Distressed Auto Industry Players Have Options to Avoid Bankruptcy

When automotive suppliers opt for alternatives to bankruptcy, original equipment manufacturers, suppliers, and lenders should understand the implications of each and how best to protect their interests.

The automotive industry continues to experience supply chain disruptions, raw material shortages, rising costs, increased labor costs, reduced volumes, rising interest rates, and ever-changing strategies for transitioning to electrification. Such challenges historically led suppliers to file for Chapter 11 bankruptcy protection to restructure or resize operations or move toward a sale or liquidation.

However, the post-pandemic environment has prompted automotive suppliers to take a less expensive path to address financial distress, including an assignment for the benefit of creditors, Article 9 sale under the Uniform Commercial Code, and out-of-court wind downs.

An assignment for the benefit of creditors, known as an ABC, is a remedy under state law where a debtor’s assets is assigned to another person in trust to liquidate those assets for payment to creditors. This type of proceeding may benefit a company if it can no longer operate and is unable to find a buyer, but the bankruptcy process is cost-prohibitive.

While ABCs are court-supervised liquidations of a company’s assets, they don’t offer some protections like those under the Bankruptcy Code, such as the automatic stay or a discharge of debts. An ABC also can’t be used for reorganization and offers fewer protections to unsecured creditors.

But the benefits of an ABC—faster than a bankruptcy proceeding, more cost-effective, less court oversight and choice of assignee—might outweigh the limitations for some companies.

The implications of an ABC on original equipment manufacturers, suppliers, and their lenders depend greatly on the law of the state where the assignment originates. States such as Florida have a codified ABC system, like that of a bankruptcy court, where the assignee files financial reports, creditors can file proofs of claim, and the state court maintains oversight of the proceedings. Other states such as Illinois use a common-law system, meaning the results from such proceedings can be unpredictable.

Secured lenders facing default also can obtain some self-help remedies through Article 9 of the UCC, where a secured lender may foreclosure on and liquidate its collateral to fully or partially pay the underlying debt.

If the secured lender is willing to cooperate with the borrower or supplier, an Article 9 sale provides a quicker and more cost-effective alternative to a sale under Section 363 of the Bankruptcy Code. Although a secured lender has more control over an Article 9 sale, those sales can be conducted privately or publicly and allow a transfer of the lender’s collateral to a buyer free of any liens.

There are limits to an Article 9 sale that companies should evaluate when considering this alternative:

• It can only be used to transfer personal property, such as collateral secured under the UCC, so real estate must be addressed separately.
• Any contract assignments will require counterparty consent as there is no protection afforded like Section 365 of the Bankruptcy Code.
• It requires borrower or supplier cooperation or repossession of the collateral without a breach of the peace.
• There is no stay of litigation by other creditors during the sale process.
• A bankruptcy sale order provides broader buyer protections and typically more robust bidding procedures.
• Unsecured creditors are less likely to receive a distribution unless the sale results in excess proceeds following distribution to secured creditors.

An out-of-court wind-down allows a distressed supplier to sell its assets (often through a UCC Article 9 sale or an ABC), reduce its workforce, terminate contracts, and ultimately dissolve the business pursuant to state law dissolution statutes, which can vary.

A supplier will choose an out-of-court wind-down where either it can pay its creditors in full and return capital to shareholders or where the company’s creditors will cooperate in asset liquidation. A wind-down gives the supplier more control over the process, takes less time, is more cost-effective than a bankruptcy, and requires no public filings or disclosures, depending on the form of dissolution.

An out-of-court restructuring or workout involves the supplier negotiating with its secured lenders, vendors, and landlords to restructure its debt (as to amount and timing of payment) and possibly infuse additional capital. But out-of-court wind-downs and restructuring afford no transparency to creditors compared to the traditional bankruptcy process.

There also is no automatic stay and no discharge, meaning that unresolved creditor claims could trigger claims against the board or shareholders of the company. The supplier also must have sufficient funds to manage the wind-down or sale of the assets.

As automotive suppliers continue to choose alternatives to bankruptcy to address financial distress, involved parties must understand the implications of these alternatives and protect their interests accordingly. These bankruptcy alternatives offer time and cost savings for both the supplier and impacted parties. But it comes with risks, so consulting with restructuring professionals is crucial.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Patricia Kirkwood Burgess is partner at Frost Brown Todd in Nashville.

Joy D. Kleisinger is an associate at Front Brown Todd in Cincinnati.

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