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.

Automotive Suppliers Take Steps to Conserve Cash

U.S. auto suppliers are scrambling to extend their holiday-season shutdowns, shedding workers and developing contingency plans to deal with a potentially devastating failure of some of their biggest customers in Detroit.

The moves come as General Motors Corp. on Friday announced more production curbs and lawmakers in Washington began hashing out conditions that the Big Three auto makers -- GM, Ford Motor Co. and Chrysler LLC -- will have to meet before Congress will consider giving them a $25 billion emergency cash infusion. Many suppliers are counting on a federal bailout to rescue their big customers -- and, by extension, themselves.

Auto suppliers are developing contingency plans to deal with potential fallout in Detroit. Above, a Ford Dearborn, Mich., plant.

In the meantime, suppliers, still unsure of what will happen to the nation's car makers, are conserving cash by shifting to shorter workweeks, canceling capital-spending plans and accelerating layoffs. Problems in the supply network have the potential to spread pain to a wide swath of the U.S. economy. Auto suppliers employ more than 730,000 workers in the U.S., about three times more than the Big Three.

Nescor Plastics Corp. in Mesopotamia, Ohio, which makes plastic parts such as cup holders, in the past month has shifted to a four-day workweek, implemented an across-the-board salary reduction and canceled costly machine upgrades planned for the company's normal two-week holiday shutdown. The company also has added a week both before and after its two-week shutdown in which it will operate at only partial strength.

Like many auto suppliers, Nescor doesn't sell directly to the car makers. Rather, its plastic parts are sold to larger suppliers that assemble modules that get fitted onto cars on the assembly line.

"Over the past 12 months, we had three customers file Chapter 11 on us, so we know what it means when you suddenly aren't getting receivables you're counting on," says Darrell McNair, the company's president. The company has cut back on purchasing materials.

Angell-Demmel Managing Director Richard Anglin says the main survival strategy for suppliers like him is a tighter credit policy. Two years ago, Angell-Demmel began shifting away from allowing customers to pay bills 60 or 90 days after they take delivery. It is now 30 days, or, in some cases, payment in advance. The Dayton, Ohio, company, which makes decorative metal parts and many of the nameplates used on cars, now relies on an outside insurance agency to rate the credit risks of customers.

"I'm not sure what would happen if a GM would go into bankruptcy," he says. "I'm just not sure how you plan for that, other than what we're doing now."

Many suppliers would like to cut their exposure to the Big Three, but that is difficult to do at a time when the entire industry is in a deep swoon. GM's sales were off 45% in October, for instance, compared with a year earlier. Most analysts expect the slide to continue.

"The biggest problem facing suppliers right now is that they still don't know where the bottom of this market is, because it just keeps falling," says Kimberly Rodriguez, an auto expert at consulting firm Grant Thornton LLP.

Ms. Rodriguez estimates that a third of U.S. auto suppliers are in danger of insolvency and this number would spike in the event of a bankruptcy-court filing by one or more of the Big Three producers.

Ms. Rodriguez says that many suppliers that normally would have already filed for bankruptcy protection themselves have resisted doing so, in part because the financing necessary to conduct a restructuring under Chapter 11 of the U.S. Bankruptcy Code is no longer available to them because of the credit crunch.