Under Pressure: Delphi Files Chapter 11 in Advance of New Law

On Saturday October 8th, Delphi Corporation ended the intense
speculation of media and industry watchers by filing for Chapter 11
bankruptcy protection in the U.S. Bankruptcy Court for the Southern
District of New York.[1]  Sources inside Delphi had indicated as late
as Friday that such a move was likely unless Delphi could negotiate a
last-minute reprieve in the form of a bailout package from its largest
creditors, General Motors and the United Autoworkers Union.

While Delphi is surely struggling, it is not currently strapped for
cash. So why file now? The answer lies in both the legal climate and in
business strategy.

Avoiding the New Bankruptcy Law

Delphi Corporation, along with 38 domestic subsidiaries and affiliates, filed voluntary petitions per 11 U.S.C. §
311 of the Bankruptcy Code, seeking relief under Chapter 11. [2]  In
one of the 40-plus motions filed on Saturday, Delphi requested joint
administration [3] to allow the Clerk of the Bankruptcy Court to
consolidate all 39 cases under a single docket for procedural and cost
efficiency while the company seeks to continue operating its business
as a debtor-in-possession.

Represented by John William Butler, partner in the Chicago law
offices of Skadden, Arps, Slate, Meagher & Flom LLP, Delphi has
filed just in time to avoid the consequences of the new bankruptcy law
that will take effect on October 17th. [4]  While there are inherent
benefits to filing under familiar laws, the new Bankruptcy Code carries
several provisions that Delphi has sought to evade with a timely
petition.

For example, under the new  §
411, the time limit imposed for filing a Reorganization Plan has been
set at 18 months from the commencement of the case. This deadline is
fixed and absolute, removing from the court the discretion to grant
extensions to a debtor who in good faith may need additional time to
reach a plan that ensures long term viability. [5]

At a time when retaining top executives and managers is crucial to implementing reorganization, the new §
331 restricts executive compensation in terms of bonuses and severance
packages. [6]  While seen by Congress as necessary to halt the
exorbitant "golden parachutes" issued to executives at the cost of
shareholders, pensioners, and rank-and-file employees, this provision
nonetheless hinders the ability of corporate debtors to retain key
management personnel. In order for a bonus or raise to be approved, the
company must show that its manager has a "bona fide job offer from
another business at the same or greater rate of compensation." Even
with such a showing, the compensation rate is capped at ten times what
the average non-management employee would receive. [7] On Friday,
October 7th, just one day prior to filing bankruptcy, Delphi announced
that it had indeed extended severance benefits up to 18 months from 12
months in order to coax its management to see the company through its
troubled times. [8] The move came even as Delphi was urging its UAW
employees to accept wage cutbacks and trim its bloated job bank.

The declaration of bankruptcy by Delphi represents the largest
Chapter 11 filing ever by a manufacturing and technology company. It is
the 5th largest Chapter 11 filing by a public company in terms of
revenues, which stood at $28.6 billion in 2004, and the thirteenth
largest in terms of assets, valued at $17.1 billion. [9]  Nearly 50,000
of its 180,000 employees are employed by the debtors and 24,000 of
those are UAW workers.

Delphi's Reorganization Plan: Catching Up with Globalization

The declaration of bankruptcy by Delphi will be a wake-up call to
the U.S. auto manufacturing industry, which has until now insulated
itself from market forces that contributed to the collapse of the steel
and airline industries. New Chairman and Chief Executive Steve Miller
has extensive experience as a turnaround specialist, with prior posts
at Bethlehem Steel and Federal Mogul. U.S. auto industry watchers will
want to see what lessons Miller has learned from the failure of those
similarly situated industries and the implications for their own.
Remarked Merrill Lynch analyist John A. Casesa:

"In
some ways the auto industry is the last bastion of the traditional
postwar labor movement in the United States. There's really no other
industry in the U.S. that has escaped the effects of globalization, and
it is finally catching up with Detroit. The fact is, companies in the
United States can't afford to pay people $70 an hour in wages and
benefits to make auto parts when they can be made in Mexico, China and
Taiwan for a fraction of that." [10]

In an extensive
affidavit filed with the Court, Miller echoed these sentiments and laid
the blame for his company's need for reorganization relief on three
factors:

(a) increasingly unsustainable U.S. legacy
liabilities and operational restrictions driven by collectively
bargained agreements… (b) a competitive U.S. vehicle production
environment for domestic OEMs [Original Equipment Manufacturers]
resulting in the reduced number of motor vehicles that GM produces
annually in the United States… and (c) increasing commodity prices.
[11]

Spun off from General Motors in 1999 as a stand
alone supplier of auto electronics, parts, and component systems,
Delphi has grown into an industry leader worldwide; however, it still
relies on GM for close to half its business. Furthermore, Delphi was
saddled with two key "legacy liabilities": first, it inherited the
collective bargaining agreements negotiated by GM and its unions that
restrict its ability to reduce workers, wages, and benefits; second, it
inherited the pricing scheme for its products imposed by GM. Delphi
argues that such legacy liabilities are uncompetitive and do not
reflect the realities of the marketplace. Dephi hopes to emerge from
bankruptcy protection by 2007 a leaner, more agile corporation.
Continued diversification and investment in new technologies, such as
fuel cells, will be a priority for reorganization.

Swift recovery by Delphi is clearly in GM's best interest. As
discussed previously in this Journal, General Motors' manufacturing
divisions have faced painful financial losses this year due in part to
an inability to maintain market share and a reliance on profits from
its financial services division. [12]  Rising gas prices and a
coinciding drop in demand for SUVs have hit the U.S. auto industry hard
in recent months. The terms of the 1999 Master Separation Agreement
provide that GM will cover the pension benefits for Delphi retirees
should the company declare bankruptcy by 2007. While the exact amount
is in dispute, GM's liability could reach up to $10 billion, causing
its stock to tumble on Monday.

With the deadline for filing under existing law fast approaching,
Delphi pushed hard for price and wage concessions from GM and UAW to
achieve a negotiated, as opposed to court-supervised, reorganization,
but to no avail. Given the
complexity and bitterness involved in re-negotiating its UAW collective
bargaining agreements, Delphi's management will need as much
flexibility as possible to achieve meaningful reorganization.
The
restrictive rules under the new Bankruptcy Code work contrary to
Delphi's interest to create a lasting solution in cooperation with its
creditors.

Sources

[1] In re Delphi Corp., No. 05-44481 (S.D.N.Y. Oct. 8, 2005)

[2] Voluntary Petition of Delphi Corp., available at http://www.delphidocket.com/delphi  (follow "PDFs of Voluntary Petitions" hyperlink)

[3] Motion for Order under Fed. R. Bankr. P. 1015(b) Authorizing Joint Administration, In re Delphi Corp., No. 05-44481 (S.D.N.Y. Oct. 8, 2005), available at http://www.delphidocket.com/delphi  (follow "Joint Administration" hyperlink)

[4] Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8 (2005)

[5] Glenn Siegel & Andrea Pincus, Provisions in New Bankruptcy Relevant to Public Companies and Claims Traders, Am. Bankr. Inst.(May, 2005), available at http://abiworld.net/newsletter/publicco/vol2num1/newlaw.html

[6] Bankruptcy Abuse Prevention and Consumer Protection Act of 2005,  § 331, 119 Stat. 23, 102 (2005), available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_public_laws&docid=f:publ008.109

[7] Id. at § 331(c)(1)(C)(i)

[8] Delphi Sews Bigger Golden Parachute, CNN Money, Oct. 7, 2005, http://money.cnn.com/2005/10/07/news/fortune500/delphi.reut/index.htm

[9] Affidavit of Robert S. Miller, Jr.
Under Local Bankruptcy Rule 1007-2 and in Support of Chapter 11
Petitions and Various First Day Applications and Motions, In re Delphi Corp., No. 05-44481 (S.D.N.Y. Oct. 8, 2005), available at http://www.delphidocket.com/delphi  (follow "First Day Affidavit" hyperlink)

[10] Jeremy W. Peters & Mary Williams Walsh, Delphi Ready to Seek Bankruptcy, NY Times, Oct. 5, 2005, available at http://www.nytimes.com/2005/10/05/business/05place.html

[11] Affidavit of Robert S. Miller, Jr. at 10.

[12] See John Eakens, Why Do We Still Make Cars?, U. ILL. J. Bus. L. Soc'y., Mar. 28, 2005, http://iblsjournal.typepad.com/illinois_business_law_soc/2005/03/why_do_we_still.html
and David Welch, Running Out of Gas, Business Week, Mar. 28, 2005, available at http://www.businessweek.com/magazine/content/05_13/b3926042_mz011.htm

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