Auto suppliers and the quick Chapter 11 pit stop
By: Colin Whitbread, Thursday, May 14, 2009, AutomotiveWorld.com
As financial pressures on auto suppliers look set to intensify, especially in North America, a new term – pre-negotiated restructuring – looks set to become increasingly familiar. Put simply, this involves pursuit of capital restructuring through the Chapter 11 bankruptcy process, having first sought the concurrence of key lenders prior to the filing. The debtor reaches agreement with major creditors ahead of filing, allowing a plan of reorganisation and disclosure statements to be prepared alongside the bankruptcy petition and, hey presto, a swift exit from bankruptcy, with a re-jigged balance sheet/capital structure, ensues. Suppliers can emphasise the swiftness of the process and a business-as-usual relationship with customers and suppliers.
A quick glance through recent supplier Chapter 11 filings – most notably those of Mark 1V Industries and Hayes Lemmerz – underlines this approach, although it’s worth noting that this is not a brand new initiative. Back in June 2007, Remy International announced it had reached agreement on the terms of a ‘consensual financial restructuring’ with key bondholders, resulting in a debt for equity swap. This also included a pre-packaged Chapter 11 filing in order to implement the plan, the company eventually exiting in early December 2007.
At Mark 1V, where the majority of the supplier’s US operations filed on 30 April, the company talks of “expecting to achieve plan confirmation and successfully complete the reorganization expeditiously.” This confidence stems from the fact that the supplier has, “already reached agreement in principle with a steering committee of its senior lenders on a plan of reorganization and new capital structure for the reorganized company.” Hayes Lemmerz, its US operations filing for bankruptcy for the second time since 2000, stresses that the majority of its lenders have already agreed to up to US$100m of debtor-in-possession (DIP) financing, allowing it to “operate business as usual going forward”. It further confirms that “the goal of a pre-negotiated Chapter 11 is to have the company emerge on an accelerated basis,” but also concedes that “it’s too soon to be able to predict” when exit from Chapter 11 will be.
Unsurprisingly, both suppliers also emphasise that the filings have been initiated for balance sheet and not operational reasons, distancing themselves from, for example Delphi’s ongoing bankruptcy saga. Hayes Lemmerz notes “the Chapter 11 filing addresses a balance sheet problem, not an operational problem.” Jim Orchard, Mark 1V’s chief executive officer describes Mark 1V’s key problem as a “balance sheet issue, not an operational issue.” However, while inappropriate debt loads may indeed have been the tipping point for the filings, in reality neither company appears amongst the leading pack in the sector as judged by recent financial results. Mark 1V has recently had to take a number of steps to lower its cost structure, including a 20% cut in the salaried work force in its North American operations, closure of a factory and what is described as “consolidation of redundant activities and offices.”
But what needs to be underscored is that a pre-negotiated or pre-packaged Chapter 11 filing, more of which are surely in the pipeline, is not a victimless strategy. The most obvious casualties are ordinary shareholders unfortunate enough to have retained their equity at the filing date and so in possession of (probably) worthless shares. Note holders will also take a very close haircut, if lucky. These are victims of the need to extinguish as much debt as possible through a debt/equity exchange. Hayes Lemmerz notes that “upon confirmation of a plan of reorganization, it is anticipated that the DIP lenders will convert certain of their loans into equity and will own substantially all of the equity of the reorganized company.” In Remy’s case, referred to above, the result was the wiping out of the interests of existing ordinary shareholders, most notably Citicorp Venture Capital and Warren Buffett's Berkshire Hathaway, but also management and other small investors.
The other key losers are suppliers unfortunate enough to have unpaid bills at the time of the bankruptcy filing. Both Mark 1V and Hayes Lemmerz predictably stress that payment terms for goods and services delivered to their US operations from suppliers will continue unchanged after the filing dates. For suppliers to the operations covered by the filings, who are in receipt of Bar Date Notices, the news is not so good – subject to certain exceptions, the US Bankruptcy Code prevents companies in Chapter 11 from paying invoices or satisfying obligations that arose prior to the filing date, necessitating a laborious, and probably largely fruitless, claims procedure by creditor suppliers.
But other risks are also attached to even pre-negotiated Chapter 11 filings. Interestingly, in its 10-K filed with the SEC on the same day as confirming its capital restructuring plans, Hayes Lemmerz detailed no less than ten risks associated with a bankruptcy filing. These include: increased difficulty obtaining additional financing and the likely loss of a significant portion of accounts receivable financing programmes; significant costs, including expenses of legal counsel and other professional advisors; customers moving business to other suppliers; and difficulty obtaining and maintaining trade credit and payment terms with suppliers and contracts necessary to continue operations and at affordable rates with competitive terms. Day-to-day operations may be preserved, to the benefit of customers, but pre-negotiated restructuring via Chapter 11 certainly isn’t a victimless, risk-free strategy.
The opinions expressed here are those of the author and do not necessarily reflect the positions of Automotive World Ltd.
Published on Thursday, May 14, 2009
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