The bankruptcy case of Global Safety Textiles Holdings LLC (“Global Safety” and, together with the affiliates who filed with it, the “Debtors”) illustrates a growing risk for US automotive suppliers and OEMs – the potential failure of an international supply chain due to strict European insolvency laws.

Not Just Another Automotive Supplier Failure

Initially, this case seems to fit the mold of another automotive supplier going bankrupt. The Debtors and their non-debtor subsidiaries comprise one of the leading Tier 2 manufacturers and distributors of one-piece woven airbags, airbag cushions and flat fabric for airbags, focusing primarily on the automotive industry. The Debtors’ customer base includes large Tier 1 automotive original equipment manufacturers.

The reason given by the Debtors for the bankruptcy filing would easily plug into any number of the first day motion affidavits filed this year:

Due to the tightening of the covenant requirements at the end of December 2008 and March 2009, and reduced operating income in such periods largely attributable to the global financial crisis and the announced planned production cuts and capacity reductions in the automotive industry, certain financial covenants were not met, thereby triggering a default under the Amended BST Facility Agreement.

Despite initial impressions, this case is not about the Global Textiles affiliates that filed bankruptcy. Most of the Debtors are holding companies. Only two of the Debtors, GST Automotive Safety Components International, Inc. and Global Safety Textiles LLC, have any operations. Only 20 percent of the ITG’s automotive safety group revenues are generated by the Debtors. Debtors employ only 217 employees in the United States. The Debtors’ consolidated list of 30 largest unsecured creditors is remarkable in the sudden drop off in amounts due – the last 12 are owed less than $10,0000.

This case is about the foreign, operating company members of the ITG automotive safety group that have not filed bankruptcy (the “Non-Debtor Affiliates”). These entities are:

  • Global Safety Textiles GmbH (“GST Germany”),
  • ITG Automotive Safety Poland Sp.z.00 (“AS Poland”),
  • ITG Automotive Safety RO S.R.L. (“AS Romania”);
  • ITG Automotive Safety Czech S.R.O. (“AS Czech Republic”);
  • ITG Automotive Safety UK Limited (“AS UK”);
  • GST Automotive Safety Components International S.A. de C.V. (“ASCI Mexico S.A. de C.V.”)

The Non-Debtor Affiliates form an integrated and interdependent inter-company supply chain. Each Non-Debtor Affiliate relies on others for supplies, component pieces, cut and sew operations, assembly or sales. If one Non-Debtor Affiliate fails, the entire supply chain fails.

The root of the problem, and the apparent reason for this bankruptcy filing, is that these Non-Debtor Affiliate operating companies, are guarantors on a prepetition credit agreement (the “Credit Agreement”). The Debtors in turn are the primary borrowers. Each of the guarantees is for the entire abount of the Debtor borrowings under the Credit Agreement versus some allocation of liability – e.g. based on percentage of intercompany borrowings. And that is where the problem lies. Upon trigger of the guarantees all of the Non-Debtor Affiliates become insolvent. This in turn kicks in the insolvency laws of the country where the Non-Debtor Affiliate is located.

The Threat Posed by Strict European Insolvency Laws

The insolvency laws in the countries where the European Non-Debtor Affiliates exist are very strict. They impose criminal or civil penalties on management if it does not timely file insolvency proceedings. Additionally, the focus of those European insolvency laws is totally different than the United States Bankruptcy Code. The primary goal of most European insolvency laws is to assure the greatest possible dividend for the creditors as a whole. Reorganization of the insolvent company is not the primary objective. Restructuring plans are rare in practice and liquidation of an insolvent company’s assets is the norm.

The objective of the Debtors’ US bankruptcy filing is to stop the triggers that require the filing of European insolvency proceeding. The Debtors have told the Delaware Bankruptcy Court:

Because the group functions as an integrated business, if one or more of the European Non-Debtor Affiliates is required to commence insolvency proceedings in their home jurisdiction — particularly when such proceedings will likely result in liquidation and the appointment of a liquidator — the whole enterprise will be seriously impacted.

Based upon this premise, concurrently with the bankruptcy filing the Debtors brought an adversary proceeding (the “Adversary Proceeding”) against the lenders and administrators under the prepetition Credit Agreement (the “Prepetition Lenders”). (We list below the defendants in this adversary proceeding.)  In the Adversary Proceeding, Debtors sought and obtained on July 2, 2008 from the Delaware Bankruptcy Court an extraordinary temporary restraining order (the “TRO”). In essence this TRO precludes the Prepetition Lenders from taking any action that would trigger an insolvency proceeding of the Non-Debtor Affiliates.

The operative portion of the TRO entered by the court provides:

ORDERED that, pending a hearing and determination of the Debtors’ Motion for a Preliminary Injunction and TRO, effective immediately and subject to the terms hereof, the Defendants in the above caption and all other persons or entities acting in concert with any of them or on their behalf, are hereby stayed, restrained and enjoined from commencing or continuing any action or legal proceeding (including, without limitation, any judicial, quasi- judicial, administrative or regulatory action, proceeding or process whatsoever) including, without limitation, the commencement of insolvency or similar proceedings against the Non- Debtor [Affiliates] in any jurisdiction whatsoever with respect to the Non-Debtor [Affiliate] Guaranties… .

Under German insolvency laws, this order will only buy the Non-Debtor Affiliates a limited amount of time to obtain a restructuring of the Credit Agreement terms. The Debtors told the Delaware Bankruptcy Court that GST Germany can only postpone insolvency proceedings “if there is a real likelihood that the situation creating the over-indebtedness or illiquidity can be removed within 21 days … .” This appears to present a real deadline for the entire ITG automotive safety group due to critical technology being owned by GST Germany.  Debtors explained to the Bankruptcy Court that

[GST] Germany holds the patents and other intellectual property that relate to the technology used by the entire Global Safety Group. None of the other Non-Debtor Affiliates have a license to use the patented technology or pay royalties to Global Safety Germany for use of the patented technology.

How big a problem is this for the OEMs?

The Debtors’ Tier 1 customers require fabrics that are fully inspected and tested to customer specification in accredited laboratories. As is the case with most components in the automotive sector, Debtors’ automotive Tier 1 customers do not permit substitute goods or services from other vendors or providers.

What we do not know is: the testing time required for these types of fabrics is extensive; if the ITG automotive safety group is a sole source supplier of these materials; or if there is low inventory of these items at the OEMs.  If any of these questions is answered in the affirmative, the failure of this supplier would be a major problem for OEM’s.

We always check the appearances of counsel to see who is concerned about a bankruptcy. Toyota Tsusho America, Inc. already has appeared. It is still early. Other OEM’s may follow. We also would expect some delay in awareness by the OEMs because the Debtors are Tier 2 suppliers.

The Lesson for Suppliers and Other Unsecured Bankruptcy Creditors

This is not a case involving a large number of US suppliers as creditors or involving big dollars owed to US suppliers. However, it readily could have been both. In the past 5 years, more and more Tier 1 suppliers and OEMs have developed or expanded intra-company supply chains involving foreign subsidiaries. Financing structures often involve these entities as guarantors or direct borrowers. We expect to see more of these types of foreign insolvency law issues arise in the coming months and years.

This presents two additional business risks for suppliers – interruption of supply from a critical vendor to the supplier; and interruption of supply to a supplier’s customer, who then has to cut demand due to line down situations.

In the context of a bankruptcy proceeding, the potential for an insolvency of a foreign subsidiary causing a US Customer liquidation, must be among risk factors carefully assessed when a supplier is deciding how to respond to a customer’s bankruptcy.

ADDENDUM

The Defendants in Global Safety Textiles Adversary Proceeding are:

  • ARES EURO CLO I B.V.
  • BACCHUS 2006-1 PLC
  • BACCHUS 2007-1 PLC
  • CREDIT STRATEGIES FUND
  • DISTRESSED OPPORTUNITIES FUND
  • GE CORPORATE FINANCE BANK SAS
  • GOLDMAN SACHS ASSET MANAGEMENT
  • HARBOUR TOWN FUND
  • HIGHLANDER EURO CDO BV
  • HIGHLANDER EURO CDO II B.V.
  • HIGHLANDER EURO CDO III BV
  • IKB DEUTSCHE INDUSTRIEBANK AG
  • IRONSHIELD ABS LIMITED
  • KINGS CROSS 12 )
  • SARL
  • LANDESBANK BADEN- WUERTTEMBERG
  • LONG LANE MASTER IV FUND
  • MARATHON FINANCING I, B.V
  • MARATHON SPECIAL OPPORTUNITY
  • NASH POINT CLO
  • NASH POINT II CLO
  • PROSPECT FUNDING I
  • PROSPECT FUNDING I, LLC
  • RACE POINT III CLO
  • ROYAL BANK OF SCOTLAND
  • SANDLER CAPITAL STRUCTURE OPPORTUNITY MASTER FUND
  • SANKATY CREDIT OPPORTUNITIES III LP
  • SUNTRUST BANK
  • THE CIT GROUP/ BUSINESS CREDIT
  • UBS LTD