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Tuesday, 16 June 2009

America: Democracy and the Rule of Law

One of the problems with doing business in many African and some Asian countries is that a plaintiff may have a hard time securing justice through the legal process. Dealing with a government in western countries is always difficult, but elsewhere it may be nigh on impossible. The court system may be said to be founded on European principles, often French or British, but somehow the result often seems to be less satisfactory. Powerful interests seem to have a way of prevailing, and the hand of the government may be seen in the background, pulling stings for the benefit of those that help to keep it in power.

Consider then the plight of the pension fund of the State of Indiana, the Indiana State Teacher's Retirement Fund, and a few others who chose to challenge the White House's involvement in the Chrysler bankruptcy filing.

Chrysler filed for bankruptcy because it had taken on debt which they would never repay. The bankruptcy process is relatively simple in principle. The assets of the bankrupt company are sold to the highest bidders and the proceeds are distributed to the creditors, but not all creditors are created equal. There are a long line of people trying to get their money back, and the bankruptcy law specifically stipulates who has the highest priority.

A company raises capital by issuing shares and debt. The debt can be secured on the assets of the company whereas the unsecured debt relies of the general credit of the company, but because the secured creditors are taking less risk on the company. At the front of the line in a bankruptcy stand the secured creditors, followed by the unsecured creditors. At the back of the line are the holders of common shares. Somewhere in the middle are preferred shareholders. When debt is issued secured creditors generally accept a lower rate of interest than unsecured creditors because they take less risk.

The White House interfered in Chrysler's bankruptcy, arguing that normal bankruptcy procedure should be ignored in the “interests of other stakeholders”, and that secured creditors should not take precedence. Most of the secured creditors were already in hock to the government through TARP, so their complaints did not last long, but the Indiana pension funds were not so sympathetic and asked the Supreme Court to strike out the bankruptcy filing, but after a stay, Judge Ginsberg let the filing proceed.

So the teachers and firemen of Indiana will suffer from the actions of the executive branch recouping about 33 cents on the dollar for their secured debts, but who is the principal beneficiary? By all accounts it is the United Auto Workers Union and their pension funds who will get 55 per cent of the residual value of the company for their supposedly higher risk unsecured paper. Under normal bankruptcy law the secured creditors would have got their money back in full before the UAW saw any value.

But then the Indiana public servants didn’t contribute to the Obama presidential campaign on the same scale as the UAW.

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