How Can GM Bondholders be Bailed In?

Is a bankruptcy for GM not only an option, now, but a necessity? At least one of Bloomberg’s interviewees thinks so:

The Democrats’ goal of preserving a U.S. auto industry is not doable without a bankruptcy, said Lynn LoPucki, who teaches bankruptcy law at Harvard University and the University of California at Los Angeles.

“A workout requires everybody’s agreement,” he said. “If I own bonds, GM can’t force me to take less than 100 cents on the dollar outside of bankruptcy court. Bankruptcy is the only thing that can work because GM and the government need the ability to force people to go along with the plan. Paying everyone in full is prohibitively expensive.”

This is exactly the question that I was asking Troy Clarke about yesterday. Of course any company can offer to its bondholders some kind of debt-for-equity swap at any time: Aiden, in the comments to that blog, mentioned Foster Wheeler and AbitibiBowater as precedents. But given the enormity of GM’s debt obligations, and the strong temptation for any bondholder to attempt to free-ride on a bond swap and get paid out in full after everybody else takes the offer, what would the chances of success be?

There is another precedent, however: the Chrysler bailout of 1981. That bailed in bondholders without formal bankruptcy, so it can be done. Does anybody know what the formal mechanism was in that case?

Update: A GM spokesman just emailed me the company’s official take on this question, which does seem to point in the direction of some kind of debt-for-equity swap:

Our plan is to convert $62B of debt to approximately $30B in outstanding debt. About $20B of the current liability is the present value of obligated payments to the UAW VEBA (the health care costs that the UAW is about to pick up).

A bankruptcy would not provide any assurances to bond holders, who could likely end up receiving minimal value for their claims in a bankruptcy. In fact, the bonds are already trading at these levels (pennies on the dollar). We believe that the capital restructuring approach outlined in our Plan would provide the best avenue to return value to bondholders by providing them an option to take a restructured stake in a viable entity in return for their current securities.

We have successfully and recently executed similar transactions, for example a pair of debt for equity exchanges in September in which we exchanged $500 million of convertible bonds into equity. We believe there is appetite by debt and bond holders to pursue this course of action, and are in discussions with our advisors to develop the best structure with the best probability of success. Finally, we believe the involvement of a federal oversight board, will help to facilitate the process.

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