The Bankruptcy Code mandates that secured creditors be paid the full value of the collateral securing their claim. Only after secured creditors are paid IN FULL is unsecured creditors to be paid anything. In thousands of cases every year, debtors and creditors are bound by the “priority scheme” set forth in the bankruptcy code. Often, a debtor’s inability to pay its secured creditors is the primary reason the debtor is unable to reorganize under chapter 11 of the Bankruptcy Code.
For this reason, Chrysler filing bankruptcy is raising a lot of eyebrows amongst seasoned bankruptcy practitioners and judges. A federal appeals court in New York had earlier approved the sale of Chrysler’s assets to Fiat. A group of Indiana pension and construction retirement funds, which hold less than 1 percent of Chrysler’s secured debt, claimed the sale unfairly favors Chrysler’s unsecured stakeholders such as the union ahead of secured debt holders like themselves.
Chrysler, Fiat and the Obama administration warned that the Supreme Court’s intervention could ruin the sale, stressing that Chrysler was losing $100 million every day its plants remain closed and that the deal would automatically terminate in less than a week, with no guarantee that a new agreement would be reached. If the closing was delayed by more than 10 days, the government will need to “either to increase its overall funding to the detriment of taxpayers, or abandon its role in the transaction,” the administration said.
Without a doubt, the stakes were high but the result – complete abandonment of 50 years of bankruptcy laws – was surprising. The Supreme Court turned down the Indiana funds’ request to block the sale, essentially deciding that the issue was not serious enough to warrant hearing a full appeal.
The general thinking is that the Obama Administration is the driving force behind these developments. Before the bankruptcy, the Administration consistently referred to any automaker bankruptcy as a “structured” bankruptcy. As anyone practicing in bankruptcy can tell you, “mega” bankruptcies such as Chrysler or GM are never structured and more often resemble a three-ringed circus. Having seen the Chrysler case play out, it is clear that the executive branch has had a controlling hand in the bankruptcy case.
Allowing the executive branch of the government to unilaterally ignore the well-established rules of the Bankruptcy Code because the debtor in the case is “too big to fail” sets a dangerous precedent. It is not hard to imagine future bankruptcy counsel arguing that future debtors are also “too big to fail.” If Judges follow the Chrysler decision, the result is that the system as we know it will not apply to large bankruptcy cases and that “new rules” will be constructed to help failing companies.
Most dedicated bankruptcy lawyers and judges maintain a stout devotion to the “integrity of the system,” a phrase often used to imply that the rules of the Bankruptcy Code must be followed no matter what the circumstance. I have always believed that the integrity of the bankruptcy system was unwavering and that all debtors – large or small, personal or corporate – were bound by the same rules. The Chrysler case calls that belief into question.