(The What-ifs of a Franchisor Bankruptcy or Government Bailout. A Call for GM, Chrysler and Ford to Take Bold, Forward-Looking, Imperative Action)
By Eric L. Chase, Esq.

Although there is the temptation to link the falling fortunes of the Detroit Three to the very recent series of American financial calamities in 2008, the reality is that GM, Chrysler and Ford have been losing market share and profitability for years. Critical events for these former masters of the car universe are now moving at breakneck speed. At the beginning of November 2008, with these three American corporate giants on the edge of bankruptcy, it seemed that federal intervention – a “bailout” – would be the most likely response from the federal government. After all, commitments in vast amounts had already been authorized for the drowning banking and financial sectors, and both the Bush administration and congressional leaders spoke of the need to inject cash.

Without a bailout, one or more Detroit Three bankruptcies are apt to follow in weeks or months. GM, especially, is on the brink, and Chrysler now warns that it, too, has little time. Only Ford seems to have staying power for 2009, but it still seeks assistance. By mid-November, however, congressional action to rescue the Detroit Three was suddenly very much in doubt. On November 18 and 19 the industry provided some high drama in pleading the bailout case before congressional committees. Arriving separately from Detroit in private corporate jets (a fact which became a subject of much ridicule), GM’s Rick Wagoner, Ford’s Alan Mulally, Chrysler’s Robert Nardelli and the UAW’s Ron Gettelfinger forecast that, without federal relief, this vital American industry would fail, and the greater economy would suffer even more. Together, they want $25 billion in bridge loans, in addition to a previously approved $25 billion for R&D linked to improved environmentally friendly standards. In a public appeal, Wagoner editorialized, “[t]he future of the domestic auto business is critical to the health of the U.S. economy.” 1

The legislators were doubtful. Some noted that such a bailout “rescue” (if it were to happen) would hardly be a panacea and might just delay the inevitable, with the taxpayer expense going to waste. Neither the auto executives nor the UAW confessed to past errors, nor were they specific in laying out their turnaround strategies. Treasury Secretary Hank Paulson (himself under fire for his stewardship of the financial crisis) expressed reservations about government intervention for Detroit. By no means is it certain that fresh government monies, whether in loans, guaranties, equity acquisition or other forms, would trigger long term solutions to problems that were decades in the making and continue even now. With the TARP controversy in mind, Democrats and Republicans alike reacted with skepticism and even hostility to bailout requests from the auto industry.

On November 20, just when it appeared that bailout possibilities had evaporated, a group of senators from the most impacted industrial states proposed a compromise lifeline for the Detroit Three. The monies would come from the already-approved $25 billion that was specifically meant for the development of energy efficient cars. By the end of the day there was an “agreement” of sorts: The Congress would put off a vote on a Detroit Three bailout until December. The bottom line seems to be that the Detroit Three need to present Congress with a realistic turnaround plan by December 2 in order to have a chance to secure their bailout.

Thus, as this article goes to press, the fates of the Detroit Three are still fraught with uncertainty. If the belated proposed compromise fails in early December, there would be little hope for government assistance before 2009. This much, however, is certain. The status quo will not continue much longer, and two alternatives seem realistic for two of the Detroit Three (GM and Chrysler)—bailout or bankruptcy.

Unfortunately, with or without bailout monies, the stress on the Detroit Three brands, their dealers and suppliers will continue. Without a turnaround in their strategies and core businesses, without cost reductions (especially by accelerating the scheduled 2010 reductions in UAW worker and retiree benefits), and without improvements in consumers’ marketplace perceptions about their brands, a bailout would almost certainly merely delay bankruptcy, not prevent it. Nor would a bankruptcy reorganization necessarily cause GM, Chrysler and/or Ford to emerge as healthy, albeit smaller, carmakers as some observers contend.2 The Detroit Three have been mired for years in their own sub-industry recession, and a deep recession in the broader economy in 2009 would impact them disproportionately.

Some argue that a bailout for the American companies will have unintended adverse reactions in the world marketplace. Economic Professor Matthew J. Slaughter warns that, “a federal bailout of the automotive industry could cost Americans jobs as well as foreign markets to trade in.”3

The affected Detroit Three franchised dealers have little say or control in all this. Yet it is vital for them to (1) realistically evaluate their positions, (2) take prudent steps to soften their losses and minimize further exposure, and (3) gain an understanding of what the possible road to franchisor bankruptcy means to them in the short and long terms.

The possibility of a GM-Chrysler merger has apparently evaporated. That would be good news, because such an alliance, if consummated between these struggling franchisors, would have had dire consequences and, predictably, would have cured few, if any, existing operational and product infirmities. In fact, as GM’s Wagoner and Chrysler’s Nardelli admitted to Congress, neither company has enough cash to operate more than a month or two. For now, the merger scenario is unlikely for any of the Detroit Three, but that prospect could reawaken in 2009.

Even if a federal bailout is authorized, all the important underlying risks affecting dealers will remain. It will take bold Detroit Three decision-making and solid (i.e., new) leadership, in addition to a financial rescue, for each of these manufacturers to outlast any new cash and guaranties, and still survive. Even then, these franchisors do not seem terribly concerned about the pressures on their dealers (e.g., GM’s recent, unilateral and sudden decision to delay for two weeks $300 million in incentive payments due to dealers). Some specific editorial thoughts on what they should do appear at the end of this article.

Today’s crucial facts are clear and grim. General Motors, Chrysler and Ford are all in acute financial distress and are prime candidates now to take the leap into bankruptcy. As recently as September 2008, all three defiantly and very publicly boasted that bankruptcy was not an option and would not happen. Those statements were highly questionable then, and since then, the Detroit Three’s tumbling economic fortunes have fallen steeply. GM’s Wagoner has warned repeatedly that, without a government rescue, the company could crash before President-elect Obama takes the oath of office on January 20, 2009. In the current political environment, both GM and Chrysler could be forced to file for bankruptcy very soon, while Ford may have the staying power to await the greater likelihood of a bailout under a new President and a new Congress with a larger majority of Democrats. Automotive News ominously predicts that, “Chapter 11 [for GM] means a collapse of sales and a spiral into Chapter 7 liquidation.”4 Incredibly, Wagoner testified that GM has not done any bankruptcy planning, and if faced with that choice, it would have to consider liquidation, because credit would be unavailable in bankruptcy.5

The American auto industry imbroglio is not good news for America. The fall of any or all of the three Michigan-based domestic automakers would directly impact hundreds of thousands of people who work for those companies, as well as dealerships and their employees, automotive suppliers, investors and consumers. It would also be a broad blow to the general economy, and in a perfect storm of three Detroit Three bankruptcies, the devastation could be more profound and enduring than all the tectonic shocks in preceding months combined (the sub-prime meltdown, home foreclosures, bank and financial company failures, etc.). Many more bankruptcies, including dealers, lenders and suppliers, would inevitably follow. Unemployment could spike to double digits, and a recession could endure beyond 2009. Thus, the motivations driving advocates of government intervention are profound and rational.

Politics will play a heavy role in furthering any bailout scenario. A bankruptcy could threaten the viability of the UAW and the jobs of its members, as well as the very existence of dealers and suppliers. Yet some, including many (if not most) congressional Republicans, agree with Mitt Romney. They argue that bankruptcy for these struggling companies would serve positive purposes (e.g., discharging debt, ending expensive obligations, and downsizing) and allow healthy and revitalized entities to emerge. They contend that, unlike a bailout, a bankruptcy would have a thorough cleansing effect. It would, for example, be “easier” and much cheaper to reduce the dealer body through bankruptcy.6 There are still about 7,000 GM dealers.

Moreover, some in Congress have expressed angst at what they perceive as manipulation by Treasury Secretary Hank Paulson in gaining a $700 billion commitment to address the financial/banking crises. A few accused Paulson of misleading them. Thus, the Detroit Three are confronting a wall of skepticism in Washington about the concept of taxpayer funded rescues.

Bailout critics, however, tend to minimize the likelihood of extraordinary long term injury to the economy and millions of people. Bankruptcy frequently ends in the closing of businesses and liquidation, not reorganization. We are in a recession that would probably be exacerbated and lengthened by Detroit Three bankruptcies. In bankruptcy, GM alone would strike a jarring blow to the overall economy.

Nevertheless, if there is a bailout, the diseases that brought these companies to their current peril will not necessarily be cured. The present weaknesses of the Detroit Three grew and solidified over decades. The UAW’s bargaining power lifted their members’ benefits (e.g., health plans, retirement, etc.) so high that the Detroit Three’s products pricing give the imports (including those made in U.S. plants) a wide advantage. (Wages are comparable, however.) Pursuant to agreements with the UAW, this “legacy” disparity is scheduled to be minimized by 2010, but the crisis is now. Moreover, American consumer perceptions of product quality and reliability now favor imports. It took many years for their collective and individual market shares to erode, and for consumer habits and preferences to shift. The combined sales of the Detroit Three now account for less than half of American new car purchases, and their downward market share spiral continues.

A bailout—without accompanying product, workforce and operational plans that radically and immediately overhaul the lethargic and unimaginative strategies of the past—will simply delay, and probably worsen, the consequences of embedded weaknesses. Everyone should hope that, in any bailout scenario, new, General Petraeus-like boldness and creativity will combine with possible government backing to cure the failings of the past and present. (The ludicrous short-lived courtship between GM and Chrysler is an example of the kind of bewildering executive thinking that cannot continue.)

The Detroit Three’s dealers have no control over, and little or no influence with, their franchisors on these overarching issues. Therefore, from the perspective of franchised dealers contemplating the possible insolvency of their franchisors, the time is now to consider their own options and strategies.

Given these unsettling facts and circumstances, let us look at the issues, and the strategies for dealer franchisees of Detroit Three brands.

First, consider the parameters of a federal bailout, and how it could affect the future of the Detroit Three:

  • Current information suggests that, together, the Detroit Three companies are asking that the government commit at least $25 billion to the industry, not counting the $25 billion already committed for “greening” R&D. Like AIG, however, the currently discussed levels would probably have to increase, because, believe it or not, the scope of the problem greatly exceeds $25 billion or even $50 billion. As of now, however, the bailout options may be limited to a developing compromise, whereby the $25 billion originally approved for R&D could be used instead for the current emergency. By January 20, 2009, it could be too late to keep GM and Chrysler from bankruptcy filings.
  • Federal bailout monies could be committed in the form of credit guaranties, loans, government equity acquisitions (probably preferred stock), or combinations of these.
  • There will be conditions on any U.S. funding. The Detroit Three need to demonstrate to Congress a specific plan conceived to cure the current market disaster.
  • An industry bailout would likely involve, not only the manufacturers, but also their affiliates and subsidiaries (including lending companies).
  • Beleaguered suppliers also want help. If the Detroit Three were to file, many dependent companies would surely follow.
  • Solving Core Problems. So far, except for the obvious observation that the Detroit Three want to survive until 2010 to outlast their competitive disadvantages of employee “legacy” benefits, no specific turnaround plans are evident. How will they upgrade core business and change consumer attitudes? If this does not or cannot happen, any bailout will fail. (See editorial comments at the end of this article.)

Second, here are some of the bankruptcy basics for all affected dealers to ponder, in the event that a Detroit Three automaker files:

  • Filing is relatively easy and is immediately effective. Any such filing would likely be under Chapter 11 (Reorganization) of the Bankruptcy Code, meaning that the debtor continues to operate as a “debtor-in-possession,” with the right to carry out most ordinary course of business activities. (Note, however, that GM CEO Rick Wagoner implied that, if forced to file, GM might have to liquidate its assets under Chapter 7, because he thinks credit to operate would not be available.) During a Chapter 11 process, the debtor will propose a plan of reorganization through which its pre-petition obligations will be resolved and have that plan approved by the Court. A franchisor could file a “prepackaged bankruptcy” in which it would seek from the outset the Court’s approval in implementing a comprehensive plan. This would entail much cooperation with creditors and, probably, the UAW. There may not be sufficient time for that.
  • Under the Court’s aegis, the Office of the United States Trustee provides oversight of various proceedings and would likely form a number of committees to protect the rights of various categories of creditors. In this web of innumerable participants, there would surely be committees composed of dealers in addition to myriad claimants.
  • The Automatic Stay (11 U.S.C. § 362(a)). As soon as bankruptcy is filed, there is an instantaneous and immediately effective automatic stay of virtually all actions against the debtor and its property. Certain enumerated acts and proceedings are exempt from the stay, and the Court may modify the stay for cause. Doing business with a reorganizing auto franchisor in bankruptcy will not be easy. The public will likely become even more turned off, and business for any bankrupt brand will be even slower. For dealers representing a bankrupt automaker’s brands, there will be many confusing and frustrating issues, involving vehicle allocations, product availability, and warranty work/reimbursement. No doubt, franchised dealers will be aligned in their own committees and will play a role in the proceedings.
  • Cash Collateral. The debtor’s pre-petition secured lenders will have the ability to object to the debtor’s continued use of cash collateral. Any continued use of such cash shall require either lender consent or court approval. The debtor will likely have its postbankruptcy budgets scrutinized by the court and lenders. Any new borrowing after a bankruptcy filing would require court approval. Such debtor-in-possession loans are typically costly and difficult to obtain.
  • A reorganization plan, if one is developed, would likely include the debtor’s decision to cancel selected dealer agreements. We already know that the American brands want many more dealer point closures. Under U.S.C. § 365, the Court is empowered to reject the continuation of “executory” contracts (i.e., those that have continuing mutual obligations). This power in the Court stands as the biggest bankruptcy threat to dealers because this kind of termination of dealer franchises may not compensate dealers for goodwill, if there is any.
  • The Court would also likely alter the rights and benefits of the many thousands of unionized employees.
  • Ultimately, reorganization contemplates an emergence from bankruptcy and a resumption to “normal” operations, presumably with many of the financial burdens lifted from the company by discharge. While many Chapter 11 cases do not result in a successful reorganization, some large debtors do succeed, as illustrated by several airlines.
  • Alternatively, as GM’s Wagoner has threatened, there could be a liquidation, either immediately in a Chapter 7 filing, or at some point which would allow for disposition of the assets and cessation of business. Some agree with Wagoner’s dire prediction, including the editorial board of Automotive News, that liquidation would inevitably follow a GM (and, probably, Ford and Chrysler) Chapter 11 filing.

What Should a Dealer Do and Not Do Pre-bankruptcy?
A dealer representing any of the Detroit Three brands has a franchisor in financial distress, with an uncertain future. If there is a federal bailout, the underlying problems may remain. Loans, guaranties or equity investments by the government could only put off the bankruptcy option for another day. For the time being, here are some thoughts for GM, Chrysler and Ford dealers to consider:

  • Do recognize the impact of a recession on consumer buying trends. New unit sales will stay down until the inevitable upturn, and other profit centers (used cars, service) will be hit, too.
  • Do stay informed. You cannot make your own strategic plan without knowledge of your franchisor’s financial wherewithal and intentions. GM dealers should be particularly attentive, because a bankruptcy filing could happen imminently.
  • Do make an unbiased assessment of your standing with your franchisor. Have you been targeted for termination? Is your franchisor a bankruptcy candidate? Is your franchisor a merger/acquisition candidate?
  • Do consider with your financial/legal advisors whether keeping funds in a Detroit Three-related CMA (e.g., Chrysler Financial) is in your best interest. (The supposed comfort that a dealer will have the ability in a lender bankruptcy to set off CMA deposits against floor plan obligations is not at all certain.)7
  • If your floor plan is shaky, do consider looking for a floor planner that is not related to, or dependent on, your financially stressed franchisor. Do try to have a floor plan with an FDIC-insured bank (where you will also keep your cash). Unlike the situation with automaker finance companies, offsets with cash deposits against floor plan balances would likely be allowed in the event of an FDIC takeover of a bank.
  • Do not go out of trust. (Author’s comment: In nearly thirty years, I have never seen an SOT situation that ultimately helped a dealer.) If you are in financial extremis, go to your lender and try to negotiate a workout. If you are out of trust, do not dig deeper. Bring your lender into the picture and try to negotiate a payment plan.
  • Do not sign any significant/expensive new, unwanted and unnecessary commitments with your franchisor (e.g., renovations, new facility or relocation).
  • Do not rely on factory representations or promises that are only verbal. And, remember, even written promises will not necessarily be enforced in bankruptcy.
  • Do manage your inventory so as to avoid stocking vehicles beyond a 60-day supply. And do not overstock parts.

During Franchisor Bankruptcy
There is no meaningful experience or precedent for a guide on the size, depth and complexity of the bankruptcy of any of the Detroit Three. Neither the 1999 filing by Daewoo Motor Company nor the 1989 bankruptcy of Global Motors (Yugo’s importer) offers much by way of comparison. The 1980 rescue of Chrysler by a federal guaranty also does not offer a workable analogy; Lee Iacocca had an inspired and substantive plan for the core business, along with the ability to deploy it and follow through. The bankruptcy of GM, Chrysler and/or Ford would spawn almost incalculable entanglements, complexities and repercussions. If GM and Chrysler file before the end of 2008, there is at least a possibility that Ford could become healthier, at the expense of its American rivals.

Without doubt, any remaining public acceptance of a bankrupt automaker’s products would instantly tumble. Consumers would worry about their warranties, lemon law rights and product reliability. The public will fly on a bankrupt airline, but will not pay $20,000 or $40,000 for a new car built by a bankrupt brand. A summer 2008 survey of 6,000 consumers by CNW Marketing revealed that 80% would defect if GM or Ford went into bankruptcy.8 If consumers abandon a bankrupt carmaker’s product to that extent, it would be a mere matter of months before liquidation, and the end of that entity. Dealers and suppliers, reliant on the bankrupt debtor, would themselves become bankruptcy candidates, if they were not already.

Dealer Participation in Bankruptcy Proceedings. If a dealer’s franchisor files for bankruptcy, the dealer will need to file a claim to try to protect what may be owed (e.g., holdback). More importantly, dealers— mostly in groups with aligned issues—will want to have a say in both ongoing operations in Chapter 11 and in any plan to emerge from bankruptcy.

Workforce. Dealers will have more than a little difficulty holding their best employees, especially if they have no prospect of doing work for another brand within the dealer’s overall operations. Difficult decisions to lay off people and reduce benefits will be necessary.

 Day-to-Day Business. There will be fewer new-unit sales, less service work, and a reduction in used car sales. Consumers will not want the automotive products of a bankrupt carmaker.

Debt Management. We have already witnessed the abandonment by some lenders of their auto dealer portfolios. As difficult as debt management may be now, it will be even more challenging for every dealer whose franchisor is in bankruptcy.

Selling/Buying a Dealership When the Franchisor Is Bankrupt. As of at least a year ago, dealers were acknowledging that franchises of American brands had little or no goodwill. (A prominent example is AutoNation, which values its Detroit Three franchises at zero.) Dealer buy-sells involving bankrupt brands will be a rarity.

Planning for the worst. If your franchisor is in bankruptcy, your plans should include a possible winding-up, in anticipation of a possible liquidation and closing of the factory.

Author’s Viewpoint: How the Detroit Three Might Pull Out of the Nosedive
Writing for the Wall Street Journal in an Op-Ed, Paul Ingrassia concluded, “pouring taxpayer billions into the same old dysfunctional morass isn’t the answer.”9 The statement is true. At the same time, Detroit Three turnarounds are possible, but Mr. Ingrassia and many others are absolutely right that “business as usual” would ensure failure. With the prospect that the Treasury of the United States, and thus the United States taxpayer, may be positioned to pony up billions to revive American auto manufacturers, the rescue must come with bold and creative conditions and requirements. Mr. Ingrassia argues that, “[i]f public dollars are the only way to keep General Motors afloat, as the company contends, a complete restructuring under a government overseer or oversight board has to be the price.”

In my view, such direct governmental operational control is a recipe for failure. Rather, the multifaceted solutions, although required as conditions for a bailout, must be entrepreneurial. It is instructive that the most successful imports, such as Honda and Toyota, have thrived at the expense of the Detroit Three; their “secrets” for doing so are hardly secrets at all. In a sense, a bailout must mimic some of the advantages of bankruptcy, without all the harmful fallout. In short, a post-bailout automaker must have a solid chance of being leaner and better than before. While the devil will be in the details, here are some of the broad parameters that could resuscitate Detroit, either in a bankruptcy scenario or through a bailout:

  • Start at the top. From the CEO on down in the executive suites, salaries would be set at a reasonable and competitive level, but no bonuses in any form would be paid, except upon measurable success, based upon specific criteria. No exceptions. This goal can be accomplished in a bankruptcy plan, or through bailout conditions.
  • Certain consolidations would be mandatory in either a bankruptcy reorganization plan or a bailout. For example, with Ford, non-performing models would be dumped, and Mercury, as a separate franchise, would be eliminated. At GM, either Buick or Pontiac would be eliminated. Model redundancies would also be eliminated.
  • In the government-subsidized alternative, franchisors would quickly move to streamline their dealer bodies, with reasonable compensation to motivate voluntary buyouts of dealer points to be closed. In bankruptcy, the Court could cancel dealer and supplier agreements.
  • Targeted layoffs and plant closings would continue, but each such action must be linked directly to the post-bailout/post-bankruptcy strategy of a stronger competitor, against the import juggernaut.
  • The benefits packages for UAW workers would be equalized with employees at the plants operated by the import brands in the United States. The UAW’s concessions should be accelerated, so that they are effective immediately, rather than in 2010. Cost parity with the imports is indispensable to any comeback of the Detroit Three.
  • Research and development would move toward combining well-established consumer preferences, along with environmental and performance improvements, and cost reductions.
  • In marketing blitzes, these franchisors would accurately inform American consumers of the exceptional improvements and reliability standards that have brought them at least even with most of the import competition.
  • Infighting and disputes with dealers have hampered the Detroit Three’s ability to present a cooperative face to the public. Each franchisor should have a dispute resolution mechanism for dealers that is informal, simple, quick and fair, with the dealer’s ultimate right to seek remedies now permissible by law if the informal process doesn’t succeed. It should be set up along the lines of Ford’s Dealer Policy Board, and staffed with highly respected and able members who would no longer be eligible to return to operational jobs with their franchisor employer.

The revitalization of the Detroit Three, or any of them, if it happens, will be a long, hard slog. I agree with some commentators that a total automotive void in American manufacturing would be harmful on many levels, including national security.10 It is not too late. But time is clearly of the essence. Unless there is to be a series of government bailouts, the fate of the Detroit Three should be reasonably clear by the end of 2009. If there is even one bankruptcy or two, (GM and/or Chrysler, most likely), the return to vitality will be long and hard; some observers say that this alternative leads to an ultimately more viable cure, but others (e.g., Automotive News) argue that bankruptcy is a death knell that will delay the U.S. economic recovery. Every dealer in the United States, regardless of brand, irrespective of whether there is a bailout or bankruptcy or both, should want robust retail auto competition to include the venerable old domestics, reborn and reinvigorated.

Eric L. Chase is an attorney and a member of Bressler, Amery & Ross in Florham Park, New Jersey. He has represented hundreds of dealers nationwide, principally in disputes with their automotive franchisors. He has published over 100 articles, and is a frequent guest speaker to dealer associations and other automotive-related audiences. His biography appears in Who’s Who in American Law, Who’s Who in America and other publications, and he has again been selected by his peers as a New Jersey Super Lawyer for 2009. The views set forth in this article are his own and do not necessarily reflect the views of his firm or any of its clients.

Note:  Nothing in this article is intended to constitute legal, financial or tax advice. Each reader should consult with his or her professional advisor regarding any such advice.

1 Rick Wagoner, “Why GM Deserves Support,” Wall Street Journal, Nov. 19, 2008.
2 Mitt Romney, “Let Detroit Go Bankrupt,” New York Times, Nov. 19, 2008.
3 Matthew J. Slaughter, “An Auto Bailout Would Be Terrible For Free Trade,” Wall Street Journal, Nov. 20, 2008.
4 “The Cost of GM’s Death,” Automotive News, Nov. 14, 2008.
5 New York Times, Nov. 20, 2008 at p. 4.
6 See Michael E. Levine, “Why Bankruptcy is the Best Option for GM,” Wall Street Journal, Nov. 17, 2008.
7 GMAC announced on November 20, 2008 that it was seeking to become a bank holding company, to make it eligible to apply for relief (bailout monies) from the $700 billion Troubled Asset Relief Program (TARP).
8 New York Times, Nov. 13, 2008, p. A26.
9 Paul Ingrassia, “Detroit Auto Makers Need More Than a Bailout,” Wall Street Journal, Nov. 10, 2008.
10 See Wesley Clark, “What’s Good for GM is Good for the Army,” New York Times, Sunday Opinion, Nov. 16, 2008, p.14.


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