On June 12 a U.S. bankruptcy judge in Houston ruled that First Brands, the insolvent auto parts manufacturer, may move forward with a proposed liquidation plan that would fund litigation against its indicted founder and other insiders as part of an effort to recover value for creditors.
U.S. Bankruptcy Judge Christopher Lopez granted First Brands permission to solicit votes on its preferred path to wind down the business, turning aside requests from the U.S. Trustee and some creditor groups to convert the case to a Chapter 7 liquidation under the supervision of a court-appointed trustee. Lopez said the company should have the opportunity to see whether its creditors will back a litigation-focused strategy, and he will decide whether to approve the plan at a court hearing scheduled for July.
First Brands entered bankruptcy in September after lenders began probing allegations that the company had fraudulently double-pledged assets as collateral on multiple loans. The company was unable to reorganize and remains responsible for more than $11 billion in debt.
Following the bankruptcy filing, founder Patrick James and his brother Edward James were indicted on federal fraud charges. The collapse of First Brands inflicted losses on several large investment firms and raised questions about fund managers' exposure to risky borrowers in the private credit markets.
Financial conditions at First Brands deteriorated further after the bankruptcy filing. The additional $1.1 billion in new financing that lenders provided at the outset of the case ran out in January, the company told the court, forcing it to rely on prepayments from major parts purchasers such as Ford and General Motors to keep operating. Efforts to sell the entire company yielded limited results, and First Brands was able to sell only a handful of business lines, generating far less than the amount borrowed under the bankruptcy loan.
Among assets sold were the Horizon towing business for $64 million, the Toledo Molding & Die unit for $80 million and the Walbro business for $50 million. Those transactions produced some cash but did not come close to covering First Brands' overall indebtedness.
Compounding the company's strain, First Brands does not have sufficient funds to satisfy debts incurred after the bankruptcy filing. Administrative expenses - the costs and claims that typically must be paid ahead of other creditors - have grown sizable. In court filings the Office of the U.S. Trustee reported that First Brands is $223 million in arrears on administrative obligations, including amounts owed to vendors that continued supplying parts after the bankruptcy petition was filed.
Under the liquidation plan that Lopez allowed the company to distribute to creditors, First Brands would establish a litigation trust to pursue lawsuits aimed at generating additional recoveries. The trust would be seeded with at least $75 million to commence litigation: $25 million drawn from First Brands' existing cash on hand and $50 million in new litigation financing provided by the same lenders that extended the earlier $1.1 billion bankruptcy loan.
The contemplated litigation would target Patrick James and others who are alleged to have withdrawn money from the business in the months leading up to the bankruptcy filing. The company and its lenders are seeking to determine whether that litigation strategy will gain creditor support before the court rules on final approval at the July hearing.
Context and next steps
If the plan wins creditor approval and is confirmed by the court in July, the litigation trust would begin pursuing claims with the initial funding. If the plan is rejected or not approved, parties that had urged conversion to Chapter 7 have argued that a trustee-led liquidation would be a quicker, more straightforward route to disposition of assets and distribution to creditors. The judge’s ruling preserves First Brands’ option to try the litigation route before the court considers other remedies.
The unfolding case continues to highlight strains in private credit arrangements and the potential for substantial losses among lenders and investors exposed to borrowers that collapse under contested circumstances.