GM, Chrysler May Face Bankruptcy to Protect U.S. Debt

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By Mike Ramsey and Tiffany Kary

Feb. 9 (Bloomberg) -- General Motors Corp. and Chrysler LLC may have to be forced into bankruptcy by the U.S. government to assure repayment of $17.4 billion in federal bailout loans, a course of action the automakers claim would destroy them.

U.S. taxpayers currently take a backseat to prior creditors, including Citigroup Inc., JPMorgan Chase & Co. and Goldman Sachs Group Inc., according to loan agreements posted on the U.S. Treasury’s Web site. The government has hired a law firm to help establish its place at the front of the line for repayment, two people involved in the work said last week.

If federal officials fail to get a consensual agreement to change their position regarding repayment, they have the option to force the companies into bankruptcy as a condition of more bailout aid. The government would finance the bankruptcy with a so-called “debtor in possession” or DIP loan, a lender status that gives the U.S. priority over other creditors, said Don Workman, a partner at Baker & Hostetler LLP.

“They are negotiating to see if they can reach an agreement,” said Workman, a bankruptcy lawyer based in Washington. “If not, they are saying ‘We are pretty darn sure that a bankruptcy judge will allow us’” to be first in line for repayment.

GM fell 1 cent to $2.83 in New York Stock Exchange composite trading. Chrysler isn’t publicly traded.

Carmaker Opposition

The automakers have dismissed calls to reorganize under bankruptcy protection, saying a Chapter 11 restructuring would scare away buyers and lead to liquidation. They are working toward a Feb. 17 deadline to show progress on a plan put in place as part of the U.S. loans received in December from the Troubled Asset Relief Program. The companies must reduce labor costs and show how they will repay the money by next month.

GM and Chrysler are already trying to restructure out of court by cutting labor costs, reducing debt levels and eliminating dealers. GM is in talks to pare $27.5 billion in unsecured debt to about $9.2 billion in a swap for equity.

The company said it plans to shutter dealers and reduce obligations to a union retiree health fund by half to $10.2 billion in a separate equity swap. Chrysler Chief Executive Officer Robert Nardelli has said his company will also try to cut debt.

Delphi Talks

GM said today it’s in negotiations to take back portions of Delphi Corp., a parts supplier the automaker separated from a decade ago, in order to maintain portions of its supply chain. GM said it’s also considering more plant closures, job eliminations and pay cuts for administrative workers.

The automaker probably will close at least two factories, which according to the Wall Street Journal may include a truck plant in Pontiac, Michigan.

Chrysler will temporarily shut three plants, the company said last week. Those closures will be in Michigan and Canada.

January sales from automakers plunged 55 percent at Chrysler, 49 percent at GM and 40 percent at Ford Motor Co., the second-largest U.S. automaker. Ford has declined bailout funds.

The U.S. government has the option of working out an intercreditor agreement outside of bankruptcy that would give it rights to some collateral ahead of others. Such agreements, often made when money is lent to a company that already has liens on most of its assets, are usually negotiated when the loan is made.

U.S. Law Firm

Cadwalader, Wickersham & Taft LLP is advising the government on how to make sure it gets paid back first, including by way of intercreditor agreements, the people involved with the talks said. The law firm, hired last month, is working for the government with Sonnenschein, Nath & Rosenthal, a Chicago-based firm with capital-markets experience, and Rothschild Inc., an investment bank, the people said.

The issues are “extremely complex,” said Bruce Clark, a credit analyst at Moody’s Investors Service.

The existing loan agreements appear to give the banks a superior position to the government, Clark said.

“The ultimate position of the government could end up being determined by whatever concessions various creditors make, and the determination of a bankruptcy court if it ever gets there,” he said.

When the automakers were lobbying the government for assistance, lawmakers made a point of saying that the government must be assured that if the companies failed, taxpayers wouldn’t lose the investment.

Existing Lenders

Workman, who isn’t involved in the negotiations, said the U.S. couldn’t force its loans to supersede existing secured lenders, so it built in a measure that allowed the debt to be converted to debtor-in-possession financing.

“A carrot and stick approach is spot on,” he said.

As it stands, the government loans fall below existing debt secured by most assets for Auburn Hills, Michigan-based Chrysler and Detroit-based GM. Prior lenders have first position on some assets. The government has first position on assets not already pledged.

Chrysler has $7 billion in loans from a group of banks, including New York-based JPMorgan, Goldman Sachs and Citigroup. It also has $2 billion in loans from owners Cerberus Capital Management LP and Daimler AG. Cerberus owns 80.1 percent of Chrysler. Daimler owns the remainder.

GM has $6 billion in loans secured by assets from lenders including JPMorgan and Citigroup. JPMorgan spokesman Brian Marchiony, Goldman Sachs spokesman Michael Duvally and Citigroup spokeswoman Danielle Romero-Apsilos declined to comment.

Lori McTavish, a spokeswoman for Chrysler, declined to comment beyond confirming the primacy of the bank loans. Treasury spokesman Isaac Baker and GM spokeswoman Renee Rashid-Merem declined to comment. GM Vice Chairman Bob Lutz will retire at the end of 2009, the company said today in a separate statement.

Unless the automakers show by March 31 that they will be able to return to profit and repay the money, the government can demand return of the loans.

To contact the reporters on this story: Mike Ramsey in Southfield, Michigan, at mramsey6@bloomberg.net; Tiffany Kary in U.S. Bankruptcy Court in New York at tkary@bloomberg.net.

Last Updated: February 9, 2009 16:23 EST

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