Posted on: 9/21/2012
Christopher O. Massenburg, Swetman Baxter Massenburg
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The bailout of the auto industry was a marvel of rapid restructuring. What normally took years in bankruptcy court was accomplished in mere days. The architects of the deal picked winners and losers among creditors as best they could under the time crunch. But while they may have succeeded in saving the US auto industry, they also set the stage for years of litigation as the losers fight for better deals in court. In contention in most lawsuits is a previously obscure passage of the bankruptcy code that made the bailout possible: Section 363.
Introduction
In 2009, the once powerful US auto industry was on the verge of collapse. A federally-funded bailout came to the rescue of General Motors and Chrysler through a restructuring that left the United States government as a reluctant partial owner of the two companies. Of the Big Three, only Ford declined government assistance, gambling that they could fix their significant financial problems on their own. Meanwhile, the outgoing Bush Administration threw $17.4 billion of TARP money at GM and Chrysler at the end of 2008, keeping them afloat a little longer. Unfortunately, TARP did nothing to fix the gashes in their financial structure at a time when their negative cash flow was more like a gushing waterfall. GM alone had gone through $21 billion of cash in a year and another $13 billion in the first quarter of 2009.
By the spring, the new Obama administration had to make a decision. The choices were stark – allow GM and Chrysler to likely bleed dry and face a liquidation bankruptcy, potentially setting off a domino effect of devastation throughout the country, or pump tax-payer money into companies that from a theoretical market standpoint should fail, at a time when public opinion was strongly against a bailout. "Team Auto," led by Wall Streeter Steven Rattner (who recently release his book recounting the experience, Overhaul: An Insider's Account of the Obama Administration's Emergency Rescue of the Auto Industry) had five weeks to recommend a plan of action to the President. In the end, the administration decided to bailout both GM and Chrysler by pumping equity from the federal government, $12 billion into Chrysler and $50 billion into GM, shaking up their management teams, and restructuring both companies through the bankruptcy code. To help streamline the process, the car task force tapped a little-used section of the bankruptcy code – Section 363 – that allows a newly formed company to buy the operating assets from a bankrupt one "free and clear" of resolving disputes with competing interests.
When the dust cleared, Ford fared the best of the Big Three with the public and with profits. Their gamble to decline government aid paid off with record earnings and the reclaiming of their perch as the #2 auto seller in the US. Public perception was a bumpy road for the bailed-out companies, but following the first quarter of 2011 GM reported its first profit in three years, and finally, Chrysler is reporting a positive cash flow. The repercussions of the bailout on litigation against those companies varied as Ford continued to be proactive and GM and Chrysler played defense. Most notable was that "New GM," with their web of legal quagmires, was able to dislodge liability for thousands of monetary decisions and pending lawsuits against "Old GM." One of the most publicized effects of the "free and clear" bailout was that accident victims who had won lawsuits but had not yet been paid by Old GM and Old Chrysler were no longer going to receive their court-awarded compensation.
Background of the Auto Crisis
In the post-WWII era, the US auto industry dominated the global market. As the German and Japanese economies slowly recovered and re-launched their manufacturing sectors as competitors, things began to change. In 1979, Chrysler was in trouble and lobbied the Carter Administration for various forms of financial relief, culminating in the Chrysler Corporation Loan Guarantee Act of 1979, a package which included $1.5 billion in government loans. By the 1990s, the winds had shifted in the auto industry. Consumers considered small-size Japanese cars superior to American versions. Instead of responding to this drop in competitiveness, American manufacturers adopted a new strategy and started relying on the larger profit margins from luxury models and particularly SUVs and trucks, which were gas-guzzlers. For a time, a seemingly insatiable SUV craze sweeping the nation supported this strategy; however, several years of the Big Three's dominance and the subsequent rise of the UAW left them with an expensive workforce. Established, unionized workers that stayed with the companies for life were aging and racking up heavy pension and healthcare bills, which were constantly rising. By contrast, Japanese plants operating in the southern United States were able to start fresh with younger workers and maintain a dramatically lower overhead cost. Because of their high labor costs, American auto-makers had to sell approximately ten small cars to equal the profit from selling one SUV. When the price of fuel skyrocketed and the recession kicked into full gear, shocked consumers could no longer afford to purchase, own, and gas up these larger cars. Newly-frugal Americans either stopped buying new cars or turned to the more fuel-efficient Japanese vehicles, and Ford, Chrysler and GM were left in the lurch without a backup plan.
Reportedly, another factor of the US auto industry's financial collapse was chronically poor management. When Steven Rattner visited General Motors, he described the management as "stunningly" bad, resulting in the worst financial condition anyone on the auto task force had ever seen at a major company. GM Executives apparently took a special elevator to avoid mixing with regular employees. Astronomical spending requests lacking basic logic were routine. Chrysler's management had no plan for the future; their new car pipeline was apparently less than impressive – a "joke" some said. At Ford, there was a practice of shifting managers from job to job without any meaningful consistency of leadership in the departments. Different wings of Ford world-wide worked independently like island nations with their own culture and goals and had trouble collaborating. Overall within the Big Three, like any aging empire, there was an entrenched culture of complacency, mixed with a stubborn resistance to change.
Ford's Path
Chairman William Clay Ford, Jr., the great grandson of Henry Ford, saw the writing on the wall. In 2006, he tapped Alan Mulally to take over for him as CEO and transform Ford. The former Boeing CEO set to work on a Ford restructuring plan called, "The Way Forward," which had been developed to return Ford to profitability through a combination of cost-cutting and faster production of new cars to respond to the market. Mulally brought discipline to a company mired down in the quicksand of the type of corporate culture endemic to the Big Three. He did away with the meetings about meetings, beloved by Ford's managers. He sold the luxury brands Jaguar, Land Rover and Aston Martin despite internal opposition – and before demand for such cars plummeted during the recession. To meet the new consumer demand for small cars, he initiated an overhaul of the Ford Taurus, the flagship vehicle of the 1980s that by the 2000s had become an automotive dinosaur.
After Ford declined federal bailout money, the company's positive public perception went up from 41% to 63%. Accusations that Ford declined bailout money as an elaborate PR stunt were met with disbelief by Alan Mulally; however, Ford did not escape the auto crisis without taking a loan. Mulally orchestrated a $23 billion infusion of cash from Wall Street by securitizing all of Ford's assets, even its blue logo, as collateral. In 2011, Mulally announced Ford had already repaid $20 billion of their gutsy bet.
Shortly after Mulally's takeover, Ford had its first profitable quarter in several years and is now on the road to sustainable profitability. By 2009, Consumer Reports recommended 70% of Ford's vehicles, in contrast to 19% of GM's and none of Chrysler's. The year after, Ford incredibly passed Toyota to become the #2 seller in the United States. And after a series of surprising positive earnings, the company issued a January 2011 report announcing their biggest profit in eleven years. In fact, Ford has made more money in the first half of 2011 than in the previous five years combined. Their success can be attributed in large part to a renewed emphasis on small, fuel-efficient cars that they were already producing in Europe and have transitioned to meet new US demand, a key tenet of "The Way Forward" plan.
To Bail or Not to Bail
While Ford embarked on a risky but bold plan to survive the auto industry crisis, GM and Chrysler were on a downward spiral. Steven Rattner's Team Auto, reporting to White House economic adviser Larry Summers, Treasury Secretary Tim Geithner and President Obama, had to weigh the possible consequences of bankruptcy versus bailout for the two companies. It quickly became clear that GM and Chrysler were running through cash at alarming speeds, and without federal intervention, were headed for certain liquidation. The government weighed the pros and cons of letting the auto giants continue on their course. On one hand, the companies were extremely unhealthy, poorly managed and financially starved, and unlike Ford, neither GM nor Chrysler had a practical restructuring plan. Academically, the companies did not deserve to be saved. However, the negative repercussions of losing GM and Chrysler could possibly be worse. The recession had left the economy fragile. The Mid-West was already decimated by years of industrial shutdown, and experts feared losing GM and Chrysler would be the KO punch. The economic network of the auto industry stretched beyond Detroit and affected myriad other support industries like parts manufacturers and suppliers. Shutting down Chrysler alone risked adding 300,000 more unemployed workers to the rolls. If the automakers collapsed, it could start another domino effect in the economy as a whole.
One Presidential adviser, Austan Goolsbee, argued persuasively for the option of saving GM, but letting Chrysler fail to boost GM and Ford sales. Fears of aftermath possibilities weighed heavily, and ultimately, the government chose to restructure both firms through the bankruptcy code. The cash needed was reluctantly funneled in as equity making the government partial owner of both companies. $50 billion pumped into GM and $12 billion into Chrysler allowed them to continue operations. Chrysler was partnered with Sergio Marchionne's Fiat. GM's CEO Rick Wagoner was replaced with his deputy Fritz Henderson, and the ineffectual board of Directors was heavily shuffled. Several production lines were sold or shut down, including Saturn, Saab, Pontiac and the ultimate icon of the SUVs - Hummer.
The debts of Chrysler and GM were renegotiated and reduced, including obligations to the UAW. In the case of Chrysler, the banks in their position as secured lenders originally wanted $6.9 billion, as compared to the $1 billion estimated liquidation value of all of Chrysler. After negotiations, they settled for around $2 billion, far more than they would have gotten if Chrysler liquidated when its debt was trading at 15 cents on the dollar. GM discharged $65 billion of liability from their balance sheets in days, and its shareholders were wiped out (Chrysler was not public).
While Chrysler had 45 lenders, GM had thousands upon thousands of bondholders, many of whom were individuals. But ticking clock negotiations with Chrysler's creditors were successful. The relative ease and speed of the Chrysler bankruptcy gave the government's Team Auto enough leverage with GM's significantly larger number of creditors to push a GM restructuring through. The semblance of order of the bankruptcies helped in the arena of public perception. The fear that consumers would be afraid to purchase a car from a bankrupt company, and would especially not want to hold a warranty from one, was quelled as consumers adapted fairly quickly to the idea of bankrupt automakers. The federal government, new partial owner, was guaranteeing the warranties, and sales were better than predicted. While Americans did not exactly rally around GM and Chrysler, it was a point of success that the car-buying public did not panic.
But after taking the bailout, public perception would take another huge hit when word got out that GM and Chrysler were using tax-payer funded bailout money to award bonuses to their employees. Once GM and Chrysler received their bailout money they began doling out hefty bonuses to executives as if they had earned the new cash – in the case of GM ranging from 15-20% of their salary and up to 50% bonuses. Not only were the auto giants getting a free pass on their failure to compete in the market, but they were rewarding themselves for it. The PR nightmare evoked wide-spread public outrage against GM and Chrysler executives all the way up to the President.
Effects on Litigation
The different paths chose by Ford versus GM and Chrysler during the auto crisis affected not only their future profitability, but also their litigation strategies. Ford, the only member of the Big Three that did not take government assistance, continues to fare better in the arena of public perception. While Ford now garners far higher esteem with consumers than GM and Chrysler, historically they had not always come out well when it came to litigation and PR. They had been particularly scandalized by the 1990s debacle of faulty Firestone tires on the extremely popular Ford Explorer. But perhaps as a reaction to the Firestone crisis, before the auto crisis even kicked into full gear Ford's legal team was praised as a Best Corporate Legal Department for their hands-on approach to problem solving and their speed of operation. For example, when highway patrol officers were injured or even dying due to a defect in Ford's Crown Victorias, the Ford legal team partnered with the law enforcement and government officials who were investigating them and formed a blue ribbon panel to fix the problem, which they did – in 90 days.
For GM and Chrysler, however, bad litigation press continues to roll in. Most cases focus on whether new GM is liable for mistakes and conduct of old GM, and determining in which cases it is liable under its restructuring. GM's legal quagmires are not surprising considering GM's larger number of creditors and highly varied levels of repayment on the dollar, some of which were zero, that were speedily assigned during bankruptcy negotiations. Trusky v. General Motors Corp, currently in US District Court for the Eastern District of Michigan, is one example. The case alleges that new GM should be responsible for repairs to suspension defects in 2007 and 2008 Chevrolet Impalas. While the plaintiff argues for breach of warranty, new GM seeks to dismiss the case and asserts that under restructuring they have no obligation to fix faulty design choices of Old GM not specifically covered in written warranties. An argument similar to Trusky failed in a recent case concerning On-Star technology. Whether or not GM, and to a lesser extent Chrysler, will successfully continue to avoid liability for such claims seems to be the trend, but is not certain. It is a classic question of successor liability, common for manufacturing companies that have gone through bankruptcy, and one that GM and Chrysler's attorneys will no doubt be encountering frequently in the years to come.
The unlikely star of much of the bailout aftermath litigation is Section 363 of the bankruptcy code, the little used portion Steven Rattner's team dug up that made the quick restructurings of GM and Chrysler possible under the time crunch. Section 363 provides a way for buyers to purchase assets from a bankrupt company and obtain successor liability protection, barring certain exceptions. The bankruptcy trustee or debtor-in-possession is permitted to sell the assets of the bankrupt entity, in this case a corporation, "free and clear of any interest in such property." During the bailouts of GM and Chrysler, the "free and clear" provision streamlined the sale of corporate assets to the buyer, i.e. the newly restructured companies; therefore, competing interests in the assets sold by GM and Chrysler to "New GM and Chrysler" did not have to be resolved as a condition for the sale.
Not surprisingly, litigation has come from competing interests left out in the cold, all of whom wish to argue they fall under the certain exceptions portion of 363. The most widely publicized and publically captivating cases concern accident victims who were injured or killed due to faulty GM and Chrysler vehicles. An often-cited example is Vicki Denton, who died in 1998 when her airbag failed to deploy during a head-on collision. Her family was awarded $2.2 million in their civic case against Chrysler, but under the restructuring will receive nothing. When Old GM went into bankruptcy, there were over 2,500 similar litigation claims filed against them totaling over $3 billion.
Another case of victims maimed or killed in accidents due to vehicle failures is Callan Campbell, et al., v. Motors Liquidation Company. Again, plaintiffs proved GM's product liability in court and were awarded compensation prior to GM's bankruptcy. During Section 363 restructuring, no money was set aside to pay such victims. Plaintiff attorney Steve Jakubowski made an appeal challenging the lack of liability in preexisting product liability claims under the restructuring asset sale. He argued that the standards of a "free and clear" absolving of product liability were not met, and that GM assumed liability for over $60 billion owed to other unsecured creditors, i.e. those considered crucial to GM's commercial success, while nothing was set aside for accident victims. Plaintiffs asserted that none of the provisions for a "free and clear" purchase were met because 1) authority for free and clear was invalid due to lack of "conceivable effect" on the estate from paying accident victims, 2) product liability immunity was not a requirement of New GM's purchase, and 3) the treatment of the other creditors of similar standing was inconsistent with the priority scheme of the bankruptcy code.
In April of 2010, the US District Court for the Southern District of New York denied his appeal as equitably moot. In an earlier case with a similar outcome, Indiana State Police Pension Trust v. Chrysler, again concerning the fateful Section 363, the Supreme Court denied the Indiana Pension Fund's appeal against Chrysler as moot. In this instance, the Court vacated an earlier decision by the US Court of Appeals for the Second Circuit.
While not all cases strike a frayed nerve with the public, GM and Chrysler continue to take a defensive approach to litigation that focuses on evading liability for pre-bankruptcy claims through procedural grounds. Although they have had success in the courts, negative public perceptions continue to pile up as collateral damage. Opponents portray the bankrupt bailees as alternately hiding behind their lawyers or trying to slink away in the night to avoid their responsibilities, but despite the bad press, there is no strong reason to think that GM or Chrysler will change their litigation strategy in the near future. Whether this approach will hamper sales and impair their financial recovery remains to be seen. However, with multibillion-dollar profits in 2010 and 2011, for the first time in decades, it does not appear to be having such a negative effect on either.
Chris Massenburg is a founding partner of Swetman Baxter Massenburg, LLC and manages its Hattiesburg, Mississippi office. His practice areas mainly consist of environmental, toxic tort, products liability, intellectual property, premises liability, construction defects, and commercial trucking litigation. Chris also serves as an Associate Professor of Trial Advocacy at Tulane Law School in New Orleans, he is a member of the LSU School of Law Trial Advocacy faculty, and he is board certified as a Civil Law Trial Advocate by the National Board of Trial Advocacy.