Crash test

** This story ran in a July 2005 issue of The Deal newsweekly. It looks relevant again today. **

It's a quiet Sunday evening in Detroit, but in the multitowered headquarters of General Motors Corp., things are humming.

The place is crawling with suits. Dozens of company executives, lawyers, financial advisers, accountants and public relations types are packed into a conference room, and even more are hooked in via conference call from the East Coast city where the world's biggest automaker plans to file for bankruptcy protection early the next morning. A voice mail message from the CEO is cued up and ready to be beamed to hundreds of thousands of GM employees once the filing is made. An enormous phone bank, to field frantic calls from GM suppliers, waits silently for the news to break. Interpreters around the world have been put on call so they can keep managers in foreign countries in the loop during the first hours of what promises to be a long, long case. Later that night, the board of directors holds a vote, authorizing the Chapter 11 filing to proceed. Sometime after midnight in a high-rise in New York - or maybe Wilmington, Del. - GM's lead debtor counsel clicks a mouse and sends the petitions hurtling through the Internet to the bankruptcy court. He turns to his weary colleagues and says, "We're in."

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Don't adjust your glasses - or call your broker. General Motors is not in bankruptcy. And despite its headline-grabbing problems of late, which include a $1.1 billion first-quarter loss, mounting healthcare obligations and a shrinking share of the auto market, the company has enough cash in the tank that it may keep chugging along for years. In fact, when faced with questions about a possible bankruptcy before, including as recently as the early 1990s, GM has staged impressive comebacks. Over the past few weeks, the company has steadfastly maintained that it has no plans to seek bankruptcy protection.

Not everyone's convinced. Standard & Poor's Ratings Services earlier this month lowered its rating on GM's debt to BB, two notches into junk territory and, in so doing, noted that "although GM has substantial cash reserves, its ability to withstand persistent poor financial performance is not unlimited."

Forget the debate over whether GM will file or not. For this article, we have. Instead, we've preoccupied ourselves with what such an unprecedented bankruptcy would look like.

For starters, it would easily be the largest ever. Setting aside the company's massive financing arm, GM's automotive unit alone has about $155 billion in assets, according to its latest annual filing with the Securities and Exchange Commission. That's more than the roughly $100 billion in assets that were on WorldCom Inc.'s balance sheet when it made the largest bankruptcy filing in U.S. history in July 2002. Even that comparison is misleading, because most of WorldCom's so-called assets vanished overnight as part of a $74 billion write-down that the telecommunications company took before emerging from Chapter 11 in April 2004 as MCI Inc.

The numbers become more surreal if you throw in General Motors Acceptance Corp., GM's financing business, which on its own would rank among the nation's largest banks. Lumped together, the two entities have nearly $300 billion in debt - about $200 billion of it unsecured - that would be affected by a bankruptcy filing.

The stakes get even higher if GM's societal role is taken into account. Thanks to the relatively generous benefits enjoyed by its workers and retirees, the company is the largest provider of private healthcare coverage in the U.S. Any drastic attempt to curtail retiree benefits - a move that some analysts say is key to GM's long-term survival - is apt to spark a bitter standoff.

And retirees are just one of the myriad constituencies that would have a stake in a GM bankruptcy. This list includes suppliers, bondholders, shareholders, dealerships, holders of warranties on GM cars and plaintiffs suing GM over alleged asbestos exposure. Don't forget GM's 324,000 employees, substantially more than the 275,000 at Kmart Corp. when the retail giant filed for Chapter 11 protection in January 2002. GM also has manufacturing operations in 32 countries that would need to be dealt with if a U.S. bankruptcy ensued.

Then add this to the mix: On Oct. 17 the bankruptcy reform bill signed by President Bush in April goes into effect. If GM were to seek protection after that, its case would be the ultimate stress test for these new provisions, many of which make life more difficult for large corporate debtors.

"It's hard to think of an issue under the Bankruptcy Code that wouldn't be implicated" in a GM filing, says Margot Schonholtz, co-chair of the business reorganization and creditors' rights group at Kaye Scholer LLP. Those issues would include the treatment of GM's captive insurance unit (which couldn't file for bankruptcy), its financing arm and its international assets, among many others.

"It would unleash a whole parade of horribles," says William T. Bodoh, a former bankruptcy judge who recently stepped down from the bench to join Frost Brown Todd LLC in Columbus, Ohio.

Imagine the thousands of GM suppliers, he says, many of which are the sole source for certain parts, refusing to ship their goods until they got paid. In this age of "just-in-time" manufacturing, the fallout from that alone could be devastating.

Bodoh has seen some thorny cases, including that of LTV Corp., which was the nation's third-largest steelmaker when it sought protection in December 2000. Many consider LTV the seminal case in what has become an all-too-familiar pattern: bankruptcies by large, highly unionized companies in smokestack industries.

Benefits for current and former GM workers would be a key battleground - but on a scale never seen before. "The big overhang is the legacy liabilities situation, namely healthcare and pensions," says Robert M. Miller, a principal at New York-based investment bank and advisory firm Miller Mathis & Co. LLC, which has extensive restructuring experience in the steel industry.

If GM were to file for bankruptcy, it would raise these and many of the other issues that have surfaced in old-economy industries such as coal and steel, Miller says, "but on a magnitude that's almost beyond comprehension."

Faced with GM's mountain of first-day motions, even the court's most jaded clerk turns a bit pale. The dozens of filings range from the mundane - a motion to make sure the automaker's utilities don't shut off the lights - to the mysterious - a motion to file various confidential business agreements under seal. A key document is a request for $3 billion in debtor-in-possession financing from a bank group that made loans to GM before the filing, plus a retirement fund and a hedge fund that also hopped on board. J.P. Morgan Chase & Co., which has spent much of 2005 giving DIP loans to auto parts makers Tower Automotive Inc., Meridian Automotive Systems Inc. and Collins & Aikman, has a prominent role in this one, too. GM hopes it won't need to tap the new credit line, but funding a bankruptcy has gotten more expensive since the code was changed in 2005. Lenders are happy to provide a just-in-case line of credit - with millions of dollars in fees attached, of course.

If it ever made the fateful decision to roll into bankruptcy court - presumably after lengthy talks with labor unions had failed - a troubled GM and its financial advisers might go trolling for DIP financing. This kind of funding gets top priority over other kinds of debt under bankruptcy law and is often the only way a debtor can keep its business running while it reorganizes.

Heretofore, Kmart has gotten the largest DIP - $2 billion. Enron Corp. and Adelphia Communications Corp. each landed $1.5 billion DIPs but never tapped them and eventually got the commitments reduced. Ditto for UAL Corp., the parent of United Air Lines Inc., which initially took out a $1.5 billion DIP facility when it filed for Chapter 11 in late 2002, only to modify its size and terms several times.

As of March 31, GM had $19.8 billion in readily available cash and securities, and presumably it wouldn't wait until it was on its last dime to file, bankruptcy professionals say. Even with enough cash on hand, though, GM might do what Kmart, Enron and Adelphia did: secure a DIP facility as a kind of security blanket.

If it wanted DIP funding, GM could certainly get billions of dollars of it. The carmaker's vast pool of hard assets, combined with the notion that a GM reorganization was too important to fail, would make it an irresistible source of low-risk income for lenders. "They'd be lining up at GM's door," one financial adviser declares.

But not necessarily in Detroit. GM has deep roots there, of course, but history suggests that the Motor City is an unlikely host for such a gargantuan bankruptcy. In fact, three of the largest Detroit-area bankruptcies of recent years - White Motor Corp. in 1980, Federal-Mogul Corp. in 2001 and Kmart in 2002 - all snubbed the Eastern District of Michigan, where they were based, says Lynn LoPucki, a professor at the UCLA School of Law who recently published a book on forum choices by large, bankrupt companies. (White Motors went to the Northern District of Ohio in Cleveland, Federal-Mogul to the District of Delaware and Kmart to the Northern District of Illinois in Chicago.)

Pundits say New York's Southern District and Delaware would be the logical choices. Each venue is accustomed to complex cases, and many legal issues related to bankruptcy have already been settled there. Plus the world's biggest law firms, financial advisory firms and lenders are a taxi away if the case is in lower Manhattan and an Amtrak ride away if it's in Wilmington, which is getting four new judges.

"Those [Delaware] judges are going to have to do something to bring in cases, and GM would certainly be a great one," LoPucki says.

The bickering has begun. The official committee of automotive suppliers is balking at GM's push for more concessions. Years ago, auto parts makers had to assume many research and development costs GM once helped with. Now GM wants other cost efficiencies. The committee for GM car dealers is miffed, too. No longer is GMAC offering zero percentage financing and other incentives to potential car buyers. Into the scrum is an appeal by shareholders to get their own committee, which the judge in the case can't blow off because of the vast numbers of pension funds and institutional investors that own GM stock.

At the heart of most bankruptcies is a triangular negotiation between the debtor, its secured lenders and a single committee of unsecured creditors. But the geometry of a GM-type filing would be much more complex.

The company would likely have to contend with an array of committees in Chapter 11, says John Collen, head of the bankruptcy practice in Duane Morris LLP's Chicago office. The court might form separate committees to represent GM's general unsecured creditors (such as trade vendors), bondholders, labor unions, retirees, shareholders and GM dealerships (as company franchisees).

Other bankruptcy lawyers raise the possibility of a separate panel for owners of GM vehicles who have claims under their warranties. There could also be a committee representing plaintiffs suing GM over its past use of parts containing asbestos, exposure to which is associated with certain types of cancer.

"Each of these committees would have their own battery of lawyers and probably their own battery of financial advisers" whose fees would be paid out of the estate, Collen says. "The number and cost of these professionals would be absolutely enormous."

How enormous? That depends on the length of the case and many other unknowns. But a fee calculator designed by UCLA's LoPucki, based on the statistical link between a company's assets and its professionals' fees in bankruptcy, offers one estimate.

Assuming only GM's automotive unit sought protection, with $155 billion in assets, LoPucki's fee calculator predicts total fees of about $276 million. That's well below the $780 million in fees racked up by Enron (not including fees incurred after its reorganization plan was confirmed) or the $657 million in fees in the WorldCom case.

But those two cases involved massive accounting fraud, which generally make bankruptcy "much, much more expensive," LoPucki says.

If GM files for bankruptcy before October, it would be grandfathered under current rules that put no limits on exclusivity extensions. Come October, however, there will be a strict 18-month limit on the debtor's ability to have the exclusive right to file a reorganization plan, which means that a GM-sized debtor would need to do some major prebankruptcy planning if it hoped to wrap things up before its exclusivity expired.

"Given what would clearly be a contentious case, they would have an awful lot of work to do before they filed," Kaye Scholer's Schonholtz says.

Collen of Duane Morris has similar concerns. "How you would get a company of that size turned around in 18 months seems inconceivable," he says.

Meanwhile, if exclusivity lapsed, things could go from ugly to utterly dysfunctional. GM would face the prospect of multiple reorganization proposals, each of which could involve expert testimony, depositions, disputes over discovery and marathon hearings, Collen says. Moreover, it could be initially possible that none of these plans had the requisite voting support from creditors. "To degenerate into a plan war would immeasurably complicate and protract the process," he adds.

Other aspects of the new Bankruptcy Code would also challenge a bankrupt GM. One provision gives vendors broader powers to demand the return of goods they've shipped in the days leading up to a bankruptcy filing. Another makes it more difficult to reward company management with large bonuses in bankruptcy.

In fact, many lawyers say that if GM plans to file for bankruptcy sometime down the road, it would be far better off doing so before the legal landscape shifts on Oct. 17.

One of the great imponderables of a GM bankruptcy scenario is the fate of its highly profitable GMAC financing arm. Would GM drag the 100% owned subsidiary, which not only finances vehicle purchases but also originates billions of dollars of commercial and residential mortgages, into bankruptcy with it?

Many lawyers doubt that GMAC would be part of a GM filing. Mark Ellenberg, a Washington-based partner in the financial restructuring department at Cadwalader, Wickersham & Taft LLP, says GMAC would want to maintain access to the capital markets and especially its securitization programs, in which it bundles loan receivables and sells them or uses them as collateral for asset-backed financing.

"They wouldn't want to upset that apple cart," Ellenberg says. "And besides, I don't see what the upside [of a GMAC filing] would be."

It's perfectly legal for GM to leave GMAC out of its bankruptcy filing. In that case, the unit would be treated as an asset of GM's bankruptcy estate.

But others aren't so sure GMAC would be spared in a GM bankruptcy. The current situation suggests their economic fates are closely linked. "We believe that in a scenario in which GM was approaching bankruptcy, GMAC's operating and financial condition would also be suffering greatly," S&P said in its May 6 report. "Given GMAC's heavy ongoing funding appetite, the situation there could be even more dire."

Both S&P and Fitch Ratings assign the same credit rating to both GM and GMAC, suggesting the agencies see a similar default risk for both. (Moody's Investors Service Inc. rates GMAC one notch higher than GM.)

Some credit agencies have even raised the question of whether, in a bankruptcy situation, the court would allow GMAC's assets to be used to pay off GM's creditors - a legal concept known as substantive consolidation.

The answer would be no, says J. Andrew Rahl Jr., head of the bankruptcy and restructuring group at Anderson Kill & Olick PC. "GMAC could not, should not, would not be substantively consolidated with GM," says Rahl, who, as special counsel to bondholders of bankrupt Owens Corning Inc., argued in favor of substantive consolidation of Owens' subsidiaries, a request that was granted in October by Judge John Fullam of the U.S. District Court for the Eastern District of Pennsylvania in Philadelphia.

But Rahl says GM and GMAC are the "complete opposite situation" to Owens, whose subsidiaries were largely invisible to the outside world.

GMAC publishes separate financial statements from GM and observes other corporate formalities that Rahl says would argue against substantive consolidation. Meanwhile, there's no evidence that GM creditors think their debt is backed by GMAC - another key test, he says.

If GMAC is dragged into a GM bankruptcy, not just institutional bondholders would get hurt. So would mom-and-pop investors who own a huge chunk of GMAC's unsecured debt. SEC filings show that individual investors currently hold $38.7 billion of GMAC's so-called SmartNotes and Demand Notes. These interest-bearing securities are sold through a network of brokers in increments as small as $1,000. But because Demand Notes can be cashed in at any time, it's likely that much of this debt would be redeemed before a bankruptcy filing. Investors holding GMAC's SmartNotes, which carry fixed terms between nine months and 30 years, wouldn't be so lucky.

Dozens of current and former auto industry workers fill the courtroom and spill out into the hall, while even more stand outside the courthouse as reporters pepper them with questions. The judge is looking testy after having to delay this morning's hearing for an hour to find a room large enough to handle the overflow crowd. On the docket: GM's request to void its collective bargaining agreement with the United Auto Workers union under Section 1113 of the Bankruptcy Code. It's the "nuclear option" that has been the backdrop for negotiations ever since the company filed its bankruptcy petition, but the parties had been hoping to avoid this day by coming to a mutual agreement. Despite months of talks, however, the two sides have come up empty.

A GM bankruptcy would have thousands of moving parts, but labor negotiations would be the engine to drive the process - or grind it to a halt.

That's because many of GM's most intractable problems relate to agreements with its unionized work force, the largest portion of which is represented by the United Auto Workers. Given GM's declining market share - about 25% of new cars sold in the U.S. last year were from GM, down from about half in the 1960s - many analysts say the company must slash its labor-related costs to stay competitive, especially as they relate to its huge pool of retired workers.

"The employee and retiree benefits could be the iceberg that sinks GM if they aren't adequately dealt with," says David Dykhouse, a New York-based bankruptcy partner at Patterson, Belknap, Webb & Tyler LLP.

In recent years, pensions have been a key flash point in large bankruptcies. Consider UAL. Earlier this month, current and former airline workers packed a Chicago bankruptcy court to protest the proposed termination of United's underfunded pension plans. The judge ruled in favor of the move, however, clearing the way for the already overburdened Pension Benefit Guaranty Corp., the quasi-governmental agency that insures defined-benefit pensions, to assume the plans in what will be the largest pension default in the agency's history.

But pension issues might not be quite so turbulent at GM. At the end of 2004, the automaker's $89 billion U.S. pension obligation was actually overfunded, according to its annual report to the SEC. That's due in part to a massive $13.5 billion bond issuance in 2003 whose proceeds were pumped into GM's pension assets.

As a result, a Chapter 11 stay might not lead GM to take the drastic step of terminating pensions altogether; the automaker could choose to "freeze" them instead to stop its pension bill from getting any higher. Current workers would likely be shifted to some kind of defined-contribution plan, such as a 401(k), where the size of the future benefit isn't guaranteed by the employer.

That wouldn't get GM out of the woods, however. It would still have its massively underfunded healthcare program to deal with. GM's unfunded retiree medical liability stood at $61 billion at the end of 2004, up from $57 billion a year earlier. GM chief executive Richard Wagoner has blamed the company's profit woes in part on its rising healthcare costs, which are expected to reach $5.6 billion this year (with $3.9 billion going to retirees and $1.7 billion to active employees), up from $5.2 billion in 2004.

Outside of bankruptcy, the UAW has little incentive to make healthcare concessions. Its current contract with GM expires in 2007. And last month UAW officials, including vice president Richard Shoemaker, the union's top negotiator at GM, made it clear it won't reopen the contract early to reduce GM's healthcare burden.

Under the Bankruptcy Code, however, a judge can permit a debtor to unilaterally alter or terminate retirement benefits if the debtor can show that a successful reorganization would be impossible without them, says Daniel Keating, a professor at Washington University in St. Louis' School of Law.

Many U.S. steelmakers have already shed their retiree healthcare obligations through bankruptcy. Unions fought bitterly, but in the end, the companies had little trouble convincing the court that ending healthcare benefits was the only way they could survive - and preserve at least some jobs.

Given GM's status as the nation's largest private healthcare provider, it's hard to underestimate the emotions such a battle might stir up.

Retiree healthcare benefits "are a promise made to the people who built America," says Stephen Presser, a principal at Monomoy Capital Partners LLC who also serves as an adviser to the Air Line Pilots Association, International in UAL's bankruptcy.

Indeed, healthcare may be more explosive than pensions because there is no legal requirement for companies to stockpile money for these benefits. With medical benefits, "there's not going to be any money in an account," Keating says.

And unlike with pensions, no backup agency exists to bear the costs if an employer walks away from medical costs. When it's gone, retirees are on their own.

It's a potentially divisive issue even within a union, because each dollar that goes to retiree healthcare means there's less money available for active employees.

Collective bargaining agreements related to layoffs and plant closures would also be a battleground in a GM bankruptcy. Under Section 1113 of the Bankruptcy Code, a debtor can cancel such agreements, provided it can convince a judge.

Such a move may be inevitable. GM's current contract with the UAW calls for temporarily laid-off hourly employees to continue receiving 95% of their take-home pay, though that amount includes outside unemployment benefits and is subject to tax. Workers who remain unemployed for longer periods of time are placed in a "jobs bank," getting full pay from GM until they find a new job.

Agreements like these make it difficult for GM to make much-needed reductions in its fixed costs, says Erich Merkle, a senior analyst at IRN Inc. in Grand Rapids, Mich. The company has the capacity to produce 6 million vehicles a year, but he only expects it to churn out 4.8 million in 2005. Closing more outdated plants would help, but "they're somewhat hamstrung" by labor agreements, he says.

Workers are apt to argue that GM's real problem is its failure to produce cars that more consumers want to buy. Why, they might ask, should labor bear the pain for management's strategic missteps? Even if this argument is compelling, it's unlikely to stop a bankruptcy judge from allowing GM or another Big Three automaker to scrap its labor agreements under Section 1113. "The judge can't order people to buy GM cars, but the judge can allow the company to get small enough" that its costs are in line with its market share, Dykhouse says.

At its worst, GM's attempts to force concessions on workers could lead to a strike. That's an outcome that many consider the ultimate doomsday scenario, hobbling an already wounded GM and quite possibly taking much of the U.S. economy down with it.

Given all these unknowns, the final act of a "what-if" GM bankruptcy is hardest to contemplate. But a few aspects seem clear.

Because of the company's large asset base, secured creditors, such as bank lenders, would almost certainly be made whole. Some of GM's prepetition loans could be rolled into exit financing, or Congress might step in with federal-backed financing as it did with Chrysler in the late 1970s or more recently with the troubled airline industry.

Most of the pain would likely be divided between workers (including retirees) and GM's unsecured creditors. A court-approved reorganization plan might give unsecured creditors a package of new debt, with a much lower face value, as well as equity in the reorganized GM.

One way or another, unionized workers would find themselves with fewer benefits and job protections than before. As consolation, they might get some kind of debt or equity securities from GM - a relatively novel concept that Monomoy's Presser and the UAL pilots recently used to reach a pension settlement with the airline.

While we're thinking the unthinkable, there's one more thing to mention.

A GM bankruptcy would be jarring enough, but Miller of Miller Mathis points out that if the automaker were ever forced to seek protection from creditors, rival Ford Motor Co. would probably be in the same dire straits as well.

That raises the scarcely conceivable prospect of an American auto apocalypse - two of the Big Three in bankruptcy at once - which would likely stun Washington into crafting some kind of a bailout plan, as it did for Chrysler years ago.

In the end, it might be politics, not economics, that makes a real-life GM bankruptcy so unlikely. But that doesn't make the possibility any less unnerving.

There's a small but unmistakable sigh of relief from the crowd as the judge signs an order confirming GM's reorganization plan, clearing the way for the company to leave Chapter 11. It's been a 30-month battle. GM's public relations team is on active standby, ready to fire off a press release announcing the company's emergence. The plan will leave a smaller GM with a cleaner balance sheet, but there's much cleanup work still to do, including the tedious processing of billions of dollars of claims. For some of GM's suppliers, these partial payouts will be small consolation. Already struggling before GM filed, many of them have been pushed into bankruptcy themselves, some for the second time in recent years. It's also a brave, new world for thousands of current and former GM employees - many of whom have learned, the hard way, that bankruptcy changes everything.

** This story ran in a July 2005 issue of The Deal newsweekly. It looks relevant again today. **

See Dealscape's complete coverage of the auto industry.

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