Bankruptcy Newsletter

Sale of Car Manufacturer's Assets Approved
A proposed sale outside the ordinary course of business of the assets of the jointly administered Chapter 11 estates of an automobile manufacturer and its affiliates to a new corporate entity that was to be partly owned by the federal government and another auto maker was not an improper sub rosa plan, a New York bankruptcy court has ruled as part of its decision approving the proposed sale.

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A proposed sale outside the ordinary course of business of the assets of the jointly administered Chapter 11 estates of an automobile manufacturer and its affiliates to a new corporate entity that was to be partly owned by the federal government, as a lender of last resort providing financing for the transaction, and another auto maker, which agreed to contribute its small car technology and access to international markets, was not an improper sub rosa plan, a New York bankruptcy court has ruled as part of its decision approving the proposed sale. A temporary stay of that sale order that was granted by the United States Supreme Court has been vacated.

The debtor-manufacturer and some of its subsidiaries filed for Chapter 11 protection, and an order provided for the joint administration of the cases for procedural purposes. The debtors and their non-debtor subsidiaries comprised one of the largest manufacturers and distributors of automobiles and other vehicles, as well as related parts and accessories. These companies employed approximately 55,000 workers, and made payments for health care and related benefits for more than 106,000 retirees. Substantially all of the debtor-manufacturer's assets provided security for first and second liens of its prepetition lenders. The underlying obligations were also guaranteed by other debtors, and these guarantees were secured by liens on substantially all of the debtors' assets.

In addition, the debtor-manufacturer's parent company borrowed $4,000,000,000 from the United States Treasury pursuant to a loan and security agreement under the Troubled Asset Relief Program (TARP). That program, which was established under the Emergency Economic Stabilization Act (EESA), authorizes the Secretary of the Treasury to buy troubled assets "to restore confidence in the economy and stimulate the flow of credit," the New York bankruptcy court explained. Moreover, the parent company gave the United States Treasury a separate promissory note for $267,000,000, and secured such financing through a first-priority lien on unencumbered assets and the debtor-manufacturer's vehicle parts inventory and a third-priority lien on other assets serving as collateral for the first and second lien prepetition lenders.

The debtor-manufacturer had attempted restructuring prior to filing for bankruptcy, seeking partnership relationships that would allow its expansion in the global market and bring it expertise in the market for smaller, more fuel-efficient vehicles. A global credit crisis, however, caused a sharp drop in vehicle sales, triggering the debtor-manufacturer's use of cash reserves to compensate for a reduced cash flow and resulting losses. The debtor-manufacturer and other entities sought government assistance to obtain new financing to fund operations so as to continue through the liquidity crunch. This resulted in the TARP financing, pursuant to which the debtor-manufacturer was required to provide a plan showing its ability to achieve and sustain long-term viability, energy efficiency, cost rationalizations, and market competitiveness. The TARP financing was used to fund operations and to pursue the viability plan.

The debtor-manufacturer entered into a term sheet with another auto maker for a strategic alliance. Under this alliance, which was to provide the debtor-manufacturer access to competitive fuel-efficient vehicle platforms, distribution capabilities in key growth markets, and substantial cost-saving opportunities, the debtors anticipated that the debtor-manufacturer would be strengthened in the long-term, maximizing the value of the debtors' enterprise.

The debtor-manufacturer's submission to the United States Treasury presented three potential scenarios: a stand-alone restructuring, a scenario involving positive synergies from a strategic alliance, and an orderly wind-down if the first two scenarios could not be achieved. A task force evaluation of the submission resulted in the determination that the debtor-manufacturer could emerge as a viable entity with an appropriate strategic partner. Additional government funding was possible if certain changes to the viability plan were made.

As part of the efforts to meet the requirements for an alliance and satisfy government concerns, a new limited liability company (LLC) was formed by the auto maker with which the debtor-manufacturer sought an alliance to serve as the alliance entity. New agreements were negotiated to address labor and employee benefit issues. The debtor-manufacturer, the auto maker, and the alliance entity tentatively entered into a master transaction agreement under which, inter alia, the debtor-manufacturer would transfer substantially all of its operating assets to the alliance entity, which would assume certain of the debtor-manufacturer's liability and pay the debtor-manufacturer $2,000,000,000 in cash. Membership interests would be issued to the United States Treasury, among others. Moreover, financing from governmental entities, including the United States Treasury, was arranged to assist post-sale operations.

Secured creditors objected to a motion to sell the debtors' assets. Additional objections were raised by automobile dealers that had been notified that their dealership agreements were being rejected. State Attorneys General also objected, as did retirees, tort and consumer claimants, lienholders, and others.

The bankruptcy court began its analysis of whether the sale was permissible with 11 U.S.C.A. § 363(b), which allows a trustee or debtor-in-possession, upon notice and a hearing, to use, sell, or lease bankruptcy estate property other than in the ordinary course of business. This provision, the court indicated, was examined by the Second Circuit Court of Appeals in Comm. of Equity Sec. Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063 (C.A.2 1983). The Lionel court rejected a literal interpretation permitting the unfettered use, sale, or leasing of estate property outside the ordinary course of business in light of the statutory safeguards protecting creditors and investors built into the Bankruptcy Code. The Lionel court also recognized, however, that a bankruptcy court had to be able to authorize action in the best interest of the bankruptcy estate when a business opportunity available only if acted upon quickly presented itself. The Lionel court thus concluded that a use, sale, or lease of estate property outside the ordinary course of business required an articulated business justification, a "good business reason" permitting a court to approve the proposed disposition of estate property. Under Lionel, the New York bankruptcy court explained, a court is to consider all of the salient factors and seek to further the interests of the debtor, creditors, and equity holders in determining whether such a "good reason" exists; in addition, the court is to consider whether those opposing the disposition have shown that the disposition was not justified.

"A debtor cannot enter into a transaction that `would amount to a sub rosa plan of reorganization' or an attempt to circumvent the chapter 11 requirements for confirmation of a plan of reorganization," the bankruptcy court said. A transaction having a proper business justification with a potential to lead to plan confirmation, however, may be authorized. Moreover, a debtor may sell substantially all of its assets as a going concern, then submit a liquidation plan addressing the distribution of the sale proceeds. Such an approach is permitted, for instance, due to a need to preserve going concern value.

The bankruptcy court found that the debtors established the requisite good business reason for selling their assets in the early stages of their Chapter 11 cases. It noted that the transaction with the allying auto maker was the only viable option, despite the extensive efforts taken to seek alliances for the debtor-manufacturer. "The only other alternative," the court said, "is the immediate liquidation of the company." The synergy promised by the alliance, furthermore, could make the whole enterprise "worth more than the sum of its parts." In addition, the debtors had been required to cease operations to conserve resources, but did so with a view toward ensuring that normal production would resume quickly after a sale, and that consumers would not be affected. Material delay in the sale could cause substantial costs, and possibly vitiate "vital" agreements negotiated by the debtors. "Thus," the court said, "approval of the Debtors' proposed sale of assets is necessary to preserve some portion of the going concern value of the [debtor-manufacturer's] business and to maximize the value of the Debtors' estates."

Moreover, the government entities providing funding for the sale transaction had indicated that financing was contingent upon a quick closing of the sale, and the allying auto maker could withdraw its commitment if a sale did not close immediately. Confronted with either a potential liquidation of their assets, and the resulting closing of plants and layoffs, or a government-backed purchase of their assets allowing for the negotiation of terms with suppliers, vendors, dealerships, and workers to satisfy obligations owed to such constituencies, the debtors exercised their fiduciary duty by selecting the only option available that did not involve piecemeal liquidation. In so holding, the bankruptcy court rejected, in a footnote, the suggestion that the debtors could have "refused to accede to the government's terms in the hope that the government would capitulate and agree to consider other alternatives," concluding that such a gamble would have been a breach of the debtors' fiduciary duties.

The bankruptcy court went on to conclude that the assets sale was not a sub rosa plan of reorganization. The debtors were receiving fair value for their assets, and that value was all going to the first-lien lenders. A valuation expert provided unrebutted testimony that the $2,000,000,000 being paid by the alliance entity exceeded the value that could be recovered in an immediate liquidation, which, it was estimated, would generate $800,000,000. The court pointed out, furthermore, that no other bidder came forward in the sale process, and the first-lien lenders could have refused to consent to the sale or, having consented, could have chosen to credit bid instead of accepting cash. Finally, after the sale was concluded, the debtors would continue to administer their bankruptcy estates, disposing of the remaining assets and evaluating claims, contracts, and leases, and seek to confirm a plan providing for the distribution of estate assets. "Thus, the classification of claims is independent of the sale process and the Debtors are not attempting to evade the plan confirmation procedures," the bankruptcy court opined.

The varying treatment being accorded to creditors, moreover, by virtue of decisions made regarding which executory contracts and unexpired leases would be assumed and assigned, did not transform the assets sale into a sub rosa plan. Fair value was paid for the assets being transferred, and the alliance entity made business decisions as to those contracts being assumed, the bankruptcy court explained. It noted that other automobile manufacturers were engaging in similar cost-cutting efforts and evaluations of their dealership networks. "In every bankruptcy case involving the sale of substantially all of a debtor's assets, a purchaser may decide to assume certain contracts but not others," the bankruptcy court said. That the purchase in the case before the court was being funded by the government did not alter the purchaser's right to make such choices.

The court also noted that the alliance entity had negotiated with various constituencies contributing to, and essential to, the new venture, such as the allying auto maker, which was providing technology and expertise, the governmental entities providing funding, and the debtor-manufacturer's employees. Although those negotiations had resulted in agreements providing such constituencies with ownership interests in the new entity, value was not being diverted from the debtors' assets and proceeds from the sale of those assets were not being allocated. Rather, the court indicated, "[t]he allocation of ownership interests in the new enterprise is irrelevant to the estates' economic interests." Moreover, certain entities, including a union and the United States Treasury, were receiving consideration under their separately negotiated agreements with the new entity, and would not receive distributions on their prepetition claims. Motions concerning various settlements, furthermore, had no effect on the sub rosa analysis, and would be evaluated on their own merit.

The bankruptcy court thus concluded that the sale satisfied the Lionel standard and so met the requirements of 11 U.S.C.A. § 363(b) for an asset sale outside the ordinary course of business. After addressing additional issues regarding the proposed sale, including whether the sale could be authorized free and clear of any liens and interests of non-estate entities, the effect of the involvement of governmental entities in the sale transaction, whether the debtors breached their fiduciary duties, and whether the alliance entity was a good-faith purchaser, the bankruptcy court approved the sale.

The Second Circuit Court of Appeals affirmed the sale on an expedited, direct appeal, according to filings made with the United States Supreme Court in connection with an application by objecting creditors for a stay of the assets sale pending certiorari review. Subsequently, Justice Ginsburg of the Supreme Court, 2009 WL 1579492, granted the application for a temporary stay of the bankruptcy court's orders. A day later, however, that stay was vacated in a decision in which the Supreme Court indicated that the applicants had not carried their burden of showing that the circumstances warranted an exercise of the Court's discretion to grant a stay. In re Chrysler LLC, 2009 WL 1507547 (Bkrtcy.S.D.N.Y., Judge Gonzalez).

The conduct of a Chapter 7 debtor and her attorney in filing a state-court complaint against the Chapter 7 trustee and the trustee's professionals, without first securing the bankruptcy court's permission in violation of the Barton doctrine, and in a clearly improper venue, was not just improper but outrageous. It warranted the imposition of sanctions, in the amount of $5,310.50, against both the debtor and her attorney, jointly and severally, in the exercise of the bankruptcy court's inherent authority. In re Steffen, 2009 WL 1491729 (Bkrtcy.M.D.Fla., Judge Paskay).

The term "interest," as used in a section of the Bankruptcy Code which sets forth the homestead exemption cap established by the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), and which prevents a debtor from claiming as exempt homestead "any amount of interest that was acquired by the debtor during the 1215-day period preceding the date of the filing of the petition that exceeds in the aggregate $125,000 in value," referred to equity, not title. Thus, a Chapter 7 debtor, by converting nonexempt assets and using the proceeds to pay down his residential mortgage debt within 1,215 days of his bankruptcy filing, thereby "acquired" an "interest" in the homestead property and triggered application of the statutory cap, even though he acquired title to his home well outside this 1,215-day lookback period. Parks v. Anderson, 2009 WL 1407786 (D.Kan., Judge Melgren).

Whether the United States Treasury had exceeded its Congressional grant of authority under the Emergency Economic Stabilization Act (EESA) by providing financing under the Troubled Asset Relief Program (TARP) to facilitate the acquisition of Chrysler's assets as part of a sale outside the ordinary course of its business was an issue that state pension, retirement, and other funds, as undersecured creditors of the Chapter 11 estate that were bound by a prior agreement regarding the disposition of their collateral, and that would be receiving at least as much under the proposed sale as the maximum value of the collateral disposed of by the sale, did not have standing to raise. The funds could not allege any injury in fact, and even if they could, it was an injury traceable to the sale itself, rather than to any alleged misuse of TARP funds in connection therewith. In re Chrysler LLC, 2009 WL 1507540 (Bkrtcy.S.D.N.Y., Judge Gonzalez).