With backing from the United Autoworkers Union, General Motors, Ford and Fiat Chrysler (along with several other global OEMs) last week announced that they were suspending operations at all U.S. manufacturing facilities through at least March 30, 2020. These closures come in addition to existing closures in Mexico and Canada, and throughout Europe. On March 18, 2020, President Trump invoked the Defense Production Act of 1950 (“DPA”) in response to the coronavirus outbreak, directing “all health and medical resources needed to respond to the spread of COVID-19 within the United States.” GM has announced that it will leverage its logistics, purchasing and manufacturing expertise to help equipment maker Ventec increase its output of ventilators; FCA has announced it will manufacture face masks; and Ford has announced it will support with producing medical equipment as well. And finally, state and local units of government across the country have issued “shelter in place” or “stay at home” orders, in many cases suspending business operations except for those related to “essential business” as defined in the orders.
In Michigan, Governor Whitmer has issued her “Stay Home, Stay Safe” order, requiring that all nonessential business operations not necessary to sustain or protect life or to maintain minimum basic operations must cease operations. Oakland County in southeast Michigan issued a supplemental order of its own. Not surprisingly, automotive suppliers have been perhaps more affected by the disruption than any other industry as they adjust to their new normal. The effects on auto suppliers will likely be felt long after supplier operations resume. Suppliers should plan that the negative impact of the shutdowns will continue beyond the immediate coronavirus pandemic, creating an environment where some companies in the supply chain will experience an extended state of financial distress.
In addition, given the spread of the coronavirus and the resulting impact on manufacturing companies in affected regions across the globe, there has been an increased disruption of worldwide manufacturing supply chains across many industries (especially automotive). China is the world’s second largest economy, so the effect of the coronavirus extends – much like the coronavirus itself – far beyond its borders. In fact, according to Fortune.com, 94% of Fortune 1000 manufacturers are being hit with disruptions as a result of the coronavirus. If companies cannot get components needed to manufacture products, the affected supply chain quickly grinds to a halt. The economic impacts of an idled supply chain are devastating.
Now is the time for automotive suppliers to assess their business rights and obligations, and take steps to mitigate the fallout from the coronavirus pandemic. In this Client Alert, we highlight the “Top Five” immediate considerations for automotive suppliers during this unprecedented and challenging time.
As an initial matter, government orders in response to the coronavirus have created a new set of legal compliance requirements for automotive suppliers (and additional orders, or modifications to existing regulations, are likely to be issued going forward). Among the new legal requirements for businesses are the provisions of the Families First Coronavirus Response Act (the “Act”), which becomes effective on April 1, 2020. The Act covers employers with up to 500 employees and provides for significant “family leave” and “paid time off” for full- and part-time employees generally up to 12 weeks. The Act is one of what appears will be a number of pieces of federal legislation coming from Washington designed to deal with the unprecedented events triggered by the outbreak of COVID-19. For Foley’s summary of the Act, click here.
In addition, most states have now imposed “stay at home” emergency orders designed to slow the spread of the coronavirus by requiring most businesses to cease operations except for those supporting “essential services.” These orders have created restrictions and obligations for suppliers, as well as challenges in terms of their interpretation and implementation. For example, Governor Whitmer’s order in Michigan (much like orders in other states) is not a model of clarity in terms of whether automotive suppliers are essential services/critical manufacturers that are exempt from the stay at home orders. But, for most suppliers, the delineated exceptions, together with the CISA explanation of critical manufacturing, provide some support for keeping plants open on a limited basis and with certain employee health safety requirements met. In particular, CISA identifies the “Critical Manufacturing Sector” as including “Transportation Equipment Manufacturing,” with a specific reference to “vehicle manufacturing.” These exceptions likely are broad enough to argue that a supplier of automotive components is not required to shut down completely. Moreover, several OEMs (including GM, Ford, Honda and FCA) have issued letters to suppliers stating that both manufacturing and service operations are “critical manufacturing” and are therefore exempt from the shutdown requirements in many states. In turn, the OEMs are designating many of their suppliers as critical because they are supporting such operations. Receipt of that designation will strengthen a supplier’s position if it wishes to remain open to an extent under applicable exceptions. Finally, OESA (the Original Equipment Suppliers Association) has generally adopted the positon that critical manufacturing, within the meaning of the order, includes automotive parts manufacturing.
Suppliers should immediately evaluate their businesses and financial resources for impact from the coronavirus crisis and proactively identify opportunities to improve their liquidity position and protect themselves through the crisis. Immediate and significant declines in operating cash flow may push companies to rely more heavily on revolving credit facilities. Those who have available borrowing capacity should strongly consider drawing on their existing credit lines, hedging against the risk that unforeseen subsequent events will make borrowing unavailable. In particular, borrowers usually need to reaffirm their representations and warranties as a condition precedent to each borrowing. Depending upon how “material adverse change” or “material adverse effect” is defined in the given credit agreement, it may become difficult or impossible for a borrower suffering temporary but material business declines to “bring down” its representation that there has been no such change or effect. Note that General Motors announced this week that it is drawing down $16 billion on its line of credit.
Some automotive suppliers may also have credit facilities with covenants that are negatively impacted because of the impact of the coronavirus. It is worthwhile to scrutinize financial covenants in loan documents and indentures to see whether add-backs (of cost savings, synergies or permitted restructuring maneuvers) to net income, EBITDA and other metrics can be used to limit the covenant impact resulting from decreased net income or EBITDA. Decreased accounts receivable (or delays in collection beyond 90 days) will decrease borrowing base availability for suppliers at the time they may need funding the most to pass through the coronavirus crisis.
Public companies should be especially attentive to compliance with covenants in their public debt indentures because it is much harder to obtain the votes necessary to waive or amend a public debt indenture than it is to amend or waive a bank covenant. And, of course, public companies should review their most recent public disclosures and update those disclosures as required. Typically, this includes withdrawing outstanding guidance and identifying for investors the risks posed by the novel coronavirus. For more advice on SEC disclosure duties in this unique context, see our prior Client Alerts here.
All companies with credit agreements, indentures and other financing arrangements should review these debt instruments to determine whether disclosures or reports to creditors are required. Now is the time to consider early proactive discussions with commercial lenders regarding compliance with, and possible adjustments to, any commercial loan covenants. These discussions may result in waivers, standstill or forbearance agreements to defer payments until after the crisis passes. Also, while it will be harder to amend or waive a public debt indenture, reaching out early to the trustees of public debt is advisable. Lead banks and trustees often have discretion that can be used to avoid calling a default prematurely, and they are more likely to exercise that discretion if a trusting relationship (nurtured by early disclosure of bad news) has been developed with the borrower. Waivers and forbearances may include additional flexibility in meeting covenants through a reasonable recovery period.
Suppliers should also consider whether to seek contractual concessions from customers, sometimes in connection with lender negotiations. Through a multi-party agreement among a supplier, its customers and its lenders, customers typically grant certain accommodations to support the cash flow and continuation of the business during the difficult time, lenders promise to continue to lend, and the supplier assures that it will continue production for the customers, maintaining value for all parties.
In addition, suppliers should look at options being provided in the pending federal stimulus plans, including expanded SBA loans, credit support, tax credits and other financial support for small, medium and large companies being negatively impacted by the coronavirus crisis. However, suppliers should not wait for government assistance to save them and should conserve cash and work with their lenders pending receipt of federal help.
Companies should also review their purchase and supply contracts to determine what force majeure rights and obligations may apply. Any party seeking to invoke the force majeure provisions in its contract usually must show that there are no alternative means for performing under the contract, because increased costs alone will not be sufficient to prevail on a claim of force majeure. Put another way, impossibility is force majeure, but impracticality is not. Companies should also evaluate, for those customers with a greater risk of nonpayment (for example, an end-customer who may suspend production under a certain program due to other parts or labor shortages), whether to seek to enforce remedies available to a seller of goods under the Uniform Commercial Code.
Many suppliers have already sent force majeure or commercial impracticability letters, notifying customers that the supplier will not be able to meet its contractual obligations as a result of the interruption of its operations or supply chain. However, as new federal legislation is enacted, and state and local emergency orders are issued, suppliers should update their notices and reassess their positions.
Automotive suppliers whose customers have suspended operations should communicate with their customers about the steps necessary to restart production when the carmakers resume operations. If there will be some delay in ramping up, due to shortage of parts, materials or labor concerns, suppliers should notify customers of their timing and estimated delays. Suppliers may also have multiple customers vying for available resources, and should make plans to fairly allocate those resources among their customers.
In recent years, the automotive supply industry experienced substantial consolidation through mergers and acquisitions. Paradigm shifts in the industry toward new technologies, such as electrification, and autonomous and connected vehicles, have increased the required capex investment by suppliers in order to be competitive in the future, and have put pressure on suppliers to consolidate in order to share larger research and development budgets.
The coronavirus crisis and attendant fallout are likely to stoke even greater and more accelerated consolidation, creating opportunity for some suppliers to purchase businesses at a discount, and risk for other suppliers of being forced to sell their businesses at a discount. Given the breadth and magnitude of risks to their supply chains, the automotive OEMs may ask their larger Tier 1 suppliers to take over some weaker suppliers. Moreover, some suppliers will be unable to absorb the financial impact of the coronavirus crisis and be forced to sell their businesses in distressed asset sales. We expect there will be an acceleration in small-and medium-sized suppliers filing Chapter 11 bankruptcy in order to continue operating and keep plants open. These bankruptcy reorganization cases often result in a balance sheet restructuring and change of control, whether under a Chapter 11 plan or through a sale of substantially all assets under section 363 of the Bankruptcy Code. Suppliers should be aware of their potential options and best steps to protect their interests through distressed merger and acquisition transactions during these turbulent times.
The effects of the coronavirus crisis on mergers & acquisition practice are profound and the deal-making environment is changing rapidly. To this point, our experience has been that many transactions are in “stop, look, and listen” mode. The terms of transactions are expected to change. For example, in this environment, buyers can certainly require sellers to use “commercially reasonable efforts” in the operation of their businesses before closing, but cannot fairly require adherence by sellers to “past practices.” As another example, Material Adverse Change and Material Adverse Effect clauses will logically carve out the immediate, industry-wide effects of the coronavirus, but perhaps not longer-term or seller-specific effects. Over time, we will issue further guidance about the terms and conditions of transactions, with particular attention to the automotive supplier base.
In summary, it is important for the automotive industry to take additional steps now in order to mitigate their risk of suffering negative impacts from the coronavirus. For more information about recommended steps, please contact your Foley relationship partner. For additional web-based resources available to assist you in monitoring the spread of the coronavirus on a global basis, you may wish to visit the CDC and the World Health Organization.
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