DETROIT -- Two auto suppliers have used the bankruptcy code to revamp at least 80 percent of their customer contracts, bucking the norm of most automotive bankruptcies seen this year.
Both companies, Recticel North America Inc. and HHI-FormTech LLC, say the contracts were unprofitable and undermined the viability of their businesses. The bankruptcy code provides an opportunity for bankrupt businesses to rewrite contracts to reflect the current market -- not the market that was projected two, three or four years ago.
But some customers have resisted, saying Recticel and HHI-FormTech essentially are holding guns to their heads, forcing them to give the companies better terms in order to keep their own assembly lines, and those of their customers, running on time.
FormTech Industries L.L.C., a suburban Detroit supplier of hot- and cold-formed metal components, filed for Chapter 11 bankruptcy earlier this fall with a new owner lined up, Hephaestus Holdings Inc., which is owned by New York-based hedge fund KPS Capital Partners L.P.
Hephaestus Holdings, or HHI, is adding FormTech to its portfolio of automotive and industrial forged-component companies it has been combining since 2006. HHI now claims to be the largest independent supplier of forged and machined components in North America.
But HHI opted not to assume agreements with Chrysler Group, Ford Motor Co., General Motors, Toyota Motor Corp., 11 Tier 1 suppliers, and others.
According to sources close to the situation, nearly all of FormTech's customers were forced to the negotiating table to work out new long-term supply agreements as a condition to continue receiving parts in the short term.
“The intent of Chapter 11 is to allow a company to start over and that's exactly what HHI did with FormTech,” said Mark Semer, of New York-based Kekst & Co. Inc., in a statement e-mailed to Crain's Detroit Business. Kekst is the public relations firm that represents HHI and its parent KPS Capital Partners.
William Wildern, CEO of turnaround and restructuring advisory firm Hydra Professionals LLC., declined to comment on the specifics of HHI-FormTech.
But in general, Wildern said such contractual actions are characteristic of a financial buyer making a play for a distressed auto supplier with the intent of building a larger company with a better shot at long-term viability.
During that process, such owners put “the need to make money and be sustainable as a requirement to do business and maintain longer viability first, knowing that they can't be a supplier if they put their plans in jeopardy,” Wildern said.
“What we've seen (emerging over the last five years) are investors bringing capital to the table to help preserve an industry in deep distress, but at the same time trying to prevent themselves from becoming a casualty of the distress in the industry.”
Recticel North America made a similar move when it filed for Chapter 11 bankruptcy on Oct. 29.
The company's subsidiary that applies polyurethane coatings to vehicle interiors to make plastic mimic the appearance of leather, Recticel Interiors North America LLC, moved to reject supply agreements with Inteva Products LLC and Johnson Controls Inc. after trying for months to win price increases from the two customers outside of court.
In an interview the day the company filed for protection, Art Vartanian, managing director for both Recticel units in North America, told Crain's that the goal was to use the protection of the bankruptcy code as an opportunity to revamp the contracts.
“The hope is not to walk away from the business,” he said.
Those contracts accounted for 80 percent of Recticel Interiors' revenue, but the company said it was hemorrhaging about $845,000 per month under the contracts after sales expectations proved too optimistic as the automotive market sank, according to the motion to reject the contracts filed in Recticel's bankruptcy case.
But JCI cried foul.
“The debtors do not truly intend to reject 80 percent of their contracts and sustain massive damage claims,” JCI said in its objection filed with the court. “Instead, they have filed the rejection motion as a bad faith ‘surprise' attack in an effort to create a hostage situation and obtain extra-contractual concessions from the customers.”
In the objection, JCI's attorneys say that rejecting the contract, stopping the flow of parts in the process, would cause ramifications up and down the automotive supply chain.
Because suppliers generally rely on a single company for a specific part and those parts are delivered to assembly lines as needed, if any single part doesn't arrive, “JCI's production will cease within hours or days, sending ripples throughout the supply chain,” the objection said.
“It's not the first time it's happened, but it is definitely not the normal procedure,” said Max Neumann, a shareholder and Chapter 11 bankruptcy attorney at Detroit law firm Butzel Long.
“Normal procedure is that this is an absolute last resort, and that you negotiate with your customers first for the obvious reason that customers don't like having contracts imposed upon them, and it will negatively impact the future business relationship more seriously than a renegotiation will.”
BorgWarner also reacted to HHI-FormTech's tactics by suing the supplier. The original contract was for FormTech to supply forged and blanked input and output shafts to BorgWarner for transfer case assemblies then sold to Ford Motor Co.'s high-selling F-150 pickup truck, as well as its Explorer SUV and other vehicles.
The two sides have been negotiating a solution outside of court since the objection was filed in October after HHI told BorgWarner it would not accept its existing supply contracts and would supply parts on an order-by-order basis until a new supply agreement was reached. If an agreement could not be reached, HHI would stop shipping parts.
“That is certainly not conducive to a positive customer relationship,” Neumann said. “It is within their rights under the bankruptcy code, subject to court approval, but is something that I would say is a last-resort strategy.”
Neumann said the tactic, which threatens the continuity of supply if the customer doesn't agree to buy under the new terms, may affect the reputation of a supplier and threaten the supplier's ability to do business long term.
“It certainly may work (to restructure) existing contracts, but it's going to be hard to imagine a customer that's been subjected to that saying, ‘we've got this new program, let's give it to HHI.' ”
But, Wildern said such circumstances are not uncommon and rarely jeopardize the future business viability, as long as both parties work in good faith.
The very nature of the modern just-in-time delivery and sole-source supplier status-quo of the auto industry creates an environment in which the continuity of supply is frequently threatened, but rarely disrupted.
And in cases like those seen with HHI and Recticel, when a supplier puts a contract to a customer to be renegotiated under the protection, and approval, of the bankruptcy court, “essentially what they're offering is a forum for the buyer and the OEM to work out a commercially acceptable contract, and if the parties can't agree to that, it's a because they feel there is a better alternative.”