Chrysler to File For Bankruptcy before Treasury Deadline

By Brendan Moore

04.24.2009

chrysler-logo-small2In an interesting twist, it appears the Treasury Department has made plans for Chrysler to file bankruptcy as early as next week, before the government-mandated deadline for restructuring. Restructuring, from the government’s point of view, is Chrysler consummating a merger with Fiat. Anything else, while not inconsequential, is not anywhere good enough to satisfy the Treasury’s conditions for viability.

Bankruptcy will undoubtedly make Cerberus, which gained control of Chrysler in 2007, go away. Bankruptcy will also make the minor shareholders disappear as their equity will be wiped out.

Bankruptcy also gives Chrysler tremendous latitude in terms of what assets (brands, physical plants, etc.) it wants to keep, and it voids labor union agreements, contractual agreements with suppliers, dealer franchise agreements, etc.

It should be noted, however, that Treasury now has an agreement with the UAW, which would wipe out an extremely contentious issue in any Chrysler bankruptcy or restructuring. Regardless of what happens, Chrysler will need workers to build vehicles if they stay in business as a viable entity.

Bankruptcy also relieves Chrysler of its debt obligations, but there is going to be a problem with the large lenders (mostly banks and some hedge funds) that hold most of Chrysler’s debt. The problem (for Chrysler, that is) is that most of that debt is asset-based loans. Chrysler promised physical assets as collateral for those loans, tangible assets like production plants, brands, etc. So, the creditors will press their claims in any bankruptcy process, and try to claim those assets so they can then sell them on the open market and redeem that sale price against the total debt. As an example, if Chrysler owes a bank $1 billion dollars USD, and the bank has two production plants as collateral, the banks would try to claim those assets as the bankruptcy moves through court so that they could then subsequently sell the two production plants. If they were to able to sell those two plants for $500 million, then they would get 50 cents on the dollar regarding the defaulted loan.

But, there is one huge problem for the lenders with this scenario. That problem is the US government, represented by the United States Treasury. As you know, the government has loaned Chrysler billions and billions of dollars (American tax dollars). They will insist that Chrysler’s debt to them is primary, since they are the primary creditor, and therefore must be satisfied first in any bankruptcy. The federal bankruptcy court is somewhat likely to agree with the Treasury Department. This would effectively shut out the other creditors, and they would get close to zero cents on the dollar if Chrysler goes under.

The Treasury’s push for a Chrysler bankruptcy next week puts tremendous pressure on the banks to accept the Treasury’s terms for debt restructuring. Treasury has previously offered the creditors 15 cents on the dollar, which was rejected. Treasury upped its offer to 22 % of total debt, and 5% of the next iteration of Chrysler, two days ago. The alliance of lenders’ counter-proposal was 60% (60 cents on the dollar) and a 40% equity position in the new Chrysler. Some of the lenders now wish to take their chances in bankruptcy court, but most wish to settle the debt through agreement. The lenders’ group has not yet made another counter-offer since the news of next weeks’ potential bankruptcy has been made public.

What does bankruptcy mean for Fiat, Chrysler’s potential savior? Bankruptcy means Fiat can basically pick whatever good parts of Chrysler they want, and discard whatever they don’t want. Fiat can buy Chrysler cafeteria-style. Fiat wants to go from their current 2.2 million unit production capacity to right under 6 million units a year, and the deal with Chrysler will get them a lot closer to that goal.

And if Fiat ultimately decides they don’t want Chrysler, even on an ala carte basis? Well, Chrysler will then liquidate.

Last, but not least, the effect of a bankruptcy on consumers that might want to buy a Chrysler vehicle must also be mentioned. A bankruptcy may send Chrysler sales plummeting even more than they have as car buyers get very nervous about buying a vehicle that could shortly be an orphan. A bankruptcy will definitely have a negative effect vis-à-vis sales, and may have a catastrophic effect. A bankruptcy is not the way to instill confidence among consumers if you’re an automotive manufacturer.

Of course, there are people that say that Chrysler sales are so low that another drop isn’t going to matter at this point, and the bankruptcy medicine is well worth taking in order to finally cure the patient.

COPYRIGHT Autosavant – All Rights Reserved

Author: Brendan Moore

Brendan Moore is a Principal Consultant with Cedar Point Consulting , a management consulting practice based in the Washington, DC area. He also manages Autosavant Consulting, a separate practice within Cedar Point Consulting. where he advises businesses connected to the auto industry. Cedar Point Consulting can be found at http://www.cedarpointconsulting.com.

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8 Comments

  1. I don’t see how it would matter that sales go down because sales already completely suck. They don’t sell enough cars now to make a profit, so Chrysler should just just bite the bullet and take the plunge into bankruptcy. It will make them more attractive to Fiat, and be much better for them long term.

  2. This is the best analysis of the Chrysler and Fiat situation that I have read.
    I would expect that the chapter 11 of Chrysler would be followed in hours by Fiat announcing the merger with (the desirable pieces) Chrysler.
    You did not mention the trimming of the dealer numbers, but bankruptcy would allow that to happen without enormous costs.

  3. And I forgot to add,
    If Chrysler goes chapter 11, then the pressure on GM to go chapter 11 will be large because GM needs to restructure its costs. And Ford will be in a tough spot too.

  4. I agree, it’s good. And now I understand the whole thing. And btw he does mention the dealer franchise agreements. And Fiat’s crazy if they don’t let Chrysler get rid of some dealers through bankruptcy before they get Chrysler.

  5. Jeep will live on. Dodge trucks will likely survive as well. I wonder, though, what will become of the cars and the Chrysler brand. Other than the Challenger, Charger, and 300, none of them are at all decent vehicles. The Challenger is a niche car in a small segment, surrounded by strong competitors in a very tepid market. And the 300 and Charger are getting a bit long in the tooth. It seems that a new New Chrysler will not emerge this time around.

  6. what about the people that bought the junk? jeep commander?who filed the lemon law case?what do they do keep paying for a vehicle that is worthless!

  7. I agree t.wile; I have a Jeep Commander that was going through Lemon Law proceedings and now that they claimed Chapter 11, the federal government will help to keep warranties in place but for those that cannot keep their vehicles on the road because they are lemons, have no claim and no backing from the federal government. Either support it all or nothing at all. I imagine I am not the only one going through a financial hardship because of this type of situation. It just shows that unfortuately you cannot depend on any american made vehicle anymore, because not even the federal government is willing to assist those that got an unfortuate vehicle which jeopardizes the financial stability of their family’s income.

  8. Dave from PA – Chrysler is still honoring the warranties. Any bankruptcy judge will clearly see the importance of honoring warranty commitments because otherwise, even more consumers would flee.

    From Chrysler:
    “The company will seamlessly honor warranty claims, pay suppliers and keep our dealer body operating to continue to serve our valued customers.”

    So unless they specifically told you “tough luck, we’re in Chapter 11,” I wouldn’t expect this to affect your situation.

    More info: http://www.chrysler.com/en/experience/news/articles/?guid=2009_4_30_chrysler_media_services_announce

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