In the current economic atmosphere, most vehicle manufacturers and Tier 1 suppliers are understandably concerned about the viability of their lower-tier suppliers. After all, the collapse of a supplier of even a minor component can shut production for the Tier 1 and its customers, with enormous financial and legal consequences. Many companies believe they are adequately protected, at least in part, by their purchasing terms and conditions. But, while a well-drafted set of terms and conditions may reduce the company’s exposure, it cannot eliminate it, as Chrysler discovered recently when it sought to re-source production from a troubled supplier.

Chrysler had taken certain key steps to obtain its tooling from Plastech – including terminating its agreements and obtaining a state court order of possession – but Plastech immediately filed for bankruptcy protection, thereby placing the dispute squarely in the hands of a bankruptcy court. The bankruptcy court subsequently denied Chrysler’s request to retrieve its tooling, thwarting Chrysler’s effort to immediately re-source the parts and effectively disengage itself from Plastech. The bankruptcy court ruled that, so early in such a large and complex bankruptcy case, and given the alleged interests of other constituents in the tooling and the potential impact of granting the requested relief on the debtor’s reorganization effort, it would not lift the automatic stay to allow Chrysler to retrieve its tooling. Rather, Chrysler’s rights and interests would have to be addressed in the context of an adversary proceeding as the case progresses.

Chrysler’s Request for Relief

Within a day after Plastech filed under Chapter 11, Chrysler sought relief from the automatic stay to recover its tooling. Chrysler thereafter filed an adversary proceeding and motion for a temporary restraining order directing Plastech to turn over its tooling or perform under its agreements. Chrysler argued that, absent such relief, it would suffer supply interruptions, plant shutdowns and catastrophic losses. Chrysler principally relied on provisions contained in two pre-petition accommodation agreements in which Plastech expressly acknowledged that Chrysler owns all of its paid tooling, that Plastech is holding the tooling as a mere bailee-at-will, and that Chrysler has the right to take immediate possession of the tooling at any time. Chrysler also argued that its pre-petition termination of its supply relationship with Plastech provided grounds for the requested relief.

The Court’s Decision

As a threshold matter, the court held that Plastech has a possessory interest in the tooling and that this interest alone was enough to make the tooling part of the bankruptcy estate and subject to the automatic stay. Having found that Plastech did have an interest – if merely a possessory interest – in Chrysler’s tooling, the court then denied Chrysler’s request for relief from the automatic stay.

The court rejected both of Chrysler’s asserted grounds for relief from the automatic stay. The court first denied relief under §362(d)(1), which requires a finding of “cause” for relief, an elastic concept that involves balancing the competing interests of the various constituents. In its effort to prove “cause,” Chrysler cited (i) its pre-petition termination of its contracts, (ii) the tooling acknowledgments signed by Plastech, (iii) Plastech’s inability to continue to supply the parts without further accommodations from Chrysler and (iv) the likelihood of supply interruptions and plant shutdowns, and resulting losses and damage to Chrysler’s goodwill.

After balancing the interests, the court held there was insufficient cause to grant relief. The court noted the conflicting testimony between Chrysler’s witnesses, who stated that the removal of tooling could be accomplished promptly and with no disruption to Plastech’s business operations, and Plastech’s witnesses, who said that removal of the tooling would cause “an immediate, extended and disastrous impact” on its ability to provide parts for its other customers. The court also noted that other parties in the case – i.e., secured lenders and manufacturers of tooling components – asserted interests in the tooling. The court concluded that “cause” had not been established, emphasizing that the case is still in its very early stages.

The court also denied relief from the automatic stay under §362(d)(2), which requires a finding that the debtor lacks equity in the property and that the property “is not necessary to an effective reorganization.” After holding that Chrysler had met its burden of establishing that Plastech has no equity in the tooling, the court held that Plastech met its burden of showing that, at least at this stage, there is a reasonable prospect that it could reorganize and that the tooling is necessary to an effective reorganization. The court hinted that the outcome may be different as more time passes.

Chrysler also failed in its request for a temporary restraining order directing Plastech to turn over the tooling or specifically perform the supply contracts. These issues will be litigated in the underlying adversary proceeding.

The bankruptcy court’s decision has been appealed by Chrysler.

[The Court’s opinion can be accessed at http://www.mieb.uscourts.gov/courtOpinions/opinions/08-42417.pdf.]

Lessons for Owners of Tooling

A review of these proceedings highlights the difficulty of obtaining summary or prompt relief early in a bankruptcy case, particularly where such a grant may doom the debtor’s reorganization effort. It will also lead many companies to ask what additional steps can be taken to protect their right to obtain possession of tooling in the hands of suppliers. Certainly, contractual acknowledgements as to ownership, like those Chrysler obtained from Plastech, can be very useful. However, tooling owners should also consider obtaining comparable acknowledgments from secured lenders and other manufacturers of components of the tooling.

Also, a clear and unambiguous termination of a lower-tier supplier (without any contractual opportunity to cure the underlying event of default) prior to a bankruptcy filing may position the tooling owner to obtain a bankruptcy court ruling that there is no longer a contractual relationship to be assumed by the debtor and, thus, the tooling would be of no use to the debtor.

Of course, a company’s best defense is to anticipate problems before they become critical. Manufacturers can retain audit rights and conduct periodic financial audits of their suppliers, hire financial consultants to analyze their suppliers’ financial position, and monitor other sources of information for signs a supplier may be financially distressed. Furthermore, now would be a good time to ensure tooling is properly tagged and segregated at the supplier’s plant and that all contractual rights are clear and exercised to the letter.

For further information, please contact:

Mary Joanne Dowd
dowd.mary@arentfox.com
202.857.6059

Marc L. Fleischaker
fleischaker.marc@arentfox.com
202.857.6053

Christopher H. Grigorian
grigorian.chris@arentfox.com
202.775.5779