Politics trumps seniority for bondholders in GM, Chrysler bankruptcies

Bondholders, who traditionally end up with the best deal in bankruptcy proceedings since they hold senior debt, appear to be losing out in both the Chrysler and GM bankruptcies. In an unusual twist, the government and employees will likely end up with a bigger share of the two companies as political expediency trumps traditional bankruptcy laws.

"They are rewriting law, and certainly bond markets never priced in an interpretation that you can rewrite things because it's in the best interest" of unintentional stakeholders -- taxpayers, the company's employees, and municipalities that will be affected, Kingman Penniman, president of KDP, told MarketWatch.

If, as now expected, GM's path to bankruptcy follows that of Chrysler's, bondholders will likely end up with a smaller stake in the reorganized business even though they are senior creditors. This trade off ensures employees will have a bigger stake in the new company.

Now that the bankruptcy has been filed, the trustee for the bondholders will contact each bondholder, probably in the next two weeks, and ask if they approve of the latest deal to restructure the company and sell its good assets to the government. If GM can follow the same quick path as Chrysler, it could be out of bankruptcy in 45 to 60 days, rather than the usual 12 to 18 months.

GM will not go through the traditional bankruptcy. The role of the U.S. government is a wildcard that has upended traditional bankruptcy procedures. Expediency will be king and seniority will take a back seat. "Based on what we saw from Chrysler, we have no idea what the bonds are worth, seniority being thrown out the window. The political and economic pressure is going to be there to get it done quickly," Michael Kalscheur, a financial consultant at Castle Wealth Advisors, told MarketWatch.

Currently the deal on the table would swap debt for 10 percent equity in the newly formed company with warrants for up to another 15 percent stake as the company grows. The legal counsel for the bondholders' committee, Weiss Rifkind Wharton & Garrison, is currently asking bondholders whether or not they support the plan.

Which do you think should take priority in what will be one of the biggest corporate bankruptcies -- political expediency to get out of the bankruptcy ASAP or bankruptcy tradition to give senior bondholders their usual strong position?

Lita Epstein has written more than 25 books, including Trading for Dummies and Reading Financial Reports for Dummies.

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