2009 March | Ganje Law Office

Bankruptcy Litigation

March 9th, 2009 |

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Tuesday, July 28, 2009 GM Media Roundup: A LexisNexis Podcast and Then Some

Most bloggers report on events; few jump in them. While I lost, I’m not done yet. Here’s my statement of issues on appeal. Here’s Old GM’s counter-designation, filed yesterday.

My Chrysler and GM posts over the last three months generated incredible traffic (around 100,000 page views since May 1 from about 50,000 unique sites), while my involvement in the GM case and appeal of the decision led to several media interviews and appearances, including this 20 minute podcast just posted on the LexisNexis communities / Bankruptcy Law Center webpage. In it, I discuss the differences between 363 sales and reorganization plans, predictions of the “end of bankruptcy,” why I got involved in GM, Judge Gerber’s decision and my appeal, why I started blogging, and the implications of GM and Chrysler for bankruptcies generally and the economy at large.

Thanks to LexisNexis’s Steve Berstler for the interview and to Erin Capellman and her colleagues at LexisNexis for making the podcast happen and for linking to my Chrysler and GM blog posts. LexisNexis was the pioneer in online legal research and remains the premiere online legal research service. And for those of you who are involved in litigation, get LexisNexis’ CaseMap and Concordance litigation management software. We use these products in every litigation matter we’re involved in, and I can’t recommend them strongly enough.

For posterity’s sake, here’s links to some other media interviews and quotes I’ve given in the past month or so. As for the experience generally, I concur with these two architects of the GM sale, who recently summed up the experience as “entirely gratifying … a ‘once-in-a-lifetime’ experience.”

TV/Radio:

with Judge Napolitano on Fox News Channel’s Glenn Beck Show
with Quinn Kiltfelter on Detroit Public Radio’s, Detroit Today and rebroadcast in part nationally on NPR’s Morning Edition (starting at 55:00 into the program)
with Canada’s BNN business news channel

Print / Blogs:

The Wall Street Journal The New York Times NYT Dealblog Bloomberg

The Washington Post AmLaw Daily National Law Journal Financial Post

Lawyers USA AP / Time ABC USA Today Detroit Free Press

Cleveland’s Plain Dealer Reuters / Forbes PR News

Lexblog’s Real Lawyers Have Blogs Tom Lindmark / Seeking Alpha

The Pop Tort China News Viet Nam News

Thanks to everyone for reading, listening, or watching, and special thanks to the producers, reporters, and bloggers who made these interviews and appearances possible!

Posted By Steve Jakubowski In Bankruptcy in the News
Wednesday, July 15, 2009 Required Bankruptcy Reading from Klee and Hayes for Justice-To-Be Sonia Sotomayor (and You Too!)

With the Second Circuit’s Judge Sotomayor soon to ascend to the Supreme Court, bankruptcy lawyers must be disappointed at the complete absence of any questioning of her on bankruptcy issues. And it’s not like there’s nothing to talk about! Only 10 days ago, Judge Gerber felt compelled by the Second Circuit’s Chrysler decision to issue this opinion and order permitting “New GM” to walk away from a few hundred million dollars of product liability claims despite the fact that We, the People (via the US Treasury) were paying $90 billion for a company that had a liquidation value of no greater than about $9 billion (on a good day). Even putting aside the equities of not assuming a de minimus amount of claims (relatively speaking) of people least able to defend themselves from loss, does she really believe–like her colleagues who decided Chrysler–that Bankruptcy Code section 363 lets a debtor sell its assets “free and clear” of in personam products liability claims that could be asserted against the purchaser under state law theories of successor liability? And if so, why? And, furthermore, exactly how was due process advanced when New Chrysler walked away from successor products liability claims of people who haven’t even been injured yet in an accident? A letter sent by Senators Reid and Durbin late last month gave me hope that we’d hear these questions asked, but it looks like that’s not going to happen.

As for Judge Sotomayor’s bankruptcy jurisprudence, Clean Slate’s Andy Winchell (here and here) and Texas Bankruptcy Lawyer Steve Sather (here and here) were the first (and last) to canvass her opinions involving bankruptcy issues. All in all, nothing to complain about, and certainly her decision in Official Comm. of Equity Sec. Holders v. Official Comm. of Unsecured Creditors (In re Adelphia Communs. Corp.), 544 F.3d 420 (2d Cir. 2008) (pdf), affirming dismissal of the equity committee’s appeal was a notable one. There, Bankruptcy Judge Gerber confirmed Adelphia’s chapter 11 plan, which stripped the equity committee of standing previously granted to it to prosecute derivative claims and transferred those claims to a litigation trust established under the plan (the first about $6.5 billion of which would go to unsecured creditors until they were paid in full, leaving equity “hopelessly out of the money”). In affirming Judge Gerber’s confirmation order (but don’t forget to look at Judge Scheindlin’s first crack at the appeal), Judge Sotomayor wrote that a court “may withdraw a committee’s derivative standing and transfer the management of its claims, even in the absence of that committee’s consent, if the court concludes that such a transfer is in the best interests of the bankruptcy estate.” In other words, she wrote, the “Equity Committee’s derivative standing under STN [did not] vest it with ownership over its derivative claims.” Curiously, she never addressed the obvious question of whether the appeal was moot because the plan had been substantially consummated. So maybe there is hope for those concerned that substantial consummation of a plan or sale moots all appeals (especially–as Steve Sather points out–given her having joined in last year’s Manville decision that was just reversed on procedural grounds, as discussed here, by the Supreme Court in Travelers v. Bailey).

This is long-winded background to what I’ve been wanting to write about for a very long time. And I figured as long as people are giving Judge Sotomayor tips on how to be a better Judge or Justice, I’d offer a tip of my own: READ THESE BOOKS!

Kenneth Klee’s Bankruptcy and the Supreme Court; and

Law Prof. Blogger M. Jonathan Hayes’s Bankruptcy Jurisprudence from the Supreme Court.

Posted By Steve Jakubowski In US Supreme Court Cases
Wednesday, July 8, 2009 Out of the Fray … Onto the “Slow Boat to China”: Putting the Brakes on the GM Bankruptcy Appeal

Three weeks ago, as I discussed here, I jumped into the GM fray and filed this objection on behalf 5 product liability claimants who, absent the “free and clear” sale protections sought by GM under Section 363, would have had the right to add the Purchaser as an additional defendant to their pending lawsuits based on each of their respective state’s successor liability laws.

After putting in 20+ hour days for a full week, including reviewing 35+ Gigabytes of OCR’d documents from GM, deposing Fritz Henderson and the Auto Task Force’s Harry Wilson over two days, attending three days of hearing, and giving everything I had in this closing argument, Judge Gerber’s opinion approving the sale and his bench decision denying my motion for direct appeal to the Second Circuit ended the fray for me and put my clients’ appeal on the “slow boat to China,” as the old saying goes. But in doing so, he issued a persuasive opinion that–on reflection–actually did my clients a favor, despite their having to endure an extra year of appeal by first passing through the district court.

How so? Well, Judge Gerber himself acknowledged that the successor liability issue was the “most debatable” and “most important” of the issues before the Court. He also correctly observed that I’d like to see this issue decided by the Supreme Court (assuming I can’t get the Second Circuit to reverse itself or at least distinguish GM from Chrysler on the facts). After all, 363 sales are so common nowadays that Baird and Rasmussen’s prediction in 2002 of the “end of bankruptcy” is now being viewed as a shocking–but inevitable–fact of life. And the undeniable split in the circuits over whether 363 sales can be “free and clear” of successor liability claims makes the case ripe for Supreme Court review, particularly given the magnitude of the claims being left behind (GM and Chrysler alone have shed about $2 billion of these liabilities in the past 45 days).

One thing we know about the Supreme Court, however, is that it doesn’t like to get “ambushed.” As Justice Ginsburg pointedly reminded counsel during oral argument in the Travelers Casualty v. PG&E case (discussed here):

We are a court of review. So no matter how well it’s been aired [in other circuit cases], we wait to see what the lower courts have said on a question. We don’t take it in the first instance.

Judge Gerber echoed these thoughts in his opinion denying my motion for direct appeal when he asked:

How could a decision presented and decided to the Second Circuit in two days (or on any other expedited basis) be helpful to the bankruptcy community, or the public, or the Supreme Court? If the Supreme Court is to decide an issue that’s the subject of a Circuit split, doesn’t it deserve the best decision the Second Circuit can provide?

Hard to argue with that. So, per Judge Gerber’s sound instruction, we’ll leave the “supercharged” Corvette ZR3 6.2L / 638 hp V8 at the dock and instead board the luxurious, brand-spanking-new, Bohai Zhenzhu, destination SCOTUS, with stops at the SDNY and 2d Circuit ports of call.

Bon Voyage!

Posted By Steve Jakubowski In Bankruptcy in the News
Friday, June 19, 2009 Objecting to the GM 363 Sale’s Treatment of Product Liability Claims: Stepping Into The Fray

In today’s depressed environment, Howard Beale’s famous rant in Network–the 1976 movie that took several academy awards against stiff competition (Rocky, All the President’s Men, and Taxi Driver)–sure reads like something that could have been written today:

I don’t have to tell you things are bad. Everybody knows things are bad. It’s a depression. Everybody’s out of work or scared of losing their job. The dollar buys a nickel’s worth; banks are going bust; shopkeepers keep a gun under the counter; punks are running wild in the street, and there’s nobody anywhere who seems to know what to do, and there’s no end to it.

We know the air is unfit to breathe and our food is unfit to eat. And we sit watching our TVs while some local newscaster tells us that today we had fifteen homicides and sixty-three violent crimes, as if that’s the way it’s supposed to be!

We all know things are bad — worse than bad — they’re crazy.

It’s like everything everywhere is going crazy, so we don’t go out any more. We sit in the house, and slowly the world we’re living in is getting smaller, and all we say is, “Please, at least leave us alone in our living rooms. Let me have my toaster and my TV and my steel-belted radials, and I won’t say anything. Just leave us alone.”

Well, I’m not going to leave you alone.

I want you to get mad!

I don’t want you to protest. I don’t want you to riot. I don’t want you to write to your Congressman, because I wouldn’t know what to tell you to write. I don’t know what to do about the depression and the inflation and the Russians and the crime in the street.

All I know is that first, you’ve got to get mad.

You’ve gotta say,

“I’m a human being, goddammit! My life has value!”

So, I want you to get up now. I want all of you to get up out of your chairs. I want you to get up right now and go to the window, open it, and stick your head out and yell,

“I’m as mad as hell, and I’m not going to take this anymore!!”

Well, Howard’s rant is what a lot of panicked plaintiffs’ lawyers involved in cases against GM are screaming these days as they watch years of toil on behalf of people seriously injured by defective GM products (like crushed roofs, exploding “side saddle” gas tanks, and collapsing seat backs) potentially go for naught as GM makes its grandest attempt ever to crush an entire class of former customers (presumably including anybody who buys a GM car between now and the closing date of the sale) and existing and future products liability claimants (including those who haven’t even been injured yet!) in a sale that many plaintiffs lawyers of record only received written notice of in the past couple of days.

Those following this blog know my rising concern (even anger) over how products liability claimants were completely stiffed in Chrysler, so much so that Howard’s famous rant came to mind!

So, I decided to do something about it, and officially stepped into the fray by filing this Objection to the GM Sale and this Memorandum in Support. On the brief with me is Public Citizen’s Adina Rosenbaum and Allison Zieve, counsel for the Center for Auto Safety, Consumer Action, Consumers for Auto Reliability and Safety, National Association of Consumer Advocates, and Public Citizen.

We should win; whether we do is a “horse of a different color.”

Many thanks to the Center for Auto Safety’s Executive Director, Clarence Ditlow, for his help in organizing the team, Public Citizen’s Adina Rosenbaum and Allison Zieve for their tremendous assistance in framing the legal arguments and drafting the pleadings, and to Public Citizen’s Director, Brian Wolfman, for his support.

And, of course, special thanks to The Coleman Law Firm’s own Bob Coleman for his generosity in dedicating the firm’s resources to this important pro bono effort.

The sad, and all too tragic, stories of my clients, taken from the filed objection, are set forth below. The only thing my clients did wrong here was buy a GM car. For this act of brand loyalty, they have paid dearly. It’s not enough that people lose their lives and get severely injured from design defects and product flaws, now they and their loved ones get thrown under the bus!

If their stories don’t bring a tear to your eye, then you probably support the sale’s treatment of product liability claimants too!

Posted By Steve Jakubowski In Bankruptcy in the News

Thursday, June 18, 2009 Supreme Court Holds in Travelers v. Bailey That a Bankruptcy Court’s Final Order Is Enforceable Even If the Court Lacked Jurisdiction to Enter the Order in the First Place

GM objection due tomorrow, so no time to pontificate on today’s “narrow” holding of the United States Supreme Court in Travelers Indem. Co. v. Bailey, No. 08-295 (pdf / WL). Suffice it to say that those who sit by idly while their rights against third parties are enjoined from further prosecution do so at their peril.

Here’s the “Reader’s Digest” version of the holding, written by Justice Souter for a 7-2 majority:

The Second Circuit erred in holding the 1986 Orders unenforceable according to their terms on the ground that the Bankruptcy Court had exceeded its jurisdiction in 1986. On direct appeal of the 1986 Orders, any objector was free to argue that the Bankruptcy Court had exceeded its jurisdiction, and the District Court or Court of Appeals could have raised such concerns sua sponte. But once those orders became final on direct review, they became res judicata to the parties and those in privity with them.

As I learned early on in law school from one of the smartest guys around, if you really want to find out what the case is about, read the dissent. And if you want to know “what’s bothering Ruthie?”, you’ll find it in dissent of Justice Stevens, in which she joined. Justice Stevens dissented, he wrote, because:

In my view, the injunction bars only those claims against Manville’s insurers seeking to recover from the bankruptcy estate for Manville’s misconduct, not those claims seeking to recover against the insurers for their own misconduct. This interpretation respects the limits of the Bankruptcy Court’s power….

We should not lightly assume that the Bankruptcy Court entered an order that exceeded its authority. When a bankruptcy proceeding is commenced, the bankruptcy court acquires control of the debtor’s assets and the power to discharge its debts. A bankruptcy court has no authority, however, to adjudicate, settle, or enjoin claims against nondebtors that do not affect the debtor’s estate. Because Travelers’ insurance policies were a significant asset of the Manville bankruptcy estate, the Bankruptcy Court had the power to channel claims to the insurance proceeds to the Manville Trust. But this by no means gave it the power to enjoin claims against nondebtors like Travelers that had no impact on the bankruptcy estate. Thus, even accepting the Bankruptcy Court’s representation in 2004 that it had “meant to provide the broadest protection possible” to the settling insurers, such relief could not include protection from independent actions. (Emphasis added.)

The limits of the Bankruptcy Court’s power will be on display in the GM case as Judge Gerber is asked to do what Judge Gonzalez was unwilling to do in the Chrysler case; that is, respect the jurisdictional boundaries of the Court and the statutory directives of Congress and refuse GM’s request to bar present and future claims of product liability claimants from being asserted against the purchaser post-closing under applicable state law theories of successor liability.

Much more on that to follow.

Happy hunting! Posted By Steve Jakubowski In US Supreme Court Cases
Tuesday, June 9, 2009 What’s Bothering Ruthie? Chrysler Bankruptcy Sale Opinion Analysis – Part II

[6/9/09 PM Update: The United States Supreme Court just cleared the Chrysler sale! "The applications for stay ... are denied," the Court wrote in this 2 page per curiam opinion. The Court still may hear the petition, but the petitioners needed to prove likelihood of success not just on the merits, but also "a likelihood that irreparable harm will result from the denial of a stay." Even the tort claimants can't prove that as they'll always have their day in court in their respective jurisdictions.]

The brilliant lawyer, author, and ex-blogger, Bill Patry (now senior copyright counsel at Google), wrote on his Patry Copyright Blog back in 2005 about the greatest Biblical scholar of all time, Rabbi Shlomo Yitzhak (whom everyone affectionately calls “Rashi”). Bill wrote:

Rashi is used as a learning device for children not because he is simple (he isn’t) but because of the unusual nature of his commentary. His commentary consists of very terse conclusions, but without the questions that prompted the conclusions. Children are left with the task of asking “What’s Bothering Rashi?” … The “What’s Bothering Rashi?” approach to learning text is useful in analyzing statutes because it teaches one to ask the why of things, rather than as we almost always do, just read the literal words divorced from what the law would be like in their absence.

Bill’s post came to mind in thinking about “What’s Bothering Ruthie?” that would prompt her to write a one-liner calling a halt to a sale that remarkably worked its way from bankruptcy filing to cert. review in less time than it takes the average person to buy a used Town & Country. Here are a few ideas:

Maybe she doesn’t like the lawyers down the street telling her (as reported here by SCOTUS Blog) that “no court, including the Supreme Court, has the authority to hear a challenge by Indiana benefit plans to the role the U.S. Treasury played in the Chrysler rescue.” Tell that to Justice Marshall!

Or maybe, like her predecessors during the Depression in the Schechter Poultry Corp. v. US case, she’s wondering whether (as argued here by Ralph Nader) Congress abdicated the essential legislative functions with which it is vested by letting the Executive Branch alone structure and implement the deal.

As noted in my Part I analysis, however, I doubt she’s losing sleep over whether the sale is a sub rosa plan or whether the absolute priority rule was violated.

I’m guessing, though, that what bothers her most — and frankly what’s really been bothering me most (hence Part II) — is the sale’s treatment of tort claimants, both present and future, and Judge Gonzalez’s cursory justification for such treatment. He wrote:

Posted By Steve Jakubowski In Bankruptcy in the News
Thursday, June 4, 2009 Chrysler’s Bankruptcy Sale Opinion – Part I: Proving “What Goes Around, Comes Around”

Well it’s official, and really no surprise: Judge Gonzalez in this opinion (WL) approved the sale of Chrysler’s assets in the Fiat Transaction “free and clear of liens, claims, interests and encumbrances.”

Part I of my quick take on the opinion focuses on the most discussed elements of the case that have caused so much unnecessary heartburn (some caused, I admit, by my own three previous posts). Here’s my thoughts on a few of the key issues in the opinion that I touched upon in prior posts:

Was it a sub rosa plan (as questioned here)? The Court said no. And I actually agree. It’s hard to argue something circumvents the chapter 11 plan process when the debtor wouldn’t have survived long enough to be able to propose a plan in the first place. Arguments that a sale is a sub rosa plan make sense when the debtor can survive to confirmation; they are irrelevant where the debtor can’t.

Was the absolute priority rule violated (as questioned here)? The Court danced around this issue pretty well, taking the position, well stated in this Credit Slips blog post, that “the allocation of ownership interests in the new enterprise is irrelevant to the estates’ economic interests” and that “in addition, the UAW, VEBA, and the Treasury are not receiving distributions on account of their prepetition claims … [but] under separately-negotiated agreements with New Chrysler … [that are] not value which would otherwise inure to the benefit of the Debtors’ estates.”

Everyone cares about the retirees’ medical claims under VEBA, but it’s hard to see why this group should get any consideration from the New Chrysler since they will provide no value to the new enterprise. Moreover, it’s quite common in bankruptcy cases (see In re UAL, discussed here) for the current employees to leave the retirees hanging out to dry precisely because they’ll provide no value to the new enterprise and the existing employees want to retain whatever benefits they can eke out for themselves. To this limited extent, therefore, perhaps the flow of consideration does violate the absolute priority rule. The auto workers union is obviously a tighter and more cohesive group, however, and they refused to do what their comrades in the pilots union did to the retiree pilots, thus enabling the Court here to find that the “unprecedented modifications to the collective bargaining agreement, including a six-year no-strike clause” were sufficient to justify New Chrysler’s assumption of obligations to all VEBA claimants, as demanded by the union.

What are the rules of the game for “last-resort” lenders? One thing I said in my 10 minute interview with Anthony Mason that didn’t make it on TV was that “what goes around, comes around” (as the apparently not so old saying goes) and that here, the secured lenders were getting a taste of their own medicine, so it was hard to feel too sorry for them. After all, in most bankruptcy cases, the existing secured lender is the lender of last resort, and it is the existing secured lender that takes the hard-line, “take it or leave it” position described by Judge Gonzalez that leaves everyone else gasping for air as it stuffs its demands down everyone’s throat, including the court’s. Such practices, Judge Gonzalez tells us, are “troubling to some, but such is the harsh reality of the marketplace.” Further, as I was quoted in my 7 seconds of fame, “the [governments'] providing the money, and they’re the ones who are ultimately going to decide how that money’s going to be spent.” And that’s pretty much what Judge Gonzalez said, though far more articulately:

The absence of other entities coming forward to fund any transaction highlights the risk presented to distressed companies that are situated similarly to Chrysler. Accompanying that risk is the lender’s ability to dictate many of the key terms upon which any funding will occur. The hard-fought “take it or leave it” approach that often drives the outcome of this type of negotiation is troubling to some, but such is the harsh reality of the marketplace. Here, the Governmental Entities, as lenders of last resort, are dictating the terms upon which they will fund the transaction, thereby leaving the Debtors with few options. Nevertheless, the usual marketplace dynamics play out and the Court applies the same bankruptcy law analysis. Moreover, the Debtors’ CEO testified that the demands from the Governmental Entities were not greater than that presented by other lenders, and in some aspects were not as onerous….

[T]he ordinary marketplace dynamic played out with respect to the lenders and whatever ability they had to dictate terms. The fact that the lenders of last resort happened to be Governmental Entities did not alter that dynamic. The Governmental Entities did not preclude other entities from participating or negotiating, they merely set forth the terms that they required to provide financing and the parties were either amenable to them or not. Finally, as noted, the Governmental Entities had no obligation to fund the transaction and Chrysler and Fiat were free to walk away from the negotiations.

Has the “Rule of Law” Been Withered (as questioned here)? Maybe, as I’ll discuss later in Part II, but not for the reasons the Indiana Pension Funds are arguing on appeal. In fact, if anything, the following well-worn rules have been affirmed in this case:

1. You can’t circumvent chapter 11’s plan process when you can’t even fund next week’s payroll.

2. You can’t violate the absolute priority rule if junior creditors necessary to the new enterprise get something out of the deal.

3. Lenders of last resort owe no duty to anyone but themselves and can dictate the terms of a plan or sale so long as the terms aren’t unconscionable, which they aren’t here.

More to follow, and thanks as always for reading!

Posted By Steve Jakubowski In Bankruptcy in the News
Thursday, May 28, 2009 CBS Evening News Interview Tonight: My Quick Take on GM and Chrysler Bankruptcy Developments

Tonight my first TV interview will air on the CBS Evening News with Katie Couric. I talked for about 10 minutes with Anthony Mason, CBS’s veteran correspondent, which should translate after editing into about 15 seconds of fame.

Many thanks to the CBS Evening News production team for the call and the opportunity, and to the TV House in Chicago for a cool, comfortable setting in which to give the interview.

5/28/09 Update: Make that about 7 seconds. Eight more to go.

And special thanks to Charles Osgood for including me in his 5/29/09 broadcast. I well remember the one time I met him when I was fresh out of college and working part-time for the CBS News / NYT Poll during the 1980 presidential election, and he was, as he always has been, the consummate gentleman.

Posted By Steve Jakubowski In Bankruptcy in the News
Thursday, May 14, 2009 Zywicki on the Chrysler Bankruptcy: Whither the Rule of Law?

Todd Zywicki, the University Foundation Professor of Law at George Mason University’s School of Law, has been a friend to me and this blog since very early in my blogging career back in 2005 when his first of many links to one of my posts on the Volokh Conspiracy blog multiplied my puny site visits by ten-fold. His justification? Polish bankruptcy lawyers always stand together!

Todd takes some pretty unorthodox views now and then, exhibiting what Professor Lawless called “cognitive dissonance” in testimony before Congress when he extolled the newly-enacted BAPCPA bill as “perfect” and “well-calibrated.” You did have to wonder though whether Todd was arguing simply because he really likes to argue!

While his backing of BAPCPA may not have been one of his shining moments, his passionate op-ed piece in yesterday’s Wall Street Journal entitled Chrysler and the Rule of Law is. In it, he articulates what has disturbed a lot of people in the business and financial community about the heavy-handed manner in which the Chrysler sale was jammed down the senior lenders by the Obama administration (as this phenomenal piece of journalism by the WSJ’s Jeff McCracken and Neil King proves). Todd wrote:

The Obama administration’s behavior in the Chrysler bankruptcy is a profound challenge to the rule of law. Secured creditors — entitled to first priority payment under the “absolute priority rule” — have been browbeaten by an American president into accepting only 30 cents on the dollar of their claims. Meanwhile, the United Auto Workers union, holding junior creditor claims, will get about 50 cents on the dollar.

The absolute priority rule is a linchpin of bankruptcy law. By preserving the substantive property and contract rights of creditors, it ensures that bankruptcy is used primarily as a procedural mechanism for the efficient resolution of financial distress. Chapter 11 promotes economic efficiency by reorganizing viable but financially distressed firms, i.e., firms that are worth more alive than dead. Violating absolute priority undermines this commitment by introducing questions of redistribution into the process. It enables the rights of senior creditors to be plundered in order to benefit the rights of junior creditors.

The U.S. government also wants to rush through what amounts to a sham sale of all of Chrysler’s assets to Fiat. While speedy bankruptcy sales are not unheard of, they are usually reserved for situations involving a wasting or perishable asset (think of a truck of oranges) where delay might be fatal to the asset’s, or in this case the company’s, value. That’s hardly the case with Chrysler. But in a Chapter 11 reorganization, creditors have the right to vote to approve or reject the plan. The Obama administration’s asset-sale plan implements a de facto reorganization but denies to creditors the opportunity to vote on it.

By stepping over the bright line between the rule of law and the arbitrary behavior of men, President Obama may have created a thousand new failing businesses. That is, businesses that might have received financing before but that now will not, since lenders face the potential of future government confiscation. In other words, Mr. Obama may have helped save the jobs of thousands of union workers whose dues, in part, engineered his election. But what about the untold number of job losses in the future caused by trampling the sanctity of contracts today?

My earlier posts on Chrysler examined whether the Chrysler sale is tantamount to an illegal “sub rosa” plan or whether the “absolute priority rule” will kill the Chrysler sale, but with nowhere near Todd’s passion. His views are resonating with many, including Jack and Suzy Welch, who are far from “speculators” or “Obama-bashers.” In their column last week in Business Week entited, A Bad Week for Business, they wrote:

Look, we don’t know how the Washington-Detroit negotiations played out. But the ease with which the large bank lenders appeared to cave to a pennies-on-the-dollar deal might suggest that TARP was involved; the government was wielding a big stick, and it wielded it in favor of the unions over the conventions of bankruptcy law. Is such a radical upending of the economic system good for business confidence and capital formation? It’s hard to imagine how.

And so, we are beginning to feel afraid—very afraid. We believe America needs to be more competitive than ever to get out of this recession.

It looks like not everyone agrees.

And so, with GM moving inexorably towards the Chrysler model of bankruptcy justice, as reported here, we bankruptcy professionals–lawyers, judges, and consultants alike–have to wonder, “whither the rule of law?” Who knows, maybe there was something to that Thracymacus guy’s view that “might is right” and justice is “the interest of the stronger,” and that because “in a state the Government is the strongest, it will try to get–and it will get–whatever it wants for itself.”

Special thanks to the incredible editorial cartoonists, Cox & Forkum, for authority to use the inset cartoon from this 2005 post entitled Backsliding.

Posted By Steve Jakubowski In Bankruptcy in the News
Tuesday, May 5, 2009 Chrysler Bankruptcy Analysis – Part III: Will The “Absolute Priority Rule” Kill The Sale?

Well, the initial pleadings have been filed, and Chrysler’s argument is essentially that it’s a “dead man walking.” In it’s opening memorandum of law in support of its motion to approve the sale, Chrysler argues that if the “sale” doesn’t close on the accelerated timetable proposed, it will wither on the vine, resulting in “a rapid and severe loss of value.” (Mem. at 10). Surprisingly, though, Chrysler’s opening memorandum doesn’t squarely address the issue laid bare in my previous post and in the preliminary objection of the dissident lenders; that is, why isn’t the proposed transaction a sub rosa plan of the kind prohibited under the law of the Second Circuit?

In dancing around this question, Chrysler’s lawyers submit a two-pronged response, arguing that the transaction should be approved because, first, Old Chrysler is receiving “fair consideration” in the transaction and, second, Chrysler’s going concern value will be preserved, jobs will be retained, and an extensive network of independent dealers and suppliers will live to see another day. Chrysler’s opening memorandum of law, however, does not address the important question of why, absent the consent of the dissident lenders, 65% of the equity in New Chrysler should go to junior creditors in satisfaction of their respective claims against Old Chrysler while the claims of senior dissenting lenders go unpaid?

One thing’s for sure, Chrysler’s (and soon GM’s) court battles will afford us a rare opportunity to witness one of bankruptcy law’s most fundamental questions being litigated in the highest stakes battles of all time, that being:

When does the “absolute priority rule” (compare FRB-Cleveland’s strict construction of the rule back in 1996 here with the Administration’s position today), which establishes a hierarchy of recovery rights among creditor classes, take a back seat to the “fresh start,” rehabilitative policy of chapter 11?

Chrysler’s opening memorandum touched upon this question by focusing on the US Supreme Court’s classic pronouncement in NLRB v. Bildisco & Bildisco, 465 U.S. 513, 528 (1984), where the Court stated that the “fundamental purpose of reorganization is to prevent the debtor from going into liquidation, with an attendant loss of jobs and possible misuse of economic resources.” This principle, Chrysler argues, is paramount and (quoting NY’s judicial patriarch, Bankruptcy Judge Lifland, in the old Eastern Airlines case) “all other bankruptcy policies are subordinated” to it. (Mem. at 4).

Many, however, will surely disagree with Judge Lifland’s statement from 20 years ago that all bankruptcy policies should be subordinated to the reorganization objectives of the Bankruptcy Code. Indeed, even on a very practical level, as the authors of this 1997 article entitled “Chapter 11’s Failure in the Case of Eastern Airlines” note, such a policy is a failure:

Eastern Airlines’ bankruptcy illustrates the devastating effect of court-sponsored asset stripping-using creditors’ collateral to invest in negative net present value “lottery ticket” investments-on firm value. During bankruptcy, Eastern’s value dropped over 50%. We show that a substantial portion of this value decline occurred because an over-protective court insulated Eastern from market forces and allowed value-destroying operations to continue long after it was clear Eastern should be shut down.

Relying on Bildisco to establish an unwavering rule of law is also risky because Supreme Court jurisprudence on bankruptcy matters is anything but a seamless web. Indeed, Ken Klee points out in his remarkable new book, Bankruptcy and the Supreme Court, Justice Rehnquist once wrote to Justice Stevens: “I do not feel that I am qualified to make any sort of exegesis on the meaning of the Bankruptcy Code.” (Klee, p. 48).

For those looking for some alternative Supreme Court pronouncements favoring the dissenting lenders, consider Raleigh v. Ill. Dep’t of Rev., 530 U.S. 15, 24-25 (2000) (argued in victory by now Chicago Bankruptcy Judge Ben Goldgar), where the Court stated:

Bankruptcy courts are not authorized in the name of equity to make wholesale substitution of underlying law controlling the validity of creditors’ entitlements, but are limited to what the Bankruptcy Code itself provides.

Consider also these two important pronouncements in Howard Delivery Serv., Inc. v. Zurich American Ins. Co., 547 U.S. 651 (2006) (pdf) (discussed at length in this previous blog post), where Justice Ginsburg, writing for a 6-3 majority, stated:

In holding that claims for workers’ compensation insurance premiums do not qualify for § 507(a)(5) priority, we are mindful that the Bankruptcy Code aims, in the main, to secure equal distribution among creditors. We take into account, as well, the complementary principle that preferential treatment of a class of creditors is in order only when clearly authorized by Congress…. (Id. at 655-56)

[W]e are guided in reaching our decision by the equal distribution objective underlying the Bankruptcy Code, and the corollary principle that provisions allowing preferences must be tightly construed…. Any doubt concerning the appropriate characterization [of a bankruptcy statutory provision] is best resolved in accord with the Bankruptcy Code’s equal distribution aim. We therefore reject the expanded [i.e., "plain meaning"] interpretation Zurich invites. (Id. at 667) (citations omitted).

Let’s also not forget an absolute favorite of Chicago’s Chief Bankruptcy Judge Carol A. Doyle, Northern Pacific Railway Co. v. Boyd, 228 U.S. 482 (1913). There, following the Panic of 1893, shareholders and bondholders combined in a proposed reorganization plan to transfer the debtor’s assets to a new company that they would own, while freezing out the railroad’s general unsecured creditors, whose priority fell between the bondholder and shareholder classes (proving, yet again, that the more things change, the more they really just stay the same). The unsecured creditors argued (much like Chrysler’s dissident lenders today) that the foreclosure sale contemplated by the plan “was the result of a conspiracy between the bondholders and shareholders to exclude general creditors” from the new company. The trial court overruled the unsecured creditors’ objection, holding that (as argued by Chrysler and the Administration today) because the debtor was insolvent and there was no value for unsecured creditors (or in this case, the dissident lenders), the unsecured are entitled to nothing. The Supreme Court, however, reversed in a 5-4 opinion written by Justice Joseph Lamar (see 4/29/1913 NY Times article), in which he stated:

If the value of the road justified the issuance of stock in exchange for old shares, the creditors were entitled to the benefit of that value, whether it was present or prospective, for dividends or only for purposes of control. In either event it was a right of property out of which the creditors were entitled to be paid before the stockholders could retain it for any purpose whatever.

This conclusion does not, as claimed, require the impossible, and make it necessary to pay an unsecured creditor in cash as a condition of stockholders retaining an interest in the reorganized company. His interest can be preserved by the issuance, on equitable terms, of income bonds or preferred stock. If he declines a fair offer, he is left to protect himself as any other creditor of a judgment debtor; and, having refused to come into a just reorganization, could not thereafter be heard in a court of equity to attack it.

Nowadays, collusive efforts to squeeze out the dissenting middle are often called “reverse cramdowns.” As noted in this previous blog post, the Third Circuit held that plans proposing such “reverse cramdowns” may violate the so-called “absolute priority rule.” More significantly, however, the Second Circuit in Motorola, Inc. v. Official Comm. of Unsecured Creditors (In re Iridium Operating, LLC), 478 F.3d 452 (2007), recently addressed attempts to squeeze out the middle in the context of a settlement that the debtor sought to have approved under Bankruptcy Rule 9019. While the Court in that case approved the settlement, it provided critical guidance in gauging the authority of Judge Gonzalez to approve the proposed “sale” transaction in contravention of the requirements of the absolute priority rule.

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Tags: albany, bankruptcy alternatives, bankruptcy litigation, chapter 11, chapter 7 |

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