See the Foamex International Docsheet™ Report for subsequent developments in the Foamex International bankruptcy proceedings.

Feb. 23, 2009 – Foamex International, Inc., together with 7 affiliates, filed for Chapter 11 protection in Delaware on February 18, 2009.  The affiliates are:  Foamex, L.P.; Foamex Latin America, Inc.; Foamex Asia, Inc.; FMXI, LLC; Foamex Carpet Cushion LLC; Foamex Mexico, Inc.; and Foamex Canada Inc..

We have made the following preliminary observations:

  1. There is a high risk of bankruptcy preference claims in this bankruptcy;
  2. This is yet another automotive supplier casualty, although the press has not noted it as such;
  3. A very high amount, in both dollars and percentage, is being sought for payment of prepetition amounts to “critical cendors”;
  4. A realistic but expansive definition of “critical vendors” is being used;
  5. Inclusion on the critical vendor list is not immunity from a bankruptcy preference claim.

We discuss each of these observations in more detail below.

High Risk of Bankruptcy Preference Claims

Based on our review of the first day motions and supporting information we believe that this bankruptcy of Fomex International is a HIGH RISK for bankruptcy preference claims.

  • The level of secured debt is extremely high – in excess of $370 million.
  • There is going to be a sale of assets through a bid procedure using a “stalking horse” buyer.
  • There has already been a loss of customer base in addition to the loss of sales due to economic conditions.

Another Bankruptcy Filing by a Significant Automotive Supplier

While not seen as such in the press, the case presents yet another case of financial distress of an automotive supplier.  Foamex provided the following description:

The Debtors’ automotive products group is one of the largest suppliers of polyurethane foam products to the North American automotive industry. The automotive products group produces, among other things, foam rolls, flame and adhesive laminated composites, thermoformable foams, acoustical foams, basic foam products and energy absorbing foams. The Debtors’ automotive foam products are sold through a range of tiers in the automotive industry’s supply chain. The Debtors primarily supply Tier 1 system integrators that in turn supply original equipment manufacturers (“OEMS,” çg, General Motors, Ford, Chrysler, Honda and Nissan).

Foamex has seen a dramatic drop in sales of automotive products “from approximately $392 million through the first three quarters of 2007 to approximately $311 million through the first three quarters of 2008.”

Very High Amount Sought for Critical Vendor Payments

A “Critical Vendor” order was sought by Foamex to pay the pre-petition claims of suppliers who met certain criteria.  What made the motion unique was the large amount of pre-petition trade debt that Foamex seeks to repay.  Foamex has sought permission from the Bankruptcy Court to pay up to $29 million out of a total of approximately $41 million in pre-petition trade debt.  This is extraordinary.  In recognition, Foamex sought to explain the unique request by noting that “the bulk, or approximately $21,709,792, is needed for “Chemical Providers.”   At the time of this post the court has only authorized $10 million in critical vendor payments.

Critical Vendors Include Sub-Suppliers Whose Parts Would Require OEM Retesting

Up to $4.5 million is being sought to pay “Cloth Producers”.  Foamex explained that Foamex’ cloth backed foam products must meet the specifications of the automotive OEMs.  Foamex noted a common reality for all automotive suppliers:

even if the Debtors could change suppliers, they might need to alter their product formulations which, in turn, could require customer consent and in some cases long qualification and testing periods, and there is no assurance that the customers would grant such consent or expedite the qualification process.

We believe this explanation is valid.  More than that, the explanation illustrates a unique aspect of automotive supplier bankruptcies that often is overlooked by private equity investors.

The impact when the bankrupt supplier is a Tier 2 or lower supplier can be devastating.  While automakers absorb the cost of a Tier 1 supplier bankruptcy, the automakers expect Tier 1 suppliers to be responsible for the downstream supply chain.  Absorbing the cost of a single supplier change can create severe administrative and financial burdens on a Tier 1 supplier. In the event of any validation or other testing requirement, the burden may be not only be costly, it may be insurmountable in a short time frame.  The threat of line down charges from an automaker is truly one of a Tier 1 supplier’s worst nightmares.  Whether a downstream supplier bankrutpcy can be considered a force majeure event is a subject for another post.

Don’t Confuse Critical Vendor Payments and Preference Claims

Suppliers sometimes confuse payment of pre-petition amounts under a “critical vendor” order with a resolution of bankruptcy preference claims.  The courts have consistently held that designation of a supplier as a “critical vendor” does not bar preference claims.  This can lead to the strange situation where a “critical vendor” has to pay back what it got paid in the 90 days preceding bankruptcy even though it would have gotten paid and could have kept the same amount as a “critical vendor” if the amount had remained outstanding on the petition filing date.