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Banks and hedge funds that hold $6.9 billion in Chrysler LLC debt have proposed forgiving $2.5 billion of it in exchange for about a 40 percent stake a Chrysler-Fiat alliance, according to two people briefed on the proposal.

One of the people said the lenders delivered their counterproposal to Chrysler and the U.S. Treasury Department late Monday night. Neither person wanted to be identified because the negotiations are private.

The counteroffer comes as Chrysler races to meet a government-imposed April 30 deadline to swap debt for equity, cut labor costs and negotiate an alliance with Italy's Fiat Group SpA. If it misses the deadline, government aid will end and Chrysler likely faces liquidation.

Last week, creditors rejected a Treasury Department offer to reduce the debt to $1 billion, absolving Chrysler of about 85 percent of its secured loans. The counteroffer, which would swap about 35 percent of the debt for equity, falls short of government restructuring goals that called for Chrysler to retire at least two-thirds of its debt.

Messages were left with spokeswomen for the Treasury Department and Chrysler.

Chrysler is living on $4 billion in federal loans and could get another $500 million to survive through April. But without massive restructuring and a Fiat deal, government officials have said they won't lend the struggling automaker any more money.

The counteroffer from a steering committee would give the equity stake to first-lien lenders including Citigroup Inc., JPMorgan Chase & Co., Goldman Sachs Group Inc., Morgan Stanley and several smaller banks, plus some hedge funds. Chrysler has about 45 first-lien lenders who would be first in line to get money if the company's assets were liquidated.

"The goal is something close to 40 percent of the equity" in the combined Chrysler-Fiat company, according to one of the people briefed on the lenders' proposal. "Taking equity is a risky proposition," the person said.

When the Bush administration agreed to give Chrysler and General Motors Corp. loans last year, they set targets for the companies to swap two-thirds of their debt for equity. The Obama administration has been less clear about how much debt must be exchanged, saying in a March 30 statement that Chrysler must have a "sustainable debt burden."

"This at a minimum will require extinguishing the vast majority of Chrysler's outstanding secured debt and all of its unsecured debt and equity, other than trade creditors providing normal trade terms," the statement said.

One of the people briefed on the counteroffer said the debtholders are aware that it doesn't meet the two-thirds debt-for-equity swap required by the Bush administration, but it would be a piece of an overall plan to wipe out most of Chrysler's debt.

Including the secured debt and government loans, Chrysler owes about $23.5 billion, including $10.6 billion to a United Auto Workers trust fund that will take over retiree health care costs starting next year. It also owes $1 billion each to its current owners, Cerberus Capital Management LP and Daimler AG.

The company is negotiating with the UAW to take equity for part of the trust fund obligation.

Bankruptcy experts have said the secured debtholders would be less likely to settle for pennies on the dollar because their loans are secured by Chrysler's physical assets and because they likely purchased credit default insurance that would repay them if Chrysler defaults.

Chrysler and Fiat are discussing a deal in which Fiat would take a 20 percent stake in the company in exchange for Fiat's small-car technology. Fiat CEO Sergio Marchionne is in the U.S. through today taking part in the negotiations.

AP Auto Writer Dan Strumpf reported from New York.

Copyright 2009 Associated Press. All rights reserved. This material may not be published broadcast, rewritten, or redistributed

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