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