Member Article

The three major automobile manufacturers in the United States, General Motors, Ford and Chrysler, have indicated that without significant financial assistance from the government a filing for reorganization under Chapter 11 of the United States Bankruptcy Code is likely. Such a filing would have a significant impact on car dealers. Some of the frequently asked questions being raised by car dealers include:

The treatment of manufacturer incentives and warranty obligations of the debtor (this is what a car

manufacturer will be called once it files its Chapter 11 case) differs depending upon whether the debtor

assumes or rejects the dealer agreement. If the dealer agreement is assumed, the debtor must perform

all of its obligations pursuant to the dealer agreement, including honoring dealer incentives and

warranties. If the dealer agreement is rejected, the treatment of dealer incentives and warranty

obligations of the debtor will depend upon whether they are attributable to the rejected pre-petition

franchise agreement, in which case they will result in unsecured claims, or attributable to the post-petition

operations of the debtor, in which case they will be administrative claims (which are paid ahead of other

unsecured creditors). The dealers, at the commencement of the Chapter 11, should insist upon

recognition by the court of the post-petition nature of these dealer incentives and warranty obligations.

The Bankruptcy Code authorizes the debtor to assume or reject executory contracts and leases. Dealer

franchise agreements are executory contracts.

As executory contracts, dealer franchise agreements can be assumed by the debtor if the non-debtor

promptly cures defaults under the executory contract. Dealers should carefully examine the ability of the

debtor to cure defaults and provide adequate assurance of future performance. Examples of “adequate

assurance” would range from a demonstrably financially secure reorganized debtor that could honor all of

its obligations, including dealer incentives and warranty obligations, to a guaranty from a solvent third

party.

Rejection of the dealer agreement by the debtor does not automatically terminate the agreement since

rejection constitutes a breach, not termination. Since rejection does not constitute termination, the dealer

can argue that it is not required to de-identify. While the debtor cannot be compelled to perform pursuant

to the agreement, the dealer may have significant damages resulting from the breach which constitute

pre-petition claims against the debtor. Damages that result from the debtor’s business operations after

the filing of the Chapter 11 case will constitute administrative claims. The debtor cannot confirm its plan

of reorganization without providing for the payment of administrative claims.

The federal Automobile Dealer’s Day in Court Act regulates termination and non-renewal of automobile

dealerships. Among other things, it requires that automobile manufacturers “act in good faith in

performing or complying with any of the terms or provisions of the franchise, or in terminating, canceling,

or not renewing the franchise with the dealer

A specific provision of the Federal statutes, 29 USC 959, requires that a debtor comply with state law in

connection with the operation of its business. Consequently, the reconciliation of the applicable state

laws regarding the relationship between the debtor and the dealers will undoubtedly be explored in the

event of a Chapter 11 proceeding for a domestic manufacturer.

Legislation has been enacted in numerous states to eradicate perceived abuses in franchisor or

non-renewal). These laws articulate numerous “prohibited practices,” ranging from the conditions under

which a franchisor or manufacturer may terminate or refuse to renew an agreement, to prohibited market

infringement by a franchisor or manufacturer against an existing franchisee and prohibited restrictions on

franchisee or dealer rights to associate. These state laws come in the form of general franchise or dealer

statutes and/or industry-specific statutes covering motor vehicles, farm equipment or other specific types

of dealerships.

These state relationship laws frequently impose an undefined “good cause” standard. The laws also

usually provide a minimum advance notice requirement during which a franchisee or dealer is granted an

opportunity to cure the default and thus avoid termination. The “cure period” may be as short as 10 days

(for nonpayment of fees under the Wisconsin Fair Dealership Law) to 90 days (under the Delaware

Franchise Security Law).

Many state laws also set forth circumstances under which the standard notice and cure requirements

need not be met. These generally include situations in which a dealer files for relief under federal

bankruptcy law, the business is abandoned, the franchisee or dealer is convicted of a crime or the

franchisee or dealer loses the right to occupy the premises of the business or makes a material

misrepresentation to the franchisor or manufacturer.

The filing of a bankruptcy petition, whether voluntary or involuntary, invokes an automatic stay preventing

essentially all actions against the debtor or its property. The concept behind the automatic stay is the

right of the debtor to have a “breathing spell” – an opportunity to rehabilitate and formulate a plan of

reorganization or liquidate in an orderly fashion. Before taking any actions against a debtor, a dealer

should closely review the provisions of section 362 to avoid any violations of the automatic stay. Section

362 contains provisions for relief from the automatic stay for certain specified reasons and for cause.

Although the debtor is not required to perform under the dealer agreement pending assumption or

rejection, if the debtor fails to perform, the dealer can petition the Bankruptcy Court for relief. The dealer

can argue that the debtor should be required to perform since the debtor is getting the post petition

benefit of the services provided by the dealer and performance by the debtor is the appropriate

compensation for those services. The dealer can also ask the Court to require the debtor to assume or

reject the dealer agreement since assumption would require cure and future compliance with the dealer

agreement. In addition, the dealer could request that either the automatic stay be lifted for cause to allow

the dealer to terminate the agreement or that the debtor be required to provide the dealer with “adequate

protection” for its interests. Some, or all, of these potential actions may be precluded by the practical

reality that a particular dealer may be dependent upon the debtor for its economic survival.

Certain state franchise or dealer laws and as well as certain industry-specific state motor vehicle dealer

laws require a manufacturer to repurchase the franchisee’s or dealer’s business or inventory upon a

termination or non-renewal. Among others, Arkansas, California, Connecticut, Hawaii, Michigan, Texas,

Washington and Wisconsin have repurchase obligations, but the state laws vary on issues such as: (1)

whether repurchase is required only when there is good cause for termination; (2) whether repurchase is

required in the case of both termination and non-renewal; (3) what must be repurchased (i.e., the

dealership or just inventory); and (4) the repurchase price. Although the debtor will contend that rejection

of the dealer agreement relieves it of this repurchase obligation, the dealers may take the position that

unless the debtor complies with these provisions it cannot terminate the dealer agreement.

The initial phases of a Chapter 11 reorganization case for a manufacturer will involve the formation of

various committees which play an important role in a reorganization. An official creditors committee will

be appointed to represent all creditors but that committee may take positions that are unfavorable to the

dealers. The dealers should attempt to have the United States Trustee or the Court appoint an official

committee of dealers. If that cannot be accomplished, the dealers may form an ad hoc committee to

protect their interests. The dealers should discuss the situation among themselves and become

organized well in advance of a potential filing in order to have a unified voice in connection with pre

petition negotiations with the manufacturer.

The automatic stay prevents the dealer from filing a lawsuit against the debtor but the dealer may seek

appropriate relief from the bankruptcy court.

The Bankruptcy Code preserves the right of setoff but subjects the exercise of the right of setoff to the

automatic stay. A separate right called recoupment is not stayed. The dealers should determine if they

have setoff or recoupment rights against the debtor.

Shortly after a bankruptcy case is filed, all creditors who were scheduled by the debtor receive notice of

the commencement of the case, the date and time of the first meeting of creditors and the fixing of certain

dates and deadlines in the case. One of the most important deadlines in a bankruptcy case is the bar

date for filing proofs of claim. In Chapter 11 cases the time for filing claims is determined by the court.

The failure by the debtor to meet its obligations under a franchise agreement with the dealer may result in

a claim by the dealer against the manufacturer.

Care should be taken, however, to analyze the jurisdictional ramifications of filing a proof of claim since

filing a proof of claim may subject the dealer to the jurisdiction of the Bankruptcy Court, which may not be

in the best interest of the dealer.

Although it is likely that the manufacturer will file a voluntary Chapter 11 case, it is possible for the

creditors to file an involuntary case against the manufacturer if they meet certain criteria. The case may

be filed in Detroit but it is possible that it will be filed in New York or Delaware. If government assistance

is involved, the fact that Joe Biden has been very supportive of maintaining Delaware as a venue of

choice for Chapter 11 cases may influence the decision of the manufacturer where to file the case.

The manufacturer will continue to run the business unless the court determines that a trustee should be

appointed to take possession of the debtor’s assets and operate the debtor’s business. If government

assistance is provided as part of a Chapter 11 reorganization, some form of governmental oversight may

be dictated.

For a debtor-in-possession, obtaining financing to support its ongoing operations can be a vital part of the

reorganization process. The financing may come from its current lenders or new sources of funding that

specialize in funding Chapter 11 debtors. The government may also provide direct financing or guaranty

the financing by third parties. The debtor in possession financing order may dictate the future course of

the case and proposed financings should be carefully reviewed by the dealers.

The Debtor may use, sell or lease its property in the ordinary course of its business. With court approval,

the Debtor may sell its property free and clear of all liens, claims and interests if certain conditions are

met. For example, the debtor may decide to sell a division, a product line or a factory to a third party.

The dealers should monitor the case to determine if prospective sales impact the dealers.

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The Bankruptcy Code empowers a Chapter 11 debtor-in-possession to recover or avoid certain transfers

made or obligations incurred by a debtor within specified time periods prior to the filing of the bankruptcy

petition. These abilities are generally referred to as “avoidance powers” The most commonly used

avoidance powers are preferential transfers, where certain payments to creditors may be avoided, and

fraudulent transfers, where transfers with actual intent to hinder, delay or defraud creditors and transfers

where the manufacturer did not receive reasonably equivalent value and the manufacturer was insolvent,

or did not have enough working capital, can be avoided.

The debtor has the exclusive right to file a plan during the first 120 days of a Chapter 11 bankruptcy case.

The 120-day exclusivity period may be extended by the court, but the period cannot be extended past a

date that is 18 months after the bankruptcy petition date. Once the debtor’s exclusivity period expires,

any creditor or other party in interest may file a plan. If exclusivity is terminated, the dealers can propose

their own plan for the reorganization or sale of the debtor.

Once a plan has been filed, and before votes of creditors can be solicited, a disclosure statement, which

has been approved by the bankruptcy court, must be provided to all holders of claims or interests in the

debtor’s estate. A disclosure statement must set forth the terms of the plan, as well as sufficient

information to allow the holders of claims and interests to make an informed decision whether to vote for

or against the plan. Once the disclosure statement is approved by the Bankruptcy Court, the disclosure

statement, the plan and a ballot will be sent to the creditors and other parties in interest. Chapter 11 is

supposed to be a transparent process, however, it has become increasingly common for debtors to

withhold “confidential” information from creditors and others. Dealers should be particularly careful to

alert the Court to attempts by the debtor to prevent the dealers from receiving critical information.

The Bankruptcy Code allows a debtor to reject burdensome contracts. Since the collective bargaining

agreements of the domestic auto manufacturers are a significant impediment to their reorganization, it is

highly likely that modifications in these agreements will be a central issue in any Chapter 11 of these

debtors.

The Pension Benefit Guaranty Corporation (the “PBGC”) is the governmental corporation established by

ERISA that insures a certain minimum level of the benefits earned under defined benefit plans when the

plan is terminated without assets sufficient to meet the plan’s liabilities. Under ERISA, each member of

the contributing sponsor’s controlled group is jointly and severally liable for certain obligations to the plan.

Issues regarding termination of the pension plans of the auto manufacturers will undoubtedly be central to

any reorganization, particularly with respect to any liability of Cerberus as a possible member of a

controlled group. The PBGC has indicated that if it is required to assume the pension liabilities of the

domestic auto manufacturers it will incur billions of dollars of liabilities.

The Bankruptcy Code authorizes modification of retiree health care benefits under certain conditions and

provides for the reinstatement of benefits modified within 180 days before the filing of the Chapter 11

case unless the balance of the equities clearly favors the modification. These retiree health care benefits

will be addressed in the Chapter 11 case of an auto manufacturer.

Robin Phelan
[email protected]
214.651.5612

or