Justices by the Indiana State Police Pension Trust, Indiana State Teachers Retirement Fund, and Indiana Major Moves Construction Fund.  Those funds had invested a total of $42.5 million in Chrysler, as part of a group of “first lien lenders” who together held $6.9 billion of Chrysler debt.

As a result of the Chrysler-Fiat deal, all of those lenders will split up $2 billion, even though they were secured creditors.  By contrast, the Indiana funds’ petition contended, the UAW and its retired workers’ benefit fund — unsecured creditors — “received over $20 billion of going-concern value in cash, new notes and stock from the reorganized business.”

This was accomplished, the petition said, by a “side door” arrangement — the use of a quick sale of all of “old” Chrysler’s assets without going through the process of court confirmation of a formal reorganization plan under Chaper 11.

The lower courts’ approval of this approach, the petition said, “now stand as precedent that disrupts the balance the Bsankruptcy Code strikes between promoting the reorganization of troubled businesses and protecting creditors’ rights; this precedent has already been followed in other cases and this trend will continue unless the Court intervenes.”

It noted that even the Second Circuit had said that the use of section 363 to accomplish quick sales of bankrupt assets without a confirmed reorganization plan appeared to be displacing the regular Chapter 11 process.  That process, it noted, includes an array of significant creditor protection steps, including creditor input into the details of a reorganization plan, assurances of a fair recovery of what creditors are owed, and clear separation of the hierarchy of rights between secured and unsecured creditors — all before a court may approve a plan.

None of that was done in the Chrysler arrangement, the Indiana funds protested.  The federal government, it contended, used section 363 “to protect a poltiically powerful ally” — the United Auto Workers and its members.  The sale of Chrysler was “not a legitimate sale of assets…it was…nothing more than a way for the government to pick winners and losers from among Chrysler’s claimants, as opposed to a forthright attempt to maximize asset value subject to market competition and discipline.”

The petition acknowledged that, under bankruptcy law, the Chrysler deal could not now be  unwound completely.  They thus are asking the Court to overturn the part of the deal that involved the distribution of proceeds of the sale.  The Court could do so, it argued, by requiring the UAW retirees’ fund and the union itself to “return to the bankruptcy estate the $4.6 billion note and common stock that they received…to be properly distributed pursuant to a Chapter 11 plan of reorganization.”

Technically, if that is done, the assets would be put back into the still-ongoing bankruptcy case of “old Chrysler.”  The new company is not involved in that proceeding.

A response to the Indiana funds’ petition is due Oct. 5, unless the Court extends the time for filing.