Speed seems to be a side effect of the long-recognized trend of
Chapter 11 proceedings amounting to sales under Section 363
of the Bankruptcy Code. Under this section, debtors can sell
their assets free and clear of any liens and without the approval of a creditor-approved reorganization plan. Buyers and
debtor-in-possession financiers tend to benefit from the process, since they get to nitpick which of the filing debtor’s assets
they want to keep.
Creditors, as many have noted, very frequently get stiffed.
In the 363 sale model of bankruptcy, creditors of any class get
very little say in how the business divvies up its assets in the
bankruptcy process, leaving them with claims, paid or not,
and very little recourse to contest a sale decision. They also
tend to be excluded from any bidding process, meaning there’s
very little competition for the debtor’s assets and a greater
potential for money for the estate to be left on the table. These
facts raise many questions, the most significant of which pertains to the goal of the restructuring process. The reason Section 363 sales are so popular isn’t just because it circumvents
the will of the creditors, or offers debtors and buyers a level of
flexibility and speed unavailable in a confirmed reorganization plan. Section 363 sales are so popular because they’ve
been successful, depending on how you define “success” when
it comes to bankruptcy.
Rule vs. Reality
One of the major controversies in the Chrysler and GM cases
surrounded the government’s decision to wade into the distribution process and reorder who was paid what. Critics cried
socialism and many suggested that the government was essentially circumventing the rule of law by redistributing and
reorganizing the two automakers’ businesses as it saw fit. In
defense, the Obama administration noted that its intervention was warranted because the stakes were higher than they
had ever been and the potential for failure in an unsupervised
Chapter 11 proceeding was too great.
In their efforts to ensure the two companies’ survival, the government essentially overruled secured creditors. The concept
of the absolute priority rule, whereby payment of certain
secured claims precedes payment of others, was turned on its
head, and while both companies emerged semi-triumphant
and are tentatively on their way back to profitability, many
observers have noted that the ramifications of this dismissal
of priority could be hard felt for years to come. Unsecured
creditors in the GM and Chrysler cases were largely favored
over secured ones, which, at the onset, seemed like good news.
Trade creditors frequently, and legitimately, gripe about the
ineffectual and impractical ways the Bankruptcy Code allows
debtors to treat their claims, and a major case that put them
in the forefront could be viewed as a positive. Still, secured
credit is a major source of financing for businesses and if such
creditors are worried about being told to take a hike in a government-supervised bankruptcy, they could stop lending
altogether, meaning less financing, less capital and, eventually, more bankruptcies.
While this is a risk, the immediate concern for Chrysler and
GM was the economy. Intervention could cause problems in
the future, but leaving the process up to Chapter 11 was a risk
the government was unwilling to take, and on this point it’s
hard to argue. Again, GM and Chrysler’s failure was economically, and politically, untenable, but in reworking the companies outside of established law, the government’s intervention
in these two cases framed a conflict between the absolute priority rule and the reality that strict adherence to that rule
might not work for the best. In a choice between respecting
the absolute priority rule and subverting the rule to protect
the economy, the government chose the latter.
Fundamentals
An assumption of the bankruptcy process is that a company
that survives a filing and stays in business is better than one
that liquidates. “The fundamental idea is that a going concern
is going have greater value than a liquidation,” said Prof.
David Epstein of the Southern Methodist University School
of Law. Epstein, along with other academics and practitioners,
served on a panel at the American Bankruptcy Institute’s 2009
Legislative Symposium, which focused on corporate restructuring and potential changes to the Code. Nowhere is Epstein’s
fu