Finance, Insolvency & Restructuring Alert - Reduction of European Plant Overcapacity and Its Impact on the Health of the Automotive Supply Chain
Not only is the integrity and viability of Eurozone threatened by the lack of a fiscal union and other pressures, but the European automotive industry is also facing years of stagnation and weakness caused by the economic downturn there. In October, the European Automobile Manufacturers Association reported that, in September 2012, European motor vehicle sales fell for the twelfth month in a row, affected by recession, spending cuts and high unemployment in the Eurozone. General Motors Corporation is negotiating with Germany’s labor unions for the closure of its Bochum plant in North Rhine-Westphalia only a few years after cancelling its planned sale of this subsidiary to a consortium led by Magna Corporation. In July, PSA Peugeot Citroen announced the closure of its plant in Aulnay-sous-Bois near Paris and the elimination of 8,000 jobs. Phillipe Varin, Peugeot’s CEO, was recently quoted that European car manufacturers expect a sixth year of falling sales in 2013 and that this situation is not expected to improve for “years to come.”
The immediate problem facing European automakers is that of existing plant overcapacity, high overhead costs and creating labor redundancies. According to a recent New York Times article,
“[h]uge overcapacity, . . . has spawned a crisis similar to the one the U.S. industry barely survived just a few years ago. In fact, the downturn in Europe threatens the remarkably rapid recoveries that Ford and General Motors were able to make after Detroit’s moment of truth in 2009. Underused plants are ruinous for car companies which must continue to pay upkeep costs and make payroll even as revenue plunges. By some estimates, the European industry as a whole is operating at only about 60 percent to 65 percent of capacity. As a general rule, plants must operate at about 75 percent or 80 percent to be profitable, analysts say.”
European carmakers are reacting to this structural problem by beginning to shutter factories in Europe, especially in higher-cost Western Europe. David Cole, the former head of the Center for Automotive Research in Ann Arbor, Mich., recently observed that he anticipated major restructuring in European automotive industry. “Everybody has decided that this is the right time to make structural changes. When they see that a company could disappear with all of its jobs, they may realize it’s better to lose 20 percent.”
These current and future plan closures and elimination of jobs, when coupled with falling motor vehicle sales in Europe, augur great economic pain not only for laid-off autoworkers but also for Tier 1 and Tier 2 automotive suppliers and tooling fabricators doing business with European auto manufacturers. Closing of factories may have the ultimate effect of pushing these suppliers and fabricators into insolvency proceedings in Europe, which will likely cause an adverse credit reaction up the supply chain that can reach North American shores.
If European firms slide into insolvency as an end result of this inevitable right-sizing of plant capacities, it is important for American creditors to realize that the insolvency laws of many European states, especially laws of the major auto-producing countries, have radically changed in the last 10 years. This sea change in the insolvency laws of European nations to foster business reorganizations comes as welcome relief to creditors, especially those creditors who do not wish to see a valued customer disappear. Rather than having a bankruptcy administrator liquidate the assets of troubled suppliers, these enterprises may now be saved, thereby reserving valuable jobs in a battered continent and keeping alive critical members of the supply chain. For example, the business bankruptcy laws of Germany, France and Italy have recently been amended to provide for Chapter 11 type reorganizations, which change represents a dramatic break with the past. These recent statutory changes are summarized below.
On March 1, 2012, a thorough revision of Germany’s insolvency laws was enacted by the Bundestag, known as Gesetz zur weiteren Erleichterung der Sanierung von Unternehmen (“ESUG”). The ESUG incorporates into German insolvency laws concepts similar to those employed in Chapter 11 of the United States Bankruptcy Code and the French procedure de sauvegarde. For example, the German insolvency court handling proceedings involving a business debtor must appoint a creditors committee when the bankruptcy petition if certain specific financial and employment criteria are present. This committee may propose a candidate for the position of preliminary insolvency administrator. The insolvency judge must appoint this candidate unless the court determines that he or she is not qualified to act in that capacity. The ESUG also encourages the administration of the debtor’s business by its existing management in ways similar to debtors in possession in Chapter 11 reorganization cases. If a debtor requests self-administration, the court will grant that request provided that no circumstances exist that could prejudice the rights of creditors. If the creditors committee unanimously supports the request, then the court must provide for self-administration.
Other similarities of Chapter 11 are also present in this new legislation. Like those two foreign reorganization proceedings, the ESUG permits the imposition of an automatic stay of creditor enforcement actions to enable debtors facing imminent illiquidity or over-indebtedness to propose and negotiate restructuring plans. Finally, debt-for-equity swaps pursuant to a reorganization plan are now specifically permitted without the risk of collateral attack after the plan is approved by the court.
In July, 2005, the French National Assembly amended the insolvency laws to add a new reorganization procedure for financially troubled business enterprises. This new proceeding, entitled procedure de sauvegarde, was inspired by Chapter 11 of the United States Bankruptcy Code with the specific purpose of preventing the debtor “from becoming insolvent by providing it with strong protection and giving it the necessary time to draw up a recovery plan.” The ultimate goal of sauvegarde proceedings is the negotiation of a reorganization plan for the debtor’s business to permit it to remain in business, which plan may provide for a disposition of a portion of the debtor’s business assets. A stay of creditor enforcement actions is imposed at the inception of the proceedings to prohibit the company’s dismemberment during plan negotiations. Two separate creditors committees will be formed in these proceedings—one for banks and another for trade creditors—to negotiate the terms of a reorganization plan which, if agreed upon by the committees, may then be approved by the court. If a restructuring plan cannot be so negotiated, the court may impose its own plan on the debtor and its creditors under certain circumstances. In October 2010, the French National Assembly enacted legislation, effective as of March 1, 2011, establishing a “fast-track” sauvegarde procedure in financial restructurings involving pre-packaged reorganization plans—the sauvegarde financiere acceleree.
Prior to 2005, Italian commercial insolvency law provided for the liquidation of business and the distribution of those liquidation proceeds to creditors. In 2005, however, the Italian legislature began enacting a series of measures:
“. . . to achieve a more modern and flexible insolvency law system based on private rather than judicial initiative (sometimes referred to as ‘deregulation’ or ‘privitization’ of bankruptcy law), with creditors as the real engine of the insolvency proceedings. The reform, in particular, brought new life to ‘agreed’ insolvency procedures as an alternative to bankruptcy. Previously, bankruptcy proceedings had been heavily regulated, burdened with strict legal requirements, and subject to the pervasive direction of the courts—and thus were rarely attractive and seldom used in comparison with other legal systems.”
Between 2005 and 2010, the Italian legislature enacted amendments to the Italian Bankruptcy Law to liberalize the process and to encourage negotiated reorganization plans. For example, Article 67 of the Italian Bankruptcy Law created the “recovery plan” concept, which is an instrument imposing certain obligations on a business debtor to restructure its debt. The recovery plan’s feasibility, however, must be certified by an independent, third-party expert before it may be adopted. Another amendment approved the use of prepackaged reorganization plans, called “restructuring agreements” under Article 182-bis of the Italian Bankruptcy Law. Another innovation was the expanded scope and use of the concordato preventivo, in which a debtor may propose to its creditors a plan for the restructuring the troubled business. Creditors are entitled to vote to accept or reject the proposed concordato and dissenting creditors may be “crammed down” under certain circumstances.
Most recently, on June 22, 2012, the Italian Council of Ministers, adopted a Law Decree containing proposed amendments to the Italian Bankruptcy Law that “are aimed at facilitating the restructuring distressed entities similar to the key principles underlying the U.S. Chapter 11.” The changes advocated in this Law Decree, which was enacted by the Italian Parliament on September 11, 2012, include (i) providing for a stay of creditor enforcement actions in concordati preventivi and Article 182-bis restructuring agreements; (ii) avoiding creditor judicial attachments of the debtor’s realty obtained within 90 days before a concordato is published in the companies registry; (iii) increasing the scope and availability of interim post-petition financing of debtors in concordati preventivi and Article 182-bis restructuring agreements; and (iv) providing for payment of prebankruptcy debts owed to critical vendors under certain circumstances.
As reported in this article, years of economic pain resulting from the restructuring of the European automotive industry have been predicted by many experts. Job losses in the automotive sector are expected to increase and the reduction in the number of automobiles manufactured in Europe will negatively impact the bottom line of auto suppliers selling to the European OEMs. The recent reforms to European insolvency laws reported herein should nevertheless soften the blow for these suppliers, thereby increasing the chances of their economic survival during these dire times.