The rough justice meted out to General Motors bondholders may have short-circuited the bankruptcy process, but it has damaged the confidence that holders of other debt can have in their right to fair treatment.
There will be a long-term cost, both to borrowers and lenders as a result. Key to this has been the use — by both GM and Chrysler — of section 363 of Chapter 11 of the U.S. bankruptcy code. By invoking the “emergency” need to restructure the companies, this section has allowed the automakers to speed through the sale of the viable parts of the businesses to new companies and leave the debt behind.
While route 363 by-passes lengthy court hearings, its use to sell prime assets drives straight through the spirit of the code, which was meant to allow companies going through a Chapter 11 to jettison non-core assets quickly as part of a longer and wider reorganisation. It was not designed to cream off the best ones.
Lawyers are already invoking the Chrysler and GM examples to try and get round long-established rules for reorganisations.
The result would be to deprive bond investors of their rights in a company restructuring.
GM bondholders who would normally have enjoyed preferred credit status in a Chapter 11 were railroaded by the Obama administration into giving the quick-fire sale the go-ahead, on the grounds that this was a one-off.
From GM’s point of view, the process has worked well, allowing the business to emerge only 40 days after filing for bankruptcy. The cost of the turnaround has been $50 billion in emergency government financing. The longer-term cost in the much bigger market for corporate debt may be far larger.