GM made it to the headlines by announcing that bankruptcy is the ONLY way forward for them with the UAW and creditors equally weary of the terms and conditions post the re-organization while Chrysler has been aggressively trying to fend it off. Earlier, when the banking crisis was setting in, Lehmann Brothers had gone the bankruptcy way or more appropriately filed for Chapter 11. This is considered the BIGGEST bankruptcy case of all times. So how exactly does filing for bankruptcy serve the business interests?

Bankruptcy maybe defined as a declaration of inability to pay back the creditors, the amount borrowed under the terms and conditions agreed upon in the first place. According to the US Bankruptcy code, bankruptcy cases should always be filed at United States Bankruptcy Courts which would then decide upon the fate of the debtor according to the scenario. Some Bankruptcy laws are also dependant on the state laws and so therefore, these laws cannot be completely generalized.

We commonly hear about firms and corporations filing for Chapter 11. So what is Chapter 11 & what does it say? The Chapter 11 of the U.S Bankruptcy code deals with rehabilitation or reorganization, used primarily by business debtors, but sometimes by individuals with substantial debts and assets. In such a scenario, the debtor or the owner of the business still retains its ownership while the bankruptcy judge would rule and negotiate with the creditors, a viable business plan that would work out and let the business pay off the debt to the creditors rather than simply liquidate it, in which case the value out of a sale would be of lesser worth. It is very important to note that once a firm files for bankruptcy, the fate of the firm lies solely in the hands of the judge (and no one else!). His experience and expertise would prove invaluable to sustaining the business.

Beyond reasonable doubt, bankruptcy is a corporation’s last resort. Filing for Chapter 11 entitles the debtor to seek financing on more favorable grounds with the first preference to the new lenders on the earnings. The law also permits the corporation or the debtor to retain or cancel any existing contracts and payments as per earlier agreements. It is also worth noting that if the debt accrued is greater than the value of assets, the owners would be forced to end their rights and exit the company completely, thereby leaving the creditors in charge of the firm. The publicly traded stocks are delisted and usually such stocks are identified with a ‘Q’ in end of the stock symbol to signify the company’s bankrupt status. Usually in bankruptcies, it is not uncommon for the firm to cancel existing contracts if doing so would be of any financial advantage. In such an event, the parties concerned would be termed unsecured creditors/bondholders.  In short, Chapter 11 deals with reorganization as against liquidation under Chapter 7.

Now, putting these into perspective, after GM filed Bankruptcy under Chapter 11 for reorganization, the US government/ Treasury would hold 60% of the firm with a mixture of capital infusion and conversion of debt to equity. The Canadian Government would hold 12.5%, the United Auto Workers getting a 17.5%, unsecured bondholders with 10% and the existing GM shareholders completely wiped out. Which means that the firms with which GM had contracts but chose to cancel it under bankruptcy laws, would end up owing 10% of the new GM. The reorganized GM would have far fewer liabilities and brands. 11 factories would face closure and 3 would be idled according to the new restructuring plan. By now GM shares have been delisted from all major stock exchanges as they’ve fell below the minimum trading regulations (this varies with each exchange).

The reorganized GM would buy most of the old GM assets and this would happen in accordance with Chapter 11 proceedings. The Treasury would provide $30 Billion financing to support GM through an accelerated Chapter 11 proceeding. The government will receive $8.8 billion in debt and preferred stock and 60 percent of the company’s equity. Governments in Canada and Ontario will lend $9.5 billion to GM and the new GM. The Canadian and Ontario governments will receive approximately $1.7 billion in debt and preferred stock, and approximately 12 percent of the equity of the new GM.

It should have become very clear now, as to why the Government rushed to save AIG from filing for Chapter 11 (or mostly Chapter 7). Chapter 11 basically provides a bankrupt firm a new chance to reorganize, pay its debt and get back on its feet as soon as possible. The Judge presiding over the proceedings would prove instrumental in confirming a viable business plan that would enable the firm to continue business. With GM being rechristened as Government Motors, who knows who is next in line? Let’s keep our fingers crossed!

Interesting links pertaining to GM Bankruptcy: