Bankruptcy

Treasury Recognizes GM/Chrysler Loan SNAFU

By Adam Levitin

It seems like Treasury now realizes that it did a terrible job structuring its loans to GM and Chrysler, as I wrote at the time. (Of course, this assumes that the government was looking to recover the loans, not just make a gift to the auto companies.)  The loan agreement gives the government a second or third priority security interest.  That's not the safest spot in the world, especially on collateral that is pretty worthless outside of the auto companies as going concerns (who else wants a 200,000 sq. foot plant in Flint, Michigan?), and there's a good chance that the companies would eventually liquidate in bankruptcy.

Now Bloomberg reports that the government hired Cadwalader last month to help establish its place at the front of the line for repayment.   They hired a law firm after they lent the money?!!!  WTF?!!!   I mean, it was pretty apparent from the GM/Chrysler term sheets that the Paulson Treasury department either wasn't getting competent bankruptcy advice or was just ignoring it.  But even within the standards of the Paulson Treasury, entering this sort of multi-billion dollar distressed deal without good bankruptcy counsel is shockingly negligent.  Paulson Treasury really embodied the term SNAFU.

So what's Cadwalder going to do?  Is there any way to improve the government's priority?  The time to get priority was when the government had the greatest leverage--before it inked the deal.  Good luck now trying to convince the senior lenders to surrender priority.  I don't think the government's threat of forcing the companies into the Chapter is viable.  Is President Obama really going to let GM/Chrysler fail in the first months of his presidency?  Seriously?  Maybe the government is thinking about putting GM and Chrysler into the Chapter with an aim of doing a roll-up on its prepetition loans as part of a DIP?  That's a pretty big gamble, and I dare say raises some real questions about whether the government is acting in good faith if it calls the loans to force BK so it can do a role up.  Methinks those might be grounds for equitable subordination of the government's claim. 

Probably the surest course is for the government to just buy out the senior lenders' positions.  If the new new TARP goal is to buy up troubled assets, this might fit the bill. (But is Cerebus a "financial institution"?  If GM and Chrysler are, then surely Cerebus is, right?)  The government does have some leverage at least with the banks because of its other deals with them, but we could see the strange situation in which the government goes from making a bridge loan to being the major lender to GM and Chrysler. 

And we still have to ask, what good is first priority when there is very limited liquidated value from GM and Chrysler's assets?  There just isn't a market for most of their specialized equipment or real estate?  Is anyone looking for a huge fancy HQ building in Detroit?  First priority might not be enough to protect the government in a liquidation. 

The lesson to be learned here is one of the most fundamental rules of secured credit and bankruptcy:  get priority before you lend.  Duh.

Full post as published by Credit Slips on February 09, 2009 (boomark / email).