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"Surgical" Bankruptcy for Big Auto Looking Increasingly Dubious

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We said at the beginning of April, when the idea of a “surgical” bankruptcy of GM and Chrylser was first mooted, that we assumed this was an effort at high stakes poker, because there was simply no way to make reality conform with the Administration’s fantasy. Readers may recall that the high concept was a variant on the good bank, bad bank construct, by which a company would be separated into two pieces, and the Administration planned to get “some” creditors to back the plan.

Our understanding is “some” doesn’t cut it for a prepak or any variant thereof.

The Times today, in less pointed language,confirms this assessment, pointing out that a judge would be very loath to set this precedent. And it also mentions another awkward fact: that suposed prepaks often linger in court quite a long time.

The reason for haste is that a bankruptcy for a company as complicated as GM would take nearly two years even if all went well (a source for the Times pegged it at three years; Delphi has been in court four years). That much uncertainty will hurt sales (the risk of losing your local dealer and having to schlepp for in warranty servicing alone would put some buyers off).

Separately, the Wall Street Journal reports that auto task force chief chief Steve Rattner was involved in payments in an alleged kickback scheme with New York State’s pension fund. If this story leads to pubic ire, Team Obama is going to have to find a replacement. (Note the New York Times says an Administration official said that Rattner appraised them of the investigation and Rattner’s firm Quadrangle stated it expected no action to be taken against Rattner). If there were a change of the guard, any new face might not be as gung ho about the “surgical bankruptcy” concept. This is going to prove to be interesting.

From the New York Times:

Any hope of a high-speed bankruptcy by General Motors faces a serious obstacle: a judge — not the Obama administration, not G.M. management and not the company’s creditors — would reign in court.

A bankruptcy judge would be required by law to listen to unions, whose members fear for their jobs, benefits and pensions. And the judge would have to pay attention to creditors, including bondholders frustrated by how much they stand to lose if G.M. is broken up into “good” and “bad” companies as the administration is planning. Even a judge sympathetic to the administration — and the administration would look for a sympathetic court — might be reluctant to rubber-stamp that plan.

“Once you’re in, nobody knows where it’s going because anyone can come into court and say no, no, no,” said Sandra E. Mayerson, head of the insolvency practice in the New York law office of Squire, Sanders & Dempsey. “I’ve had preplanned bankruptcies that we thought would be out in 90 days but we were in for a year.”

While a bankruptcy judge agreed to a lightning-quick sale of Lehman Brothers assets last fall, he did so only after a parade of government regulators insisted that a failure to sell could undermine the world financial system. That claim would be a stretch for G.M., whose assets are factories, cars and other tangible goods that, unlike Lehman’s financial contracts, have value that is unlikely to evaporate quickly…

Casting aside the deliberative processes of bankruptcy would undoubtedly lead other companies to argue for the same treatment in the future….

Unionized employees and retirees would ask that their contracts be protected, and the Bankruptcy Code has provisions specifically requiring good-faith negotiations before labor agreements can be modified. Such talks could easily take many months…..

Separating and selling off G.M.’s more valuable assets, a strategy pursued at troubled banks (usually outside of bankruptcy, it should be noted), would most likely pit the company’s financial advisers against those working for creditors…

Even if a judge went along with the government’s plan to split the company, that judge would want plenty of legal cover. Gathering and presenting evidence that the split-up is the best option would take time.

Typically, companies sell off assets to third parties as part of a reorganization in Chapter 11. Plans for G.M. would go further, selling virtually all the viable parts of the company very quickly to a new one created solely to buy it.

“What’s driving this is the concern that the customer is not going to stand for a three-year bankruptcy,” said a person briefed on the government’s plan who insisted on anonymity because discussions are continuing. “The revenues will just stall out.”

Allowing the automaker to sell off the good assets would essentially sidestep the rest of the bankruptcy process, lawyers said, especially the nettlesome requirement that creditors approve a plan of reorganization. Once blessed, that tactic would be alluring to other troubled companies.

“If you could do this, it’s too cheap a trick — everyone would do it,” said Lynn M. LoPucki, a law professor at the University of California, Los Angeles. “There would be no other kind of bankruptcy remaining.”

Lehman Brothers conducted a sale within days of its bankruptcy filing, holding an auction under Section 363 of the Bankruptcy Code, which the administration’s plan could also use. But in Lehman’s case, an outside buyer, Barclays, bid on the assets, Professor LoPucki said. “Here, there is no buyer,” he said. “G.M. is selling itself to itself. That transaction has no economic reality.”

The transaction could have very real implications, though, for creditors and unionized workers. If union contracts on pensions, employment and benefits remain tied to the old G.M., employees and retirees could be devastated financially.

If the contracts move to the new, good company, the surviving business would look considerably weaker. That creates a political problem that would make a rapid, clean bankruptcy unlikely.

“It’s going to be about the union and the pensions,” said Ms. Mayerson, the bankruptcy lawyer. “And I don’t see any way that this is a quickie bankruptcy. After all, it took them 30 years to get into this mess.”

The Financial Times points out yet another complication that would likely get in the way of the Administration’s Tinker Bell plan, namely, that due to its large supplier network, GM would need to have an unprecedented number of companies designated “critical vendors” who need prompt payment:

General Motors is prepared to argue that hundreds of its suppliers are “critical vendors” who require timely payments if it seeks bankruptcy protection, setting the stage for what would be the most sweeping attempt ever to win special treatment for such contractors, people close to the matter say.

Companies often request special treatment for a limited number of suppliers as part of bankruptcy petitions.

Bankruptcy experts say GM would stand a good chance of winning protection for more suppliers than is usual because of the large number that provide “just-in-time” car parts to the company….

GM would have to demonstrate in court that its business would be better off, and could retain more value if it pays key bills.

A judge could also force GM to prove that individual suppliers would stop operating or shipping goods if they were not paid, rather than letting GM use the money as it sees fit.

The critical vendor legal doctrine can be “subject to abuse and unfairness”, one attorney said. Roughly two-thirds of GM’s suppliers also sell parts to Ford or Chrysler, and some may be able to absorb late or reduced payments.

“It’s a game of chicken,” one attorney said. “How do you figure out which suppliers really will stop supplying tomorrow and which won’t?”

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13 comments

  1. alex black

    I hope that the policy ultimately adopted by the Administration is one forged out of brainstorming sessions consisting of the sharpest minds available, who are all discussing every conceivable ramification of their ideas – “What are all of the consequences of Plan A, of Plan B, of Plan C….”

    I fear that the policy ultimately adopted by the Administration is one forged out of Focus Groups consisting of randomly-chosen people milling about at shopping malls, who are asked, “If Plan A is adopted, would you be more likely or less likely to vote for President Obama in 2012? If Plan B is adopted, would you be more likely or less likely to vote for President Obama in 2012?”….

    Damn, I’m getting jaded.

  2. Common Sense Kevin

    The sooner GM and Chrysler file for bankruptcy protection, the better. Prolonging the inevitable is getting more and more torturous by the minute. Seriously, who their right mind would buy a car from either of these companies (while in this constant state of limbo)? It’s insane. They are making a bad situation worse by all of this inaction. Somebody with the “audacity” of common sense needs to light a fire under some ass and get the bankruptcy ball rolling!

  3. Richard Kline

    I would like to think otherwise, but the whiff of this ‘surgical bankruptcy’ hallucination seems to me to speak of a ‘shed those contracts’ mentality on the part of those designated to make this problem disappear from Bo Prez’s inbox. ‘Those contracts’ may involve the dealerships, yes, but the contracts most in question would seem to be pension and health contract obligations owed to employees. The notion is that GM could shed workers and make it if it could just cut the tow-line on those ‘legacy costs.’ Certainly, the Repubs love that meme. This strikes me as the kind of across-the-aisle compromise Obama has talked too much of, i.e. giving the designated sacrifices to Republicans they demand to get their votes on other issues, sacrifices to be taken by Democrats low on the totem pole. In short, cut the contracts loose in bankruptcy—”Tough love, but necessary for the country”—in order to get some Republican votes on more Stealout money for the zombie banks. I would love to make this idea exit my mind, but it just fits too well with what Obama’s methods are shaping up to be to exit without solid evidence of a contrary motive. *blechhh*

    On a separate note, Yves, over at Calculated Risk there is a long excerpt from a talk by Yellen regarding whether to intervene in the instance of asset price bubbles, and how. This is an important topic, and what she posits is useful, but misses an important point on systemicity. If you chose to post up on Yellen’s speech, or link up to it, I’ll comment a bit on what I mean, but I won’t otherwise insert those remarks in comments to posts of other foci. Regards, love.

  4. Brick

    There seems to be an assumption that GM’s bond holders are stupid and will fight the bankruptcy tooth and nail. Most GM bondholders will most probably have hedged their bonds possibly with CDO’s. Zero Hedge quite rightly points out that most CDO’s will suffer significant losses as a result of any bankruptcy and talks about the impacts on some of the Car rental businesses. This ties in nicely with an article today on the 10 brands mostly likely to disappear this year which included a major car rental business.
    There might be an exception though as Karl Denninger at the market ticker points out. CDO’s written by AIG probably will not suffer losses and will be bailed out by the Taxpayer. This could significantly change the motivation of large bondholders from fighting a bankruptcy into forcing it through. Sophisticated bondholders have had plenty of time to scam this so they win what ever happens. The losers will be the taxpayer and the workers, again as desperate measures by decision makers backfire with unintended consequences again.

    Zero Hedge on the auto sectorDenninger on GM BankruptcyGM and AIG with comments on a Resolution TrustI rather liked this quote from one commenter
    Debt for equity swaps only work if the equity is or is expected to be worth something

  5. MarcoPolo

    This is fascinating. A justification for outsourcing production and relying on several suppliers for the same components is that one can take advantage of new efficiencies more quickly. What is never stated directly is that a company the size of GM is in a position to beat that supply chain over the head to get what it wants. We have yet to explore the consequences of that supply chain being so independent that they can simply tell a company that won’t pay them to buzz off. What goes around comes around.

  6. run75441

    Morniing Yves:

    “'It’s going to be about the union and the pensions,” said Ms. Mayerson, the bankruptcy lawyer. 'And I don’t see any way that this is a quickie bankruptcy. After all, it took them 30 years to get into this mess.'”

    This particular comment by Ms. Mayerson stands out. It is about the Healthcare and Pension funds, the lack of which is very apparent in healthcare and the surplus in pension funds waiting to be robbed by a bankruptcy if and when the pension is passed off to the PGBC. Forget that much of the problem in either fund was caused by the over forecasting of returns and subsequent under funding of the funds and borrowing of money by GM/Chrysler (besides other companies/states) to sustain them, we begin to understand why bankruptcy looks good. Breaking those two areas will save the company money and offer them up additional resource. It is all about labor healthcare and pensions.

    If I remember correctly, Obama has already promised taxpayer help during the bankruptcy. I am assuming this is for all of those CDS written to insure those junk bonds written for GM and Chrysler. Perhaps, bond holders are just waiting for a better explanation? Any battle for lower direct labor costs is silly at best as it is already the lowest cost of manufacturing and the UAW has already agreed to concessions. The South will sink with them also.

    Marco, the hundreds of suppliers discussed, cover the ~20,000 parts in an automobile. If the number is 400 vendors, then we could expect 50 parts per vendor which may seem reasonable for screws, bolts, and not so reasonable for other parts. It is not uncommon to have 2 or three vendors for each part as a contingency against a manufacturing issue at the vendor site. Almost no one is sole sourced.

    Automotive has beaten the vendors to death as far as material cost. There is virtually little margin left, which is why so many depend on the constant flow of money from the big three. Net due payments (no discounts) from them are >60 days now. You are chasing an old paradigm from the seventies and eighties. Automotive changed their sourcing habits a long time ago and vendors are not as independent as you make them out to be.

    Today's issues are a capacity to build 15 million cars in a market that can sustain 10 million car at the most, multiple platforms (models), multiple and unique platforms requiring different parts (non-standarization), the poor economy that followed W$'s cliff diving, a manufacturing ignornant administration led by economic leaders who have an agenda, etc. From all of this and the continued downsizing, union and white collar workers will continue to decrease by the tens of thousands, the continued shrinkage in capacity will lower fixed costs as plants and facilities close, and complete carlines and models will disappear.

    No bankruptcy will resolve these issues in itself.

  7. Eleanor

    My brother the bankruptcy lawyer says the car companies have to go into chapter 11, as have many airlines, shedding their obligations to workers.

    This still looks very scary to me, as well as unjust.

    I imagine suppliers going out of business and dealers, small towns losing their biggest business and the industrial center of the country taking another terrible hit.

    Maybe because I have a limited imagination, I do not think the US can survive if it makes nothing useful.

    Someone — I think Robert Reich — suggests keeping the car companies and converting them to making buses, trains, windmills, you name it. They made this kind of quick change during WWII.

  8. run75441

    Eleanor:

    I do not believe the automotive companies had to go bankrupt. They were down sizing pretty fast and all that needed to be done was push them harder in that direction. The $70B that went to W$ from TARP in bonuses would have carried them over till year end.

    Your brother is right about shedding of pension and healthcare. That is what this game is about.

  9. Ryan

    “A judge could also force GM to prove that individual suppliers would stop operating or shipping goods if they were not paid, rather than letting GM use the money as it sees fit.

    The critical vendor legal doctrine can be “subject to abuse and unfairness”, one attorney said. Roughly two-thirds of GM’s suppliers also sell parts to Ford or Chrysler, and some may be able to absorb late or reduced payments.

    “It’s a game of chicken,” one attorney said. “How do you figure out which suppliers really will stop supplying tomorrow and which won’t?””

    The people that are jumping up and down excited about a carmaker going down have entirely missed this point I’ve been trying to tell them for a few months now. That one attorney is missing the point when he says that some suppliers will be fine because they supply to Ford and Chrysler as well. Those suppliers could lose GM, which for the sake of argument gives a supplier half its business, and then said supplier says “we can’t make the numbers work anymore, we’re declaring bankruptcy”. That then affects all other companies they supply to, and not just Ford and Chrysler, but any carmaker with the same source: Toyota, Honda, Nissan, etc. If a range of North American suppliers go bankrupt, all of the carmaking business in the U.S. will be affected. And what will result then is poorer quality product because you’ll have to find a replacement supplier that you have not done testing on to ensure it works fine with no problems like you did the product from the previous supplier, which will result in higher warranty across the board for all carmakers.

  10. HoosierDaddy

    Of course if the suppliers also have Chrysler as a customer they may well have two bankrupt customers. IIRC when the administration rejected the viability plans the threat was if Chrysler did not get in done in 30 days they would be put in Ch 7.

    This whole thing has turned into a horror show. How many Billions have been added to the cost of the affair with the early and often invocation of BANKRUPTCY in the administration’s pronouncements. “Cool Hand” Obama has now put himself in a corner. Unless all the stakeholders choose self immolation instead of what’s behind door #2, O’s bluff will be called. We are going to wind up with the worst of all worlds. We are going to spend tens of billions and still have a disorderly collapse of the auto industry.

  11. run75441

    If one has a plant made up of mutliple presses of 50, 100, 250, 500, 700, and 1000 ton (pressure) injection molding presses (plastic parts), you are 80% utilized (which is full capacity), you have business with each of the big three by the size of the company (which means GM is the largest portion), and you lose the GM portion; then you “may” not be able to justify that portion of the fixed cost of that facility and the variable cost of it either.

    A purpose of QS and ISO was to standarize the methods of production between the automotive companies and suppliers and the resulting quality from that production. GM should be able to move parts from one vendor to another and that vendor should be able to supply “1st Article” inspection parts to be checked for critical dimensions as listed on the print in a short period of time. The caveat to ISO/QS is the standarization of manufacturing and most companies are at least ISO certified, in order to sell internationally. I do not believe Ryan it is as difficult as you believe; but, a change and movement of critical molds and dies is not cheap or quickly accomplished.

    “Testing a Vendor” is old methodology. No one waits to the end product to find out if the new vendor is manufacturing capable to make an accurate part. ISO/QS will give a basis for it. Inspection by a team of people from the customer will look at processes and note all flaws or issues to be corrected before handoff of the production. The chances of getting a lower quality part have decreased dramatically.

    Ryan, there is always a risk; but, I believe it is less than what was experienced a decade ago.

  12. run75441

    Hoosier:

    I agree. Shouting “bankruptcy” from the White House pulpit lowered the price for Chrysler and certainly put a damper on any plans either GM or Chrysler would have had. This is coming from economists and financial score keepers who are macro-oriented and don’t have a clue as to manufacturing. Obama is being led by Summers and company. It was a stupid move on the part of this administration. Look to 15+% unemployment in Michigan and it is 12.6% eom March.

    The end of the year would have been reasonable.

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