05 March 2009

Would a GM Bankruptcy Crash Its Suppliers?

As Originally Posted in The Wall Street Journal

General Motors Corp. is back in Washington, this time asking for $12 billion to add to the $18 billion loan the government approved last year. The possibility of bankruptcy for GM is very real -- the company posted a loss of $30 billion in fiscal 2008.

GM continues to argue that it couldn't survive a Chapter 11 proceeding, but the truth is that bankruptcy could boost its ability to survive. As the Obama administration considers its response to GM's request for more cash, it should be mindful of the advantages of bankruptcy that haven't been highlighted -- certainly not by GM's management.

Consider two big issues: restructuring GM's roughly $30 billion of bond debt, and the potential collapse of the automotive supply chain. Both are easier to deal with if the company is in Chapter 11.

GM executives have been saying that in Chapter 11 its network of suppliers would collapse, dragging down the rest of the auto industry with their company. But Chapter 11 has well-established procedures to deal with this concern.

Courts know that bankrupt companies need to keep getting supplies, inventory and parts for manufacturing to be viable. Hence, the bankruptcy code and the bankruptcy courts put payments for new supplies at the top of the queue, even ahead of most old lenders. Send in fresh supplies, and the courts have the bankrupt company pay for them, even while prebankruptcy creditors cool their heels.

When that is not enough, courts can do more. Critical vendors can have their prebankruptcy invoices paid if that's what's necessary to keep the supply conduits fluid. A bankruptcy judge has to approve these kinds of payments -- they're not automatic -- but the approvals are regular and quick, sometimes made on the first day of bankruptcy.

GM may run out of cash to pay its suppliers -- whether it files for bankruptcy or not. But GM's supply network is probably more robust with GM bankrupt, as Chapter 11 assures that suppliers get paid out of whatever cash GM has.

As for bond debt, GM has been negotiating with its bondholders for months, thus far unsuccessfully. There's a reason out-of-bankruptcy bond deals often collapse: Outside of Chapter 11, every bondholder gets to decide for himself whether to take the deal. It's not uncommon for some bondholders to hold out and hope that the others take equity or a new debt security, strengthening the company just enough so that the holdouts can be paid in full.

But when a few hold out, other bondholders can decide to hold out as well. Many bondholders may consider the company's offer of an exchange a good enough deal, but conclude that holding out for more is even better. This friction is typically a factor in failed out-of-court workouts.

While holdouts can unravel a recapitalization outside of bankruptcy, inside Chapter 11 bondholders vote on the plan. If a majority of GM's bondholders (actually those holding two-thirds of the bonds by dollar value) think the deal is good enough, it applies to all of them.

There are other reasons why a Chapter 11 resolution may be the best solution for GM. Bankruptcy may be the only way for GM to fully confront its operational problems, deal with its legacy costs, reconfigure its dealer network, and achieve a viable labor agreement.

But one issue that has not been discussed much is that bankruptcy usually leads to a sharp change in management. There are turnaround teams expert at restructuring troubled companies, and they may well be more effective than GM's current management. It's no surprise GM's management isn't advertising this fact, but taxpayers and the government should know about it.

In the end, the administration needs to keep in mind that vital elements in GM's restructuring -- recapitalizing its large bond debt and keeping what cash it has flowing to key suppliers -- are often dealt with successfully by bankruptcy courts. A bankruptcy could save GM -- though maybe not its management.

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