Response to Arguments against Chapter 11 Restructuring


Last week, the chiefs of the Big Three automakers returned to Washington bearing "turnaround plans' that they say will, with the addition of $34 billion in government loan guarantees, return their firms to profitability. But in revealing the dire straights faced by General Motors and Chrysler (Ford, despite its request, says it really does not need taxpayer dollars), the plans provide further evidence that a taxpayer bailout will be insufficient to save the industry. Future bailouts, or eventual bankruptcy, would be sure to follow, say industry analysts and economists.

Nonetheless, the automakers continue to maintain that allowing them to restructure under the protection of a bankruptcy court would not work, devoting pages of their plans to this point. The automakers' criticisms contain, at most, grains of truth, but they fail to demonstrate that bankruptcy would not work for their firms, as it has worked for so many others. Though a bailout may be better for the automakers' current executives and shareholders, restructuring in bankruptcy remains the best choice for the automakers' continued viability and future success. This paper considers, in turn, each of the automakers' arguments against allowing the normal operation of law--that is, bankruptcy--when a firm becomes insolvent.

Argument: Bankruptcy would lead to "failure' and millions of jobs lost.

Fact: Bankruptcy actually prevents failure, and liquidation makes sense only when a firm's business model is obsolete and its resources could be put to better use elsewhere in the economy--a circumstance that a bailout could not remedy.

Officials of the Detroit automakers claim that allowing any of the Big Three to "fail' would have a devastating effect on jobs and the economy. In particular, they frequently cite a report by their trade association that finds that a "major contraction' of the Big Three would cause 3 million job losses and billions in economic decline.

That doomsday scenario, however, is impossible, for two reasons: First, bankruptcy and "failure' are not synonymous; indeed, bankruptcy protection actually prevents failure. Though a bankruptcy filing may imply that a business has "failed' at maintaining solvency as it is currently organized, it does not mean that the business and its assets will "fail'--that is, cease operations. Many companies, including the bulk of the airline industry following 9/11, have entered bankruptcy, reorganized under its protection, and then emerged as stronger, sustainable businesses.

Second, the auto industry's job-loss projections are premised on assumptions that actually ignore bankruptcy protection. Their chief assumption is that, without government aid, the industry would suffer a 100 percent contraction--that is, it would just stop. Under bankruptcy, however, that would not be possible. Once a company has filed for bankruptcy, it receives an automatic stay and may suspend payment of all debts, giving it breathing room to take stock of its assets and situation. Most likely, the automakers would file under Chapter 11 of the Bankruptcy Code (a reorganization). But even if they file under Chapter 7 (for liquidation), there is no reason to believe that the entire auto industry--all the factories, all the assembly lines, etc.--would simply shut down. More likely, entire plants and brands would be sold to other companies. In neither case, however, would the industry experience anything like the 100 percent shutdown assumed in the auto industry's projections.

Read the full article at: The Heritage Foundation

Date published: Dec 09, 2008


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