GM Bondholders Shun Offer, Setting Stage for Bankruptcy

General Motors fell far short of persuading enough bondholders to accept a debt-for-equity swap, setting the stage for the largest-ever U.S. industrial bankruptcy within days.

The event marks a critical disappointment for GM, the largest U.S. automaker and once considered the bellwether of U.S. manufacturing.

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"I would say this is a sound rejection of an unsuitable offer," said Pete Hastings, a credit analyst at Morgan Keegan who has followed GM. "I have been saying for some time that this thing was dead on arrival and we were just waiting for the doctor to pronounce it dead. Now that's happened."

The largest U.S. automaker had so far failed to gain anywhere near the 90 percent of bondholder support desired to stave off bankruptcy, two sources familiar with the discussions told Reuters. Bondholders have until midnight to make their final decision on the tender and negotiations have been far from smooth.

They have balked at proposals that they forgive $27 billion in debt in exchange for a 10 percent stake in a restructured company. A member of the bondholder group resigned from the ad hoc committee of bondholders negotiating with the U.S. government Tuesday evening.

Jim Graves, a former GM employee, said in a statement issued by the Main Street Bondholders -- a coalition of small  investors -- that he could no longer serve on the panel. GM had no comment on the bond exchange. The automaker said it would detail results of the exchange on Wednesday morning.

The Main Street group, affiliated with a larger organization of retail investors, also said it plans to seek legal representation to form a creditor committee, assuming the debt proposal fails and GM files for bankruptcy.

Reuters sources said GM could file for bankruptcy sometime after midnight Tuesday, but before June 1.

GM's shares have been volatile in recent months as auto sales crumbled and the Detroit automaker was forced to terminate contracts with dealerships, close down plants and lay off tens of thousands of workers. The stock hit $1 on May 13, its lowest point since 1933.

On Tuesday, GM shares dropped as low as $1.12 but later reached as high as $1.84, up 41 cents or 29 percent from Friday's close.

Meanwhile, sources told Reuters that the US government wants to be as inactive a shareholder in General Motors as possible if it ends up taking an ownership stake during a reorganization of the automaker.

"We are reluctant, somewhat involuntary shareholders in this situation," one of the sources said. "We want to be shareholders for as short a period of time and almost in as inactive a way as we can responsibly be."

The government would not engage in day-to day management of the automaker, in which it would take a majority stake, the source said. "We're not going to put U.S. government people, employees on the board," the source said.

Separately, a source told CNBC that Chrysler, which entered bankruptcy on April 30, could emerge from it in restructured form as early as next week.

"I think we're pretty close to the end," the source said.

If GM does enter bankruptcy, the process will be more time-consuming than for Chrysler because of the complexity of GM's global network, sources told Reuters.

But the government would like to get out of an ownership stake once it was certain that taxpayers' interests were protected in a going concern.

"We're going to exit this investment as soon as we responsibly can in a way that's both fair to the other stakeholders in the company as well as fair to the American taxpayers," the sources said.

While the failure to reach a bondholder deal is a severe blow, GM did reach an agreement Tuesday with the leadership of the United Auto Workers (UAW) union.

The key for GM's negotiations with the UAW has been how the two sides restructured payment terms on $20 billion that the automaker still owes to a trust fund for retiree health care (the Voluntary Employee Beneficiary Association, or VEBA).

The UAW agreed to take 17.5 percent of common stock in a restructured GM, a person familiar with the terms told Reuters. The union would also be paid $6.5 billion in preferred stock and would be granted a $2.5 billion note.

A deal on those terms would mean that the union was successful in taking on less risk than it would have under an earlier proposal from GM that would have given it 39 percent of the automaker's common stock.

As part of the plan, GM will offer buyouts to all UAW employees. Workers with 20 years or more will be offered $115,000 and a $25,000 voucher toward purchase of a new GM vehicle.

The UAW rank-and-file will vote on the contract Wednesday and Thursday.

Union officials who met in Detroit Tuesday unanimously endorsed the pact after a briefing with UAW President Ron Gettelfinger, a person at the meeting said.

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GM, which has lost $82 billion in the past four years and has received $19.4 billion in government funding since the beginning of this year, has been struggling to cut costs and reduce debt to continue to receive more government aid.

The company said on Friday that it expected to need another $7.6 billion from the U.S Treasury after June 1.

GM has said it is unlikely to make a $1 billion debt payment due June 1, a day after its government-imposed deadline to cut enough costs or face bankruptcy.

Current shareholders would be left with just 1 percent of a restructured company.

© 2009 CNBC