A key provision of proposed legislation to bailout  General Motors and Chrysler, which say they are on the brink of insolvency, may be an unconstitutional taking of private property. The Takings Clause of the Constitution has been the subject of considerable public interest since the Supreme Court’s Kelo decision involving the taking of a private residence for the benefit of a pharmaceutical manufacturer.

To protect taxpayers, the legislation requires that government loans to the automakers be given priority over all other debt held by the companies. In general, when a business becomes insolvent, debts with higher priority are paid first and are more likely to be repaid in full.

But General Motors and Chrysler already carry significant loads of “senior” debt with priority over other claims, and it is a standard feature of such debt agreements that borrowers cannot subordinate this senior debt—that is, as a condition of the loan, the borrower agrees not take on additional debt that has a higher priority and would therefore imperil the senior debt.

But that’s precisely what the bailout bill purports to do.

As Randy Picker of the University of Chicago Law School explains, that may amount to a taking under the Fifth Amendment of the Constitution, which prevents the government from taking private property for public use without “just compensation.” Without providing any compensation to senior creditors, the bailout legislation would convert their loans to junior debt, increasing the likelihood that they will not be paid, which amounts to a partial or total taking.

There is also a real question as to whether this taking would be for a “public use,” as also required by the Constitution.

In contrast to a bailout, bankruptcy offers two solutions to this constitutional infirmity. First, Congress has independent power to establish bankruptcy law under the Bankruptcy Clause, and it is a necessary feature of bankruptcy law that creditors may receive less than they are owed. This gives Congress some flexibility in crafting bankruptcy procedures that subordinate senior debt, to an extent, while still recognizing its priority over other debt. But that power is available only in bankruptcy, not in a bailout, because the text of Bankruptcy Clause necessarily contemplates that subordination of debt will be a part of the bankruptcy process, as understood at the time of the framing. Thus, it would not be enough for Congress merely to reference this power as it attempts to exercise it outside of the bankruptcy process. Second, the bankruptcy code requires courts suborning senior debt to assure that its creditors are afforded “adequate protection” by requiring the debtor to take certain steps to protect the creditor’s interest. In some cases, the creditor can prevent its debt from being made junior.

Picker suggests that the bailout legislation could be fixed by requiring the “car czar” established by the legislation to provide adequate protection to lenders who debts are subordinated by government loans, but it is not apparent that, without drawing on the power of the Bankruptcy Clause–unavailable outside of bankruptcy–this would be sufficient to correct the constitutional infirmity.

There are only two sure-fire fixes to the legislation. One is that the government could pay off the automakers’ senior debt-holders with “just compensation.” The downside is that this could add billions to the bailout’s price-tag and be a windfall for lenders that might otherwise face a “haircut” on their payouts in a bankruptcy proceeding.

As an alternative, the government could simply drop the provision or recognize the priority of existing senior debts. This would leave taxpayers holding lower-priority unsecured debt, greatly increasing the likelihood that they will not be repaid. This is the approach that the Senate’s version of the bailout bill is likely to take, according to reports.

But the best, safest, and most fiscally responsible solution is the simplest: Don’t use taxpayer funds to bail out the Detroit automakers. Instead, rely on the mechanism established in the Constitution to let the automakers confront their problems and reorganize: bankruptcy.

For more on how an automaker bankruptcy would work and why it is the best choice, see this paper. And look here for responses to the automakers’ arguments against bankruptcy.