Editorial: General Motors Death Watch 219: Rrrrrrescue Pack!
In recent congressional testimony, GM admitted that its experts are “exploring” Chapter 11 reorganization. At the same time, GM continues to argue that a bankruptcy filing is the nuclear option– it would vaporize jobs and inflict cataclysmic damage on the overall U.S. economy. While acknowledging the danger, many argue that reorganization is both necessary and unavoidable. They suggest that GM’s recreation should somehow take place outside of the time-tested legal process known as Chapter 11. Sentiment is growing that a taxpayer-finnaced “prepackaged” Chapter 11 is the best way to solve both GM’s business and financial problems, and perhaps of other automakers. Maybe so. Let’s have a look…
Why is a non-bankruptcy loan to GM a poor use of taxpayer money?
A lender to an insolvent company on the verge of bankruptcy wants its loan to be repaid. It would not allow loan proceeds be used to pay off existing liabilities. GM owes unsecured bondholders about $40b. There is no indication that bondholders have agreed to standstill, waive interest payments, or restructure the debt. GM’s Series D debt of $800m comes due in June 2009, when GM must pay the debt, default or get bondholders to extend the maturity date. GM owes trade creditors about $28b and owes another $34b in accrued expenses.
GM’s legal obligations to bondholders and trade creditors cannot be changed or modified without a bankruptcy case, or the written consent of each individual creditor, That’s a near impossible task. Attempting to reorganize GM outside of a legal proceeding would encourage creditors to holdouts for special treatment, delaying any chance at restructuring
A commercial lender supporting GM– which is insolvent on the basis of its balance sheet– would ask how paying the existing claims of bondholders and suppliers will help GM with its current cash flow problems. They would not allow loan proceeds to be diverted to unsecured creditors. Without a Chapter 11 case, taxpayer loans to GM could be used to pay interest on $40b of GM unsecured debt, and to pay the $800m Series D debt coming due in June 2009.
GM must also pay $7.5b to the retiree trust in January 2010,– another liability for which it does not have funds. Taxpayer money should not be used to bailout existing debt or to pay non-essential existing liabilities. The restructuring of GM’s payment obligations can be most quickly and effectively accomplished in a pre-packaged chapter 11 case.
What is a prepackaged chapter 11?
In a true “pre-packaged” reorganization, the debtor proposes its reorganization plan and solicits votes before they file for Chapter 11 protections. For companies with publicly traded debt and other securities, Chapter 11 gives them the chance to restructure its debts without the “normal” delay and expense of extended negotiations.
A partial “prepack” involves a pre-petition solicitation of certain classes of creditors (e.g. bondholders) and a post-filing solicitation of other classes of creditors (e.g. unsecured suppliers). If the parties have agreed in writing on how their claims will be treated under the plan, sometimes called a “pre-negotiated” prepack, pre-filing voting on the reorganization plan is not essential. [Under a GM reorganization plan, the common shareholders receive nothing and therefore do not get to vote.]
Bottom line: a prepack doesn’t have to address every issue of every creditor group. Smaller claims are usually resolved after a Chapter 11 plan is approved.
A prepackaged reorganization is not ideal for companies that want to terminate large numbers of unprofitable or burdensome contracts. However, GM qualifies. They’ve been restructuring/downsizing for a few years, implementing plant closings, laying-off employee and making other changes to address market realities.
A big advantage of Chapter 11 pre-pack: the debtor can quickly and easily sell assets and operating divisions (e.g. Hummer, AC Delco) to create cash for ongoing operations. The claims of persons affected by the sales are funneled into the bankruptcy court for expedited resolution. Disputes with creditors need not delay the sales.
What is involved in preparing a business plan and application for a chapter 11 “debtor-in-possession” loan?
In a prepackaged chapter 11 reorganization, the financing for the chapter 11 debtor is in place before the Chapter 11 case is filed. The financing often includes a commitment to provide the “exit” financing used to fund the debtor’s obligations– after creditors and the bankruptcy court approves its Chapter 11 reorganization plan.
Given the current state of commercial credit markets, the U.S. Treasury will have to commit to the reorganization plan exit financing. The reorganization plan will set forth the repayment terms for the existing secured debt, the new U.S. Treasury loan and the Department of Energy (DOE) loan.
As with any loan application, the starting point for GM will be its current assets and liabilities, its cash flow and its realistic projections. All of which go into a measured calculation as to the borrower’s credit worthiness and ability to repay the loan, with interest.
In Chapter 11 cases, the debtor prepares detailed projections and budgets, taking into account the reduction in its current liabilities that result when the case is filed. For example, after GM files for Chapter 11, it will no longer pay interest or principal on its unsecured debt. Chapter 11 lets GM stop paying liabilities incurred before bankruptcy. This will increase the cash available for operations. The debtor’s cash flow projections reflect all these deferrals and changes to current liabilities.
How will retiree claims be treated in a pre-packaged chapter 11 case?
GM retiree claims are– primarily– unsecured claims, As such, they have the same priority as bondholders and other unsecured creditors.
In January 2010, the UAW and its related retiree trust will assume most of GM’s retiree liabilities for current retirees. In January 2010, GM has to pay the retiree trust $7.5bin cash and other transfers of assets. The trust also receives a $4.4b GM convertible debt issue– which is an unsecured claim against GM.
Over ensuing years GM must pay the trust additional amounts estimated to be between $10b to $17b. A basic rule of bankruptcy: claims having the same priority in payment get the same treatment under a Chapter 11 reorganization plan. Thus, all unsecured claims, including claims of the retiree trust, should get the same treatment.
In a pre-packaged Chapter 11 case, creditors can agree on different treatment of claims having the same priority. But this invariably leads to more delay and expense. In a GM chapter 11 case, these future payments to retirees are frozen. They’re treated as unsecured claims; they’ll get a distribution under the GM reorganization plan.
What happens at the beginning of a pre-packaged chapter 11 case?
Despite assertions that reorganization in Chapter 11 is not a realistic option, a company with pre-arranged financing is quite able to operate in Chapter 11. In nearly every mega case where a restructuring of an operating business is contemplated, the bankruptcy court enters “first day orders.” Basically, these are all the court approvals that the business needs to continue to operate its business in the ordinary course. First day orders deal with everything from financing, to advance payments, approval of bank accounts, authority to honor customer warranty claims, and reimburse dealers— all the details needed to prevent disruption of the operating business.
While it is definitely a lot of paperwork, legal and turnaround professionals do this type of work every day. The courts routinely approve first day orders designed to save operating businesses.
GM’s assertion 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. GM already finances its largest suppliers (Delphi and American Axle) and has a receivable financing program for other suppliers so that the suppliers have access to cash.
These programs can continue in Chapter 11, or even be improved. For example, GM could ask the reorganization court to approve cash pre-payments to essential suppliers. The past due claims of suppliers are unsecured claims. In bankruptcy, these claims have the same priority in payment as GM’s unsecured debt. In planning a prepack, it’s not unusual for the debtor, with the consent of its major creditors, to prepay critical suppliers before the prepack is filed.
What will creditors get in a pre-packaged GM reorganization plan?
A GM reorganization plan must be based on 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. Fortunately for taxpayers, in a Chapter 11 case the debtors’ financial projects are open to public scrutiny and to the comments and objections of creditors affected by the Chapter 11 plan.
GM will not have resources to make a cash distribution to creditors. So the reorganization plan will involve a distribution of newly-issued debt and new common stock, with the old debt and old common shares being extinguished. The new common stock will be listed on a national exchange, It wil,l have an immediately ascertainable value based on the financial projections that GM will have to produce to get creditor approval of its Chapter 11 plan.
Under the reorganization plan, the trust for retirees should not receive payment on the $4b short term note, the $4.4b long term note, or its other claims against GM. But will the trust will get its pro rata share of the newly issued debt and common stock of reorganized GM.
Since the new common stock will be publicly traded, it can be sold to fund retiree obligations assumed by the retiree trust. In a Chapter 11 case, creditors can also agree that retirees will get better treatment than is customary. But this requires a vote of creditors and special treatment that’s likely to be contentious, and delay the Chapter 11 case.
Government financing for a GM pre-packaged reorganization
A U.S. Treasury non-bankruptcy equity investment in GM (i.e., purchase of GM preferred stock) is a bad investment for a company already balance sheet insolvent by more than $60b. A primary beneficiary of an equity type investment: the existing unsecured bondholders and unsecured creditors, who would have a claim on the proceeds.
Some suggest that taxpayers should make an unsecured loan. Any such a loan would have the same priority as the other $105b of existing GM liabilities, making loan repayment unlikely. Taxpayers should demand that any loan made to GM be made only in connection with GM’s Chapter 11 filing, that it be fully secured, and only disbursed pursuant to detailed written budgets.
Naturally, lenders to Chapter 11 debtors should insist on competent management. They should also hire their own accountants and reorganization professionals so that the lender has an independent analysis and opinion of the debtor’s viability, business plans and the “viability” of the debtor’s goals and financial projections.
In a pre-arranged Chapter 11 case, the U.S. Treasury could extend to GM a secured debtor-in-possession line of credit for say $40b, a line of credit secured by a first security interest on all GM assets, being junior only to GM’s existing secured line of credit of $4.4b.
A portion of the U.S. Treasury line of credit should be available to support essential suppliers through loans, letters of credit and pre-payments. On the first day of a pre-packaged Chapter 11case, the bankruptcy court is likely to give interim approval to a portion of the total credit line. Ten day’s later, they’ll have a hearing to approve the balance of the loan facility.
Since the government lacks experience in administering secured loans to insolvent companies in Chapter 11 reorganization, it might be preferable to have the loan guaranteed by the US 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.
This would not eliminate oversight by the US Treasury and Congress. But it would delegate the devilish details of loan administration to experts.
GM’s Chapter 11 reorganization plan can be expedited
Given the importance of US automakers to the economy, and the need for a successful reorganization to preserve jobs, a GM Chapter 11 reorganization case will be expedited. The chief judge can assign multiple judges to handle different aspects of the case, recognizing that speed is essential to a successful reorganization. Bondholders and other creditors should support expedited handling of their claims– a successful reorganization is the best way for creditors to realize value.
A pre-packaged plan can be approved quickly; the plan has been negotiated and accepted by creditors entitled to vote before the Chapter 11 case is begun. In a partial “pre-pack,” the largest creditor groups informally approve the general principles of the plan before the case is filed. Formal solicitation and voting take place under the supervision of the bankruptcy court.
By using accelerated schedules, a prepack can be accomplished in months, not years. Pre-filing negotiations over the terms of the reorganization plan often result in agreement on difficult issues: payments to suppliers, support for the dealer network, honoring customer warranty claims, and even changes to employee work rules and benefits. All of these agreements can be rapidly documented.
Treatment of claims and shareholders under a GM reorganization plan
Given GM’s own statements about its shortage of cash for the foreseeable future, it’s unlikely that GM would make any cash distributions to existing creditors. Cash will be needed to retool plants and complete ongoing restructuring efforts. It will also be needed to eassure trade creditors that enough cash is available– so that trade creditors will extend new trade credit to GM.
Under a reorganization plan, creditors and shareholders are put in classes. Creditors having the same priority in payment often grouped in the same class. A simple GM reorganization plan would have the following elements:
-Taxpayers have a $40b first lien on all GM assets for monies lent by the US Treasury and the DOE. If GM’s debtor in possession financing cannot be refinanced by commercial banks, then taxpayers will finance GM’s exit from Chapter 11. Taxpayers should get warrants for 10 percent of GM’s new common shares, to reward them for the risk of financing GM in Chapter 11.
-GM’s existing $4.4b secured line of credit will retain its lien on GM’s assets and be extended.
-Consumer warranty claims are expressly assumed under the Chapter 11 plan.
-$40b of unsecured bondholder debt will receive its pro rata share of any new unsecured debt issued by GM and a pro rata share of GM’s new common shares. The common shares will trade on the public market and will have an immediately realizable value. No interest will be paid on any new debt until all taxpayer loans to GM are paid in full, with interest
-Trade payables of about $39b (the $17 to $27b owed to the retiree trust,) and any other unsecured claims get their pro rata share of any new debt and new common shares.
-The retiree trust may merit special treatment, although potential future liabilities to the trust of $27b not only would weigh heavily on GM’s post reorganization success, but also would depress the market value of any new common shares issued by GM. With creditor consent, the retiree trust could receive subordinated debt, with future maturity dates timed to GM’s future profitability. Without access to GM’s cash flow projections, it is hard to suggest what treatment would be fair to retirees while still protecting GM’s other creditors.
-Old common shares do not vote on the plan, get no distribution, and are canceled. Existing stock options are eliminated
-A new Board of Directors selected by creditors is in charge of reorganized GM, with board representation for the major creditor constituencies.
GM’s Hypothetical Post-Reorganization Balance sheet
Projected Assets: $90b
$4.4b: existing secured line of credit
$10b: secured term note to US Treasury
$12b: secured term note to the Department of Energy (GM’s share of the DOE funds for alternative vehicles)
$1b: trust or secured letter of credit established to guarantee payment of consumer warranty claims
$2b: current tax liabilities
Subtotal: $29.4b of secured and priority claims
$9b: accrual for consumer product warranty liability
$10b: for current claims arising in during the Chapter 11 case which will be paid by GM in the ordinary course of business
$5b: new unsecured debt (payment in kind) set aside for miscellaneous claims, with maturities deferred and no cash interest payment
$5b: subordinated debt, issued with laddered maturity dates timed to fund the retiree trust only if it runs out of money in the future
$15b: accrual for pension and retirement obligations for current employees
$5b: leases and other obligations, including liabilities to foreign subsidiaries
Subtotal: $39bof unsecured debt and unsecured liabilities
Total estimated liabilities: $78.4b
90 percent of newly issued GM common shares distributed to bondholders, the retiree trust, and other unsecured creditors
10 percent of new equity reserved for the US Treasury
Final thoughts on labor, management and Detroit
The UAW represents labor in negotiations with GM management. GM’s management, not labor, has been behind the GM steering wheel as GM went over the cliff of Insolvency. UAW negotiators are tough, well-informed professionals. The UAW is not inflexible; witness its recent agreement to defer $1.7b of payments to the retiree trust, a deferral which has helped GM stay alive. The UAW has its own staff of accountants and restructuring professionals who are prepared to sit down and negotiate and help GM propose a viable reorganization plan
GM’s Board of Directors, its management and the UAW have made mistakes. But their serious efforts to restructure GM should not be doubted. Rick Wagoner has spent 30 years at GM, but his efforts have been overtaken by circumstances. In reorganization the board will be replaced, as will some of the operations managers and senior executives.
Undue criticism of GM’s management and the UAW distracts from the need to urgently develop and implement a viable pre-packaged reorganization plan. GM’s management needs to get down to business and develop a reorganization plan that will protect taxpayers and earn the support of Congress.
Anyway, GM’s chapter 11 case should be filed in Detroit. The birthplace of the American auto industry should be the place of GM’s rebirth.
(Mr. Tilton is a corporate bankruptcy attorney. He represented creditor banks in the Chrysler restructuring and has represented creditors and debtors in prepackaged Chapter 11 cases. He is the editor of the book Bankruptcy Business Acquisitions, Second Ed., published by the American Bankruptcy Institute in 2006)
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