October 03, 2011
If Lawrence Summers believed that the “Gov is a crappy VC,” could the government have been a better Distressed Investor?
Posted by David Groshoff

In a memo dated today from the House Subcommittee on Oversight and Investigations Democratic Staff to the Democratic Members of the Subcommittee on Oversight and Investigations regarding additional documents relating to the now infamous Solyndra Loan Guarantee (and related articles), we learned that “some of the language used in the documents [received last Friday, September 30, 2011, by the Subcommittee on Oversight and Investigations from the OMB and White House] is colorful . . . . When a private investor emailed Lawrence Summers, the Director of the National Economic Council, about his concerns about the government’s investment in Solyndra, Mr. Summers responded: ‘I relate well to your concern that gov is a crappy vc and if u were closer to it you’d feel more strongly” (emphasis added).

A little (too much?) background for the unfamiliar

The Energy Policy Act  (“EPA”) of 2005 authorized the Energy Secretary to make loan guarantees to businesses investing in certain clean or renewable energy technologies, and businesses who received those loan guarantees were to pay a subsidy credit cost representing the alleged “cost of the loan to the taxpayer” in the event of a credit default. 

Fast forward four years later, and 2009’s American Reinvestment and Recovery Act (the “Stimulus”) allocated several billion dollars for credit subsidy costs for various certain renewable energy and biofuels systems.  The loan guarantees eligible for stimulus funding were commonly referred to as “Section 1705” loan guarantees.  [To avoid any appearance or claims of potential impropriety, my husband is a chemical engineer working on clean technologies and synthetic biofuels; I have no idea, however, whether his corporation received any U.S. government investment].

Solyndra filed its initial loan application in late 2006, and after several years of concern by the Department of Energy (DOE), the DOE under the Bush administration apparently refused to grant any loan guarantees to Solyndra, despite Solyndra’s project demonstrating some merit. A conditional commitment followed after the change in administrations, and the Solyndra loan guarantee closed in September 2009 for approximately $535 million

In 2010, apparently only three months following Solyndra’s S-1 filing, Solyndra cancelled its anticipated IPO, financial distress worsened, and a restructuring occurred involving several existing Solyndra investors in early 2011. 

In the restructuring, the DOE agreed not only to delay the first repayment date by a year, to 2013 (seemingly innocuous in a restructuring), but also that in the event that Solyndra liquidated prior to 2013, the existing Solyndra investors who participated in the restructuring became senior secured lenders with respect to any recovery of the first $75 million in liquidated Solyndra assets.

Solyndra announced that it would file for bankruptcy on August 31, 2011 and made its bankruptcy filing in Delaware on September 6, 2011.

This restructuring, therefore placed the DOE in a subordinated position for that $75 million.  The existing Solyndra investors therefore would have lost their priority creditor position relative to the DOE had Solyndra not liquidated prior to 2013. 

Moreover, § 1702(d)(3) of the 2005 EPA reads: “the obligation shall be subject to the condition that the obligation is not subordinate to other financing.” 

Some Questions I Have

After reading today’s memorandum and the “colorful” language it contained, I was left with some questions beyond the “how did an obligation that appears unable to be lawfully subordinated become subordinated?”  

While I articulated my initial views in late 2008 and early 2009 on many problems associated with the federal government as a corporate stakeholder, and while today’s revelations regarding Mr. Summers’ view that the government is a “crappy VC” may underscore my prior analysis, from a policy perspective, if the proper role of the federal government is to involve itself as an investor in a variety of business entities (which, admittedly is an entirely different inquiry), then shouldn’t the federal government attempt to act as many other large and sophisticated investors do?

For example, I might agree that by the government pushing back a payment date can relieve some immediate financial distress on the debtor entity and that such loan modifications often occur in corporate financial restructurings.  However, shouldn’t the government extract some material compensation for doing so? 

And I might also agree that the government subordinating its position to another investor might be in the government’s best interest as a creditor -- but almost in the exclusive scenario in which the investor to whom the government subordinated itself were a DIP lender, not an existing investor simply wanting to gain a senior secured position.   And if no DIP lender appeared, might that fact serve as a signal about the arguable lack of wisdom in subordinating to any other creditor?

Moreover, if the government were to act as other large investors, why wouldn’t the government attempt to buy default protection in the form of Credit Default Swaps (CDS) or some similar customized synthetic CDO (thus going “short risk”) in case of a credit event, such as a payment default or bankruptcy filing?  I’ll leave a discussion as to the practical availability and valuation of such CDS for another day, but is arguably good risk-reduction simply bad politics?  In other words, if, as a matter of policy, we're going to have the government allocate "venture capital," then shouldn't the government employ arguably sound investment theory and risk-diversification strategies to hedge its bets in the case of entities that appear on the verge of financial distress?  Or do the potential political risks involved in placing those calculated and opportunistic risk-reduction bets to avoid a situation that we’re seeing play out simply outweigh making those bets in the first place?

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