On May 31, 2009, approximately 30 days after Chrysler Group LLC and affiliated debtors filed for bankruptcy relief, the United States Bankruptcy Court for the Southern District of New York authorized the sale of substantially all of Chrysler’s assets to “New Chrysler” – an entity formed by Chrysler and Fiat Automobiles SpA and initially majority-owned by Chrysler’s Voluntary Employees’ Beneficiary Association (VEBA) – free and clear of liens, claims and encumbrances under section 363 of the United States Bankruptcy Code (the Fiat Transaction). The sale was approved in record time for a company of Chrysler’s size and despite more than 350 objections. While the facts and circumstances surrounding the asset sale were unique, to say the least, the opinion demonstrates a simple truth – a bankruptcy court will act as quickly as the circumstances require in order to enable a debtor facing immediate liquidation to take advantage of a lone business opportunity that the court believes will maximize value for the benefit of creditors.
In this case, the Court found that Chrysler’s sale was justified under the circumstances and rejected any suggestion that it amounted to an impermissible sub rosa plan of reorganization or that the sale process somehow violated due process – concerns raised by numerous parties objecting to the sale. Addressing the involvement of the US and Canadian governments as prepetition, debtor-in-possession (DIP) and exit lenders, the Court found that they were the lenders of last resort and that, notwithstanding their involvement, the sale was a proper exercise of Chrysler’s fiduciary duties, New Chrysler was a good faith purchaser for purposes of section 363(m) of the Bankruptcy Code and due process was afforded creditors and other parties under the circumstances.
Chrysler’s Business Judgment
The Court commenced its analysis by addressing the standard for approving a sale of substantially all of a debtor’s assets outside a plan of reorganization. In the Second Circuit, as in most circuits, a debtor must demonstrate that a good business reason exists in order to approve such action. The Court determined that this standard had been met. Crucial to this determination was the fact that after two years of trying to identify alliances, the Fiat Transaction was the only viable option – the only other alternative being immediate liquidation. Additionally, given the US and Canadian government’s involvement, the Fiat Transaction was an opportunity that the marketplace alone could not offer and that exceeded the liquidation value of Chrysler’s businesses.
Sub Rosa Plan of Reorganization
One of the primary objections to the sale was that it arguably contained numerous hallmarks of a Chapter 11 plan of reorganization and was in essence a plan disguised as an asset sale – a scenario known as a sub rosa plan of reorganization. In rejecting these concerns, the Court found that Chrysler’s valuation expert presented unrebutted testimony that the sale proceeds would exceed the immediate liquidation value of Chrysler’s assets. As a result, the Court held that Chrysler would be receiving fair value for its assets and that none of the sale proceeds would be allocated to anyone other than Chrysler’s first lien lenders. Importantly, the Court also found that Chrysler was going to continue to administer its estates subsequent to the asset sale, including through disposing of remaining assets, evaluating claims, contracts and leases, and seeking confirmation of a plan that will provide for the distribution of remaining assets. As such, the debtors were not attempting to evade plan confirmation procedures.
Perhaps more noteworthy, however, is the fact that certain unsecured creditors (i.e., the United Automobile Workers union, VEBA and the US Department of the Treasury) would be receiving equity in New Chrysler and that this feature did not change the Court’s sub rosa analysis. The “absolute priority rule” prohibits any junior creditor from receiving any form of consideration (including equity in an asset purchaser) on account of its prepetition claims prior to more senior creditors being paid in full. In this case, however, the Court found that these creditors were not receiving equity in New Chrysler on account of their prepetition claims. Rather, the equity was in exchange for new, substantial consideration under separately negotiated agreements with New Chrysler. The Court further explained that these parties were essential to New Chrysler’s viability and that, as such, New Chrysler negotiated and reached certain agreements with these entities (including providing ownership interests in New Chrysler). The Court found that doing so was neither a diversion of value from Chrysler’s estate nor an allocation of the sale proceeds and that the allocation of ownership interests in New Chrysler was irrelevant to the estate’s economic interests.
The Role of the US and Canadian Governments
Certain objections to the sale alleged that the US and Canadian governments were impermissibly controlling Chrysler as well as the sale process itself. It was therefore argued that the sale process was intrinsically flawed, that Chrysler had not fulfilled its fiduciary duties and that New Chrysler was not entitled to the benefits provided by section 363(m) for good faith purchasers of assets of a debtor.
The Court noted that the decision of these governments to fund the Fiat Transaction was politically motivated and that these governments had determined that it was in their respective national interests to save the US automobile industry. Throughout the opinion, the Court also noted that these governments have been the only source of any debt or equity funding and are the lenders of last resort.
In the Court’s opinion, the extent to which a governmental entity should be involved in protecting certain industries is a political decision regarding which the Court declined to express a view. The Court observed, however, that the economic reality in this case was that no one other than these governmental entities was willing to lend and that the only alternative to the Fiat Transaction would be an immediate liquidation. The Court explained that its role is to either grant or deny the relief sought based upon the record before it, not to interject itself into the business judgment of the entity funding the transaction, even if that entity is the government.
There was no question as far as the Court was concerned that Chrysler had appropriately exercised its fiduciary duties. Notwithstanding an 18-month worldwide search for potential alliance partners, no other bidders stepped forward. As such, Chrysler was faced with either accepting the Fiat Transaction or liquidating. Moreover, as there were no other funding sources, Chrysler was necessarily limited to pursuing only those proposals that the US and Canadian governments viewed as viable, regardless of Chrysler’s view of a particular approach. The Court explained that “whether one is considering a stand-alone restructuring or other option, absent the consent of the entity that will provide capital to fund the effort, any perceived ‘going concern value’ or ‘enterprise value’ cannot be realized.” The Court noted that while Chrysler consistently believed in and pursued a stand-alone restructuring plan, Chrysler’s view was not shared by anyone who was willing and able to finance such proposal.
There was also no question in the Court’s opinion that New Chrysler was a good faith purchaser entitled to the protections provided by section 363(m) of the Bankruptcy Code. The Fiat Transaction was the only viable option outside of liquidation. Further, it took months of intense, good faith negotiations to finalize the terms of the Fiat Transaction. The government did not control Chrysler. As a lender, the US government simply conditioned its lending to Chrysler and to New Chrysler on the consummation of the Fiat Transaction. Chrysler was free to reject the funding offer. To do so, however, would have resulted in liquidation.
Appellate Court Affirmance
The Sale Order was appealed directly to the Court of Appeals for the Second Circuit, and the Fiat Transaction was stayed pending the appeal. Days later, the Second Circuit affirmed the Sale Order in its entirety. Soon after the US Supreme Court declined to extend a stay of the Sale Order, the sale closed.
On August 5, 2009, the Second Circuit issued its written opinion. The Court held that: (1) the asset sale was not an impermissible sub rosa plan; (2) Chrysler’s secured lenders consented to the sale free and clear of their liens – their assertions to the contrary notwithstanding; and (3) the secured lenders did not have standing to challenge the US government’s use of TARP funds to finance the asset sale. The Court also considered and rejected each of the arguments advanced by present and future tort claimants.
Supplementing the analysis and holdings in its 1983 In re Lionel Corp. decision – 722 F.2d 1063 (2d Cir. 1983) – the Court engaged in a refreshed and in-depth analysis of the “apparent conflict” between a debtor’s authority to sell assets outside the ordinary course of business under section 363(b) of the Bankruptcy Code and the various features and safeguards provided for by the Chapter 11 plan confirmation process. Noting that 363(b) asset sales have become common practice in large corporate bankruptcies in the 25 years since Lionel, the Court explained that the criticism of 363(b) asset sales remains unchanged: “fear that one class of creditors may strong-arm the debtor-in-possession, and bypass the requirements of Chapter 11 to cash out quickly at the expense of other stakeholders, in a proceeding that amounts to a reorganization in all but name, achieved by stealth and momentum.” However, where the assets are of a perishable nature or liable to deteriorate in value – i.e., the “melting ice cube” scenario – and a good business opportunity exists, a sale of those assets under section 363(b) is warranted and permissible.
The Second Circuit held that the Bankruptcy Court found good business reasons for Chrysler’s asset sale, noting that the “linchpin of the [Court’s] analysis was that the only possible alternative to the Sale was an immediate liquidation that would yield far less for the estate – and for the objectors.” Moreover, “[w]ith its revenues sinking, its factories dark, and its massive debts growing, Chrysler fit the paradigm of the melting ice cube.”
Impact of the Sale Order
It is not entirely clear what impact the Sale Order will have on the use of section 363 sales in future bankruptcies. The facts and circumstances surrounding the asset sale were extraordinary. While there are signs that the recent credit crunch is easing, DIP financing remains difficult to secure, and debtors frequently find themselves with only a single source of funding, if they’re lucky enough to find funding at all. However, it is not typical for the lender to be a governmental entity whose interests are guided by both economic and political factors. Not every asset sale case will be a part of an effort to save an entire industry, nor will every asset sale case produce only a single bidder. The confluence of these factors is what drove the result in the Chrysler case. Depending on the circumstances in future cases, however, the same results may not follow.
Certainly, the Court’s sub rosa analysis is cause for concern by senior creditors who find themselves receiving less than full payment on their claims when junior creditors are receiving debt from or equity in the purchasing entity. The Court has seemingly recognized an exception to principles of “absolute priority” applied in the nonplan sale context – namely, a junior creditor may be able to receive equity or other consideration prior to senior creditors being paid in full if the junior creditor negotiates for such consideration directly from the purchaser itself, rather than from the debtor. How this arguable departure from well-settled principles of creditor ranking will develop in future cases involving asset sales remains to be seen.