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U.S. Supreme Court urged to protect secured creditors' rights in bankruptcy‏

By Nick Rees | Oct 13, 2009

U.S. Supreme Court building

NEW YORK (Legal Newsline) - Important Chapter 11 protections that secured creditors rely on in bankruptcy proceedings will be threatened if a 2nd U.S. Court of Appeals decision is not overturned, the Washington Legal Foundation said.

In urging the U.S. Supreme Court to take the case on in a brief filed in Indiana State Police Pension Trust v. Chrysler LLC, the WLF argued that the appeals court basically cordoned the U.S. Treasury's redistribution value in the Chrysler bankruptcy from senior, secured creditors with priority liens to junior, unsecured creditors.

The WLF said the appeals court, in affirming the bankruptcy court's ruling in the case, will cause the destabilization of existing and future credit markets by undermining the property rights of secured creditors.

WLF's brief was filed on its own behalf as well as on behalf of its clients, the Allied Educational Foundation, the Cato Institute, and Professor Todd Zywicki.

The case came about following the Chrysler Corporation's high-profile bankruptcy, during which the U.S. Treasury orchestrated a sale under Section 363 of the Bankruptcy Code, which allowed debtors to avoid having to fully compensate a group of first lien priority creditors. The first lien priority creditors in Chrysler's case included two funds invested on behalf of approximately 100,000 retired Indiana teachers and police officers.

A $4 billion loan was extended to Chrysler by the Treasury prior to the filing for bankruptcy. At the time, the Treasury strongly urged Chrysler to proceed with its sale in bankruptcy.

The WLF has argued that the federal government is not authorized by the Emergency Economic Stabilization Act, which the Treasury used as its authority to extend Chrysler the loan, to use TARP money to bail out the automobile industry. The use of TARP funds was also a contradiction to previous public prior announcements by the Treasury about its authority.

The Indiana pensioners objected to the bankruptcy sale, arguing that the Section 363 sale would deprive them of the priority preference afforded to secured creditors, which was a preference the group had bargained for in deciding to invest in Chrysler. The bankruptcy court, however, approved the sale, stating that it was in Chrysler's best interest.

The WLF has argued that the Treasury owes a fiduciary duty to all of Chrysler's creditors and not to just a select few and that it is fundamentally unfair to exploit its unique powers by saddling such private parties as the Indiana pensioners with losses attributable to the federal government's own plan to rescue Chrysler from insolvency.

"The Chrysler bankruptcy sets a dangerous precedent," Cory Andrews, WLF's senior litigator, said. "By allowing debtors to use the expedient of a Section 363 sale to circumvent the important protections normally afforded secured creditors under Chapter 11, the decision below creates a powerful disincentive for investors to lend vital capital to troubled companies that might be in danger of insolvency."

Economists, legal scholars and other commentators have warned that the precedent that the bankruptcy court established in this case could destabilize the nation's investment markets.

Banks have expressed fear that both the lack of transparency and the lack of consistency in applying bankruptcy rules could cause a lack of confidence among investors and lenders.

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