Chrysler sale raises tough legal questions
Did the Obama administration overstep its powers in an effort to save the ailing automaker?
NEW YORK (Fortune) -- When Justice Ruth Bader Ginsburg unexpectedly stayed the sale of Chrysler to Fiat yesterday -- only minutes before a lower court stay would have expired, allowing the deal to close -- a world of stakeholders gasped.
If Fiat walks away from the deal, as it is entitled to do if the transaction hasn't closed by next Monday, Chrysler will have no choice but to liquidate, Manhattan bankruptcy judge Arthur J. Gonzalez has found.
In that event, according to a government brief opposing the stay, "More than 38,000 Chrysler employees would lose their jobs; 23 manufacturing facilities and 20 parts depots will be shuttered; more than 3,000 Chrysler dealers would suffer significant and possibly fatal harm to their businesses; and billions of dollars in health and pension benefits for current and former Chrysler workers would be wiped out."
Nevertheless, the objections being raised to the deal are nontrivial, as lawyers understatedly put it. The challenges go to whether the young Obama Administration is exceeding the executive branch's constitutional powers in its efforts to cope with the economic catastrophe bequeathed to it by the Bush Administration.
One of the most challenging questions raised by the objectors is how the government came to give Chrysler billions of dollars in loans from the Troubled Assets Relief Program (TARP) to finance and backstop this deal, when TARP moneys are supposed to go only to "financial institutions" according to the statute that set up the program. Lurking right behind that question, of course, is an obvious follow-up query: How can the government be doing exactly the same thing, on an even grander scale, vis-à-vis General Motors?
The two Indiana pension funds that are objecting to the sale have likened the situation to the one that prompted the U.S. Supreme Court to intervene in 1952, when it determined that President Harry Truman had exceeded presidential power when he tried to seize steel mills during the Korean War to keep them from being idled by a labor strike.
Alternatively, Obama supporters wonder if we are about to see a replay of the early years of the Franklin D. Roosevelt Administration, when a reactionary Supreme Court repeatedly struck down New Deal initiatives until 1937, when changes in Court personnel cleared the road bloc.
But nobody should panic just yet. Justice Ginsburg's one-sentence order did not necessarily mean anything more than that she, and perhaps the other justices, wanted time to read the stay application and the opposing briefs before letting the deal become a fait accompli.
To fully review this case, five of the nine justices (not just four -- the number ordinarily required to grant review) will have to vote for a stay, and each justice is supposed to do so only if he or she sees, among other requirements, a "fair prospect" for reversal. So a betting person would still expect a lifting of Justice Ginsburg's temporary stay to be the most likely outcome, especially since the bankruptcy judge has opined that Chrysler is losing $100 million for each additional day it has to spend in bankruptcy.
If the Court does agree to hear the merits of the case, however, then the dispute it will grapple with will look like this.
Although secured creditors holding 92% of the bonds outstanding have approved of the prospective sale to Fiat, two Indiana pension funds, which hold less than 1% of those bonds, are objecting. While that fact alone might make the Indiana funds seem greedy or unreasonable, the reality is more complicated, in that the majority of these bonds were held by institutions like JPMorgan (JPM, Fortune 500), Citibank (C, Fortune 500), Goldman Sachs (GS, Fortune 500), and Morgan Stanley (MS, Fortune 500), all of which were themselves TARP recipients and, therefore, arguably subject to considerable government arm-twisting.
In any case, the backdrop for the case is this. When a company goes bankrupt and must be liquidated, the secured creditors must be paid off completely before any of the unsecured creditors can recover a dime.
Formally, the Chrysler sale has abided by that rule, in that Chrysler will be sold to a new entity -- let's call it New Chrysler -- for a sales price of $2 billion, and all of that $2 billion will be distributed entirely among the secured creditors, with unsecured creditors getting nothing. Since there are $6.9 billion in bonds outstanding, the resulting payoffs to secured bondholders will be about 29 cents on the dollar. (Actually, the Indiana funds are getting close to 72 cents on their dollar, according to Chrysler's opposition papers, in that they purchased their face-value $42 million worth of bonds at a distressed price of just $17 million, and stand to recover $12.2 million of that under the planned sale. An attorney for the Indiana funds did not immediately return an email seeking comment.)
The Indiana pension funds' first key objection to the planned sale is that the above analysis exalts form over substance. The problem, they say, is that after the sale, the New Chrysler plans to give away 55% of its equity to various entities affiliated with the United Auto Workers, who happen to have been major unsecured creditors in the Chrysler bankruptcy (due to the billions in pension and health benefits owed to Chryslers' past and current hourly workers). Accordingly, the Indiana funds claim that the government-sponsored sale effectively gives unsecured creditors a recovery before secured creditors have been fully recompensed, violating the fundamental rules of bankruptcy and amounting to an unconstitutional taking of their property.
Nevertheless, Edward Morrison, a bankruptcy law professor at Columbia Law School, says in an email that that the formalistic analysis will probably pass muster in this case.
"Once New Chrysler buys Old Chrysler's assets," Morrison writes, "New Chrysler can do whatever it wants with its money. . . . If it wants to share the wealth with workers, it can do that."
Morrison explains that "form matters a lot here" because the New Chrysler appears to be paying a reasonable price for the Old Chrysler's assets. "This would have been a very different case if there were proof that the sale price is artificially low [and, therefore] . . . that the government is diverting wealth from the senior bondholders to the workers. But there's not enough proof here. No other bidders showed up at the auction."
In fact, according to bankruptcy judge Gonzalez, who held a three-day hearing on the sale in late May, the value of Chrysler's assets in liquidation would have only come to about $800 million, rather than the $2 billion in going-concern value that they're fetching in the sale. Accordingly, secured creditors, including the Indiana pension plans, are doing better in the sale than they could have done otherwise.
That's part of the reason that Judge Gonzalez found in the end that the Indiana plans actually lacked "standing" to object to the sale -- a procedural hurdle that ensures that courts aren't asked to officiate over abstract, academic questions. According to Gonzalez, the pension plans weren't suffering any "injury in fact" from the sale (the prerequisite for standing) because they'd be even worse off if the sale didn't go through.
Judge Gonzalez also found that the plans lacked standing to raise the still bigger question presented by the sale: whether Congress really ever authorized the Obama Administration to treat automobile companies as "financial institutions" eligible to receive TARP funds. In addition to the fact that the Indiana plans were doing better under the sale than they would have under liquidation, Judge Gonzalez wrote, the question of whether the government had authority to act as Chrysler's pre- and post-bankruptcy lender was simply irrelevant to the Indiana plans' predicament. Had Chrysler been able to find a private lender willing to back the same deal, the Indiana pension funds would still be in the same situation, voicing the same grievances.
For readers wondering what the U.S. would say, if it ever has to, in response to how Chrysler and GM (GM, Fortune 500) became "financial institutions," solicitor general Elena Kagan's papers opposing the stay do provide at least a sneak-preview of the answer. The law creating TARP defines the term "financial institution" to mean "any institution, including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under the laws of the United States or any State . . . and having significant operations in the United States." (Emphasis added.) Thus, regardless of what we might ordinarily picture when we hear the phrase "financial institution," the statute in this case spells out what it means, and the express definition provided is broad enough to encompass auto companies. That's the argument, anyway.
On balance, professor Morrison appears to believe that the government should win the case, but that's not to say that he's completely comfortable with the course of events. "The government exercised leverage in two ways," he writes. "First, it obtained leverage by monopolizing the flow of liquidity to Chrysler. Second, it obtained leverage over Chrysler's creditors [i.e., financial institutions like JPMorgan, Citibank, and others], by monopolizing the flow of liquidity to them too. So the government had a stranglehold over this bankruptcy case. Every step the government took was kosher; no law was violated. . . . But when you combine all of these actions, the government does indeed have a stranglehold. . . . Does this influence amount to a violation of bankruptcy or other laws in this case? I don't think so, but I'm still mulling over the issue."
Because of the pressing time constraints, bankruptcy judge Gonzalez's ruling was appealed directly to the federal appeals court (rather than going, as it normally would, to a district judge). A three-judge panel unanimously upheld his ruling on Friday "for substantially the reasons stated in the opinions of bankruptcy judge Gonzalez," and promised to issue a written opinion in due course. It then stayed the ruling's impact until 4 p.m. on Monday. Shortly before the sand in that timer ran out, the Indiana funds won an additional temporary stay from Justice Ginsburg. There's no telling how long that will last. She could lift it without further comment minutes after this article is posted, or the full Court could agree to hear the case, potentially licensing Fiat to walk away from the deal.