Have you heard the news? A new General Motors emerged from bankruptcy this past week.
What’s so new about it? Well, let’s start with its new name. Historically, the firm had been named General Motors Corp, but now it’s named General Motors Co. That seems like a tiny modification, doesn’t it?
Financial and legal bankruptcy professionals, though, understand that this change of name actually reflects a major change in corporate structure. In fact, the bankruptcy proceedings were altogether quite remarkable in how quickly and thoroughly they enabled the firm to shed many of its fiscal obligations.
Government Behind The Wheel
Business analysts were surprised by several aspects of the process. One surprise, of course, was that the firm declared bankruptcy at all. And another surprise was that it agreed to eliminate so many brands. Rick Wagoner, long time GM chief executive, repeatedly insisted that GM would derive no benefit from shedding brands and could not possibly survive a bankruptcy filing.
But that was before the federal government stepped in and brusquely dismissed Rick Wagoner. The bankruptcy proceedings were completed in merely six weeks, and more than half of its brands – including Hummer, Pontiac, Saab, and Saturn – were targeted for sale and/or elimination.
Analysts were also surprised at the speed, determination, and forcefulness of the government’s actions. After all, analysts often criticize government bureaucrats for being slow-moving dinosaurs, and yet these so-called dinosaurs moved at lightning speed to implement the very decisions that analysts had recommended for years.
It’s NewCo Time!
Even more surprising was the strategy that was implemented to permit GM to escape its obligations to its shareholders, bondholders, and employees. This approach is known as a NewCo asset transfer; it’s a common technique that helps firms shed troublesome assets and liabilities.
The strategy is, in theory, quite simple. We begin with an OldCo (here, General Motors Corp.), a firm that possesses certain valuable assets but that is also burdened with very significant liabilities. We then create a new corporate shell, an entity known as NewCo (here, General Motors Co.). Finally, we transfer all of the valuable assets from OldCo to NewCo, leaving the liabilities (and perhaps a few relatively insignificant assets) with OldCo.
Voila! NewCo, shed of its burdensome liabilities, suddenly becomes an unstoppable competitive juggernaut. And what happens to OldCo? Well, its shareholders, bondholders, and employees realize that there is little left within OldCo to pay their debts, and thus they agree to settle for pennies on the dollar.
So who ends up owning NewCo? It depends on the circumstances. The new General Motors Co., for instance, is majority owned by the United States government and minority owned by the automobile unions. Other NewCo firms may be owned by private investors, employees, bondholders, i.e. any one who may wish to possess a stake in the new entity.
Defeasances, Any One?
Sound familiar? This strategy has actually been employed in various forms over the years. Debt defeasances, for instance, first became popular in the 1980s; they involve the shifting of liabilities to NewCo entities and the concurrent transfers of sufficient assets at the times of the transactions to repay creditors over time. Though in these situations (unlike the situation involving General Motors) a significant amount of assets is indeed transferred to repay the debts, the risk that fluctuating valuations may create future imbalances between NewCo’s assets and liabilities are borne by the creditors and not by OldCo.
Of course, there is another distinct difference between debt defeasance transactions and the General Motors transaction. Namely, in debt defeasance transactions, the old debt is transferred into the new firm and the bulk of the original firm’s assets remain in the original firm. GM, on the other hand, left its old debt in the original firm and transferred its valuable assets into the new firm. That’s because the old firm, upon entering bankruptcy court, was doomed for liquidation.
Financial service professionals may also recognize this strategy in Treasury Secretary Hank Paulson’s original proposal to use federal bailout funds to purchase illiquid (i.e. worthless, at least in the short term) investment securities from banking institutions that were sliding into bankruptcy. He proposed the creation of a federally owned Bad Bank that would restore financial institutions to health by removing toxic assets from their balance sheets.
Government: The 800 Pound Gorilla!
Interestingly, some critics seem to be more concerned about the prospect of the government managing an automobile business than about the specter of government helping a private corporate entity evade its obligations through legalistic restructurings. Truth be told, though, many governments in established capitalist economies have managed private companies for many years.
Airbus, for instance, is a sterling success story of a number of Western European nations that joined forces to create a business goliath that has seized half of the aircraft manufacturing market away from Boeing and other competitors. And in the United States, the FDIC has often exercised its authority to determine that commercial banks are insolvent, to dismiss their executives, to seize control of their operations, and to manage all day-to-day activities until sales or liquidations can be arranged.
In other words, the General Motors transaction may be a surprising one, but it is not at all a new phenomenon. Rather, it is simply a new “spin” on a long history of balance sheet restructuring and government intervention.