US BANKRUPTCY LAW

Power to reject contractsPerhaps the primary reasonsChapter 11 makes sense for GMand Chrysler are Sections 365 and1113 of the Bankruptcy Coderegarding “executory contracts”(including dealer agreements) andcollective bargaining agreements(union contracts), respectively.These provisions make it relativelycheap and easy for a debtor to riditself of “burdensome” contracts.Section 365 gives the debtor theright to assume, or reject, anexecutory contract. Rarely does a

Bankruptcy Court challenge theexercise of a debtor’s businessjudgment on this point,particularly in absence of keycreditor objections.

The rejection of an executorycontract is treated as a breach ofcontract by the debtor. Thedamage claim arising from thedebtor’s breach of contract isdeemed to be a pre-petitiongeneral unsecured claim, whichoften has minimal value.

As the US auto industryattempts to right-size itself inresponse to declining sales and

market share, reducing the dealernetwork is, unfortunately, anecessary step. Section 365 of theBankruptcy Code is the perfecttool for this purpose.

Bankruptcy Code Section1113 is a powerful tool for dealingwith union contracts, which aretreated similarly to executorycontracts. A debtor can reject aunion contract if the union refusesto accept modifications to thecontract necessary to permitreorganisation and to assure allcreditors, the debtor and affectedparties are treated fairly andequitably. With GM and Chrysler,it appears that political forcestempered the full power andimpact of Section 1113. In thesecases of unprecedentedgovernment intervention, itappears that while modificationswere made to the union contractsto reduce costs, the unions haveended up owning a substantialequity stake in the new entities.

Without Section 365 and

DAVID H. CONAWAYAttorney at Law, Shumaker,Loop & Kendrick, LLP

36 Autumn 2009

GM and Chrysler:The Chapter 11 SolutionAfter US Government “bailout” loans, days of USCongressional hearings, and months of speculation about“too big to fail” or the “cascading” effect throughout thesupply chain, GM and Chrysler both filed for protectionunder Chapter 11. Here’s why Chapter 11 makes sense

Bankruptcy Law in the USIn this edition we start a regular column by UScontributor David H. Conaway, an Attorney atLaw with Shumaker, Loop & Kendrick, LLP

US BANKRUPTCY LAW

1113, debtors would be required toterminate contracts under variousstate and federal laws includinglabour laws, franchise laws,dealership laws and state contractlaw. This would be anoverwhelming task as virtuallyevery state’s laws would beinvolved and litigation wouldalmost certainly be required. Itcould take years and incrediblefinancial resources to terminatecontracts without Section 365 ofthe Bankruptcy Code… neithercheap nor easy.

Power to writedown secured debtAnother reason why Chapter 11makes sense relates to theBankruptcy Code’s treatment ofsecured debt. The recent headlinesreported that GM and Chrysler’smajor creditors took substantial“hair cuts” regarding theindebtedness owed to them. Inparticular, in Chrysler the secured

lenders received only 29% of theirclaims. The reason why securedlenders can be compelled to acceptless is Section 506(a) of theBankruptcy Code, which providesthat a creditor is secured only tothe extent of the value of itscollateral. In GM, the BankruptcyCourt found that even though thesecured debt was approximately$50 billion, the liquidation valueof the GM assets was between $6–$10 billion. Another motivationmay have been the leverage of theUS Treasury Department as manyof the lenders were TARP(Troubled Asset Relief Program)participants. Interestingly, onenon-TARP secured lender toChrysler, the Indiana StateTeachers Retirement Fund,objected to the Chryslersettlement.

Other dynamics may impactthe debtor’s use of Section 506(a)as a tool to write-down debt. Forexample, the debtor’s pre-petitionlender is often the debtor’s

Chapter 11 and exit lender. Thus,lenders may be able to “negotiate”the secured debt write-down.

Power to sell assetsfree and clear of liensOne more reason Chapter 11 isthe best option for GM andChrysler is Section 363 of theBankruptcy Code, relating to salesof assets. In a non-bankruptcysetting, to sell assets, a debtor mustcomply with the laws of eachjurisdiction where assets may belocated. The respective rights ofparties’ competing secured or lieninterests must be resolved prior tosale, which will likely requirelitigation and very often results in anon-unified, piece-meal sale ofassets. By the time the parties’respective rights are adjudicated,the operating losses have likelyeroded the asset valuessubstantially.

Section 363, by contrast,allows a debtor to sell assets,including substantially all of itsassets, free and clear of liens, withthe liens attaching to the proceedsof sale. This eliminates the need toadjudicate the rights of variousparties in the assets prior to sale.Moreover, Section 363 allows for aquick sale of assets to avoid furtheroperating losses and hopefullyachieve maximum value for theassets. The Section 363 sale oftenculminates in an “auction” wherethe “best” bid is selected andapproved by the BankruptcyCourt. In the case of GM andChrysler, both “debtors” were ableto obtain quick Bankruptcy Courtapproval of Section 363 sales.

The tools of Chapter 11,specifically Sections 365 and 1113(rejection of contracts), Section506(a) (write-down of secureddebt) and Section 363 (sale ofassets) make Chapter 11 the idealsolution for GM and Chrysler.These tools have been and willcontinue to provide strugglingbusinesses in all industriessubstantial incentive to chooseChapter 11 as a business strategyto restructure, reorganise, and toliquidate business operations andtheir assets.

Autumn 2009 37

Section 363 allowsa debtor to sellassets free andclear of liens

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