General Motors' chapter 11 bankruptcy and automobile industry restructuring

¶ … Auto Industry

On June 1, 2009, General Motors became the second-largest industrial bankruptcy case in history. Contrary to consumers' views about bankruptcy, GM executives portrayed the move as "an unprecedented opportunity to reverse decades of decline" (King & Terlep, 2009). The case illustrated how Chapter 11 bankruptcy protection can be utilized by ailing companies to re-organize their businesses and salvage their companies. President Obama predicted that GM would emerge from Chapter 11 as a "stronger and more competitive company" within months. Indeed, GM exited bankruptcy only a few weeks later in July (CBS, 2009).

The use of Chapter 11 in the automobile industry is contentious for a number of reasons, but has been deemed necessary by management. Reorganization under Chapter 11 allows automakers to rid debts, break burdensome contracts and shed liabilities. The legal framework for the GM bankruptcy was set by the prior Chrysler bankruptcy. It should be noted, however, that the legacy liabilities these automakers have sought to shed via Chapter 11 are not the only issues these companies face. This paper will analyze the issue of Chapter 11 with respect to how it impacts the automobile industry. While it is expected that reorganization will yield some benefits, but Chapter 11 alone will not address the major strategic issues that these firms face.

Chapter 11

Chapter 11 bankruptcy can be filed by either the debtor or a creditor. Under the statute, the debtor must file a schedule of assets and liabilities, of income and expenditures and of contracts and obligations (UScourts.gov, 2009). The debtor is required to file a reorganization plan that the creditors and the court can examine. Once the reorganization is approved, the plan can be executed.

Section 363 of the bankruptcy code allows for the execution of virtually any asset sale or transaction that has been approved by the bankruptcy courts (Cornell University, no date). Application of section 363 is at the discretion of the bankruptcy court. The judge can approve of a 363 sale if it is deemed necessary to the survival on the company (Morath, 2009). In the case of General Motors, its assets were sold to a new operating company. The stock was removed from New York Stock Exchange and the company is now owned by the existing bondholders, a UAW health care fund and the U.S. And Canadian governments. The argument for this sale was that the company would have been liquidated had the sale not been allowed. As such, the judge allowed the sale under Section 363 in order to save the company.

Chapter 11

An analysis of GM's financials reveals the problem posed by the legacy liabilities. According to the company's 2008 Form 10-K the company had automotive sales of $147 billion and automotive cost of sales of $149 billion, the latter figure including the legacy liabilities that were built into the per hour labor cost figure. The company was losing money on every vehicle it sold.

The primary benefit of Chapter 11 reorganization then was to shed some of these liabilities and break contracts in order to restore operating profitability to the company. Under GM's reorganization, its key ongoing assets were sold to a new operating company. Chrysler's reorganization took the same form. The new company would have fewer assets, as those to be liquidated were left with the old company. The Chrysler bankruptcy cleared the path for GM, in part because the bankruptcy judge essentially shut down the creditors' objections to the restructuring (CBS, 2009). The use of Section 363 was instrumental. Asset sales under 363 are common in large scale bankruptcies because they allow for the preservation of the company. The case of the automakers, in particular GM, was influenced by the federal government's desire to keep these companies afloat in some form.

There were three key decisions in the GM case that illustrate how the Chapter 11 bankruptcy filing and asset sale under Section 363 allowed the automakers to restructure and theoretically emerge from bankruptcy in a stronger competitive position. The first was with respect to the debtor's motion for approval of the sales of its assets, assignment of contracts and entry into a UAW retiree settlement (U.S. Bankruptcy Court, 2009). This motion laid the framework for the agreement. The use of 363 was allowed, in particular because GM had negotiated with the United Auto Workers to protect some of the key retiree benefits. The old contractual obligations to the UAW with respect to the retirement plan were reworked. As a result of the reorganization, the UAW is now responsible for the plan's administration, and in exchange has received a substantial ownership stake in the reorganized General Motors.

The second key element that allowed for the invocation of Section 363 was the involvement of the federal government. That the U.S. And Canadian governments backed the asset sale (as majority and minority owners of the new GM entity respectively) guaranteed the survival of the firm. The judge was able then to weigh the merits of a General Motors that had not turned a profit in five years, was losing tremendous amounts of money and was insolvent vs. A General Motors whose existence was essentially guaranteed by the U.S. taxpayers. The near certainty that the company as previously constituted would need to be liquidated in its entirety, plus the fact that major creditors and the UAW were accounted for in the deal, convinced the judge to allow the asset sales under Section 363 (Ibid).

The new GM post asset-sale is a company that is owned by two major governments and a handful of major creditors. All of the "good" assets were sold to the new company. What was left behind is a shell company consisting of "bad" assets, plants to be closed and minor creditors not invited to the restructuring. The old General Motors then will be liquidated, with the proceeds going to the remaining creditors, who do not receive nearly as much of the company as those who were allowed by buy into the new General Motors. In essence, the asset sale that came about as a result of the bankruptcy protection served two important functions -- to allow GM to separate assets it would like to keep from those it would like to jettison, and to do the same with its creditors. The residual creditors receive little for their investment, which was part of GM's plan.

The other important function of the plan was to shift responsibility for the pension obligations from the company to the United Auto Workers. While smaller creditors and contractual partners need not be satisfied with the reorganization, it is difficult to believe that the reorganization could have been done with the cooperation of the UAW. It would not have been politically expedient for the federal government to become involved and without their involvement the judge would have had had the option of the 363 asset sale. In accepting responsibility for the pension, the union has lifted a major portion of the liabilities from General Motors. In addition, a deal reached before the filing adjusted some of the work rules, ended bonuses and froze wages, all of which combined to save GM $1.2-1.3 billion per year. Combined with plant closures, the moves are expected to bring GM's labor costs more in line with those of its competitors. This will eliminate a major competitive disadvantage. The cost to the company is a significant UAW ownership stake and a union seat on the board (Strumpf, 2009).

It should be noted that the unique structure of automakers' operations stretches the impacts of the Chapter 11 reorganization's internationally. General Motors and Ford in particular have a significant amount of their production capacity in Canada. The Canadian government, therefore, needed to become involved in the Chapter 11 process. The Canadian Auto Workers, however, did not have the same involvement as the UAW in large part because the health care liabilities to pensioners are dramatically lower in Canada due to the socialized medical system. It is highly unusual for one federal government to become heavily involved in a Chapter 11 case, let along two governments, which makes the case of the automakers unique.

Impacts

In theory the automakers have utilized Chapter 11 to free themselves from the majority of their liabilities. Without these liabilities on their balance sheets, and other burdensome contracts that were left behind during the course of the bankruptcy proceedings, the automakers are theoretically better equipped to compete with their rivals. The cost of goods sold will be significantly lower, since not only with the average hourly labor cost be lower but so will the average number of hours per vehicle.

By altering the underlying financial situation of the automakers, the focus can be shifted towards improving the operations side of the business. With the less efficient plants and product lines jettisoned, General Motors expects at this point to only have four lines of product. They will be able to better focus on meeting customer needs, the lack thereof in the past has contributed to the dire financial situation in which they found themselves.

Conclusion

Chapter 11 bankruptcy allows for insolvent companies to reorganize themselves in order to satisfy their creditors and relieve their debt burdens. If there is reason to believe that the company will otherwise fail, Section 363 can be utilized in order to allow the company to sell its assets, if there is a willing buyer. Two automakers, General Motors and Chrysler, filed for Chapter 11 protection in order to restructure their operations and balance sheets.

At GM, the company was able to cut unproductive assets, renegotiate union contracts and transfer its good assets to a new GM company backed by the federal government. The most significant of its legacy liabilities was its pension obligations, particularly with respect to health care. These obligations were transferred to the United Auto Workers in exchange for an ownership stake in the new company. Some other major creditors also received a stake.

The reorganization served some key functions, such as lower labor costs and dramatically improving the firm's balance sheet. What it did not do was address some of the other strategic and competitive issues facing the automakers. The hope is that by restructuring, these firms will be better able to respond to the challenges in today's competitive environment, allowing for their long-term survival.

Works Cited:

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