GM in bankruptcy

Congress continues to waver over whether General Motors Corp. and Chrysler LLC should get $14 billion to get them through the first quarter. If the bailout passes (or if it doesn't), Rick Wagoner Jr. will, for now, retain his job as GM chief executive, and the United Auto Workers will continue to declare how willing they are to negotiate concessions.

Relief? Hardly. The credit crisis and recession continue. And the plight of automakers will persist, bailout or not.

Here's the reality: Bailout or not, GM will file for bankruptcy. There's no escaping it. To drastically reinvent the 101-year-old company to keep it alive and return it to prosperity will require tools only available in a bankruptcy process. All the talk about no one buying cars from a bankrupt company will evaporate as everyone realizes consumers aren't buying GM vehicles, anyway. There will be a car czar, but it won't matter. Congress will fulminate, but it won't matter. GM will have to file, Wagoner will be fired, a new CEO hired.

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What will this bankruptcy of bankruptcies look like? In the pages that follow, we offer a speculative look at how the GM bankruptcy scenario will unfold.

By its own admission, GM is suffering from "the worst economic downturn, and worst credit market conditions since the Great Depression." The company has negative net worth of nearly $60 billion and massive losses since 2005 -- $21.3 billion in net losses in just the first nine months of 2008. Even worse, GM is a relic, making as many as 14 million vehicles a year, hemmed in by collective bargaining agreements, lifetime employment contracts, too many dealerships and brands.

Despite the unions' political clout and fears that GM's image will be fatally wounded, the federal government finally makes bankruptcy a condition for further help. Only bankruptcy can impose the discipline necessary to remake GM. "It's the rule of law instead of the rule of politics," says John Jerome of law firm Saul Ewing LLP. "The judge ... operates in a nice confined box with a set bunch of rules and laws."

After the short-term bailout fails, GM files for bankruptcy, ousts Wagoner and receives a $25 billion debtor-in-possession financing provided by the federal government either directly or out of the Treasury's Troubled Assets Relief Program, or TARP. The company make its Chapter 11 filing in the U.S. Bankruptcy Court for the Eastern District of Michigan in Detroit. It's neither prepackaged nor, for that matter, significantly prenegotiated. Congress has been throwing the prenegotiated concept around, but in reality, because of GM's size, only a partial prenegotiated filing is practical.

Why no prepack? GM simply lacks the time to prepare a prepack, where a company works with lenders, creditors and shareholders to craft a reorganization plan and then solicits votes, all before entering bankruptcy. A prepack would require a "bajillion" creditors to buy in, says veteran auto industry attorney Jean Robertson of Calfee, Halter & Griswold LLP, an inordinately lengthy process when GM is burning through roughly $1 billion in cash a month.

According to James Wilton of Ropes & Gray LLP, who was debtor counsel to auto parts maker Holley Performance Products Inc., a complex case such as GM's would require negotiation after filing instead of before. A free-fall bankruptcy, however, with no planning whatsoever would be catastrophic. In such a case, constituencies from unions to creditors to shareholders would grapple for information and spend a lot of court time -- and, by extension, money -- battling to increase their recoveries. Every day spent trying to diffuse the situation would be one not spent fixing operations.

So GM prenegotiates a deal with creditors only. The company has already said in Securities and Exchange Commission filings that it has begun negotiations with lenders, bondholders and its unions to whittle its debt at year's end by $32 billion to roughly $30 billion. It hopes to complete the process by March 31, the deadline under the tentative bailout bill for agreement on a long-term viability plan.

One big issue with a filing: What happens to the government's short-term bailout stake? The DIP will represent new funds above the bailout money. In the creditor hierarchy, the DIP will take a senior position to other creditors, with the bailout debt just below. At the least, the federal presence ensures huge pressure and publicity.

The first chunk of money the feds provide to GM and Chrysler will get GM through the first quarter of 2009. Then the DIP kicks in, with $15 billion for operations and all the rest, and $10 billion to preserve GM car warranties. The carmaker estimated as of Sept. 30 that warranties represented $9.04 billion in liabilities. The DIP is a big leap for the feds. One lawyer who was in a meeting with Federal Reserve officials says that when the idea of DIP financing first arose, one Fed staffer asked, "What's a DIP?" But a federal DIP is a necessary step, since it dwarfs the largest in history, Calpine Corp.'s $10 billion in 2007, and credit markets remain partially frozen in early 2009.

"It would take a Herculean effort to raise [the necessary] cash from the private sector in this market," says a source at one of the automakers, adding that back-channel discussions have already been held with lawmakers about the federal government providing at least part of a DIP.

GM won't get the whole thing at once, of course; the bankruptcy court will give it interim access to, say, $10 billion so suppliers know they'll be paid, car owners won't worry about warranties and workers can plan their immediate futures. The court will review final approval for the entire DIP three months or so after the interim OK -- fairly standard in bankruptcies -- to ensure the money isn't being frittered away.

Downtown Detroit -- at least the hotels and restaurants -- rapidly fills up with all the visiting lawyers and advisers. GM isn't going to pull an Enron Corp. and make its petition hundreds of miles away in New York (too expensive) or Delaware (the appellate court isn't kind to the idea of abrogating collective bargaining agreements). Michigan's sitting jurists may not have the sophistication of their Wilmington or Manhattan counterparts regarding big bankruptcies, but they're hardly slouches. Parts makers Collins & Aikman Corp., Cadence Innovation LLC and Intermet Corp. all filed in Detroit, and silicone implant maker Dow Corning Corp. chose Bay City, about 115 miles away on Saginaw Bay.

The sheer size of a GM proceeding mandates that other high-profile cases not overwhelm a court. Many of GM's suppliers are nearby, as is the United Auto Workers' headquarters. These are the kinds of reasons why United Air Lines Inc. parent UAL Corp. chose to file in Chicago, says Deborah L. Thorne of Barnes & Thornburg LLP.

Another factor: Delaware isn't a particularly friendly place to break union contracts. "The standard for doing that in the 3rd Circuit [Delaware, New Jersey and Pennsylvania] is hard to accomplish," says David Stratton of Pepper Hamilton LLP, debtor co-counsel for Holley.

The feds charge LIBOR plus 300 basis points on the DIP, 300 basis points below the current rate, but still capable of providing a return for taxpayers without killing GM. And by providing the DIP, taxpayers get paid before other GM creditors. Providing DIPs, says Saul Ewing's Jerome, is "a more rational use of bailout money, less political."

Given the day-to-day pressures of a GM bankruptcy, political heat is the last thing a new CEO will need. Who will that be? Lots of names circulate for the CEO's post -- Nissan Motor Co. Ltd. CEO Carlos Ghosn, former General Electric Co. über-CEO Jack Welch, among others -- but GM's board and the new car czar want to think outside the box. They consider Robert Crandall, the one-time head of AMR Corp.'s American Airlines Inc. who, in a 1998 interview with "The NewsHour with Jim Lehrer," downplayed his representation as a union adversary but contended, "I'm tough enough to do what has to be done when it must be done."

Others, too, are vetted, including Jerome York of investment firm Harwinton Capital LLC, an outspoken GM critic and Kirk Kerkorian confederate, who is known as a cost cutter and worked at Chrysler for 14 years until 1993; Frank Macher of Finance Manufacturing Acquisition & Capital, brought in as Collins & Aikman CEO after serving as chairman and CEO of bankrupt parts maker Federal-Mogul Corp. and CEO of ITT Automotive Inc.; and Wilbur L. Ross Jr. of WL Ross & Co. LLC, who deftly dealt with the United Steelworkers while rolling up a bankrupt U.S. steel industry.

But with the car czar's blessing, GM's board goes after Stephen Cooper, the crisis manager who navigated Enron's contentious and highly controversial Chapter 11 and later was Collins & Aikman chairman while it was in bankruptcy. Cooper, still doing some advisory work for Zolfo Cooper, has the restructuring chops the board wants, experience dealing with controversy and a deep understanding of bankruptcy. They also like what Cooper lacks: muscle memory about how a carmaker should operate or should deal with its unions.

"A turnaround of GM could be a five- to 10-year undertaking," Cooper tells us. "I've lost a lot of my hair over the years; I'm not sure I'm prepared to lose the rest. Candidly, I would have to think very hard about it and assess whether it could be successful. It would be an unbelievable challenge."

Still, we believe he'll take it. He heads to Detroit.

One thing Cooper and GM won't do is ask the court to approve a so-called critical vendors motion. Such motions are common in bankruptcies, put forth by debtors so they can pay those creditors that they need to keep operating, even though they would normally have to wait for other creditors to be repaid before receiving funds. But a restructuring adviser familiar with the auto industry says it would be difficult to determine which of GM's suppliers are critical. And few suppliers could afford a lengthy wait for payments.

GM, therefore, "would plan ahead and have this kind of vendor motion that would allow [it] to continue and pay creditors in the ordinary course and maintain the status quo," the adviser says. "If you don't, then you have incredible disruptions in the supply chain." The vendor motion and DIP funding would head off a chain of cascading bankruptcies that might result from a Chapter 11 filing.

But what about GM's financial creditors? GM's debt load, SEC filings show, includes a secured revolving credit facility with the full $4.4 billion drawn on it, a $1.5 billion secured term loan, three series of unsecured convertible debentures with more than $6.9 billion outstanding, about $16 billion in unsecured bonds and $19 billion in other long-term liabilities, ranging from municipal bonds and capital leases to contingent convertible debt and foreign currency-denominated bonds. Then, of course, there are GM's bailout funds. It's unlikely that all those debtholders will reach agreement, even after substantial talks.

Thus the seeds of dissension among creditors will have already been sown, and the chances of even a prenegotiated deal exploding are high, Calfee Halter's Robertson says. "I would hope that the creditors would work together, because they have everything to lose," she says.

Barnes & Thornburg's Thorne is more hopeful. "Even if all the 'I's weren't dotted and the 'T's weren't crossed [before the filing], constituencies would come together," she says. "There will be fights over money, but creditors will be working together because if they can't and production stops, the costs are monumental."

Nearly every constituency, of course, wants its own official committee in order to have its professional expenses paid out of the GM estate. As in almost every bankruptcy, an official committee of unsecured creditors is appointed. But U.S. Trustee Daniel M. McDermott, who oversees bankruptcies in Michigan and Ohio, wants to keep committees to a minimum. (The judge in the case has some say here, too.) McDermott must decide whether GM retirees and bondholders get official committees. Ditto for car dealers. Those without official status assemble informal panels. GM shareholders try to get an equity committee, and they're laughed out of court.

What isn't funny to McDermott are the fees a GM bankruptcy will generate, so he moves early to appoint a fee examiner to review fee applications from various professionals -- Cooper included. Fees will be controversial, particularly with a big federal presence. McDermott also considers pushing for cooperation among creditor classes -- and thus have fewer committees -- to keep fees down. One example: A future retiree representative, the UAW and the federal Pension Benefit Guaranty Corp. all join the creditors' committee.

While this jockeying is going on, Cooper turns his attention to his biggest task: reshaping GM's operations. He will have to downsize the company, cutting brands, dealers, workers. The only thing to increase will be mobs of unhappy people. Cooper decides to retain Cadillac as GM's luxury brand, Chevrolet as its core and GMC as its truck line. Everything else has to be unloaded through Section 363 sales.

GM will become more like Nissan, Toyota Motor Corp. and Honda Motor Co. Ltd. Gone are Buick, Pontiac, Hummer, Saab and Saturn. For GM, it serves as more than a catharsis. There is now much less duplication, less overhead and more cash from sales to pump back into the business. Some discarded brands don't sell quickly (Hummer), while others will (Buick operations in China, where the nameplate is very popular). Overall, GM must sell millions of fewer cars a year to become profitable again. "The fundamental change [for GM] is that it's going to have to not be all things to all people and create all these niche cars for niche markets," says the restructuring adviser, adding that GM has to realize that being a carmaker is simply not about grabbing the biggest market share. "It's better to say, 'Lets find products to build profitably.' "

But before GM can begin 363 sales, it must deal with labor and dealers, says Conway MacKenzie & Dunleavy managing director Gregory A. Charleston. "Once you deal with that baggage," the turnaround consultant says, "you can potentially sell the pieces."

At first glance, its collective bargaining agreements don't seem to be a huge stumbling block. The automaker has said in regulatory filings that after recent labor talks, its cost for new hires can be as low as $25 an hour. Even with a potential increase to $35 over time, that's far lower than the average cost of $45 to $50 per hour for Toyota workers, GM says. The company adds, however, that it won't be fully competitive with Toyota on wages and benefits for all workers -- existing employees and new hires -- until 2012.

But GM can't afford to wait. And with Wagoner & Co. out of power, GM won't be saddled with what's been a comfortable long-term relationship with the UAW. Cooper has to shutter plants to reflect a smaller GM and to reduce labor costs. Like UAL and other bankrupt airlines, GM invokes Section 1113 of the U.S. Bankruptcy Code and breaks its union contracts. Section 1113 allows a debtor to reject CBAs after it proposes modifications that were previously declined by a union without good cause and where a new transaction would be in the best interests of the parties involved in the bankruptcy.

At the very least, GM needs to modify labor pacts to lower costs for existing, longtime workers, which may be difficult if not impossible, given recent contract modifications. And then there's the question of brand elimination and its effects. While such actions might not be technically included in labor deals, any actions concerning workers would force more talks. GM no longer has the time for them, if it ever did.

GM might try to soften the blow by giving the UAW board seats in the reorganized company, an equity stake or some form of profit sharing, restructuring pros say. "If both union and management want to survive, they'll work something out," Jerome says.

Ultimately, after great struggle, GM gains the upper hand with its union workers. A new deal doesn't necessarily drastically alter GM's pension or healthcare costs. According to GM spokeswoman Julie Gibson, the U.S. pension plans for salaried and hourly employees are "overfunded on a combined basis."

UAW retiree healthcare costs of roughly $46.7 billion, meanwhile, are set to shift to a voluntary employee beneficiary association, or Veba, in January 2010, in exchange for set payments by GM negotiated last year. A similar deal with another union, the IUE-CWA, takes effect two years later.

Still, even here lurk potential pitfalls. Thomas Salerno of Squire, Sanders & Dempsey LLP says "overfunded is an estimate" and that the debtor has to work to avoid contingent liabilities -- another sign that Section 1113 or related Section 1114, which governs rejection of retiree benefits, needs to be invoked. Plant closures can spark early retirements, which can turn overfunded plans into underfunded ones in a hurry.

GM won't reject its pension plans, however. To do so, says attorney Carol Connor Cohen of Arent Fox LLP, the debtor would have to show that it and related entities couldn't stay in business with the need to make payments on the plans. "I'd be very surprised if they could meet that test," she says.

But healthcare is a different matter. The automaker has already deferred $1.7 billion in payments to the UAW Veba and could seek further deferrals; SEC filings indicate GM must either contribute $5.6 billion in 2010 -- a tall order -- or make annual payments of anywhere from $421 million to $3.3 billion through 2020. An additional $1 billion contribution is due in 2011, and $285 million of other payments is due on the implementation date.

Robert P. Simons of Reed Smith LLP says GM "shouldn't kick the can down the road like what happened with the steel industry during the 1980s."

He cites LTV Corp., which settled with unions in its July 1986 bankruptcy rather than force a rejection of its CBAs, which included pension and health benefits. LTV, after emerging from Chapter 11 in May 1993, filed again in December 2000. Had it dealt with the liabilities in the first case, Simons says, there never would have been a second filing.

With fewer personal ties to union management, new GM management is in a better position to invoke Section 1113 and Section 1114 and negotiate rolled-back benefits.

The same equation holds for GM's bloated dealer network. The company's own plan calls for the current 6,450 dealers to shrink to 4,700 by 2012. Veteran auto industry attorney Stephen Gross of McDonald Hopkins LLC says Chapter 11 gives GM "an ability to reject its car dealerships' franchise agreements," which otherwise would be a nightmare process. "You've got 50 state laws governing those agreements," he says. "This way you could very quickly eviscerate them."

Less cut and dried are GM contracts with parts makers. The ripple effect of GM's woes extends over hundreds of suppliers. That's why payments to them won't be interrupted. But there are certain suppliers GM realizes it no longer needs as the bankruptcy progresses. Breaking those contracts earlier would have been problematic. In bankruptcy, they're not.

The remaining suppliers will have to restructure with the support of GM -- and their lenders -- to supply parts for future GM vehicles, Robertson says. She acknowledges this won't be painless. "There will be a lot of casualties along the way. A lot of people going out of business. But," she says, "like Darwinism, the people that can find a way to adapt will survive and be better for it."

One parts maker in particular trouble is Delphi Corp. Spun off from GM in 1999, it has increasingly relied on its former parent as its own bankruptcy case, which began in October 2005, has progressed. GM agreed to advance Delphi up to $950 million in 2008, although no amounts were outstanding as of Sept. 30. And as part of a deal with the UAW and Delphi, GM agreed to pay $450 million to settle a UAW claim against the parts maker and certain healthcare costs.

Delphi, set for a Dec. 17 hearing to modify the reorganization plan that won confirmation in January, may have to return to the drawing board, even without a GM filing. "They've got to ... lever themselves out of Chapter 11 in another form than off GM's back," the restructuring adviser says.

Both the adviser and Gross see Delphi trying to sell off its remaining business lines, but the credit crunch may keep potential bidders on the sidelines and force it to reorganize around a piece of its operations.

That, in turn, would require GM support -- and keep Delphi locked in bankruptcy court as GM completes its own restructuring. It could take until 2010 or longer before Delphi emerges from Chapter 11, if it succeeds at all, given that GM would likely look to adjust any parts agreements

One set of liabilities GM management refuses to touch is its active vehicle warranties. GM has enough of an image problem in bankruptcy -- at least, that's the conventional thinking. And while GM will eventually overcome those fears and file for bankruptcy, it also will be careful not to boost any negatives by torching warranties.

By law, it could go after the warranties, which are contracts; GM would have the right to assume or reject millions of general unsecured claims. Rejecting them would save billions. But it would destroy goodwill, produce a public relations nightmare, imperil future sales and alienate current customers. "The consumer-customer backlash would be huge," says Lynn Butler of Brown McCarroll LLP, who serves as debtor counsel for Warranty Gold Ltd., a liquidating after-market retailer of extended warranties that filed for Chapter 11 in November 2003.

GM wants to avoid that backlash. So it goes out of its way to publicize the $10 billion of its DIP that it will reserve for warranty costs.

"As a practical matter, it's hard to imagine any successful reorganization that didn't assume the warranty obligations," says Joel Levitin, a restructuring partner at Cahill Gordon & Reindel LLP. "The enterprise value would likely diminish if [a carmaker] didn't have continuity with the existing customer base." Assuming the contracts -- and making sure the liabilities they represent are covered by the DIP -- keeps GM's customer base reasonably happy and shows that the manufacturer has the financial means to stand behind its product.

Keeping warranties in place also aids relations with remaining dealers, since warranties keep dealership repair facilities busy.

What won't enamor the dealers is the tough medicine Cooper has to administer to financial services affiliate GMAC LLC. The health of GMAC, 49% owned by GM, the rest by a consortium led by Cerberus Capital Management LP, is precarious. It posted a $5.6 billion net loss in the nine months ended Sept. 30 and had $6.6 billion in cash on hand, down from $13.3 billion at year-end 2007. About $12.2 billion of debt is due in 2009. (None of GMAC's debt is guaranteed or backed by GM.)

A GM bankruptcy could push it into default. A GM filing would cut into GMAC's financing volume if customers fled -- perhaps not a huge concern, since GMAC's difficulty in accessing secondary credit markets has already cut GM sales it can finance to a minuscule 6%.

GMAC, which owns the cars in its leasing fleet and sells them after they're returned, might also take more write-downs on the vehicles because of decreased demand for GM products, and thus depressed resale values.

GM could ask for amendments of contracts that share promotional costs for GMAC's leasing and auto-finance operations -- or even for forgiveness of amounts owed.

When combined with GMAC's own problems with its ResCap residential mortgage business, which is in even worse shape than GM, the unit could have to prepare its own filing -- potentially wiping out both Cerberus' and GM's stakes. The automaker valued the equity at $1.95 billion on Sept. 30.

GMAC will look to the same savior that GM is: the government. GMAC has applied for conversion to a bank holding company, which would allow it to seek retail deposits for financing, borrow from the Federal Reserve discount window and seek TARP funds.

If GMAC can work out the complications -- it has indicated it may be unable to raise required capital -- it could boost financing volume, helping GM while helping itself.

Eventually, sometime in late 2010, GM resolves its issues with GMAC, dealerships, parts suppliers and unions. Asset sales are now well under way or concluded under the auspices of the bankruptcy court. A new capital structure has been welded to a new, streamlined operational chassis. And there are some nifty, new fuel-efficient cars, too.

GM's proposed reorganization plan will enable it to compete on a level playing field with foreign rivals. All creditor classes are likely to take haircuts, with labor and the government assuming partial equity stakes. Old shareholders will be wiped out.

And after a creditor vote and a closely watched confirmation hearing, a trim GM rolls out of court one blustery winter day in Detroit and heads into the automotive future.

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