Ohio Practical Business Lawyer & Attorney : Teri Rasmussen : Lane Alton & Horst Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

As a business/commercial attorney whose practice is becoming increasingly weighted towards the Chapter 11 bankruptcy, workout, and general creditors' rights side of the ledger, I freely acknowledge being completely captivated (in the intellectual isn't it cool that something I do work about is being talked about a lot way) by the distressed financial plight of Detroit's Big Three automakers and the various proposals being bandied about  as possible solutions.  The bankruptcy alternative - prepackaged or otherwise - has of course been of particular professional interest to me, mainly because it - properly tweaked - may just be the only way out of this mess.  

One could easily spend entire days just Googling away on this topic without running out of interesting and informative blog posts, news feeds, and websites to read.  Everyone seems to understand and agree that SOMETHING has to be done, but after that, the WHAT and HOW become murky and a source of great disagreement.  And most recently, we're now hearing that a "study" -  to which we all tend naturally to give great weight -- claims that a bankruptcy of at least two U.S. automakers would cost as much as FOUR times more than a "bridge loan" from the federal government.    

So, how to make sense of all this and figure out what it really makes sense to back?  Three detailed discussions of proposed strategies for addressing the crisis have caught my attention  which I think help illustrate the various arguments being made.  I wanted to highlight those, along with some commentary of my own.

• NYU School of Business Professor Edward Altman, who recently testified on Capital Hill presents "My View: Why GM Should File for Bankruptcy" on the Turnaround Management Association website.    
• Weathorford School of Management (Case Western Reserve University) Professor of Economics Susan Helper and Wharton School of Business (University of Pennsylvania) Associate Professor John Paul MacDuffie, self described "scholars who have spent our professional lives studying the auto industry" advocate a "Better Than a Bailout" nonbankruptcy plan in a recent issue of The New Republic magazine.   
• Corporate bankruptcy attorney Richard N. Tilton sets out a very detailed proposal in "GM Death Watch 219: GM Prepackaged Reorganization"  in a guest post on the Truth About Cars blog which I think comes closest to my view that some form of bankruptcy is necessary, but the significant participation of the feds is still a crucial component 

Altman: Bankruptcy IS the Answer.   Altman advocates forcing General Motors (and presumably at least Chrysler, if not Ford, as well) into Chapter  11, although he acknowledges that the U.S. government may have to be the DIP (debtor-in-possession aka post banklruptcy filing company for the uninitiated - see, isn't bankruptcy fun with its terms of art?)  lender.  Altman's conclusion:

Management and boards of Detroit's Big Three "which have been in a state of denial, should face up to the reality of their dismal outlook and request the DIP loan.  The government should be given the choice of supporting this unique rescue,  concluding that it would be better for the country and the economy to 'right-size' the U.S. Auto business now and make it more competititive, rather than to have it deteriorate further and to be sold off at a later date with even  ore lost jobs and cuts in pensionn, /health care benefits. " 

In support of his conclusion, Altman makes the following points:

• "All this talk about a government rescue of General Motors and other automakers is misguided, likely a waste of taxpayers' money, and a potential dimunition in the creditworthiness of the U.S. government."
• Absent bankruptcy, the automakers face not only the prospect of a severe prolonged U.S. recession, but also "the weight of their own inefficiencies, huge pension and health care benefit packages, and their now clear bankrupt profiles," things much more difficult to address outside bankruptcy.
• Chapter 11 provides enormous benefits  and options to companies availing themselves of its protections, including protecting their assets, suspending fixed payments on most liabilities, allowing superpriority lending to occur in the form of DIP lending  which substantially reduces the risk to lenders, and "enhanc[ing] the ability of management to renegotiate existing and legacy pension and health care claims."

Avoid Bankruptcy - It's the Kiss of Death.  In contrast to Altman, Susan Helper and John Paul MacDuffe contend that a nonbankruptcy solution is the preferable choice.  They start, logically enough, with an examination of the companies themselves and their strengths and weaknesses.  Unlike many commentators, their view is that "labor costs are  no longer a big problem," (although they do acknowledge that obligations to retirees remain an issue).  They also point out that labor costs only account for perhaps ten percent of the overall cost of an automobile .  Helper and MacDuffe say that larger challenge for the automakers is relations with parts suppliers and having a better understanding of how to utilize their leverage with suppliers appropriately.  As they see it,

The companies really are too big, although the problem starts with the number of brands, rather than the number of factories.  Each brand has its own set of delaers, each of whom demands vehicles and attention to their product lines.  It's impossible for the companies to fill out each brand's lineup  with innovative, quality products -- let alone to  market each of them appropriately.  In other words, it's hard for GM to push Pontiac, when  it's also pushing Buick, Chevrolet, and Saturn.  (emphasis supplied)

Helper and MacDuffe see several problems with forcing bankruptcy on the Big Three automakers:

• Incentives inherent in Chapter 11 might discourage the automakers from further integrating production techniques in favor of focusing on short-term profits even more relentless.
• Consumers may be concerned about warranties, continued availability of service and parts, and other drawbacks of purchasing a vehicle from a company in bankruptcy.  
• Suppliers would be unsecured creditors and would receive substantially reduced payouts on their debts, something their precarious financial situation may not be able to weather.

Helper's and MacDuffe's solution is similar to what has been recently been discussed on Capital Hill in the sense that it seeks to mimic the effect and benefits of a Chapter 11 proceeding without the "disgrace" of filing.  According to them, this solution

could not only spare GM -- and its counterparts -- much of the messy, wasteful litigation that goes with Chapter 11 filings; it could also encourage the right kind of restructuring.  Instead of simply paying people less for doing the same inappropriate tasks they used to do, the Detroit Three would further change the way they design, build, and sell cars -- yielding a set of smaller more sustainable automakers headquartered in the United States.   (emphasis supplied)

 Their plan:

instead of letting a bankruptcy judge supervise the process, the government would appoint a special advisory committee to oversee the process.  This committee would consist of knowledgeable, independent monitors -- a mixture of former industry executives with experience working for Toyota or Honda' academics who study the industry; and experts in aternative engine technology or labor-management collaboration.  It would, naturally, have a director and full-time staff, plus the ability to work with outside consultants.  Under the scenario we envision, the committtee would set goals and require the companies to report on progress quarterly, as a condition for obtaining additional funds.  If a company missed its goals for, say, two quarters in a row, the committee would then provide only enough funds to prepare for liquidation or nationalization.  (Leftover money could go to retraining workers and softening the blow of downisizing on communities.}

Prepack Bankruptcy - with a Twist - Is the Way to Go.   Finally, Richard Tilton (who is apparently keeping a really low internet profile since I really wanted to add a link to him and couldn't find anything), in a somewhat lengthy (by internet blog posting standards), but useful article, succinctly recognizes the basic problem facing the Big Three:

GM's legal obligations to bondholders and trade creditors cannot be changed or modified without a bankruptcy, or the written consent of ech individual creditor.  That's a near impossible task.  Attempting to reorganize GM outside of a legal proceeding would encourage creditors to holdouts (sic) for special treatment, delaying  any chance at restructuiring.

  His points:

• While a true "prepack" Chapter 11 bankruptcy would by definition involve the agreement of all major stakeholders, that is not absolutely essential so long as the U.S. Treasury as sgined on to be the DIP lender.
• Because Chapter 11 allows DIPs to stop paying interest or principal on unsecured debt, cash available for operations will be increased.
• Although the automakers have significant obligations to retirees, these are unsecured claims under the Bankruptcy Code and therefore would be frozen and entitled to less favorable treatment in a Chapter 11 bankruptcy.
• The assertion of Detroit's Big Three  that "millions of jobs will be 'lost' ignores the simple fact that companies continue to operate their businesses while in chapter 11, albeit under a great deal of scrutiny ....  While it is definitely a lot of paperwork, legal and turnaround professionals do this type pf work every day."
•  "A GM reorganization paln  must be based upon a realistic projection of future profitability.  Future cash flows will determine the enterprise value of the reorganized company, and hence the value of new  common shares which will be distributed under the plan."

His plan:

• U.S. Treasury extends a secured  DIP loan in the amount of perhaps $40 billion.  "Taxpayers should demand that any loan made to GM be made only in connection with GM's Chapter 11 filing, that it be fully secutred, and only disbursed pursuant to detailed written budgets."
• A portion of the U.S. Treasury DIP loan "should be available to support essential suppliers throough loans, letters of credit and pre-payments."
• "Since the government lacks experience in administering secured loans to insolvent companies in Chapter 11 reorganizations, it might be preferable to have the loan guaranteed by the U.S. Treasury.  Funds would be advanced periodically by a consortium of financial institutions experienced in lending to Chapter 11 debtors.  They'd be better able to monitor day-to-day compliance within the terms and covenants of the loan."  
• "potential future liabilities [for payments to the retiree trust for rtiree benefits]... not only would weigh heavily on GM's post reorganization success. but also would depress the market value of ay new common shares issued by GM.  With creditor consent, the retiree trust could receive  subordiated debt, with future maturity dates timed to GM's future profitability."
• Existing shareholders get NOTHING.
• New Board of Directors includes representation from major creditor stakeholders and constituencies..   

Under his hypothetical plan, Tilton forsees: 

• Taxpayers getting a warrant for 10% of GM's post-confirmation stock as security for the repayment of the DIP loan.
• GM's existing secued creditors will stay in place and be treated in accordance with federal bankruptcy law
• Warranty claims assumed under plan
• Unsecured debt, including bondholder, trade payables, legacy/retiree claims, and other unsecured claims get their pro rata share of the stock of the reorganized automaker

I don't pretend to know the answer to the crisis presented by the financial problems of Detroit's Big Three automakers, although I am beginning to form a definite opinion which I'll share in a subsequent post.  I do, however, think it's very important for each of us to think hard about this and about what should be done.  Hopefully, these three proposals can be helpful in ordering and organizing that analysis. 

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Unless you've been living under a rock for the last few weeks, you are all too painfully aware that General Motors, Chrysler Corporation -- and to a lesser, but still significant extent, Ford Motor Company --- are in DEEP DEEP TROUBLE.  And that like any other red-blooded American when the "going gets tough", they are looking to the government to make it all better... or else....  >>> well, no one really wants to find out if it really would be the end of American prosperity as we know it. 

General Motors has even established a website called GM Facts and Fiction to present its position. 

The New York Times Live Blog summary of last week's hearings on Capital Hill as they were occurring is well worth a click for Thursday's Senate Banking Committee proceedings and here for Friday's House Financial Services Committee hearing.

Problem Solved?  Based on the most recent news reports, it sounds as if the Big Three Detroit automakers  may have managed to stave off the day of reckoning for at least a while.  Apparently, Congress has decided to give them the proverbial "half a loaf" by allowing  $$ already ticketed their way to assist in the development of more fuel efficient vehicles to be utilized more generally.   (Click here for the NYT perspective, here for Detroit Free Press perspective, together withn its rundown of the Sunday morning news talk shows,

Unfortunately, no one really believes that this is anything remotely approaching a permanent solution.  Chrysler is already apparently hedging its best, having reportedly retained Jones Day as potential bankruptcy counsel.  

SO the question remains, ultimately what should be done?  Is the American automobile manufacturing industry really too big and too intrinsic a part of the overall American economy to "let" fail?  Or are those who say that bankruptcy with its unique provisions is really the only true hope for a beneficial solution actually correct?  A couple of my favorite quotes (and there are many) so far on this whole mess:

• Courtesy of Friday's, Grand Rapids Press in a story entitled "Hey Congress: 'Prepackaged bankruptcy' for automakers is bad idea -- and impossible" >>> "The Detroit Lions have a better chance of winning the Super Bowl than GM has of getting a prepackaged bankruptcy," said John Wykamp, a business restructuring expert at the Grand Rapids office of Crowe Horwath LLP.   
•  
• "Congress must save the industrial infrastructure that these companies control and the jobs they create…. And Congress must do all this by NOT giving GM, Ford and Chrysler the $34 billion they are asking for in "loans" (a few days ago they only wanted $25 billion; that's how stupid they are -- they don't even know how much they really need to make this month's payroll. If you or I tried to get a loan from the bank this way, not only would we be thrown out on our ear, the bank would place us on some sort of credit rating blacklist)."  - Michael Moore >>> Read the WHOLE post !

Prepackaged Bankruptcy a Solution?   Although a part of the answer to this question is certainly politically based, depending  in part perhaps on how one views labor unions and/or "legacy costs",  or one's overall philosophy on economic policy, there is also a more pragmatic element which is sometimes misunderstood or overlooked.  One of the possiblities being thrown around of late is something now being referred to as a "pre-arranged bankruptcy", a variant of the "prepackaged bankruptcy" option.  (For a general discussion of this variety of Chapter 11 bankruptcy and its basic operation, read my previous post "How Prepackaged Bankruptcy REALLY Works".

Prepackaged bankruptcy - that's gotta be "the ticket", the one terrific solution, for the mess America's Big three automakers find themselves in, right?  And what could possibly be more interesting for business bankruptcy practitioner like myself than the ultimate Chapter 11 prepack?!!!?   (Click here, here, here, and here for general discussions of the push towards the prepack option.)

The problem is - it's not.  While I, like many others, found the concept initially attractive (and let's face it, downright exciting from a professional creditors' rights attorney perspective), as I've thought harder about it,  I've realized it's just not the panacea we're all looking for to solve this aspect of our growing financial crisis.  Some form of a a prepack still has a role to play, but it it won't be the pure form of a prepack, prenegotiated, or even pre-arranged bankruptcy; substantial government involvement will still be required to maximize the opportunities offered by the prepack option.  Why?

Those jumping on the "why not bankruptcy?" bandwagon early with respect to Detroit's Big Three tended to focus on (1) the ability under the Bankruptcy Code for the automakers to rid themselves of burdensome contracts such as perhaps obligations to the autoworker unions and dealers, as well as "legacy costs" for retiree benefits; and  (2) the perceived efficiency of the prepackaged bankruptcy option in comparison with the average Chapter 11 proceeding.

     >>>  Breaking Burdensome Contracts

As far as the ability to make changes to union collective bargaining agreements and other burdensome contracts, it is certainly true that the Bankruptcy Code has some useful provisons the auto companies might be able to utilize to their benefit.  However, the full benefit of section 1113 of the Bankruptcy Code with respect to union contracts, section 1114 of the Bankruptcy Code with respect to pension and retiree benefits, and section 365 of the Bankruptcy Code would almost certainly NOT be a part of a prepack.  Rather full exploitation of these provisions from the automaker perspective would almost certainly prolong any bankruptcy proceeding.  At most the power of these provisions might allow the automakers to drive a harder bargain in the context of a possible prepack.

     >>>  Prepack Efficiencies    

Although the time ACTUALLY SPENT IN BANKRUPTCY is generally less by design in prepacks, it would be fallacious to conclude that the overall time to a solution is in fact any shorter than when the more traditional Chapter 11 path is followed.  Key to the success of any prepack variation is the prepetition agreement of the major players to the financial reorganization of the financially distressed company.  In the case of Detroit's automakers, there are a number of different constituencies with conflicting objectives and needs who have yet to reach common agreement.

Given what appears to be an especially stubborn refusal on the part of the automakers to even remotely consider any sort of bankruptcy type scenario of any kind until quite recently, it seems unlikely that any substantial productive discussions have yet occurred with any of these crucial partners to a successful prepack.  To achieve the benefit of a prepack, votes for a specifically delineated plan of reorganization have to have been successfully solicited before any filing is ever made.  Because the automakers don't even have such a plan, let alone gotten the requisite buy-in, or even the beginnings of the negotiation of acceptable terms, the prepack option isn't realistically even on the table!

Recent reports suggesting some willingness on the part of union leaders to discuss union contracts and the "legacy costs" of retiree benefits is certainly a hopeful sign that the productive discussions with major stakeholders so necessary to a successful prepack may actually be beginning.  But it is only a beginning and a long way from the uanimity or at the very least general agreement needed among the principal players!!

Where Things Stand.   Hopefully,the brief respite Detroit's Big Three Automakers may now receive will be put to good use.  What needs to happen now is for them to focus on building a specific restructuring plan and developing a strategy for obtaing the needed support from lenders, unions, and others, including Congress.  Within limits - mainly relating to the likely need for involvement of the feds in some capacity with respect to some sort of postpetition DIP and exit financing -- a prepack is still a possible alternative.  There's just a heckuva lot Detroit's Big Three need to do to position themselves properly to beneift from such an option.   

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If you've been paying any attention at all to the national news of late, you know that Detroit's Big Three automakers are in deep trouble and that a substantial number of folks seem to think that forcing them into a "prepackaged " bankruptcy is the ANSWER.  When I first heard this, I thought this seemed like a pretty good idea ....  until I started really thinking about both what can and can't be accomplished  with this sort of Chapter 11 bankruptcy proceeding. 

So in a two-part post, I want to first explore the nature of the beast  those of us in the "biz" call a "prepack" and then focus more specifically on how it might actually operate in the context of the problems being faced by America's automakers.  While superfically appealing, a prepack is far from the panacea some seem to think it could be.  To understand why, you first have to understand how prepacks work in general.

Prepack Coming of Age.  Chapter 11 (and they always are Chapter 11 reorganizations) prepackaged bankruptcies came to the fore about twenty years ago.  Many say that  Dallas based hospital owner Republic Health Corp. was the first successful prepack with a plan confirmed less than five months later.  Prepacks became somewhat more popular during the 1990's in the context of failed LBO's, to implement mass-tort settlements, or as a vehicle to consummate sales or mergers of companies.   In the August issue of the Turnaround Management Association's Journal of Corporate Renewal, an article by Douglas Foley and James Van Horn entitled "Prepacks on the Rise in Chapter 11 Bankruptcies Prenegotiated Plans Can Accelerate Reorganization", asserts that there has recently been renewed interest in this variation of Chapter 11 with four filed in 2007 and more than a dozen filed in the first half of 2008. 

Companies utilizing the prepackaged option have included Donald Trump's Taj Mahal Casino in Atlantic City, Zenith Electronics, Aurora Foods-Pinnacle Foods merger, and TWA.  More recent participants have included Davis Petroleum (Case No. 06-20152, Bankr. S.D. Tex.) (whose plan was confirmed less than a week after filing), Blue Bird Body Co. (Case No. 06-50026, Bankr. D. Nev.), Bally Total Fitness (Case No.07-12395, Bankr. S.D.N. Y.), and Mrs. Fields' Original Cookies (Case No. 08 - 11953 , Bankr. D. Del.) (plan confirmed in less than sixty days after bankruptcy filed).

To promote organization and judicial economy, some jurisdictions such as the Northern District of California Bankruptcy Court and the Southern District of New York Bankrptcy Court have even adopted local rules governing prepackaged bankruptcies.   

Prepack Advantages.  The hallmark and principal advantage of a successful prepack is a substantial savings in time and disruption as compared with the ordinary Chapter 11 bankruptcy case.  The average Chapter 11 case, even a relatively small one, is rarely likely to be completed in less than a year and it can often take two or three years, or even longer, for a company to emerge from Chapter 11.  By contrast, prepackaged cases typically take less than six months, thus saving both time and money typically spent on case administration.  Conventional wisdom also holds that deterioration of the intrinsic value of a business which is often a consequence of a Chapter 11 filing and the attendant uncertainty is lessened through use of the prepackaged option.  (For a general discussion of the general effect of a Chapter 11 bankruptcy on a public company's shareholders, visit the discusssion of "What Every investor Should Know ... Corporate Bankruptcy" on the SEC's website.)

Technically, a prepackaged bankruptcy differs from a prenegotiated bankruptcy in that votes for a plan of reorganization have already been solicited and agreed upon prior to the filing, thereby leaving nothing to chance when it comes to achieving a successful confirmation of the Plan of Reorganization.  In a prenegotiated bankruptcy, actual votes or agreements to vote have not yet been reached with the critical mass of creditors, although resolution has typically been reached with those creditors deemed most crucial to success. 

The most important characteristic of a prepack  (or a prenegotiated bankruptcy) is that the major players in the bankruptcy have come to an agreement among themselves about the most important issues of subsequent financing, lien priority, and the extent to which the debt owing will be discounted or terms of repayment extended.  This reduces the potential for the debtor to lose control of the proceeding and allows it to proceed directly to its contemplted reorganized operations.  By minimizing the time spent subject to the restrictions and various oversight provisions embodied in the Bankruptcy Code and reaching important agreement before  even filing, the liklihood of full blown creditor second-guessing and need to balance the influence of various interests is thought to be significantly and productively decreased. 

Nuts and Bolts.  Section 1126(b) of the Bankruptcy Code and Bankruptcy Rule 3018(b) explicitly allow prepetiton solicitation of votes for approval of a Plan of Reorganization as long as certain procedures are observed.  The key elements to a successful prepetiton solicitation crtical to making a prepack a "go" are:

• The proposed plan must have been transmitted to substantially all creditors or equity security holders entitled  to vote in a class;
• Sufficient time  must have been allowed for voting (or in the words of the statute, the time allowed must not be "unreasonably short" which is of courae a case by case judgment call)
• Those solicited must have been provided with "adequate information" in connection with the solicitation of their vote.
• The provisions of any applicable nonbankruptcy law  such as federal securities law governing communication with shareholders of public companies must be complied with.

In essence, a prepack allows the debtor to bypass the lengthy time (starting with a 25 day notice period  for a hearing on the Disclosure Statement) involved in getting a disclosure statement approved by the Bankruptcy Court, distributed to creditors, and gathering/tabulating ballots approving or rejecting the proposed Plan of Reorganization.  There is of course the risk that the Court will determine after the fact that the prepetition solicitation process did not meet the requirements set forth above; this can happen either as a result of a motion by a party in interest on the Court can make such a finding on its own initiative.

What a prepack does not do, however, is change the requirements concerning creditor approval of a Plan of Reorganization.  Pursuant to section 1126(c), a class of "impaired" creditors (i.e. those not being paid in full) will be deemed to have accepted the plan if and only if the creditors in that class voting hold two-thirds in amount and at least a majority in number of claims voted do in fact vote to accept the plan.  In addition, pursuant to section 1129(a)(10), the plan cannot be confirmed unless at least one class of impaired creditors vote to accept the plan.  there are also the other usual requirements of feasibility and the like. 

Prepack Risks and Obstacles.  Prepackaged bankruptcies tend to work best where there are a limited number of sophisticated secured creditors involved with whom productive negotiations can actually be had.  They tend to work less well when a debtor has a large number of creditors, especially if unsecured, with a variety of different claims ( e.g. trade creditors, employees, landlords, equipment lessors,etc.) entitled to varying treatment under the Bankruptcy Code and which may fluctuate considerably during the period immediately preceding a filing.  Large numbers of contingent claims can also be an obstacle for the obvious reason that time must be spent determining how to estimate the amount of such claims.

In addition, by immediately proceeding to the plan confirmation phase, a debtor does lose the benefit of the "breathing spell" provided by the automatic stay which arises immediately upon the filing of the petition.  And, of course, it does tip the debtor's hand as to its financial distress (which may often be obvious anyway).

Drawing Conclusions.  While there are certainly some useful rights and remedies available to Detroit's Big Three should they decide to file Chapter 11 - being able to shed burdensome labor and/or dealer contracts springs to mind - there are also substantial risks - will consumers continue to spend thousands of dollars to buy vehicles from a car company in bankruptcy.   Prepackaged bankruptcy seems to be advanced by many of its advocates as a way to maximize the advantages of being a Chapter 11 debtor while eliiminating the "down side" of a bankruptcy filing.  I just don't think it's that simple.

So next time I will focus more specifically on how well suited the prepack option really is for Detroit's Big Three and what it might and might not be able to do for them.,

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