The auto parts supply industry has been beset by financial problems for several decades. Original equipment manufacturers ("OEMs") typically have the right to immediately seize their tooling, which the supplier holds in order to make parts. This allows OEMs to quickly move the tooling to another supplier and avoid an assembly line shutdown if the supplier fails. The right to immediately reclaim tooling, however, may be restricted if the supplier files for bankruptcy.
The ability of OEMs to reclaim their tooling when a supplier files a voluntary petition for relief under chapter 11 of the Bankruptcy Code recently was addressed by the United States Bankruptcy Court for the Eastern District of Michigan. Plastech Engineered Products, Inc. ("Plastech"), a large "Tier 1" supplier to Chrysler and other OEMs, filed for bankruptcy in order to prevent Chrysler from reclaiming its tooling after Chrysler demanded return of its tools and obtained a state court "seizure order." The Bankruptcy Court held that Plastech's possessory interest in Chrysler's tooling is "property of the estate" under section 541 of the Bankruptcy Code and protected by the automatic stay under Section 362(a) of the Bankruptcy Code. The Bankruptcy Court's decision prevented Chrysler from immediately reclaiming its tooling and is likely to impact negotiations between OEMs and troubled suppliers.
Plastech provides parts to Chrysler and other OEMs. In order to produce these parts for Chrysler, Plastech uses specialized tools that were either manufactured by Plastech at Chrysler's expense or were provided to Plastech by Chrysler. All of the specialized tools are owned by Chrysler.
Prior to its bankruptcy, Plastech entered into two Accommodation Agreements with Chrysler so that Plastech would continue production. Plastech, among other things, acknowledged that Chrysler (a) owned the specialized tooling, and (b) had the right to take immediate possession of the tooling without payment of any kind if Chrysler chose to do so or Plastech was in default. In late January, Chrysler served notice of default and commenced a repleven action in Michigan State Court to recover its tools. The Circuit Court in Michigan entered an ex parte order giving Chrysler the right to enter Plastech's facilities and retrieve the tooling. Plastech, believing this would cause a shutdown and liquidation of its 36 plants, filed a chapter 11 Bankruptcy case literally as Chrysler's representatives were in the process of entering Plastech's facilities. Chrysler's representatives stood down and left Plastech's premises without the specialized tooling.
The following day, Chrysler filed an emergency motion for relief from the automatic stay. Chrysler argued that the specialized tooling was not property of Plastech's bankruptcy estate under Section 541(a)(1) of the Bankruptcy Code because a state court had ruled that Plastech did not have any right, title or interest in the tooling. Further, Chrysler argued that, even if Plastech did have a legal interest in the tooling, Chrysler should have relief from the automatic stay under Section 362(d) of the Bankruptcy Code because the specialized tooling was not necessary for an effective reorganization and cause existed for relief from stay in order to prevent Chrysler's production lines from shutting down.
In response, Plastech argued that its possession of the tooling was a property right protected by the automatic stay, and that Section 362(a)(3) of the Bankruptcy Code prohibits any act to obtain possession of "property of the estate." Plastech argued that the case had only just begun, the specialized tooling was essential to Plastech's reorganization, and it had a right to try to put together a reorganization plan. Plastech also asserted that Chrysler had failed to properly terminate its agreements with Plastech.
The Bankruptcy Court's Opinion
The Bankruptcy Court denied Chrysler's motion for relief from the automatic stay. The Bankruptcy Court agreed that Plastech's possession of the tooling alone was sufficient to constitute an interest under Section 541 of the Bankruptcy Code and invoke the protections of the automatic stay. The Bankruptcy Court did not address the impact of the State Court's prepetition order awarding legal possession of the tooling to Chrysler.
After finding that Plastech held a protected interest in the tooling, the Bankruptcy Court weighed the harm to Chrysler of preventing Chrysler from taking the tooling against the harm to Plastech if Chrysler were permitted to take the tooling and re-source production. Based on the evidence submitted at the hearing, the Bankruptcy Court stated that if Chrysler were permitted to take the specialized tooling, 11 of Plastech's plants would immediately turn to negative margins and 8 would be immediately shut down, threatening all of Plastech's 7,700 employees and harming its creditors. On the other hand, if Chrysler were prohibited from taking the tooling, it would have to pay more than it had bargained for and might face a shutdown of its facilities if Plastech ultimately failed to produce parts. The Court therefore decided there was risk to both parties.
The Bankruptcy Court, however, refused to grant Chrysler relief from the automatic stay because permitting Chrysler to take possession of its tooling would likely destroy any possibility for an effective reorganization. At bottom, the Bankruptcy Court unsurprisingly decided to let a one billion dollar company with nearly 7,700 employees live on for a while so it might have a chance to come out of bankruptcy.
All companies involved in the automotive industry should be aware of this decision. Lawyers can quibble over the Bankruptcy Court's ruling. The Court did not address some of the issues it will ultimately need to resolve, particularly whether there can be an "effective reorganization" given that Plastech has no right to continue holding Chrysler's tooling. Further, the Court did not address whether Plastech could provide "adequate protection" to Chrysler for its use of the tooling. The Court acknowledged that Chrysler could be harmed, but decided the matter based on the need to afford Plastech an opportunity to reorganize.
But there is no doubt the decision is important and will impact future negotiations between all types of OEMs and their suppliers. The Bankruptcy Court's decision to protect a supplier's mere right to hold its customer's tooling gives suppliers more bargaining power. OEMs are now aware that they either have to win the race to the courthouse, and then the second race to the tools, or else reach another "accommodation" in bankruptcy.