While uncertainties loom around the auto industry, suppliers and OEMs can try to prepare for the road the lies ahead.
During the first quarter of 2009, Moody’s Investor Services projected a 70 percent chance for a “Big 3” filing of a “pre-packaged” bankruptcy in the third quarter of 2009. Moody’s Analyst Bruce Clark commented, “Under a bankruptcy scenario, the United States government would provide debtor-in-possession (DIP) financing to allow the company to continue its operations while restructuring. A bankruptcy would give the industry more leverage in renegotiating contracts and forcing stubborn bondholders to accept a debt for equity swap.”
Before President Obama took office, the out-going Bush administration approved a proposed $50 billion bailout for General Motors (GM), Ford and Chrysler pursuant to the Troubled Asset Relief Program (TARP). The proposed bailout schedule included a total of $13.4 Billion to be paid by mid-January and another $4 Billion to be paid in February 2009. The government loan was structured as convertible DIP financing.
Currently, President Obama is authorizing further use of TARP funds to sustain GM and Chrysler, while the companies attempt to carry out restructuring plans under the government’s direction, which reportedly includes the production of “fuel-efficient” cars, the merger of Chrysler and Fiat and the potential for more changes in management like the forced resignation of Rick Wagoner, president of GM.
Further, there have been reported discussions of a congressional amendment to the U.S. Bankruptcy Code, to provide for a new chapter for automakers - “Chapter 10.” The so-called Chapter 10 amendment, would allow bankrupt automakers to keep paying suppliers for a regular flow of parts. Under the current law, Chapter 11 bankrupt automakers are prohibited from paying pre-petition accounts payable and could stop paying many bills for months or years. Suppliers then have to compete with other creditors for repayment.
The potential devastation of a “Big 3” filing on auto suppliers was captured in a paper for the American Bankruptcy Institute Journal by George Kuney, a law professor at the University of Tennessee College of Law, and San Francisco Bankruptcy Attorney Michael St. James, who wrote, “By arbitrarily and unnecessarily putting all accounts payable on hold for months or years - a mandatory aspect of existing Chapter 11 law - the bankruptcy filing of one large company would likely result in cascading business failures among its vendors, and the vendors of its vendors.”
The host of ideas that have surfaced have left Tier 1 and Tier 2 auto suppliers with much uncertainty. Even with the variety of concepts on the table, most commentators still foresee a “Big 3” filing on the horizon. The following is a list of several pre-filing considerations for Tier 1 and Tier 2 to suppliers to prepare for the road that lies ahead.
General Considerations and Courses of Action
- Shut and consolidate additional plants as soon as possible.
- Seek the advice of a financial advisor.
- Tighten accounts receivable collections:
- Age receivables in 20-day increments and 45-day increments.
- Demand that electronic data interchange payments be accelerated from 45 days to 10 days.
- Avoid directly threatening to withhold shipments from original equipment manufacturers (OEMs).
- Compile all contracts with “Big 3” and OEMs.
- Seek insolvency counsel to analyze contracts including all termination provisions.
- Monitor shipping performance, billings and payments for delayed payments, increasing receivables, decreasing market share and delayed deliveries or negative changes in product quality.
- Monitor reports for suppliers such as Dun & Bradstreet for changes in key management positions, delays in payments or dividends or payments on funded debt and lengthening of credit terms.
- Monitor margins, volume adjustments and effects on costs.
- Cease practice of expediting parts and paying for additional shipping costs.
- Seek adequate assurances of future performance under Uniform Commercial Code (UCC) Section 2-609 (i.e. change in payment terms, security, and letter of credit).
- Perform physical inventory at OEM customer plants and request bailment on consigned inventory and any equipment Tier 1 or Tier 2 supplier owns.
- Freeze all capital expenditures and downsize operations by 20 percent beyond what you think you can bear.
- Identify alternate suppliers having readily available commodities.
- Consider adopting a key employee retention plan (KERP) to incentivize critical members of your corporate team to remain in place.
Strategies for trade creditors to minimize preference exposure
- Maintain current and adequate record-keeping.
- Continue to supply new parts and services (“new value”).
- Insist on cash on delivery (COD) or cash in advance (CIA) terms at first sign of financial distress.
- Do not apply incoming payments to the oldest outstanding invoice; apply them to invoices that are still within the stated credit terms.
- Safeguard Production Process Intellectual Property-
- Place in special purpose entity with no direct contractual relationship with OEM to create more negotiating leverage.
Tooling Concerns and Issues
As tooling encompasses a broad range of tangible personal property that is used to make metal or plastic parts for incorporation into a motor vehicle (i.e. dies, molds, jigs, fixtures, gauges, patterns and equipment), the following considerations are specific to tooling concerns and issues:
- Research all primary production tooling to ensure detailed understanding of what belongs to Tier 1/Tier 2 supplier and OEMs
- Such analysis should include creation of data to lay claim to production tooling, including whether documents or agreements are stamped by supplier or OEM;
- Consider including attachments (i.e. pans, sliders, brackets, clamps, other structural fixtures used in production and some machines) not owned by OEMs, because fabrication issues between different tiers of suppliers leads to gray areas; and
- Refuse to fund new program tooling immediately (even for awarded programs)
- Demand immediate payment for all funds expended and insist that program will advance only if automaker pays tool suppliers.
Consider Out-of-Court Workouts
Out-of-Court Workouts are the negotiated sale of troubled company and/or new agreements, and may include:
- Accommodation and Access Agreements
- Common Accommodations; or
- Common Financing Operations