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Bankruptcy Question-Gumby or other attornies
Old 12-21-2008, 12:50 PM   #1
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Bankruptcy Question-Gumby or other attornies

Auto Bailout

posted by Adam Levitin

TARP funds are now going to be used to bail out the auto industry. Whether or not this is ultimately a good or responsible idea is something that I will reserve comment on for now. The loans' term sheet isn't out yet, but it's outlines are being reported: $13.5bn now, callable on March 30 (conveniently on the Obama administration's watch) if the automakers haven't reduced their debt by 2/3s (including via deb/equity swap--shareholders will get diluted) and worked out a competitive labor deal.

The idea animating these bridge loans is that the exploding deadline will force the automakers and their major creditor constituencies--labor, secured creditors, suppliers, dealers, and bondholders--to work out a restructuring. That's a nifty move, but it is a gamble, and as I explain below, it is a very risky one for taxpayers. The Times reports that the loan will have priority over other creditors, which should protect taxpayers/ Only problem is that I don't know how that would be possible under existing law.



There isn't any mechanism in existing law for giving new money priority over old money outside of bankruptcy, other than secured credit, and I don't think there are any significant unencumbered assets at GM or Chrysler. Therefore, even if these are "secured" loans, there really can't be priority from security unless existing secured creditors can be convinced to give up their liens (and what fool would do that?).

If the loans aren't secured, there isn't any way to give them priority under existing law, and this deal doesn't change the law. Absent a subordination agreement (and there isn't one here), if the government lends unsecured, it is on equal priority with all other unsecured creditors outside of bankruptcy, and equal priority with all general unsecured creditors in bankruptcy. Note that this is very different from the bank bailout deals where the government took preferred stock. Companies can issue preferred that has a priority senior to common. But there's no ability to do this with debt. At best, GM or Chrysler could issue senior notes (and that depends on the notes they have already issued), but these would only have priority over other bondholders, not over other general unsecured creditors. If you want to give priority to new money, the only way to do it currently is in bankruptcy.



Credit Slips: Auto Bailout

My question here is not about the auto bailout per se, or the wisdom or fairness of it. My question is about this sentence: At best, GM or Chrysler could issue senior notes (and that depends on the notes they have already issued), but these would only have priority over other bondholders, not over other general unsecured creditors.

Under current law, can a firm issue new debt, outside of bankruptcy, not secured by specific liens, that gives the new debt priority over existing senior debt? If so it seems that a bondholder is always in a very risky situation unless he has liens on something like modern airplanes or ships or locomotives or general purpose real estate or somthing that can retain its usefullness separated from the going concern.

Any comments will be appreciated.

Ha
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Old 12-21-2008, 01:05 PM   #2
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Ha, never underestimate the creativity of lawyers to find a way to prime existing creditors. There are a number of ways to do this, all of which could conceivably be exploited. You could get a blanket lien on all unencumbered assets (whatever those might be, and might not be specified); you could use corporate structure game-playing to get ahead of bondholders (stick a new holdco between the underlying asset and the existing bndholders and you achieve structural subordination of existing bondholders); you could exploit loopholes in senior unsecured bond indentures; etc. Finally, Congress could simply pass a law saying they get to prime everyone else. But suffice it to say that I have seen many a deal in which the existing bondholders get partially or totally primed.

If the boobs have to reduce their debt by 2/3, I would guess that they will do a restructuring deal that has the existing bondholders trade in their bonds for some combination of cash, new bonds, equity, and/or maybe some preferred stock. The existing equity holders will likely get heavily diluted and the bondholders will get a package of stuff that is worth at least a bit more than the current (very depressed) trading prices of their bonds. Lots of this going on in the market today, unfortunately.

Is it any surprise that Ford spurned the bailout? No way the family is willing to see their equity get diluted out of existence.
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Old 12-21-2008, 01:14 PM   #3
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Ha, never underestimate the creativity of lawyers to find a way to prime existing creditors. There are a number of ways to do this, all of which could conceivably be exploited. You could get a blanket lien on all unencumbered assets (whatever those might be, and might not be specified); you could use corporate structure game-playing to get ahead of bondholders (stick a new holdco between the underlying asset and the existing bndholders and you achieve structural subordination of existing bondholders); you could exploit loopholes in senior unsecured bond indentures; etc. Finally, Congress could simply pass a law saying they get to prime everyone else. But suffice it to say that I have seen many a deal in which the existing bondholders get partially or totally primed.

If the boobs have to reduce their debt by 2/3, I would guess that they will do a restructuring deal that has the existing bondholders trade in their bonds for some combination of cash, new bonds, equity, and/or maybe some preferred stock. The existing equity holders will likely get heavily diluted and the bondholders will get a package of stuff that is worth at least a bit more than the current (very depressed) trading prices of their bonds. Lots of this going on in the market today, unfortunately.

Is it any surprise that Ford spurned the bailout? No way the family is willing to see their equity get diluted out of existence.
Right you are Brewer.

Absent Congress simply changing the law, whether or not existing unsecured bondholders or lenders can be primed involuntarily depends on the strength of the negative covenants in the existing bond indentures or loan agreements. Generally bonds and loans issued when the company was not in financial distress will have "looser" covenants than those issued when a company is sliding downward. In the latter situation, lenders are much more interested in positioning themselves for the ultimate bankruptcy. That is why they will often have very strict limits on incurring additional debt (secured or unsecured), selling assets or creating subsidiaries -- to avoid, as much as possible, the priming situations outlined. Unfortunately, those holding bonds issued in the halcyon days of the last century may be in trouble.
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Old 12-21-2008, 06:11 PM   #4
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I read in an article (perhaps in the WSJ but I can't find it) that because Uncle Sam is involved the situation is even more complicated. In particular the 5th amendment
Quote:
No person shall ... be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.
gives a existing bond holders (which includes me via Vanguard High Yield) a pretty solid case for arguing against the taxpayers getting there money back. Potentially because it is the executive branch (clearly without authorization of Congress) the case maybe stronger than just the garden variety smart lawyers screwing existing bond holders.

One of the comments in the article Ha linked mentioned that in the term sheet said in the event of bankruptcy, the UST loan become a Debtor in Possession law. Is this legal?

There is little doubt in my mind that bond holders will be in worse shape now then if some government supported bankruptcy was arranged. Right now GM has 110B worth of assets and 170B with of liabilities. The company has shown it is quite capable of losing 10B+ in a quarter.

It is entirely possible that by March GM assets will have shrunk to <100B and liabilities increase to >180B and if Uncle Sam claims that the first 10B worth of assets belong to the treasure, punishing bond holders further.

One thing is crystal clear bankruptcy lawyers don't need to worry about unemployment for the next few years.
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Old 12-21-2008, 06:37 PM   #5
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One of the comments in the article Ha linked mentioned that in the term sheet said in the event of bankruptcy, the UST loan become a Debtor in Possession law. Is this legal?
Yes. The likely bankruptcy venues generally permit a "roll up", where the pre-petition lender's claim is rolled up in the DIP super-priority lien if the pre-petition lender is also the DIP lender. Note that this anticipates the government will likely extend further DIP financing during a Chapter 11. I have only seen this happen where the lender was already secured at the time of the filing and merely gained a super-priority lien for it's entire claim by becoming the DIP lender. I don't recall a prepetition unsecured lender elevating a prepetition claim to a secured super-priority claim by virtue of being the DIP lender, but that doesn't necessarily mean it has never happened.
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Old 12-21-2008, 06:40 PM   #6
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Thanks everyone for the very well informed comments.

Ha
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Old 12-29-2008, 10:16 PM   #7
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The only thing I will add is that Donald Trump has SCREWED over many banks and gone bankrupt countless times, but everytime he cooks up another "can't miss" deal, the banks line up to give him capital, often the same banks he screwed not too long before...........
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