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July 7, 2009 6:57 PM

GM and Chrysler: The End of Bankruptcy as We Know It?

Posted by Zach Lowe

Almost every bankruptcy expert The Am Law Daily talks to agrees that the super-fast General Motors and Chrysler bankruptcies diverted from traditional bankruptcy law because of the government's huge role in each case and the danger that liquidation might have posed to the broader economy. 

What they don't agree on is whether the cases set a meaningful precedent for future judges. "What happened in GM and Chrysler is so outrageous and so illegal that until March of this year, nobody even conceptualized it," says Lynn LoPucki, a bankruptcy expert at UCLA Law School. "Wouldn't almost every company like to get out [of bankruptcy] in 30 or 60 days? Is there any reason they cannot all propose to do what GM and Chrysler have now done?"

Others are less worried: "These cases are huge outliers," says Kenneth Klee, name partner at the bankruptcy boutique Klee, Tuchin, Bogdanoff & Stern and LoPucki's colleague at UCLA. "They involve such major political elements and companies of such importance to the economy that the legal principles involved will not carry over to other cases."

Several other experts and Am Law 100 partners echoed LoPucki's concerns, though no one else directly labeled the sale illegal. But their basic views are the same: The courts stretched section 363 of the bankruptcy code--which allows a company to sell its best assets to a new buyer rather than go through a complete reorganization--beyond the code's intentions. The section, they say, was not originally intended for companies to sell essentially their entire business to a new buyer, though the U.S. Court of Appeals for the Second Circuit has upheld such a sale in a handful of cases, says Howard Seife, head of the bankruptcy and restructuring practice at Chadbourne & Parke

What General Motors and Chrysler did, experts tell us, is more akin to a restructuring of the business, a process that normally unfolds in a longer Chapter 11 case and not a section 363 sale. In the former, creditors have more powerful rights, including the right to vote on the reorganization plan. They can object to a section 363 sale--and hundreds did in both Chrysler and GM--but those objections are not enough to hold up the sale. 

Bondholders in both cases claimed that the sales gave some unsecured creditors better return for their bonds than others. A section 363 sale normally nets a pile of cash for the bankrupt estate, which then distributes the cash to creditors according to the order of their claims, says Klee. That's not exactly happening in these cases, court records show. 

In the GM case, for instance, the U.S. Treasury Department, which will own a 60 percent stake in "new GM," is leaving about $1.125 billion behind in the bankrupt GM estate. That money is intended to pay administrative claims and wind down the GM estate, says Michael Richman, a Patton Boggs partner who represented small bondholders opposed to the GM sale. Bondholders will get a 10 percent equity stake in the new GM in lieu of cash, Richman says. That might amount to pennies on the dollar, while another unsecured creditor, the United Auto Workers union, is getting a larger equity stake in the new company plus ownership of other debt.

"What I find troubling is the distribution to creditors that isn't consistent with priorities established under bankruptcy laws," Seife says. "Clearly, shortcuts are being taken here. The argument is that these are special cases."

The judges who handled the cases (Arthur Gonzalez for Chrysler and Robert Gerber for GM) essentially ruled that there was no other alternative, short of liquidation, than the government-brokered sales to new consortiums, court records show. That argument--made first by Chrysler's lawyers at Jones Day and GM's legal team at Weil, Gotshal & Manges--is intended to undercut the notion that bondholders could receive more cash in a straight liquidation, experts say. 

"The judges put the burden on the objectors," says Thomas Cullen, who headed the Jones Day litigation team in the Chrysler matter. "The judges were saying: 'What other deal have you got?'"

The pressure was especially high in the GM case, with the government threatening to pull its financing by July 10 if the court had not approved the sale by then, Richman says. He urged Judge Gerber to call the government's "bluff" and force GM to ditch the 363 sale and undergo a full reorganization plan. 

Finding another buyer might have yielded more money in the end, says LoPucki, who co-authored a major 2007 study which concluded that 363 sales yield about half the proceeds for creditors compared with a traditional reorganization. James White, a professor at the University of Michigan Law School, wrote a response to LoPucki's work challenging those conclusions, and says he doesn't have any major objections to the interpretation of section 363 in the Chrysler and GM cases. 

"I don't think it's bad," White says. "Lynn would probably disagree."

Indeed, LoPucki obviously does. But both acknowledge that we have just witnessed something historic in bankruptcy law. Whether the cases have any long-term impact is another question, and most agree any impact will be limited.

"What bankruptcy courts will have to be very careful of in the future is the use of Chrysler and GM as precedent," Seife says. "These are very special cases."

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one wonders if there is any difference between the U.S.and Venezuala

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