Chrysler to File for Bankruptcy
It looks like Chrysler will be filing bankruptcy today.
Q. Will Chrysler cease to operate?
A. No. Chrysler is reorganizing under Chapter 11 of the United States Bankruptcy Code. The law allows companies to shed assets, restructure debt, cancel contracts and close operations that normally would have to continue running. Once they secure financing to leave bankruptcy, these companies are reconstituted as new legal entities.
Q. How long will this take?
A. The Obama administration spoke of a “surgical bankruptcy” which it said could be completed in 30 to 60 days. It plans to use Section 363 of the bankruptcy code to sell assets, rid the company of liabilities and restructure its debt, creating a new Chrysler.
In reality, most bankruptcies take much longer. United Airlines spent more than three years under bankruptcy protection. Delphi, the auto parts supplier, has been in Chapter 11 since 2005. The bankruptcy by LTV, a steelmaker, took seven years to resolve.
Q. What happens to Chrysler employees?
A. The White House said it did not anticipate any reductions in white- or blue-collar jobs as a result of the bankruptcy. However, Chrysler employees who are not union members do not have any job security. The company can ask a judge for an immediate pay cut for its salaried employees, and can announce job eliminations and close offices, just as it can outside bankruptcy,
Contracts covering members of the United Automobile Workers union and other unions will remain in force, until the company asks a judge to void them. U.A.W. members approved changes to their contract on Wednesday that presumably would mean the contract would stay in place.
But if the company asked for contracts to be terminated and replaced with terms it can more readily afford, the union would have a chance to respond in court. Negotiations would take place before any cuts were imposed. This process could take months.
Here is President Obama’s statements on Chrysler’s bankruptcy. So it looks like there will also be a deal between Chrysler and Fiat as well. If you think that this will end the large amounts of money going from the government to Chrysler, think again.
Consistent with the President’s commitment to provide adequate working capital to help Chrysler through this restructuring period and loan up to $6 billion to the Chrysler-Fiat Alliance, the U.S. government has committed to provide assistance sufficient to help give Chrysler a chance to achieve financial viability.
• Working capital: The U.S. government is prepared to provide approximately $3.3 billion in debtor in possession financing to support Chrysler through an expedited chapter 11 proceeding.
• Loan to the New Chrysler: Upon closing, the U.S. government is prepared to loan approximately $4.7 billion to New Chrysler, in the form of a term loan with $2.1 billion due in 30 months and the balance 50% due on the 7th anniversary and 50% due on the 8th anniversary of the loan. The interest will be an appropriate combination of cash and payment-in-kind. There is also an additional note of $288 million which is a fee for making these loans. The loans will be secured by a first priority lien on all of Chrysler’s assets.
Update: Frequent commenter Drew asks,
But what struck me was the notion that the govt loans will be secured by a first lien on assets.
What happened to the secured creditors in Chrysler today?? One of the most hallowed principles of lending is that secured creditors get flushed last, and that they can liquidate for their claims.
Has this principle been abandoned?? If so, this is mind boggling.
I don’t know the answer to the question. However, there’s this article in the WSJ that Greg Mankiw points to. I don’t have access to it, but Prof. Mankiw does quote this part:
“Like many others I made the mistake of buying what I believed was ‘value,'” Mr. Gwin says, adding that investors who bought at the time believed the loans were worth more than their market price. “We did not contemplate having our first liens invalidated by a sitting president,” he adds.
Prof. Mankiw then follows up with,
As the President intervenes in more and more industries, a key question is how he does it and what he is trying to achieve. Is he trying to reorganize insolvent firms while, as much as possible, preserving the rights of stakeholders as established under existing contracts? Or is he trying to achieve a “fair” outcome as he judges it, regardless of preexisting rules and agreements? I fear it may be the latter, in which case politics may start to trump the rule of law.
So it looks like the first lien creditors are taking a haircut. How much I don’t know, but there is this from the statement put out by the Obama Administration,
Chrysler’s largest secured creditors have agreed to exchange their portion of the Company’s $6.9 billion secured claim for their pro-rata share of $2 billion in cash at closing. The Bankruptcy Court process will be used to confirm this treatment on those lenders that failed to accept the offer that was accepted by a majority of the lenders.
If that is the haircut the first lien creditor took it is a signifcant one. If it was done by President Obama for political reasons it is cause for concern. It is cause for concern because it calls into question our rule of law and property rights, and whether or not this will be an isolated incident or one that will likely be repeated many times. If it is the latter, it could have serious repercussions on the financial sector. Why lend money if the government could come in and tell you, you are just S.O.L. I hope I’m wrong here.
Photo by Flickr user dok1, used under the Creative Commons license.