Misery Loves Another Company

Federal-Mogul Corp. had already recognized a $1.6 billion liability for asbestos-litigation costs when it filed for bankruptcy. But that expenditure got it no closer to ending these liabilities. The nature of asbestos claims is such that companies rarely solve their problem, no matter how much they pay out. But after a bankruptcy, says Todd R. Snyder, managing director of reorganization and restructuring for Rothschild Inc., the American arm of the global investment bank, it becomes easier to craft a lasting solution.

And Rothschild, which is working with auto-parts maker Federal-Mogul in its case, is all about helping clients in bankruptcy find a solution. Rothschild has made a practice of finding innovative, even aggressive, interpretations of bankruptcy law for its clients.

In 2000 it extended the bounds of asset sales typically completed under Section 363 of the bankruptcy code when it helped TWA complete the sale of 100 percent of its assets out of Chapter 11 protection. Rothschild also negotiated a $1.5 billion debtor-in-possession financing for United Airlines, a large portion of which, says Snyder, was predicated on such unconventional assets as the airline's Bank One credit-card relationship and its frequent-flier program.

Rothschild is now helping break more new ground with Federal-Mogul. In January it announced a deal that may lead to settling not only Federal-Mogul's present and future asbestos liabilities, but also those of Honeywell, whose Bendix friction-parts division — like Federal-Mogul's own — has been plagued with lawsuits related to its use of asbestos, a material that causes serious respiratory diseases. (Honeywell took a $1.5 billion restructuring charge in its 2002 fourth quarter related to the settlements.)

In a move that could suggest how future asbestos cases may be resolved, Honeywell has agreed to transfer its Bendix unit to Federal-Mogul, along with the value of Honeywell's $2 billion insurance policy. If the arrangement is approved by U.S. Bankruptcy Court in Delaware, the U.S. and U.K. liabilities of both companies, and the value of the insurance, will be placed in a special trust. The trust, authorized under the bankruptcy law's Section 524(g), is designed to insulate companies from ongoing asbestos lawsuits while providing mechanisms for paying current and future claims.

The transfer of Bendix assets is contingent on court approval of the deal and on Federal-Mogul's emergence from Chapter 11. With those two objectives achieved, as presently structured, Honeywell will give Federal-Mogul Honeywell's foreign Bendix assets and transfer the capacity of its domestic Bendix assets, making Federal-Mogul one of the nation's largest friction-parts makers. (Honeywell will also phase out the last vestiges of its asbestos use in Asia.)

Federal-Mogul CFO Mike Lynch sees nothing in that structure that should be a problem, although the specifics of the reorganization plan and the trust distribution plan haven't been hammered out.

The Icahn Factor
The genesis of the deal, says Snyder, was an early agreement in the bankruptcy proceedings. Coming to terms were lawyers for asbestos complainants, who automatically became unsecured creditors when Federal-Mogul filed, and the company's bondholders, who also became unsecured creditors.

Most notable among the bondholders was billionaire financier Carl Icahn. The two unsecured groups decided on the creation of a 524(g) trust, holding 50.1 percent of the stock of the postbankruptcy firm. Bondholders would receive the remaining 49.9 percent.

The unusual nature of the deal — with plaintiffs' attorneys negotiating with other unsecured creditors rather than with secured lenders, who have legal first dibs on the company's assets — apparently resulted from the influence of Icahn, who asserts that he holds a blocking position in the Federal-Mogul bonds. Icahn, says Snyder, was able to convince plaintiffs' attorneys that he, not the banks, could most efficiently help manage the company "for value that would reward the plaintiffs as well as the bondholders."

Because a provision of Section 524(g) inhibits "cramdown," in which reorganization plans are confirmed over the objections of an impaired class, the only deal plaintiffs would accept was probably the one they'd negotiated already with Icahn. So Rothschild, Federal-Mogul CEO Frank Macher, CFO Lynch, and other executives were left to design a plan permitting the reorganized Federal-Mogul to successfully continue to service upward of $2.5 billion in debt.

Without the ability to convert some amount of pre-petition bank debt to equity, Federal-Mogul had no choice but to restructure its debt load, which would be difficult, says Lynch. "Prior to going into bankruptcy, because of cash-flow problems associated with the asbestos liabilities, we were in danger of defaulting on bank covenants," he says.

This meant the company had to find a way to increase its cash flow. That need, coupled with a 524(g) provision extending a release from future asbestos liabilities to "affiliated parties," gave the Federal-Mogul-Rothschild team an idea.

"We started looking for companies that could contribute to the reorganized Federal-Mogul within the context of the deal," says Snyder. "We came to the conclusion that what we had to offer other asbestos defendants that they potentially lacked was the Section 524(g) release." Because of Federal-Mogul's already-high asbestos liabilities, adding more didn't "alter the calculus of the deal all that much," he adds.

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