1. US BANKRUPTCY LAW
Bankruptcy Law in the US
In this edition we start a regular column by US
contributor David H. Conaway, an Attorney at
Law with Shumaker, Loop & Kendrick, LLP
market share, reducing the dealer
GM and Chrysler: network is, unfortunately, a
necessary step. Section 365 of the
The Chapter 11 Solution Bankruptcy Code is the perfect
tool for this purpose.
After US Government “bailout” loans, days of US Bankruptcy Code Section
Congressional hearings, and months of speculation about 1113 is a powerful tool for dealing
“too big to fail” or the “cascading” effect throughout the with union contracts, which are
supply chain, GM and Chrysler both filed for protection treated similarly to executory
contracts. A debtor can reject a
under Chapter 11. Here’s why Chapter 11 makes sense
union contract if the union refuses
to accept modifications to the
contract necessary to permit
DAVID H. CONAWAY Power to reject contracts Bankruptcy Court challenge the
reorganisation and to assure all
Attorney at Law, Shumaker, exercise of a debtor’s business
Perhaps the primary reasons creditors, the debtor and affected
Loop & Kendrick, LLP judgment on this point,
Chapter 11 makes sense for GM parties are treated fairly and
particularly in absence of key
and Chrysler are Sections 365 and equitably. With GM and Chrysler,
creditor objections.
1113 of the Bankruptcy Code it appears that political forces
The rejection of an executory
regarding “executory contracts” tempered the full power and
contract is treated as a breach of
(including dealer agreements) and impact of Section 1113. In these
contract by the debtor. The
collective bargaining agreements cases of unprecedented
damage claim arising from the
(union contracts), respectively. government intervention, it
debtor’s breach of contract is
These provisions make it relatively appears that while modifications
deemed to be a pre-petition
cheap and easy for a debtor to rid were made to the union contracts
general unsecured claim, which
itself of “burdensome” contracts. to reduce costs, the unions have
often has minimal value.
Section 365 gives the debtor the ended up owning a substantial
As the US auto industry
right to assume, or reject, an equity stake in the new entities.
attempts to right-size itself in
executory contract. Rarely does a Without Section 365 and
response to declining sales and
36 Autumn 2009

2. US BANKRUPTCY LAW
“Section 363 allows
Chapter 11 and exit lender. Thus,
lenders may be able to “negotiate”
the secured debt write-down.
a debtor to sell
Power to sell assets
free and clear of liens
assets free and
One more reason Chapter 11 is clear of liens
the best option for GM and
Chrysler is Section 363 of the
Bankruptcy Code, relating to sales
”
of assets. In a non-bankruptcy
setting, to sell assets, a debtor must
comply with the laws of each
jurisdiction where assets may be
located. The respective rights of
parties’ competing secured or lien
interests must be resolved prior to
sale, which will likely require
litigation and very often results in a
non-unified, piece-meal sale of
assets. By the time the parties’
respective rights are adjudicated,
the operating losses have likely
eroded the asset values
substantially.
Section 363, by contrast,
allows a debtor to sell assets,
including substantially all of its
assets, free and clear of liens, with
the liens attaching to the proceeds
of sale. This eliminates the need to
adjudicate the rights of various
parties in the assets prior to sale.
Moreover, Section 363 allows for a
1113, debtors would be required to lenders received only 29% of their quick sale of assets to avoid further
terminate contracts under various claims. The reason why secured operating losses and hopefully
state and federal laws including lenders can be compelled to accept achieve maximum value for the
labour laws, franchise laws, less is Section 506(a) of the assets. The Section 363 sale often
dealership laws and state contract Bankruptcy Code, which provides culminates in an “auction” where
law. This would be an that a creditor is secured only to the “best” bid is selected and
overwhelming task as virtually the extent of the value of its approved by the Bankruptcy
every state’s laws would be collateral. In GM, the Bankruptcy Court. In the case of GM and
involved and litigation would Court found that even though the Chrysler, both “debtors” were able
almost certainly be required. It secured debt was approximately to obtain quick Bankruptcy Court
could take years and incredible $50 billion, the liquidation value approval of Section 363 sales.
financial resources to terminate of the GM assets was between $6– The tools of Chapter 11,
contracts without Section 365 of $10 billion. Another motivation specifically Sections 365 and 1113
the Bankruptcy Code… neither may have been the leverage of the (rejection of contracts), Section
cheap nor easy. US Treasury Department as many 506(a) (write-down of secured
of the lenders were TARP debt) and Section 363 (sale of
Power to write (Troubled Asset Relief Program) assets) make Chapter 11 the ideal
down secured debt participants. Interestingly, one solution for GM and Chrysler.
non-TARP secured lender to These tools have been and will
Another reason why Chapter 11 Chrysler, the Indiana State continue to provide struggling
makes sense relates to the Teachers Retirement Fund, businesses in all industries
Bankruptcy Code’s treatment of objected to the Chrysler substantial incentive to choose
secured debt. The recent headlines settlement. Chapter 11 as a business strategy
reported that GM and Chrysler’s Other dynamics may impact to restructure, reorganise, and to
major creditors took substantial the debtor’s use of Section 506(a) liquidate business operations and
“hair cuts” regarding the as a tool to write-down debt. For their assets.
indebtedness owed to them. In example, the debtor’s pre-petition
particular, in Chrysler the secured lender is often the debtor’s
Autumn 2009 37