Opinion

Felix Salmon

Memewatch, legal-rights edition

By Felix Salmon
June 3, 2009

David Reilly has come out with one of the purest forms yet of the “legal rights” meme:

Bondholders are told to give up legal rights, and cash, as part of a government-mandated tradeoff that favors a politically connected special-interest group.

The big threat is that this policy will extend to all bonds, including Treasury and municipal debt, not just corporate obligations…

The president, Einhorn said, had introduced a “quixotic idea” into credit markets: “that creditor recoveries in troubled situations can be determined by an arbitrary sense of shared sacrifice rather than legal agreements and long- established prior practice.” …

That theme was echoed at the Sohn conference by Paul Singer, head of Elliot Associates LP, one of the biggest and most successful hedge-fund managers.

Singer’s funds have used the courts to enforce their rights as creditors. He spoke of his concern the law will be circumvented.

Yet even here, in an 800-word column devoted to the subject, Reilly can’t actually name a single “legal right” which GM bondholders have been told they have to “give up” or which has been “circumvented”. Instead, he’s reduced to a vague sense of “that’s not fair”:

In the run-up to GM’s Monday bankruptcy filing, bondholders were told they would do far worse in a government-organized and -financed restructuring than would a health-care trust fund for GM’s unionized retirees. That was the case even though bondholders were owed $27 billion versus $20 billion for the trust, and even though bondholders’ claims were legally equivalent to those of the trust…

The deal certainly didn’t represent, as Obama said during a Monday press conference, an “equitable outcome” for bondholders.

Reilly neglects to mention, here, that the bondholders are going to get a huge chunk of the “old GM” — the assets which will remain in Chapter 11 after the “new GM” emerges from it. The UAW isn’t.

But more to the point, an unsecured creditor has no “legal right” to get exactly the same outcome as any other creditor with whom she is pari passu. The creditor does have the legal right to kvetch to a judge about fairness, that’s about it. And if the bondholders have a better idea of what’s fair, they’re more than welcome to provide tens of billions of dollars in debtor-in-possession financing in order to make that happen. But of course they’re not willing to put in so much as a nickel, which means that it’s not up to them, and the entity providing the financing — in this case, the US Treasury — gets to call the shots.

As for Paul Singer, I’m curiously untouched by his crocodile tears over bondholder rights. Yes, he regularly goes to court to enforce those rights — that’s how he makes high returns for his hedge fund. If there were nothing to complain about, he’d be out of a job. And, of course, he’s very politically active on the Republican side of the aisle: it’s unlikely he’ll ever have anything particularly nice to say about the Obama administration.

So let’s find a legal expert to come out and say that certain specific rights have been overridden. Or, if we can’t, let’s drop this meme altogether.

Comments
19 comments so far | RSS Comments RSS

nice article, I really enjoy read this artikle

 

Not sure why you persist in this, Felix. Pari Passu means “of equal step”. Now, when I do a law search I find hundreds of cases which assert that bondholders who are pari passu do in fact have exactly this legal right to get the same outcome as other creditors with whom they are pari passu.

Posted by Sean | Report as abusive
 

[I find hundreds of cases which assert that bondholders who are pari passu do in fact have exactly this legal right to get the same outcome as other creditors with whom they are pari passu.]

and indeed they would have been paid pari passu in a liquidation. However, that isn’t what happened.

What happened is that the government volunteered to provide debtor-in-possession financing in a Chapter 11 bankruptcy, on condition that the UAW trust was treated as it was. The bondholders agreed to this, because they thought that less than pp of somethin’ was worth more than a pari passu share of nuthin’.

What you’re looking for is even a single case in which the bondholders are found to have a right that anyone offering DIP finance to a firm in Chapter 11 bankruptcy may only do so on a pari passu basis.

Posted by dsquared | Report as abusive
 

I think you should check out this blog. I’m not a lawyer by any means, but bankruptcy is all about priority and procedure. I think there is probably a good case that this procedure has been very unusual.

http://www.bankruptcylitigationblog.com/

Posted by chappy | Report as abusive
 

We keep being told that the “bondholders” have approved this deal. Actually, the vast majority of bondholders have never been consulted, and the institutional groups who took this deal paid far less than par for their holdings. The individual bondholders (about $7 billion) paid full value for their holdings so they have much more at risk, yet they were never consulted in any way. many of these people are retirees who depend on this income to live.
So those with 20 cents on the dollar at risk took a deal for 20 cents on the dollar. Those with 100 cents on the dollar at risk are being coerced to accept this same deal. FAIR?????

Posted by Unrepresented Bondholder | Report as abusive
 

No individual GM bondholders have ever been consulted on this matter. The institutions who “approved” the current deal have purchased their bonds at steep discounts so have little at risk. The individual bondholders have purchased $7 billion at or near full price mostly to fund their retirements.
So those with 20 cents on the dollar invested have accepted a deal of 10 – 20 cents on the dollar, and those with 100 cents on the dollar invested are being coerced to accept the same deal. FAIR?? I think not!

Posted by Unrepresented Bondholder | Report as abusive
 

I was involved as a bondholder in a bankruptcy involving a certain, now deceased, ruthless investor and one of his companies. He threatened that we’d receive less in certain circumstances – which he’d make difficult. The creditor meetings were, in retrospect, a hoot because of the posturing which played creditor class versus creditor class. The point is a deal was made because that’s how the process works. The alternatives to a deal were worse for the creditors.

My point is that you can’t compare litigation results to negotiation results. Litigation and court decisions means a deal was not reached. Those cases are useful for determining how future games play out but they are different from cases where hard bargaining results in a deal. As in this case, the odds of getting a sufficient liquidation – partial or complete – that would pay off the bondholders at a high enough rate to risk that course was zero. (It was actually negative, given the political fallout.)

The distorted general point that the government forced bondholders to cave misses the point that this was a negotiation, not a lawsuit, that rights were exchanged not invalidated in court. The government used the power of finance not of nationalization as its lever and that’s the main lever any financing group has – essentially as noted by dsquared in his comment.

Posted by jonathan | Report as abusive
 

I think the broader point is, what if another well-connected industrial complex manufacturer reaches a similar tipping point as GM and Chrysler both did? Who is to say that another large conglomerate with web-like tentacles reaching into everyday American life looks to the govt for “knight in shiny armor” salvation? Bondholders are being told “you’ll get nothing and like it”…thus the problem.

if GM can’t obtain DIP financing in the private arena then perhaps failure is another option to be considered. perish that thought

GE bond-holders take note…I JOKE! Yet, it seems the BROADER THEME (by a few) in the present admin that banks / bondholders are not needed…I guess when taxpayers get to fund a dying breed we all win. I am waiting for someone to tell us all how the UAW will continue this hypocrisy of paying above-market wages to produce vehicles that are less-desirable than the competitive market demands.

Posted by Griff | Report as abusive
 

Keep at it, Felix. You are correct that by providing DIP financing, the Feds could call the tune. They did the very smart thing for all taxpayers, *even Republicans*, by prioritizing the workers, since (as you mentioned in the other post) the whole point of the US’ participation was to avoid -as much as possible – the huge damage to US finances that a GM liguidation would cause. In other words, give preference to the workers because their alternative is turning to the US government for unemployment, retraining, healthcare. We presume most of the hedge fund operators are, by and large, less eligible for government largesse.

So this was a simple, completely legal transaction that results in the best possible outcome for all US taxpayers.

As for Griff, you mentioned ” this hypocrisy of paying above-market wages to produce vehicles that are less-desirable than the competitive market demands.” I don’t really think that describes the UAW. Since the decisions to build and sell “less-desirable” vehicles were entirely in the hands of the managerial class, I believe that describes the MBAs in the glass towers of GM. And they were certainly paid well…..

Posted by dollared | Report as abusive
 

It’s fruitless to say this but the cost differences are almost all legacy not current labor costs.

Posted by jonathan | Report as abusive
 

Taxpayers can expect about the same outcome here as in the case of Citigroup…name another dying company / industry “we” get to invest in next. IF this isn’t socialism it’s a stone step in that direction. I support aiding GM in this process…anything to prevent disorder seems logical in the short-term.

Long-run I do not support a taxpayer subsidy for continued employment of a 20-year veteran making $95,000 with full benefits and few out-of-pocket costs for health premiums.

As for those white collars, they’ll do their penance in the unemployment line and pay for their mismanagement. Managers fail in private industry all the time, however…the UAW workers seem to be an isolated class highly involved in their negotiations to garner ever increasing wage / benefit increases in spite of plentiful evidence that competitive forces are driving the industry to non-union, right to work states where quite capable employees are prevalent.

Textile / furniture factories left the southeast last 15 years…North Carolina was able to transition to more services-type economy / jobs. Why not the rust belt ?!?

Posted by Griff | Report as abusive
 

It is my understanding that the entity providing DIP financing would rarely choose which of the unsecured creditors get how much. That is generally a negotiation between the company, the creditors as a class, and the court. Why the government should receive different treatment as the DIP financing is a mystery. To call the discussion between the government and Chrysler creditors a negotiation is like saying that the Russian president is ‘elected’.

Here is a question to consider. Would the economic fallout of letting Chrysler go under be less than the approximately $30Bn of government money that has gone in? What about the $50Bn (>50?) that will be provided to GM?

Posted by Rustbelt | Report as abusive
 

[It is my understanding that the entity providing DIP financing would rarely choose which of the unsecured creditors get how much.]

absolutely not the case; it is completely standard for a provider of DIP financing to clear wage arrears, for example.

Posted by dsquared | Report as abusive
 

The DIP financiers have been pulling this $#!% for decades — the difference is that one of their conditions was always that the pension benefits get dumped on the government.

We should all be pleased that Obama’s willing to pay these guys back with a little of their own medicine.

Posted by Anonymous | Report as abusive
 

Here’s your answer. Go to http://www.sec.gov/investor/pubs/bankrup t.htm

Posted by Mark | Report as abusive
 

OK, I am the DIP provider to a bankrupt company which has two issues of $100 unsecured bonds ($200 total) that are pari passu.

I provide the DIP and _tell the judge_ “I call the tune” on the recovery which, lets say is equity only. I give bond #1 10% equity and I give bond #2 90% of the equity.

Later, it is revealed that I, the DIP lender, owned bond #2.

Posted by von Pepe | Report as abusive
 

[Later, it is revealed]

What material facts about the GM insolvency and the government’s position do you think there are which haven’t been revealed? Otherwise this is pretty transparently disanalogous.

Posted by dsquared | Report as abusive
 

Yes, that was for drama; as if the Obama and the UAW were the same entity due to political bribes. Let me revise the scenario:

I am the DIP provider to a bankrupt company which has two issues of $100 unsecured bonds ($200 total) that are pari passu.

I provide the DIP and _tell the judge_ “I call the tune” on the recovery which, lets say is equity only. I give bond #1 10% equity and I give bond #2 90% of the equity.

Is there a problem?

Posted by von Pepe | Report as abusive
 

von Pepe,

If the liquidation value of the company was $0 and bond #2 is owned by the scientist who is the only person with the knowledge make the company’s software work, while bond #1 belongs to a passive investor, I would say that’s the natural result of a bargaining process.

Or as many have been trying to explain — in bankruptcy the final resolution often depends on the details of the case at hand.

Posted by Anon | Report as abusive
 

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