As is now well known, General Motors, Inc. and Chrysler LLC financially restructured themselves with the help of the United States Treasury. These restructurings occurred very quickly – Chrysler and GM each filed for bankruptcy and sold substantially all of their automobile-producing assets to newly created companies2 within approximately forty days. Each company used the bankruptcy process to massively deleverage and free itself from personal injury liability claims. New Chrysler and New GM will now attempt to become viable and profitable entities unencumbered by these burdens, while creditors of “old” Chrysler and “old” GM go through a traditional chapter 11 process. These sales occurred so rapidly because each company demonstrated after substantial litigation that they were appropriate, pursuant to section 363 of the Bankruptcy Code.3
In a recent opinion affirming the Bankruptcy Court’s decision in Chrysler, the United States Court of Appeals for the Second Circuit detailed the broad scope of section 363.4 The Second Circuit’s opinion makes clear that while the facts in Chrysler were remarkable, the use of section 363 to achieve the sale fell within the mainstream of prior applicable precedent.5 However, by adopting the holding of the Third Circuit’s T.W.A. decision permitting the sale of assets free and clear of personal-injury claims, the Second Circuit made its law even more appealing to debtors and purchasers.
Chrysler is notable both because the case was of substantial national importance and because of the increasing prominence of section 363(b) sales. As the Second Circuit observed: “in the current economic crisis of 2008-2009, § 363(b) sales have become even more useful and customary . . . the “side door” of § 363(b) may well ‘replace the main route of Chapter 11 reorganization plans.’”6 Thus, Chrysler confirms that the Second Circuit is a very attractive forum for a debtor needing to immediately sell substantially all of its assets to avoid destruction of value and jobs.7
Factual Background of Chrysler8
In November 2008, facing a dire liquidity situation, Chrysler received billions of dollars in “rescue financing” from the United States Treasury, and additional assistance in 2009. This funding was conditioned upon Chrysler proposing a financial and operational restructuring that would enable it to achieve long-term viability. While Chrysler could not achieve an out-of-court restructuring, it entered chapter 11 with agreements from key stakeholders: including a strategic alliance with Italian automaker Fiat S.p.A., a new collective-bargaining agreement with the UAW establishing a more rational wage structure, and creating a new voluntary employees’ benefit association (the “VEBA”) structure to fund legacy UAW retiree health-care obligations. In April 2009, these parties agreed on a sale transaction pursuant to which Chrysler would transfer substantially all of its operating assets to New Chrysler,9 a newly-created company that would be owned by Fiat, the UAW, and the governments of the United States and Canada. In exchange for Chrysler’s assets, New Chrysler would assume certain of Chrysler’s liabilities and pay it $2 billion in cash to be distributed in accordance with appropriate bankruptcy priorities. The sale transaction (referred to as the “Sale”) was to be effectuated via section 363 of the Bankruptcy Code. Section 363 was the chosen mechanism because it permits debtors to sell property outside the ordinary course of business free and clear of all liens and other obligations.
Upon filing for bankruptcy on April 30, 2009, Chrysler shut down its manufacturing operations, had very limited cash on hand to fund ongoing operations, and had no other viable purchaser of its assets other than New Chrysler. In light of these facts, Chrysler sought approval of the Sale on a highly expedited time-frame, with hearings to commence approximately four weeks after the commencement of the bankruptcy cases.
Although Chrysler had secured consent from most of its key constituencies, including over 90% of its first-lien lenders, the Sale faced strong opposition from a small group of dissident first-lien lenders, including the Indiana State Police Pension Trust, the Indiana State Teachers Retirement Fund, and the Indiana Major Moves Construction Fund (collectively, the “Indiana Pensioners” or “Pensioners”) as well as products-liability and asbestos personal-injury claimants (collectively, the “Tort Claimants”). Judge Gonzalez conducted an extended evidentiary hearing on the motion to approve the Sale. On May 31, 2009, Judge Gonzalez issued a lengthy opinion approving the Sale and overruling all objections, relying heavily on the factual record establish at the hearing.10 The Second Circuit required briefing and oral argument on the appeal from Judge Gonzalez’s sale order to be completed by June 5, 2009 – a mere four days after Judge Gonzalez approved the Sale. After extensive briefing and argument, the Second Circuit affirmed Judge Gonzalez’s order from the bench.11 On August 5, 2009, the Second Circuit issued a lengthy opinion explaining its rationale.
The Second Circuit’s Opinion
The Second Circuit addressed three primary objections to the Chrysler Sale:
- The Sale, considered together with the associated intellectual property and (selected) dealership contractual rights, so closely approximated a final plan of reorganization that it was an impermissible “sub rosa plan,” barred under § 363(b);
- The Sale impermissibly subordinated secured lenders and allowed assets on which they had a lien to pass free of liens to other creditors and parties, in violation of § 363(f); and
- Chrysler could not sell its assets free and clear of personal injury and asbestos claims.
Overview of Use of Section 363
The Second Circuit started from the familiar proposition that section 363(b) authorizes a debtor-inpossession to use, sell, or lease estate property outside the ordinary course of business, requiring only that a debtor provide notice and a hearing. 11 U.S.C. § 363(b). Section 363 sales have been increasingly common over the past twenty-five years, particularly where all or a portion of the debtor’s estate is “perishable in nature or liable to deteriorate in value.”12 Section 363 sales have proliferated because debtors need “flexibility and speed to preserve going concern value.”13 “Resort to section 363(b) has been driven by efficiency, from the perspectives of sellers and buyers alike. The speed of the process can maximize asset value by sale of the debtor’s business as a going concern.”14 However, there is tension between “the expedien[ce] of a § 363(b) sale and the otherwise applicable features and safeguards of Chapter 11,”15 such as those embodied in sections 1123 and 1129 of the Bankruptcy Code related to the requirements of a plan of reorganization. Indeed, as in Chrysler, opponents of section 363 sales frequently contend that the proposed sale constitutes an unlawful “sub rosa” plan of reorganization that impermissibly evades the requirements of chapter 11 plans.16
Avoiding Decrease in Value is the Most Important Factor
To balance these competing interests, the Second Circuit has an open-ended, “multifarious” balancing test, measuring several factors, including:
the proportionate value of the asset to the estate as a whole, the amount of time elapsed since the filing, the likelihood that a plan of reorganization will be proposed and confirmed in the near future, the effect of the proposed disposition on future plans of reorganization, the proceeds to be obtained from the disposition vis-à-vis any appraisals of the property, which of the alternatives of use, sale or lease the proposal envisions and, most importantly, perhaps, whether the asset is increasing or decreasing in value.17
While this test gives bankruptcy courts discretion, the Second Circuit held that the last factor – whether the asset is increasing or decreasing in value – is of paramount importance.18 Thus, perhaps the most critical factor in the Second Circuit is whether a debtor can prove that the asset for sale is a “melting ice cube.” In Chrysler, the debtors demonstrated this overwhelmingly, showing that the debtors’ “revenues [were] sinking, its factories dark, and its massive debts growing. . . . [g]oing concern value was being reduced each passing day that [Chrysler] produced no cars, yet was obligated to pay rents, overhead, and salaries.”19
Also salient was Chrysler’s “prolonged and well-publicized effort to find a strategic partner or buyer”20 prior to its chapter 11 cases but no other proposals were forthcoming. The fact that Chrysler had “shopped itself around,” combined with dissipating value, permitted approval of the Sale on a time-frame the Court viewed as “tight” and “seemingly arbitrary,” because the reality was that Chrysler had “little leverage to force an extension” of the Sale process or closing date.21 Moreover, Chrysler and the purchasers demonstrated that the only alternative to the Sale was a liquidation that would result in creditors receiving less in value than the $2 billion sale price.
While the facts in Chrysler are fairly extreme, they are not a benchmarkfor parties seeking to use section 363. The Second Circuit was very clear that a debtor need not establish the same dire facts as were present in Chrysler, noting that section 363 does not require an “emergency” but, rather, the lesser standard of preserving a “good business opportunity.”22
Size Does Not Necessarily Matter
An important facet of the Court’s analysis is that the “size of the transaction, and the residuum of corporate assets, is, under our precedent, just one consideration for the exercise of discretion by the bankruptcy judge(s), along with an open-ended list of other salient factors.”23 As the Court further explained in a footnote, the fact that the section 363 sale had “inevitable and enormous influence on any eventual plan of reorganization or liquidation” was not a reason to disapprove of the Sale. Indeed, the Second Circuit held that, by selling virtually all of the assets of a debtor, “a 363(b) sale may well be a reorganization in effect without being”24 impermissible. The “reorganization in effect” in Chrysler resulted from fact that the face value of the liens encumbering the assets exceeded the sale price for the assets; in effect, this roughly established recoveries for secured and unsecured creditors. This is a different approach than was recently adopted by a bankruptcy court in Texas in rejecting a sale pursuant to section 363, which held that the “likelihood of approval of the § 363 sale is inversely proportional to the percentage of the value of the debtor’s assets that are to be sold.”25 Rather than focus on the size of assets sold (either on an absolute scale or relative to the assets of the estate as a whole) the Second Circuit held that the Chrysler sale was not a sub rosa plan because it did not “specifically ‘dictate’ or ‘arrange’ ex ante, by contract, the terms of any subsequent plan of reorganization.”26 Thus, the Second Circuit distinguished between the unavoidable consequences of a sale (which can functionally dictate outcomes for creditors in accordance with the priority scheme of chapter 11) and a sale intentionally designed to alter applicable distribution priorities.
Allocation of Equity Interests in the New Entity Did Not Violate Bankruptcy Priorities
On a related point, the Second Circuit clarified that the planned distribution of equity of New Chrysler was irrelevant to whether the Sale was an improper sub rosa plan. The Indiana Pensioners (among others) argued that allocating equity to the VEBA was improper because it gave value to an unsecured creditor of Chrysler without paying off secured creditors in full. The Second Circuit rejected this argument completely, holding that the Bankruptcy Court “demonstrated proper solicitude for the priority between creditors and deemed it essential that the Sale in no way upset that priority [by finding that]. . . . ‘[n]ot one penny of value of the Debtors’ assets is going to anyone other than the First-Lien Lenders.’”27 Critically, the appellate court upheld the finding that the equity stakes in New Chrysler were attributable to “new value--including governmental loans, new technology, and new management,” which were not assets of the debtor’s estates.28 Thus, purchasers wishing to share equity in a new company with a party which happens to be a junior creditor of the debtor’s estate must be careful to make a factual showing that the equity is not given on account of the creditor’s pre-petition claim and the value of the new equity is derived from and belongs to the new company.
Selling Assets Free and Clear of Liens
Chrysler also makes clear that an individual bank-group member’s right to object to the release of liens pursuant to § 363(f)(2), when the bank group as a whole consents, is a contractual matter. Under § 363(f)(2), assets sold in a § 363(b) sale may be sold “free and clear of any interest” (including liens) when the entity holding the interest consents to the sale. After analyzing the relevant contractual agreements between the Indiana Pensioners, other co-lenders in its bank group and the collateral agent under Chrysler’s first-lien lending agreement, the Second Circuit determined that the Pensioners “effectively ceded to an agent the power to consent to such a sale; the agent gave consent; and the Pensioners are bound.” The specific contractual details resulting in the Second Circuit’s decision are set forth in detail in that opinion. It is noteworthy that Chrysler confirms that where a majority of lenders instructs an agent or trustee to take specific action in a chapter 11 case, dissident lenders may find they can exert little leverage or be unable to extract hold-up value in proceedings.29 Chrysler adds to a significant body of law holding that the terms of a credit agreement may bind a minority of lenders to the will of a majority or require that lenders take collective action through an appointed trustee rather than acting on their own upon an event of default.30
Sale Free and Clear of Personal Injury Claims
As a manufacturer of automobiles, Chrysler naturally faced a substantial number of personalinjury/ product-liability claims for cars manufactured prior to the section 363 sale. To maximize its sale price, Chrysler sought to sell its assets free and clear of any such claims so that the purchaser would be acquiring as few liabilities as possible. Objectors representing (1) existing productliability plaintiffs and (2) unknown and unidentified individuals with potential claims arising from defects in Chrysler’s production of vehicles asserted that their claims attached to New Chrysler, and the Sale could not be free and clear of their claims. The Bankruptcy Court overruled these objections, and the Second Circuit affirmed this ruling in virtually every respect.
Existing claimants argued that, while section 363(f) permits property to be sold free and clear of any “interest in property,” personal-injury claims are not “interests in property.” Rather, the claimants argued that only in rem interests in property, such as liens, fell within section 363(f). While the issue was one of first impression in the Second Circuit and its bankruptcy courts, Judge Gonzalez followed the leading case on the issue, In re Trans World Airlines, Inc.,31 which “makes clear that such tort claims are interests in property such that they are extinguished by a free and clear sale under section 363(f)(5) and are therefore extinguished by the [sale].”32 The Second Circuit affirmed, noting that, while the phrase “interest in property” is not defined, the structure and purpose of the Bankruptcy Code counseled for a broad interpretation of that language.
Chrysler held that “interest in property” encompasses all claims that “arise from the property being sold.” The Court rejected the notion that unsecured claimants could assert “successor liability claims against [the purchaser] while limiting other creditors’ recourse to the proceeds of the asset sale,”33 as inconsistent with the Bankruptcy Code’s priority scheme. Thus, the proper remedy for a personal claimant against Chrysler is a claim against Chrysler’s bankruptcy estate, which is what all other similarly situated creditors are entitled to. Additionally, taking a practical approach, the Second Circuit noted that, if the claimants had “successfully blocked the Sale, they would have been unsecured creditors fighting for a share of extremely limited liquidation proceeds. . . . [and would have] fared no better had they prevailed.”34 And, the Second Circuit observed that permitting existing personal-injury claims to pass through to New Chrysler could have interfered with the Sale, as “the possibility of transferring assets free and clear of existing tort liability was a critical inducement to the Sale.”35 Adopting the reasoning of the Third Circuit in T.W.A., the Second Circuit held that the sale of assets “at the expense of preserving successor liability claims was necessary”36 to preserve thousands of jobs and provide funding for various employmentrelated liabilities. While Chrysler’s free-and-clear liability does not appear to rest entirely on this calculation, a seller seeking to take advantage of Chrysler should attempt to introduce evidence demonstrating the preservation of jobs and other positive impacts of a proposed sale.
With respect to future claimants, the Second Circuit held that a section 363 sale can extinguish successor-liability claims to the fullest extent possible permitted under the Bankruptcy Code. However, the Court declined to delineate what the “fullest extent” permitted is, thus, setting up the high probability that the issue will be litigated in the future when a court is presented with a valid state-law successor-liability claim for an injury caused by Chrysler occurring after the Sale.