General Motors and Chrysler: The Changing Face of Chapter 11 By Stephen B. Selbst What two marquee bankruptcies tell us about the evolving use of the Bankruptcy Code. he highly publicized Chapter 11 cases of The Chrysler Case Chrysler LLC and General Motors Corpora- Ttion (GM) have changed existing bankruptcy Although Chrysler had been a laggard performer practice. The trend toward using Chapter 11 to in the auto industry for many years, its descent effect the sale of a debtor’s business has literally into Chapter 11 began in 2008. From the start, auto received the federal government’s seal of approval. industry sales had been off sharply from 2007 levels, The Chrysler and GM cases have proven that even and by June, Chrysler sales were down 22 percent enormous and complicated industrial businesses can compared to 2007, the worst of the three domestic be reorganized at lightning speed and the attendant automakers.2 These pressures on Chrysler only in- risks to the business limited and contained. The sale tensifi ed in the fall, as the entire U.S. auto industry of Chrysler to an alliance in which Fiat took over the reeled from the impact of the fi nancial system melt- management occurred in just 42 days, including the down and the deepening recession. By November, appeals to the Second Circuit and the Supreme Court. Chrysler’s sales were off 28 percent compared to The GM case was even faster. The Chrysler and GM 2007.3 In December 2008, both Chrysler and GM cases were unique in that the federal government had sought and obtained emergency loans from played a dominant role in shaping those sales, and, the federal government to prevent them from run- as this article explores, the asset sales that occurred ning out of cash and being liquidated by the end of in those cases were in many ways atypical. the year. After an intense debate in Congress about Despite the unusual aspects of these cases, how- the wisdom of providing aid to the automakers, ever, it is undeniable that the Chrysler and GM cases Chrysler received $4 billion in emergency aid and have changed forever traditional thinking about GM received $9.4 billon.4 In February 2009, the what Chapter 11 can accomplish—and the pace at Obama administration appointed a task force to which a restructuring of a debtor’s business can be oversee the restructuring of the ailing automakers.5 put in place. The chief executive of every business As a condition to receiving the aid, both Chrysler that is considering Chapter 11 should ask counsel: and GM were required to submit viability plans to Why can’t we accomplish the same result? And ev- the federal government by February 17, 2009.6 ery lawyer who contemplates fi ling a new Chapter In Chrysler’s case, the auto task force quickly 11 case should consider how to apply the lessons determined that Chrysler was not viable as a learned from these cases. Those lessons apply with stand-alone entity.7 After making that decision, equal force to lenders, who should insist that their the federal government began to lead a multiparty borrowers use the same discipline to resolve their negotiation among Chrysler, the United Auto Work- cases quickly and inexpensively and avoid the risks of protracted cases and the attendant risks of litiga- Stephen B. Selbst is at Herrick, Feinstein LLP, New York, New York. Contact tion and high legal fees.1 him at [email protected]. NOVEMBER–DECEMBER 2009 COMMERCIAL LENDING REVIEW 3 General Motors and Chrysler: The Changing Face of Chapter 11 ers (UAW), Fiat and the government of Canada The banks holding fi rst liens on Chrysler’s as- to assemble a joint venture that would carry on sets received $2 billion in cash for their claims Chrysler’s business. Beginning in March, the par- of approximately $7 billion. ties engaged in furious nonstop negotiations that Chrysler used Section 365 of the Bankruptcy did not end until shortly before Chrysler’s Chapter Code to reject and terminate approximately 800 11 fi ling on April 30, 2009.8 of its dealers. At the time of the Chapter 11 fi ling, Chrysler and Approximately 95 percent of Chrysler’s sup- its subsidiaries comprised one of the world’s largest plier contracts were assumed, meaning that the manufacturers and distributors of automobiles and prebankruptcy claims of those creditors were other vehicles, together with related parts and acces- paid in full. sories. When the case commenced, Chrysler had 32 The Chrysler case Section 363 sale was unusual in manufacturing and assembly facilities and 24 parts many respects. The bank lenders, who had liens on depots worldwide and a network of 3,200 indepen- all of Chrysler’s assets and who had a fi rst claim dent dealerships in the United States, with 72 percent to be repaid in a liquidation of Chrysler’s assets, of Chrysler sales occurring in the United States. received less than 30 cents on the dollar. The UAW’s Prior to the bankruptcy fi ling, Chrysler had a $9.6 billion in unsecured pension and benefi t claims worldwide annual production of approximately received a note for $4.6 billion and 55 percent of the two million vehicles under the Chrysler, Dodge equity of reorganized Chrysler. Fiat obtained man- and Jeep® brands. Chrysler and its subsidiaries agement control, a sizable equity stake and the right employed approximately 55,000 hourly and salaried to obtain majority ownership of Chrysler, despite workers, with approximately 70 percent, or 38,500, the fact that it contributed no cash to the deal and of that workforce based in the United States. Ap- only modest technological support to the new joint proximately 70 percent, or 27,600, of the domestic venture. Finally, most unsecured supplier creditors workforce was covered by a collective bargaining had their claims paid in full. agreement. In addition, Chrysler made payments By contrast, the holders of other unsecured claims for health care and related benefi ts to more than were relegated to claims against “Old Chrysler,” 106,000 retirees. For 2008, Chrysler had revenues of meaning the assets not sold to the new alliance, and more than $48.5 billion, with assets of approximately are likely to receive little or no payment on their $39.3 billion and liabilities of $55.2 billion. For that claims. Because Fiat put up none of the purchase same period, the net loss was $16.8 billion. price and because the government insisted on key To conserve cash, Chrysler, which was losing elements of the deal, the reality is that the federal $100 million per day, idled its production facilities government used the value of its prepetition emer- in Chapter 11. 9 Despite fears that Chapter 11 would gency loans and its DIP loan and political power destroy sales, Chrysler’s sales, although somewhat to buy Chrysler and distribute its value as it saw affected, did not shrivel to zero.10 fi t among the creditor constituencies.12 For all these The main points of the Chrysler transaction follow:11 reasons, the Section 363 sale in the Chrysler case did The federal government provided $3.5 billion in not look like a typical sale of a business and, in fact, debtor-in-possession (DIP) fi nancing. had many of the characteristics of a sub rosa plan. 13 The UAW restructured its wage and benefit Because the Chrysler sale was so extraordinary, claims and received a note for $4.6 billion and 55 it was the subject of a brief but furious legal fi ght, percent of the equity in the new entity. The UAW which started in the U.S. Bankruptcy Court for the also granted some wage concessions. Southern District of New York (bankruptcy court) Fiat received a 20-percent equity stake, which and ended in the Supreme Court of the United could be increased to as much as 51 percent if States, which ultimately decided not to hear the performance thresholds were met. Fiat also took case, paving the way for the sale to be closed. In over the management of Chrysler. Fiat contrib- the bankruptcy court litigation, a group of Indiana uted no cash but did grant the new alliance the pension funds, which were among the holders of the right to manufacture small vehicles using Fiat fi rst-lien debt, argued that by virtue of the sale, they technology. were being illegally stripped of their rights to their 4 COMMERCIAL LENDING REVIEW NOVEMBER–DECEMBER 2009 General Motors and Chrysler: The Changing Face of Chapter 11 collateral, which, they argued, was worth substan- testimony and be prepared to rebut it through their tially more than the payments they were receiving. own expert testimony. They also argued that their defi ciency claims (the In an opinion issued on May 31, 2009, Judge Arthur difference between the face amount of their claims Gonzalez rejected all of the objections and approved and the payments they were receiving) would not be the sale.14 Under Section 363 of the Bankruptcy Code paid while unsecured supplier debt was being paid and the case law that interprets it, a sale of substan- in full, which, they argued, violated the Bankruptcy tially all of a company’s assets outside of a plan of Code. They opposed the UAW deal, arguing that it reorganization can only be approved if there are valid violated the priority rules of the Bankruptcy Code, business reasons for pursuing that course. That rule because the UAW’s unsecured claims were being was fi rst laid down in the Lionel case in 1983, and paid nearly in full, while they were receiving just subsequent cases have added further conditions to $0.28 on the dollar.