Much is being written about the significant losses suffered by automobile suppliers to both the domestic and transplant automobile manufacturers. These losses are creating alarm among many others, including the OEMs themselves, according to Dave Hannon at Purchasing Magazine.
The reason for OEM concern is that the industry relies largely on sole source suppliers that deliver inventory in a just-in-time environment. The inability of a supplier to deliver daily (or more often than one time a day) can cause OEM shutdowns, costing millions of dollars. In recent years, OEMs have had to pay (in some larger supplier failures, hundreds of millions of dollars) to keep the supplier operating so that it could continue to supply components.
On the other hand, if one or more of the domestic OEMs files for Chapter 11 bankruptcy, unprecedented devastation is likely because a Chapter 11 debtor is prohibited from paying prepetition accounts payable to its suppliers.
With bankruptcy filings threatening the domestic OEMs, there is one potential remedy to this crushing problem for both tier-one companies and their tier-two suppliers that is gaining momentum: Congressional action to amend the Bankruptcy Code by providing a new chapter that would be made primarily for automakers.
Such an amendment could create the statutory requirement that OEM Chapter 11 debtors must continue to pay their vendors in the ordinary course of business during a Chapter 11 proceeding as though the bankruptcy did not occur.
This would also significantly encourage lenders to lend money on OEM accounts receivable prior to an OEM bankruptcy and prevent the devastation to suppliers that would result from a Chapter 11 filing which freezes accounts payables, perhaps for years.
Rep. Barney Frank has recently raised the possibility of rewriting the Bankruptcy Code to help protect the automotive industry and last week the American Bankruptcy Institute Journal published an article that suggested implementing a new “Chapter 10” bankruptcy for the auto industry to isolate the damage from the rest of the economy. Justin Hyde from the Detroit Free Press does a nice job capturing the merits of a so-called Chapter 10 filing here.
The concept of this “Chapter 10″ makes sense and has good precedent. It makes sense because the primary purpose of an OEM Chapter 11 would be to convert debt to equity. Trade credit is not the issue facing OEMs. During the time that railroads were the lifeline of our country, beginning in the late 19th century, using the principal of the public good, railroads in reorganization were required to pay their trade credit as though the bankruptcy did not occur. These payments were required to make sure that vendors to the railroads continued to supply needed goods and services. This same principal applies to today’s auto industry.