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US COLUmN

Takata: The unfortunate recall David Conaway reports on the global effects of a major product recall, and the subsequent innovative application of the Section 363 auction

The tragedyTakata Corporation is a Japanese-based company that manufacturessafety products, primarily airbagsand seat belts, as a tier one supplierto the global auto industry.Unfortunately, due to allegeddefective airbags produced, Takatahas recalled reportedly 122 millionairbags globally, with a projectedcost of $12 billion.

Takata’s airbag recall is tragicbecause the airbags are allegedlyresponsible for over 15 deaths andover 150 accidents around theworld, according to the December,2016 reports by the Wall StreetJournal and the Bangkok Post.

The economic lossThe Takata airbag recall hasalready caused enormous economicconsequences to certain of Takata’sstakeholders, including customers,lenders, investors and equityholders. The customers are mainly19 automakers throughout theworld including BMW, Ford,Honda and Volkswagen.

Honda is also one of Takata’smajor investors. An October 7,2016 Wall Street Journal articlereported that the recall burden ofthe automakers was Honda 47%,Toyota 21%, Nissan 11%, and allothers 20%.

According to numerous mediareports, the airbags recalled globallytotal 122 million, and the cost ofreplacement and repair totalsapproximately $12 billion.Moreover, the U.S.’s NationalHighway Traffic SafetyAdministration (“NHTSA”) issued astatement that the automakers have“ultimate responsibility” for thecosts of replacing the airbags.NHTSA appears to be particularly

concerned about the risks of airbagexplosions in older Honda vehiclesmade from 2001 to 2003. The U.S.Government will emerge as amaterial stakeholder, with Takatacurrently operating under a five-year, $200 million consent decreewith the NHTSA.

In addition to the $12 billion ofairbag replacement liabilities,Takata reported it has sustained acash operating loss of over $500million since the inception of therecall in 2013. Moreover, Takata isfacing civil and criminal fines andpenalties from various governmentagencies, throughout the world. Anumber of class action lawsuitshave been filed seeking redress fromTakata for the tragic loss of life,personal injury, and propertydamage allegedly caused by thedefective airbags.

As a result of the economicloss, the automakers will likelyemerge as Takata’s largest class ofunsecured creditors. Takatasupplied defective products to theautomakers, which at a minimumcreates claims for breaches ofcontract, for the $12 billion ofreported losses. It is not clear who,between Takata and theautomakers, is paying the costs ofthe airbag recall, but it is areasonable assumption that Takatais unable to absorb all of the costs,and that the automakers areabsorbing a significant share.

There has been no indicationthat Takata is not paying itssuppliers in the ordinary course ofbusiness. Faced with uncertainty,vendors often impose cash-before-delivery terms on its customers, tohedge against a potential lossshould the customer file forinsolvency protection, including aChapter 11 filing. A materialimposition of cash payment terms

for Takata will impact its workingcapital requirements and pressureits lenders and investors to coverthis additional cost. The scope andultimate loss for the class actionlawsuits will not be known for sometime. As with mass tort lawsuitsgenerally, the number of plaintiffs isincreasing as losses continue tooccur and there will be futureplaintiffs. Ultimately, there will bepressure to create a dedicated fund,or source of funds, to address theselosses over an extended period oftime.

Takata’s corporate structureTakata was started in 1933 in Japanprimarily producing lifelines forparachutes and other textiles. Overtime, Takata expanded into seatbelts, child restraints, and airbags.To accommodate a world-wideauto industry, Takata expandedgeographically, including in theU.S., Mexico, Brazil and Uruguay.In Europe, Takata has facilities inGermany, Czech Republic, Poland,Hungary, Romania, and Russia. InAsia, Takata maintains facilities inSingapore, the Philippines,Thailand, Malaysia, Korea, China,India and Indonesia.

Prior to the airbag recall whichbegan in 2013, Takata had a seatbelt recall in the U.S. in 1995relating to about 8.5 millionvehicles built from 1986-1991,which at the time was identified asthe second largest recall in the 30year history of the U.S.Department of Transportation.

The restructuringFaced with the consequences of theimpact of the airbag recall, inFebruary, 2016, Takata’s Board ofDirectors appointed a steeringcommittee to explore solutions

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DAVID H. CONAWAyShumaker, Loop & Kendrick

LLP (USA)

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including a restructuring of itsbusinesses. According to the WallStreet Journal on May 25, 2016,Takata engaged Lazard Ltd. to seeka cash infusion and negotiate withautomakers over “the ballooning”costs, and to help craft arestructuring plan to deal with“billions of dollars” of liabilities.Reuters reported that therestructuring would focus onTakata’s Michigan-based assets,which account for one-half ofTakata’s global sales. Takata’sMichigan-based entity is TKHoldings, Inc. Indeed, Takata alsoengaged the well-known New York-based restructuring law firm, Weil,Gotshal & Manges LLP to adviseregarding a restructuring.

Numerous news reportsincluding from Reuters, Bloombergand the Wall Street Journal in thefall of 2016 indicated that Takatasolicited bids from various strategicand financial buyers or investorswith respect to certain of its assets,presumably primarily the U.S.-based assets. The reported biddersincluded Daicel Corp., Autoliv Inc.,Bain Capital, Kohlberg Kravis andRoberts (KKR), Key SafetySystems, Inc. and Carlyle Group.On October 17, 2016, the WallStreet Journal reported that a jointbid of $3.5 billion was made byDaicel and Bain Capital, which wasone of five bids that cleared the firstround of bids. Subsequently, basedon November 16, 2016 Wall StreetJournal and December 15, 2016Bloomberg reports, the automaker-customers preferred a bid thatincluded either Sweden’s Autoliv or Michigan-based Key SafetySystems, as automakers seek apartner with a track record ofquality control and operations inmajor world markets.

Based on the continuous flowof news reports from reliablesources, it is clear that Takata isattempting to address the financialand other issues arising from itsairbag recall. It is now clear that arestructuring is being considered,that would involve an investment orpurchase of assets by a combinationof financial and strategic buyers.The bidding process continues andon December 15, 2016, Bloombergreported that the successful biddermay be named in the 1st quarter of

2017. Reportedly, all of the bidders’proposals have included a U.S.Chapter 11 filing of certain ofTakata’s U.S.-based subsidiaries.Undoubtedly, the bidders prefer aChapter 11 filing to obtain thebenefits and protection of Section363 of the Bankruptcy Code, whichgenerally allows a debtor to sellassets free and clear of liens andencumbrances to a third partybuyer, with liens attaching insteadto the proceeds of the sale.However, news reports indicate thatTakata Corporation’s managementexpressed a preference to avoid abankruptcy filing. One wrinkle ofthe Section 363 strategy is therecent U.S. 2nd Circuit Court ofAppeals ruling in the GeneralMotors case holding that “newGM” (the Section 363 purchaser)could be sued for faulty ignitionswitches made by “old GM” priorto its Chapter 11 filing. Perhapsbidders would be willing to pay lessor require a purchase priceholdback, to account for thispotential risk.

Another interesting questionwill be, in the event of a Chapter 11filing, would the normal Section363 procedures be followed? TheLehman Brothers Section 363 saleto Barclays in 2008 clearlydemonstrated a U.S. BankruptcyCourt’s willingness to flex thecustomary Chapter 11 proceduresto accommodate business goals.Lehman Brothers was sold toBarclays, as the sole bidder, withinfive days after Lehman’s Chapter11 filing, to avoid an apparent

meltdown of the global financialmarkets.

Normally in a Section 363 sale,a debtor procures a “stalking horse”bid that is subject to higher andbetter bids, and ultimately courtapproval. It appears that the“auction” may already be occurringand upon a Chapter 11 filing, asingle-bidder Section 363 sale couldbe presented to the BankruptcyCourt. Takata could assert to theU.S. Bankruptcy Court that theSection 363 sale procedures andsafeguards were in fact followedpre-petition, and provide evidencethat the winning bid was indeedsubject to rigorous marketing,negotiation and auction, albeit pre-petition, and that the highest andbest bid is in the best interests ofTakata’s estate and stakeholders.

Whether any non-U.S. Takataentities seek insolvency protectionunder foreign insolvency laws is farfrom clear. Thus, whether suchTakata entities may also seekrecognition of the foreignproceeding the U.S. pursuant to aChapter 15 petition for recognitionis likewise uncertain. It neverthelessappears somewhat likely thatTakata’s U.S.-based entities will seekChapter 11 protection in 2017 toaddress the economic consequencesof its unfortunate airbag recall. �

Note:1 Takata Corp. is a limited reporting company in

the U.S., thus financial and other informationproduced by the company is not available.Reliable business news sources including the Wall Street Journal, Reuters, Bloomberg and Dow Joneshave frequently reported on the airbag recall, the potential losses and potential restructuring.

US C OLU m N

IT IS NOT CLEARWHO, BETWEENTAKATA AND THEAUTOMAKERS, IS PAYING THECOSTS OF THEAIRBAG RECALL,BUT IT IS AREASONABLEASSUMPTIONTHAT TAKATA IS UNABLE TOABSORB ALL OF THE COSTS

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