The billion-dollar cloud lingering over GM’s bankruptcy

March 20, 2013

More than two years after General Motors received court approval for a plan to issue its old creditors stock in its shiny new self, a dispute among those creditors threatens to saddle the new company with almost $1 billion in liability. In a statement filed this week before U.S. Bankruptcy Judge Robert Gerber of Manhattan, the new company and warring creditor factions disclosed that mediation has failed to produce a settlement of creditor allegations that one group of noteholders extracted preferential treatment from the company as it teetered on the verge of Chapter 11 in 2009. The failure of mediation means that Gerber will be left to reach a ruling based on testimony he heard last fall in an adversary proceeding initiated by the trustee for GM’s unsecured creditors.

Depending on what the judge makes of the trustee’s allegations that four distressed debt hedge funds – Elliot, Appaloosa, Aurelius and Fortress – forced old GM to accede to what amounts to a $367 million fraudulent conveyance, there’s even an outside chance that GM’s entire 2009 asset sale could be voided. That’s a very remote prospect, but the mere possibility shows the risk to new GM in this little-noticed case.

The backstory on the hedge funds and their deal with old GM is incredibly complicated, but I’ll boil it down. According to the trustee’s complaint, filed in March 2012, distressed debt investors began snatching up notes issued by a GM subsidiary called Nova Scotia Financing Company in late 2008 and early 2009, when GM seemed to be well on its way to Chapter 11. Nova Scotia’s only real assets were two intercompany loans to GM Canada, which was operating in the same straits as its parent company. GM did not want GM Canada to go into bankruptcy, presumably because it didn’t want to deal with bankruptcy proceedings in two different countries at the same time. So the hedge funds that held Nova Scotia notes knew GM was desperate to resolve their potential claims against GM Canada.

Days before GM filed for Chapter 11, the parent company loaned $450 million to GM Canada, earmarked for a deal with the Nova Scotia noteholders. Lawyers for GM and the noteholders negotiated right up to – or possibly just after – GM’s filing on June 1, 2009. Indeed, the precise timing of their actual settlement is a matter of dispute (and legal consequence). The trustee for GM’s other secured creditors claims that the final agreement was not completed until after GM filed for Chapter 11, which would make the deal subject to the bankruptcy court’s approval. GM says it reached the agreement minutes before it filed its Chapter 11 petition. (New GM’s lawyers at King & Spalding have also argued that details of the settlement with the Nova Scotia noteholders were repeatedly disclosed in various documents early in the bankruptcy.)

Under the terms of the last-minute settlement, the hedge funds that owned Nova Scotia notes received a $367 million “consent fee.” GM also agreed that it would support the Nova Scotia noteholders’ claim against the estate, which totaled about $2.7 billion (about $1.7 billion in statutory liability based on GM’s position as the sole shareholder of Nova Scotia Financing and about $1 billion for outstanding notes). In return, the Nova Scotia noteholders released their claims against GM Canada.

New GM has argued that the old GM creditors’ committee knew about and assented to the Nova Scotia deal. It also contends that the lockup agreement with the hedge fund noteholders caused no harm to the bankruptcy estate since GM Canada repaid the $450 million loan to GM. But GM’s unsecured creditors’ committee and the trustee subsequently appointed to represent the interests of unsecured creditors with some $50 billion in claims against the old GM estate have all along opposed the claim of the Nova Scotia noteholders. That’s not a surprising stance. If the other creditors can knock out the Nova Scotia noteholders, that leaves an additional $2.7 billion for them in the old GM estate.

Last March, the trustee’s counsel at Dickstein Shapiro filed the creditors’ adversary proceeding against the Nova Scotia noteholders. The case was tried with surprisingly little fanfare in the summer and fall before Judge Gerber, who heard 16 days of testimony from (among others) GM CFO Daniel Ammann, hedge fund managers from Aurelius and Fortress and hedge fund counsel Bruce Zirinsky of Greenberg Traurig. (To its credit, the Wall Street Journal recognized the significance of the case in coverage last fall.) The evidentiary record closed Tuesday and the judge is now awaiting post-trial briefing.

You may be wondering why the allowance or disallowance of a claim against old GM could impact the successor company. GM offered an answer to that question last August in a filing with the Securities and Exchange Commission: It faces potential liability to the Nova Scotia noteholders if the court invalidates the $367 million consent fee they were paid by GM Canada. GM’s SEC filing estimated that the company’s “maximum reasonably possible loss” was $918 million, which represents the value of the benefit old GM obtained from the consent fee deal with the hedge funds. (GM CFO Ammann reportedly said the same thing in testimony at the trial.)

But there’s a chance that the creditors’ case could be even more costly for new GM. According to comments by the company’s own lawyer at a hearing before Gerber in July, the 2009 sale order that created new GM from the ashes of the old company is “an all or nothing type of proposition.” If the judge voided the agreement with the Nova Scotia bondholders, GM’s counsel suggested, the entire sale order could be in danger.

Creditors and noteholders used the leverage of GM’s exposure to persuade the company to sit down for mediation, but, according to this week’s filing before Gerber, couldn’t force GM to kick in enough money to end the dispute (presumably by paying Nova Scotia noteholders to drop their claim against the estate, which would, in turn, prompt the other creditors to end the adversary proceeding). Interestingly, some of the hedge funds that struck the original 2009 deal with GM and GM Canada have since sold off their notes. Paulson & Co, meanwhile, has become a major holder of Nova Scotia notes, whose only value is in their claim against the estate of old GM. The fund, which participated in the failed mediation with GM and other creditors, seems to be betting that new GM, like its predecessor, will eventually end the game of chicken and pay noteholders to go away.

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