action in this deal is going to be focused on whether Chrysler and the government can force this through over any objections of the secured lenders

TO BE NOTED:

The Ins and Outs of the Chrysler Sale

Update | 11:15 a.m. Sunday evening, Chrysler filed the documents related to the proposed sale of its business.

Chrysler, backed by the federal government and the United Auto Workers, is petitioning to sell its business to a “newco” in an expedited procedure under Section 363 of the bankruptcy code. The goal is to push the sale through over any objections from senior secured lenders and allow the Chrysler business to be purchased by Fiat, the UAW’s retirement trust and the United States and Canadian governments. Once the newco purchases the Chrysler business, it will change its name to Chrysler, and the old Chrysler will similarly change its name to something without Chrysler.

New Chrysler will then continue on its hopefully successful way. Behold the magic of bankruptcy at work.

The filing is more than 300 pages. It sets forth the mechanics and details of the Chrysler deal in legal terms. And a review of the papers, and the intricacy of the deal it describes, show without a doubt that a large number of people have been working on this potential bankruptcy filing for a fair bit of time. This is a well-thought out and nicely documented deal.

The filing also contains lots of public-relations nuggets that people can grab onto, depending upon their disposition. On page 211 of the documents (downloadable below) is the letter from the UAW to its retirees outlining the minor changes to the health care retiree trust, known as a VEBA, that are currently planned. The plan’s biggest cuts are to dental and vision coverage, but the UAW states that more changes will be made starting in 2010.

Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the legal aspects of mergers, private equity and corporate governance. A former corporate attorney at Shearman & Sterling, he is a professor at the University of Connecticut School of Law. His columns are available at The Deal Professor blog.

This is a political punt to put off the harder decisions to the VEBA trustees, who will be majority independent, rather than the union. Also — and this is strange — one of the few cuts to retiree benefits occurring now is that retirees are losing their entitlement to erectile dysfunction medicine. Go ahead and laugh, but it seems odd to negotiate such a small detail with all that is going on. They must have really been looking for sacrificial lambs.

But for those who are deal junkies, the real interest in the papers is in the asset sale agreement. This is the operational document that will transfer the Chrysler business to the newco, if the bankruptcy court approves the transfer.

The most interesting part is on pages 67 to 73, which set forth the terms of the transfer of the assets and liabilities of Chrysler to the newco. This sale is not a stock sale, but rather a sale of assets. Asset sales are much more complicated, since the buyer actually picks and chooses the assets and liabilities that it purchases. The parties must therefore negotiate in painstaking detail which assets and liabilities are transferred.

The agreement takes a broad approach. It transfers all of the assets of Chrysler to the newco except for specified excluded ones. The assets not transferred include a number of plants and assets scheduled on the disclosure schedules to the agreement. These are unfortunately not all disclosed, though the excluded plants are listed on page 25.

The second part of any asset sale is the assumption of liabilities by the buyer. This is the most important, and where one of the main benefits of an asset sale typically lie. The reason is that the buyer can simply refuse to assume those liabilities it does not want to pay for. It can therefore make a clean break with the parts of the seller that are undesirable to keep.

Here, the Chrysler agreement is again overbroad in transferring liabilities in excessive amounts than normal to the buyer, among other things transferring accounts payable, environmental liabilities and obligations for warranties. The last is important, as it allows Chrysler to stand by its cars and preserve reputation.

But there are still exclusions from the transferred liabilities that will remain with the bankrupt Chrysler entity. This appears to include all claims for product liability that are pending. Selected litigation liabilities are also excluded, including workers’ compensation claims, and liabilities related to litigations brought by Getrag Transmission Manufacturing and Faurecia Interior Systems. Claimants here are likely to also be out of luck as they will now become unsecured creditors in bankruptcy.

Sorry, old Chrysler customers — it appears that if your warranty is expired or inapplicable, and your claim is one for negligence for product liability, you are one of these out-of-luck people.

The key to this deal is that the parties have put it on a short leash. The agreement states that if the Chrysler sale is not completed by June 15, 2009 — extendable by 30 days if antitrust clearance is still needed — then Fiat can terminate the agreement at any time. This allows Chrysler to argue to the bankruptcy court that the sale must be completed as soon as possible or otherwise will be lost. The deal will not close right away even if the court allows it: there is a target closing date in the first week of June. And the United States, Canada, the European Union (or any relevant member states of the European Union) and Mexico are required to obtain antitrust clearance for the approval.

Ultimately, the agreement is interesting more for what it transfers than anything else.

The real action in this deal is going to be focused on whether Chrysler and the government can force this through over any objections of the secured lenders. Here, I suspect that the case has been made, and we will find out in Monday’s 10 a.m. bankruptcy court hearing when these papers are considered. Update: Monday’s hearing on the sale motion has been adjourned to Tuesday at 2:30 p.m.

The value of Chrysler’s assets are uncertain at best, and the purchase price to be paid here is $2 billion cash, funded by the federal and Canadian governments. Moreover, Chrysler appears to be retaining a fair bit of assets, including the ability to sell the Viper assets. Compare this to the likely liquidation value of Chrysler, a large part of which consists of the scrap metal price for its factories.

The government has now passed the crisis stage of the bailout and is now in the less heroic business of day-to-day administration of its liabilities accrued during this time period. This is not only a political game, but one that is likely to push off costs and create more obligations far, far into the future. Remember, this is Chrysler’s second, and likely not last, drink at the federal well.

Download the Chrysler Sale Motion (PDF) »

"Who controls A.I.G.?"

Here's more on AIG from Steven M. Davidoff in the NY Times:

"The terms of the government’s investment in the American International Group were released last week. After reading these terms, I have a multiple-choice question.

Who controls A.I.G.? Is it:

1) The Federal Reserve
2) The Department of the Treasury
3) The current shareholders of A.I.G. (but not the government)
4) All of the above collectively
5) No one knows

The best answer I can discern right now is number 5.

1. In exchange for its $40 billion preferred share injection under the Emergency Economic Stabilization Act, the government is getting a 10 percent dividend on these shares (plus A.I.G.’s agreement to restrictions on lobbying), the same limitations on executive compensation as in other preferred equity injections, a further limitation on annual bonus pools for senior partners not to exceed 2007 and 2006 levels, and compliance with an expense policy. As for control rights — the $40 billion preferred is nonvoting except on certain major issues affecting the preferred. If A.I.G. misses dividend payments for four consecutive quarters, the Treasury has the right under the terms of this preferred stock to elect two directors and a number of directors (rounded upward) equal to 20 percent of the total number of directors after giving effect to such election.

2. In exchange for the new $60 billion Federal Credit Facility (down from $85 billion), the Federal Reserve obtains the general rights of a creditor including senior security over A.I.G.’s unregulated subsidiaries, but no real governance rights except for some negative covenants limiting A.I.G.’s operations and expenditures.

3. Finally, the government is receiving 100,000 Series C preferred shares convertible into 77.9 percent of A.I.G.’s outstanding common stock. This second preferred stock has a vote equal to 77.9 percent of A.I.G.’s share capital and is entitled to 77.9 percent of any dividends paid by A.I.G. on its common stock.

Thus, whoever controls these Series C preferred shares controls A.I.G. These Series C shares, the stock that will vote and control A.I.G., will be owned by is a trust for the benefit of the Treasury Department. The trust is called the A.I.G. Credit Facility Trust. And who are the trustees of this trust and the controllers of A.I.G.? I have no idea nor have I seen any public disclosure on the issue except for news reports in October that these trustees would be appointed by the Fed and that there would be three of them. Moreover, under Section 5.11 of the original credit agreement, a provision that appears to be unamended in the new deal, A.I.G. “shall use all reasonable efforts to cause the composition of the board of directors of [A.I.G.] to be … satisfactory to the Trust in its sole discretion.”

So, why this oddity? I must admit, I am puzzled. Perhaps it is related to accounting or some other legal requirement? But I also suspect it may be political — the government does not want to control A.I.G. directly. Rather, it is preserving some separation of ownership and control to bar future administrations from political meddling (read the Obama administration). This is probably a worthy goal — allowing A.I.G. to operate on an economic basis protected from political meddling.

Of course, this worthy goal is probably trumped by the fact that A.I.G. is a mess and now can borrow up to $170 billion from the government. The governance arrangements simply show what a mess this is.

In any event, there should be adequate oversight of the trust and some mechanisms to prevent the trustees from obtaining their own private benefits from controlling A.I.G. and its $1 trillion in assets. In addition, the trustees themselves should be chosen for their acumen and ability to right the sinking A.I.G. ship. Here, the government could begin by disclosing the terms of this trust once they are drafted."

Here's my comment:

“But I also suspect it may be political — the government does not want to control A.I.G. directly. Rather, it is preserving some separation of ownership and control to bar future administrations from political meddling (read the Obama administration). This is probably a worthy goal — allowing A.I.G. to operate on an economic basis protected from political meddling.’

But it doesn’t, because they’ve been lobbying. That’s the problem with a hybrid plan like this. It looks private, but the company keeps pressuring the government through lobbying to alter the terms in their favor.

You need to have someone who’s only concern is for the taxpayer’s investment. That means someone who actually influences policy. The real issue should be letting the people who got into this mess, or from the same company, keep making the decisions. Either the government should run it, or have a real power of decision. Otherwise, let them deal with their problems on their own.

— Posted by Don the libertarian Democrat

On Government Intervention And Complexity

Great article by Steven M. Davidoff in the NY Times on the Wachovia deal:

"The Law of Unintended Consequences Rules the Day

The slew of legislation, regulation and government intervention is going to engender a cascade of unintended consequences. We saw the first signs of this in the Wachovia deal. The Tuesday after it was announced, the Internal Revenue Service announced that banks would be permitted to deduct on an accelerated basis losses on loans or bad debt acquired in any bank acquisition. This rule will allow Wells Fargo to take substantial tax deductions -– Wells Fargo conservatively predicts a $74 billion loss on Wachovia’s $498 billion loan portfolio. That is a big tax deduction, and no doubt this made Wells Fargo’s decision to bid easier. Incidentally, this means the Wells Fargo bid may ultimately cost the government more money than the Citi transaction, because of the lower taxes that Wells Fargo would pay.

In addition, the parties are battling over the meaning of 126(c) of the TARP bill, for Troubled Assets Relief Program, that Congress passed last week. Each side contends that this provision nullifies the other’s agreement with Wachovia. But at this point, no one definitively knows what the provision means."

My problem with this statement is the problem I had with Bob Barr calling this a non-government solution. Excuse me, but tax policies are government interventions.

Here's another quote:

"Complexity Is Death in Today’s Market

Citi went with a letter of intent because it was arranging an asset purchase. Carving out these depository institutions from Wachovia and negotiating the arrangements could not be done overnight. Hence the use of a term sheet, and perhaps in this haste the reason for the failure to put in a break-up fee. But the need to negotiate these complex documents allowed Wells Fargo to slip in and make a higher bid on a 27-page merger agreement that needed little negotiation. Speed is everything in this market and complexity unduly delays things."

I agree with this, which is why I favored the Swedish Plan and not TARP.