Why A Chapter 11 Reorganization Cannot Work For The Car Companies

[Guest]

A Chapter 11 reorganization under the auspices of the federal bankruptcy court simply cannot work for one or more of the automobile companies. In the case of companies has big and as complex as the auto companies, everyone that I've heard or read has said that it is unlikely that the companies could survive the amount of time that it would take to have the stakeholders in the company reach agreement on a Plan of Reorganization. Such a reorganization would take years and without considering who would fund company operations during the reorganization, it's pretty clear that consumers would not risk buying a new vehicle from a bankrupt company or a financially-threatened dealer, neither of whom might be able to fulfill the warranty or provide parts.

In the case of the car companies, let me present an abbreviated list of the parties who would have to reach an agreement on how mucb of a "haircut" each would take in a Plan of Reorganization that would be presented to a bankruptcy judge for approval. The bankruptcy court does not dictate the terms of the reorganization. That's the product of negotiation between the parties at interest. The role of the court is to approve those parties who have standing in the bankruptcy, approve the senior standing of any new lenders to the company during the bankruptcy, approve the members on a Creditors Committee and manage the process of the negotiation of a Plan of Reorganization, and finally approve the adequacy and fairness of the Plan with the objective of creating a new financial structure that can be sustained following the bankruptcy. The bankruptcy court does not determine how much each of the creditors of the company will adjust their claims, nor does it dictate how the employees or suppliers of the bankrupt company will change their relationships with the company. Those issues are the product of negotiation among and between the parties at interest.

In the case of the car companies, the parties that would certainly have "standing" would include all of the following and probably many more that I haven't thought of...

• Management
• Common shareholders
• Preferred shareholders
• Secured bondholders
• Unsecured bondholders
• Effected local and state governments
• Unions (there are many who have contracts with the companies)
• Trustees for pension funds
• Trustees for employees' funds, such as 401k or medical savings plan funds
• Many medical insurance companies who provide coverage for employees
• Property owners, lessors and agents
• Owners of leased equipment located in plants and offices and used for everything from manufacturing to housekeeping to office operations and computing
• Service providers (there are probably thousands which do everything from office and plant maintenance to data processing, payroll, pension administration, 401k administration, etc.)
• Property and casualty insurance companies (on a state-by-state basis)
• A wide range of suppliers, some critical and some easily replaced
• Dealers (again on a state-by-state basis as dealer contracts are state documents, not federal)
• Banks
• General unsecured lenders or parties with unsecured credit to the companies
• The federal government (there's a wide range of parties at interest here ranging from the IRS, SEC, FTC, EPA, OSHA, FPGC, NHTSA, etc. Most of these also have state equivalent agencies)
• Representatives of the car owners who still have outstanding warranty coverage

I am certain this list is quite abbreviated. I would estimate that it might take a bankruptcy judge the better part of a year to just identify and approve all those who would be deemed to have standing and be represented in the negotiation of a Plan of Reorganization. The bankruptcy law limits the number of parties that serve on the creditor's committee and who negotiate the Plan for all creditors. While there wouldn't be an unmanageable number of parties "at the table", in practice each of the members on the creditor's committee consults with other creditors whose claims are not large enough to be represented on the committee. There are certainly many, many more parties than listed above who would have to negotiate and agree on a Plan of Reorganization. None would "give up" easily. Each will be trying to negotiate the best deal for themselves as they can, attempting to minimize their losses. With as many "moving parts" as there are parties at the negotiating table, the negotiations would go on for years. Some of the parties wouldn't survive the bankruptcy themselves. They would go out of business and would have to be replaced during the bankruptcy. In the case of a key parts supplier, this would be difficult to impossible.

The bankruptcy court does not dictate the terms of the agreement, only the process for the parties to enter into the negotiation and which parties are determined to have standing in the negotiations. Each of these parties and the company would have to be represented by both specialized attorneys, investment bankers, appraisers, accountants, etc. While their fees are subject to approval by the bankruptcy court, they are always significant--in the case of even one car company the fees alone would be measured in the hundreds of millions of dollars, maybe even more than a billion dollars.

What I'm saying here is that a Chapter 11 bankruptcy proceeding simply won't work for a company of the size and complexity of an auto company. A bankruptcy reorganization would take an extended period of time, during which time who would buy cars? Who would fund ongoing operations if sales revenues weren't available? Under normal economic conditions a consortium of banks would provide debtor-in-possession financing and would be placed by the court in the top position to receive liquidation proceeds if the reorganization failed. But with the banks themselves being undercapitalized and with credit markets virtually non-existent, there are no banks that will step up to provide such D-I-P lines of credit, regardless of the fees and interest they might enjoy.

As distasteful as a bailout of one or more of the car companies might be, I believe that our alternatives are to bail them out with as many conditions or as much oversight as can be negotiated or dictated by the Congress...or simply let the companies fail, be liquidated, and suffer whatever public expenses that would result from such an event.

There is no "in between". A Chapter 11 reorganization cannot work. As a banker, I've been thru many, many bankruptcies, reorganizations and liquidations and I can tell you with 100% certainty that while the theory of a reorganization sounds good, it cannot work in the case of any of the car companies. They are too big, their roster of parties with a stake in the bankruptcy is too big and complex, and there is no viable way for them to fund themselves during a long bankruptcy proceeding, probably one that takes years to resolve.

Some might opine that such a reorganization could be a "pre-packaged" bankruptcy where all the parties at interest agreeing on the reorganization plan before the bankruptcy is filed. Then all the bankruptcy court does is review the plan, approve it and declare the company out of bankruptcy. This is not possible in the case of a car company of course. If it might take years for the roster of hundreds or even thousands of creditors and stakeholders to reach an agreement while under the jurisdiction of a bankruptcy court, does it make sense that they might accomplish such an agreement before the companies actually ran out of money and became insolvent? A pre-packaged bankruptcy is not even a remote option.

While there have been many estimates by so-called experts, I believe that the costs to the taxpayers of a liquidation of the auto companies would, over a period of years, exceed the cost of funding them until the U.S. economy recovers--even though that amount is likely to be a multiple of the $34 billion they are currently requesting. There will be thousands of hours of TV coverage and millions of words written describing the options, but in my opinion they are as simple as I've described above. It's not a pretty picture.

[Guest]

I respectfully disagree.

As reportetd by CNBC (http://consumerist.com/5051220/the-10-biggest-chapter-11-bankruptcies-in-us-history) companies as complex as Ford, GM and Chrysler have gone this route and the "system" has prevailed.

10. United Airlines - Assets: $25.2 billion - Date Filed: Dec. 9, 2002

9. Pacific Gas and Electric - Assets: $29.8 billion Date Filed: April 6, 2001

8. Global Crossing - Assets: $30.2 billion - Date Filed: Jan. 28, 2002

7. Refco - Assets: $33.3 billion - Date Filed: Oct. 17, 2005

6. Financial Corp. of America - Assets: $33.9 billion - Date Filed: Sept. 9, 1988

5. Texaco - Assets: $35.9 billion - Date Filed: April 12, 1987

4. Conseco - Assets: $61.4 billion - Date Filed: Dec. 18, 2002

3. Enron - Assets: $63.4 billion - Date Filed: Dec. 2, 2001

2. Worldcom - Assets: $103.9 billion - Date Filed: July 21, 2002

1. Lehman Brothers - Pre-Bankruptcy Assets: $639 billion - Date Filed: Sept. 15, 2008

What gripes me is that there is such a rush to avoid the law and seek an alternative that has no proof of ever working and gives all the impression of being money down the drain, with Chapter 11 only staved off until the bailout money (this installment and any future installments) runs out.

I can appreciate the complexity of the auto company, but having worked in that environment with a firm that made: aircraft, missiles and other high tech weaponry, OEM parts for Mercedes and others; precision optics, leather goods, various electronic systems and subsystems, and a host of other things with plants in six countries and subcontractors/suppliers in over two dozen other countries, we somehow kept track of all of it. We would tell you where every franc, shilling, pence, dollar and lira was in-and-out, who owed us and who we owed (and the terms), and were aware of all of the vendors in the subcontractors/suppliers chain as well. At any given time we had subcontractors/suppliers in their country's bankruptcy proceedings and had to deal with it, and had customers who also reneged, terminated or busted. We too had labor issues, and the number of unions in various countries could drive a temperence guru to drink, with at least one on any given day on strike for something. For any major manufacturer or systems integrator, THAT"S BUSINESS in the big time!

If the auto companies can go to Congress with a "plan" that will result in them receiving BILLIONS, I find it strange they cannot put together a "reorganization" plan which addresses those very issues TK has cataloged above. Surely, with their army of lawyers, accountants and other such folk, that's an effort they could have done already (and may already have, just in case...).

Why do they need to be "above the law" that's applied to every other business owner?

[Guest]

While I can not argue with either VK or SteveZ on this issue, as I would be looking for a fast ball and received the Knuckle Curve with 30degree down bubble attached to it with blown balast tanks.

Most of us do not in any way comprehend the complexity of this issue and I for one will not try to pretend I do. I do think that Steve has a point in what happens when the bail out money runs out and still the crisis is not solved. To me if you solve the automakers problems it will not solve the big issue. It wouldnt matter to me if the cars where a dime. I would not by one right now with the condidtion or the markets and the rest of the economy. Maybe Bankruptcy should be their best bet and restructure the whole industry as needed. Why give them all this money, when there is no proof that in 3 days or 3 months they will be wanting more money again. I know there is alot more to it than meets the eye. Something has go to give and give fast.

I just think there is something that needs all that money more than the auto industry when the proof for a fix is not there.

[Guest]

Steve, the list of large bankruptcies you provided proves my point, I think. Of the ten companies listed, only Texaco and United Airlines survive in some form today. All of the other eight companies listed that filed for bankruptcy have been liquidated. Only United Airlines (UAL) and the remnants of Texaco survive today.

Texaco had a sound business model and filed for bankruptcy for protection from lawsuits that had been filed with regard to their transactions with Getty Oil. Once those claims were settled by the court, Texaco came out of bankruptcy just as healthy a company as when it filed, but with its legal obligations substantially reduced. Since then it has been acquired by Chevron Oil.

United Airlines is the only company of the large bankruptcies listed that had a faulty business model and was reorganized within a Chapter 11 proceeding. The airline was a far simpler business than an auto company, of course. The main parties with standing in that bankruptcy were the three major unions, the bank lenders, the lessors of the airplanes used by UAL, and the municipalities that owned the airport gates used by the airline. Even with that relative simplicity, it took almost 4-1/2 years for a successful Plan of Reorganization to be confirmed by the court. Of course, that bankruptcy occurred during a time when debtor-in-possession financing was readily available for the banks. That is not the case now. There is no identifiable source of D-I-P financing should one of more of the auto companies declare bankruptcy. The credit markets are currently frozen and only the most creditworthy borrowers can get loans, certainly not a company in bankruptcy.

So the list of large bankruptcies provided pretty much proves the point I made in my original post--reorganization of one or more car companies within a bankruptcy proceeding cannot work. The alternatives are for the government to bail out the car companies, extracting as many conditions and agreements as they can obtain...or refuse to provide bailout/bridge funding and simply permit the companies to become insolvent and be liquidated.

My argument is that the cost to the taxpayers will almost certainly be greater if we permit those companies to fail and be liquidated than it would be if we bailed them out or bridged them with injections of working capital until the economy recovered to the point where they could be self-sustaining.

As I said, either alternative is distasteful and expensive and it's not a pretty picture. The only alternative that I can possibly think of might be for one or more of the companies to file a Chapter 11 bankruptcy and have the government step in to provide the debtor-in-possesion working capital financing. The amount of money the taxpayers might have to inject would be the same as if they simply gave the companies the money with some weak oversight authority. But because the capital would be injected under the jurisdiction of a bankruptcy court, the necessary "reorganization" (reduced payroll, reduced pension and healthcare benefits, reduced pension payments and benefits to reireees, loosened work rules, etc.) could be negotiated among the parties at interest under the big stick of the government who would be threatening to withdraw further financing. That approach might not be any less expensive, but it would at least give the taxpayer a seat at the table in the reorganization of the industry.

The approach with the taxpayers providing debtor-in-possession financing leaves open the question of how long it might take to achieve a reorganization and whether so few cars and trucks might be sold under the cloud of a bankruptcy that there wouldn't be much of an auto industry left after the reorganization was achieved.

[Guest]

Ironically, I believe your post proves my point.

The fact that two of ten companies successfully reformed thanks to Chapter 11 proves its value. These companies - Texaco and United - were successful because they had products/services desired by the marketplace, and their customer base was reasonably forecasted to continue seeking their products/services. If Ford, GM and Chrysler can say the same, they are indeed Chapter 11 candidates. If their customer base has evaporated, and obtaining or maintaining any market share is doubtful, all the free money in the world accomplishes nothing.

What Ford, GM and Chrysler have intentionally deferred to discuss is that merger and acquisition may be more viable that maintaining separate status. Ford acquired Lincoln and Mercury that way. GM did the same with Cadillac, Chevy et al. Chrysler did the same (remember American Motors, Nash and Jeep?). The marketplace has options other than Chapter 11 or the world's biggest tin cup - they just need to apply them, but greed is preventing that.

The scare tactic of saying that "liquidation" will cause the end of life as we know it is silly. Companies sell off and buy assets all the time, and if the asset has value (e.g., a factory which can be made profitable), it's title transfers to someone else and business continues, even if it is in a different form. If the asset has no value, no amount of money can turn dung into doughnuts.

So, if the cost to the taxpayer really is relatively the same in the end (which is doubtful), then Chapter 11 still makes sense. At least there would be oversight - courts can do that, but nowhere else in the Fed is there such capacity, and any attempt to put it in elsewhere effectively would be wishful thinking. Somehow, giving a lot of money with no effective oversight to the same folk who got their companies into this situation is like going to eat again at the same restaurant where you got food poisoning.

If the concern is subcontractors/vendors/suppliers having debtor protection, they too took risks knowing their customers and their shaky status, and Chapter 11 is open to them if they are over-extended. If we are hell-bent into opening our wallets and playing Santa to the auto industry, then the Chapter 11 plan(s) could be based on the Fed providing limited debtor protection via bailout moneys distributed via a commercial bank currently under task-order contract to the Treasury (there are a few of these) under specific conditions. That way the court still has control and we may financially survive. Anything else is like our Foreign Aid giveaway programs which find a goodly chunk of the funds spirited away into offshore numbered accounts.

I've seen a lot of con games in my life, and most of them have the "mark" having to act quickly, or else they will miss out on the bargain, or there will be catastrophic results. This has all the trappings of a con game where there are just more zeroes at the end of the number on the check.

We have a solution under law. Nothing stops it being exercised, and modified as necessary under court oversight. That's OUR protection! Don't we deserve that?

[Guest]

I agree with SteveZ. Sounds a little like the Village sales pitch...."We can only hold it for 3 hours". (But remember, there are 200 more houses just like the one you're looking at).

Seriously, if one compares the U.S. auto makers to the foreigners manufacturing on our turf, it's like night and day. Unfortunately, the U.S. companies have failed to recognize (apparently) that the foreign firms have been successful here not only because of better quality but because of better operations overall. The Big Three have vastly improved their quality but strategically marketing wise they've dropped the ball.

Honda, Toyota, Nissan have been cleaning the BIg 3's collective clocks for years and they've just been too damn slow to respond.

Tribune Newspapers bankruptcy filing today underscores the fact that some entire legacy industries need to be rethought. The Trib's problems were hastened by an over"zell"ous buyer who assumed mountains of debt in a declining industry while thinking he could buck the tide of change. According to VK's thinking, perhaps we should be providing bailouts to all the newspapers that will be going by the wayside in the next year or two.

Anyone who has thought about it will realize that the real reason for a newspaper's existence has gone by the board with internet news, blogs and the like. It's similar to the huge increase in web-commerce which is fast replacing the bricks and mortar model.

I would submit that the auto industry is perhaps in the same boat. A downturn shakes out the weak and inefficient and rewards those who have innovated and moved ahead with the times.

I was a plastics supplier to GM and Ford in the 70's and 80's and suffered through the 80-84 auto recession with them. Fortunately, only 50% of our business was auto related so we managed to muddle through. Many suppliers did not and went out of business. I dare say many of today's suppliers will be going out of business anyway because when the autos cut back 10%-20% it can translate to shutdowns at dedicated suppliers. Today's sales drops are dictating far greater cutbacks 10% or 20%.

I've rambled a bit but I think the bottom line is that times are changing in ways we dared not imagine just a decade ago. I'm afraid there are going to be a lot of bitter pills along the way. The auto industry re-alignment is just one.

[Guest]

I absolutely agree that the U.S. auto companies need to be restructured, downsized, focused, whatever words you want to describe the massive change that needs to occur to them. My only arguments have been how that is accomplshed. A free market approach--let happen what will happen, let them fail and go out of business--will have a disastrous impact on both the U.S and the world economies. Such failures will dramatically deepen and prolong the economic recession we're entering.

The re-structuring of the U.S. auto companies must be done in a controlled way. If it can be done with a quick bankruptcy, they could probably survive that. But they cannot survive a prolonged bankruptcy, so the alternative seems to be a government bailout of some kind.

My arguments are not to save the auto companies and all that is wrong with them. I'm arguing to save the rest of our economy and the impact that a lengthened and deepened recession will have on all of us.

[Guest]

I also agree with SteveZ.
As a union member with 43 years in USW I am pro union. However I must say I am 100% against any bailout for the Little 3. I work for Arcelor Mittal and half of Mittal's American holdings had to file Bankruptcy. Whenever we run steel for Toyota or Honda the specifications are very strict on what they require for their product. Who do you think buys all the steel that Toyota and Honda turn down for prime? Why of course it is GM .Yes they care for the bottom line and nothing else. I can't blame the union for making cars that are sub par at most.
Most analysts will tell you that GM is a $1.00 stock weather it get bail out money or not.

[Guest]

If the goal is to save the rest of the economy, that's simple. All Congress has to do is to fund the General Services Administration to purchase a to-be-defined number of US-manufactured automobiles (defined as over 90% US-content). That would result in the movement of existing inventory (and influx of cash to the sellor(s)). The new cars can be distributed in any manner Congress decides, such as:

1) cars to schools for drivers education programs;
2) cars (adapted accordingly) to military personnel upon release from a military hospital for war wounds;
3) a swap of junker-for-new-car to citizens in dire need (but they can't sell the car!);
4) and many other ideas that can be dreamed up to help the less-fortunate.

This "giving away of money" with nothing tangible in return gets all of us nothing. GM, Ford and Chrysler cannot survive without sales, especially of existing inventory. If that doesn't happen, what has been accomplished other than a short-term wage supplement? If the Big-3 keep making cars that further glut the existing inventory, what good is that? They MUST move the existing inventory via sales or they may as well throw all of the parts and product into the ocean!

What is it that I don't understand? ? ?

[Guest]

Ironically, I believe your post proves my point.

The fact that two of ten companies successfully reformed thanks to Chapter 11 proves its value. These companies - Texaco and United - were successful because they had products/services desired by the marketplace, and their customer base was reasonably forecasted to continue seeking their products/services. If Ford, GM and Chrysler can say the same, they are indeed Chapter 11 candidates. If their customer base has evaporated, and obtaining or maintaining any market share is doubtful, all the free money in the world accomplishes nothing.

What Ford, GM and Chrysler have intentionally deferred to discuss is that merger and acquisition may be more viable that maintaining separate status. Ford acquired Lincoln and Mercury that way. GM did the same with Cadillac, Chevy et al. Chrysler did the same (remember American Motors, Nash and Jeep?). The marketplace has options other than Chapter 11 or the world's biggest tin cup - they just need to apply them, but greed is preventing that.

The scare tactic of saying that "liquidation" will cause the end of life as we know it is silly. Companies sell off and buy assets all the time, and if the asset has value (e.g., a factory which can be made profitable), it's title transfers to someone else and business continues, even if it is in a different form. If the asset has no value, no amount of money can turn dung into doughnuts.

So, if the cost to the taxpayer really is relatively the same in the end (which is doubtful), then Chapter 11 still makes sense. At least there would be oversight - courts can do that, but nowhere else in the Fed is there such capacity, and any attempt to put it in elsewhere effectively would be wishful thinking. Somehow, giving a lot of money with no effective oversight to the same folk who got their companies into this situation is like going to eat again at the same restaurant where you got food poisoning.

If the concern is subcontractors/vendors/suppliers having debtor protection, they too took risks knowing their customers and their shaky status, and Chapter 11 is open to them if they are over-extended. If we are hell-bent into opening our wallets and playing Santa to the auto industry, then the Chapter 11 plan(s) could be based on the Fed providing limited debtor protection via bailout moneys distributed via a commercial bank currently under task-order contract to the Treasury (there are a few of these) under specific conditions. That way the court still has control and we may financially survive. Anything else is like our Foreign Aid giveaway programs which find a goodly chunk of the funds spirited away into offshore numbered accounts.

I've seen a lot of con games in my life, and most of them have the "mark" having to act quickly, or else they will miss out on the bargain, or there will be catastrophic results. This has all the trappings of a con game where there are just more zeroes at the end of the number on the check.

We have a solution under law. Nothing stops it being exercised, and modified as necessary under court oversight. That's OUR protection! Don't we deserve that?

I am with you on this one Steve. VK maybe you see something we cant see yet. Not sure. but I am looking at it trying to figure it out.

[Guest]

VK - I think you lose on this one but it was a stimulating post.

[Guest]

There are no losers. We all gain (especially me!) because we learn more collectively than we do muddling along on our own.

The best part of a forum like this is the opportunity to engage ourselves in a civil and thoughtful manner, and for all those who post with the goal of idea-exchange and thought-provocation, my heartfelt thanks for putting up with me and my ramblings. This is enjoyable as well as educational.

[Guest]

While I realize the magnitude of the bankruptcy process for an organization as complex as the auto companies, I too believe it can be done in an reasonably organized way. A pre-packaged deal would be a good first step that would then have to be modified as it progressed. A pre-packaged deal could address the warranty issues that would deter buyers. If the pre-packaged deal would include some warranty protection - even if by the Fed - then buyers might not balk as much. I think the only way to eliminate the cripiling contractual obligations they have to the unions and retirees is to use the bankruptcy process. If they get a bail out and no restructuring, we will be re-visiting this issue soon and it will not be solved.