General Motors (NYSE:GM) won a huge legal victory in federal court on Wednesday, as a judge ruled the automaker can retain a bankruptcy shield that protects it from billions of dollars in claims related to faulty ignition switches.
U.S. Bankruptcy Judge Robert Gerber said the current General Motors cannot be held liable for the mistakes made by its legal predecessor, GM as it existed before its 2009 bankruptcy.
This ruling could be worth $10 billion or more to the company. Here's why.
A legal "shield" that protects New GM from Old GM's mistakes
Revelations that General Motors engineers had known about defective ignition switches for years triggered a massive wave of belated recalls last year -- and, predictably, a massive wave of litigation.
But GM has maintained that it was legally "shielded" from claims arising from the behavior of "Old GM," its pre-bankruptcy incarnation, as a result of its bankruptcy. Most of the events related to the defective switches (and most of the resulting accidents) happened before GM's 2009 bankruptcy proceeding. As GM saw it, that meant the shield should have been sufficient to stop most of the litigation in its tracks.
That's a big deal, as claims against Old GM were expected to reach as much as $10 billion.
Lawyers for victims of accidents related to the defective switches tried to challenge the shield, arguing GM committed fraud by not disclosing its potential liability for the switches to the bankruptcy court.
The company's post-bankruptcy management team -- CEO Mary Barra, her predecessor Dan Akerson, and other senior executives -- maintained it did not find out about the defective switches until late 2013. The lawyers challenging the shield couldn't prove otherwise, and so the shield has been allowed to stand.
The court just erased a $10 billion worry for GM
The ruling prevents customers from suing GM for injuries related to the defective switches. It also blocks lawsuits alleging the recall publicity has hurt the resale values of millions of older GM vehicles. Together, those suits could have exposed GM to as much as $10 billion in damages.
This doesn't mean GM will escape the recall mess without spending several billion dollars. General Motors has already spent billions on last year's recalls, and set aside several hundred million dollars more for a settlement fund to compensate accident victims without compromising the liability shield.
The automaker also faces a variety of investigations, including a U.S. Department of Justice probe, that could force it to pay another $1 billion or more to settle charges related to the ignition switches. Toyota (NYSE:TM) ended up paying $1.2 billion to settle criminal charges related to its own recall scandal; it's a fair bet GM will have to pay at least that much, and likely considerably more.
A boon for GM shareholders in more ways than one
Whatever the final costs, it's clear now GM can afford them: It had $25.2 billion in cash reserves as of the end of 2014. That's why the court's decision gave GM shares a boost in after-hours trading on Wednesday.
But that's not the only reason shareholders should be a little more optimistic now. General Motors has been working on ways to return some of its cash to shareholders, but CFO Chuck Stevens was (rightly) concerned about the potential for $10 billion in added liability. In February, Stevens said he wanted to wait for a clearer understanding of GM's potential exposure before committing to spending significant amounts of cash on dividend increases or other measures.
The automaker subsequently committed to a $5 billion share repurchase program. But with this massive worry removed, GM might take more steps to reward its patient shareholders. Stay tuned.