The Big 3 and Chapter 11

Over the past few months there has been much "public discourse" (a Newspeak term for what was once described as equal parts of lying, threats, counter-threats, name-calling, and blame-casting) concerning the necessity of a federally-funded "bailout" of the automobile industry.

The fact that the American automakers are under financial pressure is not disputed. As to the why they are on the financial ropes, well, that depends on who answers the question and will not be debated here. Rather, in this posting, I will argue that the "Big 3" (as General Motors, Ford, and Chrysler are usually referenced) should be denied such preferential refinancing and instead should accept reorganization under Chapter 11 of the United States Bankruptcy Code as the best solution to a complex problem.

First of all, under American bankruptcy law the Big 3 will have several attractive options available. Despite their repeated statements that bankruptcy is "not an option," a growing number of reports in the news media suggest that the automakers may now be developing contingency plans for a "pre-arranged" Chapter 11 reorganization.

A Chapter 11 bankruptcy is a business reorganization plan as opposed to a business liquidation under Chapter 7. Under a "pre-arranged Chapter 11" the debtor company "does the paperwork," such as creating a new business plan and/or working out a more favorable financial arrangements, before filing a bankruptcy petition with the court. This option is particularly attractive in that a company can file for bankruptcy and then "emerge" from a Chapter 11 bankruptcy within a few months or a few years, depending on the size and complexity of the bankruptcy.

The automobile industry would still exist during a Chapter 11 bankruptcy but its legal status would change to that of a "debtor in possession," meaning that it would continue to operate but within the oversight and approval of the court and the industry's creditors and would be able to negotiate favorable loan packages from the government. As a bonus, the industry would be granted a "stay" from pending legal actions related to its debts as well as preventing the filing of new actions.

Another very attractive factor of Chapter 11 reorganization is that some contracts, known as executory contracts, may be voided if canceling them would be financially favorable to the filing company and its creditors. Executory contracts are those in which each party has duties remaining under the terms of the contracts. Such contracts can include labor union contracts, supply or operating contracts, and real estate contracts. In the event an executory contract is voided, the remaining parties to that contract become unsecured creditors of the filing company. And therein, to paraphrase the Bard of Avon, lies the rub.

A reorganization would not allow everyone to walk away unscathed because bankruptcy law establishes priorities regarding whose debts get paid and in what order. Holders of secured, or collateralized, debts move to the front of the line. Then come the bondholders who have, by purchasing a company's bonds, essentially loaned the company money but without collateral being pledged to guarantee that they will be repaid. After the bondholders come the owners of the company itself, a group known as its shareholders. Given the debt to asset ratio of the industry, it is very likely that the common stock of the industry would become worthless.

A direct infusion of cash into the Big 3 would accomplish nothing except protect the financial investment of the shareholders and bondholders, the very groups that turned a deaf ear and a pair of blind eyes to the fact that the automobile industry was mismanaging itself into extinction. These groups have had their chances to demand that the Big 3 come back to earth, but they said nothing. They should not be given special treatment now.

As to those that will whine about "losses" to pension funds and other such operations that have "invested" in the bonds or common stocks of the Big 3, I will simply point out that no investment is without some degree of risk. To expect the rest of the nation to relieve you of the consequences of your negligence is absurd. If the federal government wants to make good your losses, that is its decision.

Yes, this is a very critical period in the economic history of the nation and, no, I don't think that I'm a legal scholar or an economist. Like many of you, I'm not a musician either. But that doesn't mean that I can't tell the difference between Bach and bullsh*t.

In closing, allow me one quote that is attributed to my idol, the great H.L. Mencken. I can close my eyes and almost hear the old boy laying it out for the Big 3:

"The fact that I have no remedy for all the sorrows of the world is no reason for my accepting yours. It simply supports the strong probability that yours is a fraud."