I wrote about (link here) the curious case of GM financing the leveraged buyout of Delphi by Platinum Equity a few days ago. The post didn’t garner much attention and indeed the whole issue seemed to be of little interest to the MSM or the blogosphere. Well the federal bankruptcy judge overseeing the Delphi Chapter 11 proceedings seems to smell a rat as well.

This afternoon, he scotched the deal and ordered an auction of Delphi. From the WSJ here are his comments:

Judge Robert Drain ordered Delphi to hold an auction and allow bids to challenge the government-brokered sale to Platinum Equity. “What’s so special about Platinum?” asked Judge Drain. “They’re just guys in suits. Why can’t the other guys in suits just pay more?’

It’s important to note that the lenders providing the debtor-in-possession financing are the ones fighting the sale to Platinum. That’s weird because normally the DIP lenders want to see a resolution of a bankruptcy proceeding. Their loans are normally money good as they have a senior position to any other creditor. In this case their looking at somewhere between a 10% and 20% recovery rate on their loans.

The structure of the deal is a bit eyebrow raising as well. Platinum is putting in $250 million and committing to an additional $250 million of debt while GM is putting in (taxpayer money by the way) $2.5 billion of equity. I’ve heard but not been able to put my hands on other figures that indicate that this might be more egregious than it appears on its face. Nevertheless, here is how the attorneys for the lenders view the case:

The lenders argued that Platinum was a puppet of the government and GM, which needs Delphi to emerge from bankruptcy for its GM bailout to succeed. Platinum “is an entity funded principally by GM (and thus controlled by the Auto Task Force) in which GM’s and the Auto Task Force’s hand-picked private-equity buyout partner Platinum provides the appearance of an independent third-party in exchange for disproportionate economic returns,” wrote lawyers for a group of lenders in court papers.

The lenders “believe that the GM-Platinum transaction will siphon an extraordinary amount of value from Delphi’s stakeholders to Platinum by offering Platinum rewards incommensurate to its relatively modest investments,” wrote separate lawyers for J.P. Morgan, the agent on a $4.5 billion loan provided to Delphi in 2007 so it could continue to operate under Chapter 11.

The plan calls for some DIP lenders, including the most senior creditors owed about $2.5 billion, to receive 20 cents on the dollar for their loans. These lenders argue that Delphi’s plan overstates the amount they would receive. A Delphi reorganization plan that collapsed in April 2008 called for DIP lenders to receive full payment.

“A DIP loan should be money good,” said Mr. Abrams, whose clients include Silver Point Finance LLC and Monarch Alternative Capital. “It’s the T-bill of a bankruptcy claim.”

A majority of the lenders would have to approve the plan, as would Judge Drain, who expressed similar skepticism as the lenders.

If it ended there that would be fine, but this one takes a turn for the worse. Some pretty big players on the auto task force are more than a little conflicted:

In court papers the lenders also complained that the auto task force refused to negotiate directly with them, citing government ethics concerns. Silver Point, one of the largest DIP lenders, employed until last year Harry Wilson, the auto task force executive in charge of the Delphi deal. And Matthew Feldman, another auto task force member, was until this spring a partner at Willkie Farr & Gallagher, the law firm representing Silver Point and other lenders.

“The Treasury is picking winners and losers in an effort to salvage the auto industry,” said Mr. Abrams. “To achieve a common good for the auto industry, lenders are being asked to sacrifice too much.”

I haven’t been a prude about the Chrysler and GM bankruptcies and the government’s rough shod tactics in getting the deals done. I think it’s a misguided effort and one likely to end either in failure or an unconscionable expenditure of money in order to assure success but I am also enough of a realist to recognize that Chapter 11 is a rough and tumble game. Been there, got the T-shirt.

This might be taking the game a little too far. Kudos to the judge who has the cajones to stand up to the government and say there are other parties with viable interests here. And kudos to the banks who seem to have found their stones after caving cravenly in the Chrysler negotiations.

If a little light is shined on the auto task force as a result of this then so much the better. Probably too much has been going on in the shadows for the good of the Republic.