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:
What Will Happen To The Dealers?
How Do I Get Paid On My Manufacturer’s (Sales) Incentives and Warranty Service
Reimbursements?
What Can Happen to My Dealer Agreements?
What Can Happen If My Dealer Agreement Is Assumed By The Manufacturer?
What Happens If My Dealer Agreement Is Rejected By The Manufacturer?
What Is The Impact Of State Regulations Regarding Franchisors?
Am I Prevented From Doing Anything?
What Can A Dealer Do If The Manufacturer Doesn’t Perform Under The Dealer Agreement?
If My Dealer Agreement is Terminated, What Happens to My Inventory of Cars and Parts?
Who Will Protect The Interests Of The Dealers?
Can I File a Lawsuit Against The Debtor?
Can I Set Off What The Manufacturer Owes Me Against What I Owe The Manufacturer?
When Do I Have to File My Claims Against The Debtor?
What Will Happen To The Manufacturer?
Who Will File the Chapter 11 and Where Will It Be Filed?
Who Will Run The Manufacturer’s Business During The Chapter 11?
How Will The Manufacturer Be Financed During The Chapter 11?
Can The Debtor Sell Its Property During the Chapter 11?
Can The Debtor Avoid Transactions?
How Long Does The Debtor Have To File A Plan Of Reorganization?
How Will I Know How To Vote On The Plan Of Reorganization?
What Will Happen To The Union Contracts?
What Will Happen To The Pensions?
What Will Happen To The Retiree Health Benefits?
What Will Happen To The Dealers?
How Do I Get Paid On My Manufacturer’s (Sales) Incentives and Warranty Service
Reimbursements?
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.
What Can Happen to My Dealer Agreements?
The Bankruptcy Code authorizes the debtor to assume or reject executory contracts and leases. Dealer franchise agreements are executory contracts.
What Can Happen If My Dealer Agreement Is Assumed By The Manufacturer?
As executory contracts, dealer franchise agreements can be assumed by the debtor if the non-debtor party (i.e., the car dealer) is provided with adequate assurance of future performance and the 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.
What Happens If My Dealer Agreement Is Rejected By The Manufacturer?
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.
What Is The Impact Of State Regulations Regarding Franchisors?
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 manufacturer practices in its business dealings with its franchisees and dealers (e.g., termination and 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.
Am I Prevented From Doing Anything?
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.
What Can A Dealer Do If The Manufacturer Doesn’t Perform Under The Dealer Agreement?
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.
If My Dealer Agreement is Terminated, What Happens to My Inventory of Cars and Parts?
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.
Who Will Protect The Interests Of The Dealers?
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.
Can I File a Lawsuit Against The Debtor?
The automatic stay prevents the dealer from filing a lawsuit against the debtor but the dealer may seek appropriate relief from the bankruptcy court.
Can I Set Off What The Manufacturer Owes Me Against What I Owe The Manufacturer?
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.
When Do I Have to File My Claims 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.
What Will Happen To The Manufacturer?
Who Will File the Chapter 11 and Where Will It Be Filed?
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.
Who Will Run The Manufacturer’s Business During The Chapter 11?
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.
How Will The Manufacturer Be Financed During The Chapter 11?
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.
Can The Debtor Sell Its Property During the Chapter 11?
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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Can The Debtor Avoid Transactions?
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.
How Long Does The Debtor Have To File A Plan Of Reorganization?
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.
How Will I Know How To Vote On The Plan Of Reorganization?
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.
What Will Happen To The Union Contracts?
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.
What Will Happen To The Pensions?
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 he 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.
What Will Happen To The Retiree Health Benefits?
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.
For more information, please contact:
Robin Phelan
Robin.Phelan@HaynesBoone.com
214.651.5612
Wilson Chu
Wilson.Chu@HaynesBoone.com
214.651.5088
