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

GMAC stays mum on debt swap

By BREE FOWLER , 12.29.08, 02:39 PM EST

The financing arm of General Motors Corp. remained silent Monday on whether it had raised enough capital to become a bank-holding company and eligible for access to billions in federal bailout money.

Analysts have speculated that if GMAC (nyse: GJM - news - people ) Financial Services LLC doesn't obtain financial help it would have to file for bankruptcy protection or shut down, which would be a serious blow to parent GM's own chances for survival.

GMAC had received the Federal Reserve's approval to become a bank holding company last week, but the approval was contingent on the auto and home loan provider raising at least $30 billion in regulatory capital. The company had been attempting to raise the needed funds through a complicated debt-for-equity exchange that expired at 11:59 p.m. EST Friday.

In an e-mail Monday, GMAC spokeswoman Gina Proia said GMAC still had no news to announce regarding the debt swap. That came after Saturday e-mails that did not provide any specifics but said that GMAC planned to announce the results of the debt swap soon.

"The offer did expire yesterday at 11:59 p.m. as planned. We have not yet issued final results but intend to in the near term. I have no further comment on the exchange until then," Proia wrote Saturday.

Becoming a bank-holding company would both qualify GMAC to access the government's bank rescue funds and support GMAC loans to car buyers and GM dealerships. GM owns 49 percent of GMAC.

The Federal Reserve apparently needed to see that bondholders were willing to inject more capital into GMAC. The bondholders needed reassurance that the Fed would approve GMAC's application to qualify for federal aid.

If the financing company fails to become a bank holding company, it could mean severe consequences for automaker GM.

General Motors (nyse: GM - news - people )' ownership of GMAC has kept the finance arm lending to dealers and car buyers, even as credit from traditional banks has dried up. If GMAC goes under, other institutions aren't likely to step in to replace the credit lost by GM's dealers and customers.

The Fed's action Wednesday came as GMAC was struggling to get bondholders to convert 75 percent of their debt into equity of the company. It's been nearly two weeks since GMAC has released any information about the amount of participation so far.

As of Dec. 17, only about 16.9 billion, or 58 percent, of its GMAC notes had been tendered, along with about $3.5 billion, or 38 percent, of the notes issued by its Residential Capital LLC mortgage business.

GMAC's goal is to reach $30 billion in capital, the majority of which would come from the exchange of debt. Another part of the equity requirement included a demand from the Fed that $2 billion of the total come from new equity. So far, GMAC has received a commitment of $750 million from GM and private-equity firm Cerberus Capital Management, which owns the majority stake in GMAC.

It's unclear whether that funding would come from the $17.4 billion in bridge loans the U.S. Treasury granted GM and Chrysler LLC - which is owned by Cerberus_ earlier this month.

Some of the rescue money will be available this month and next - $9.4 billion for GM and $4 billion for Chrysler, which have said they could be facing bankruptcy soon without government help. GM is set to receive the remaining $4 billion in loans after more money is released from the financial rescue account.

It was unclear Monday exactly when the Treasury Department planned to release the first set of loans.

"We're making good progress finalizing the automaker loans and are committed to closing them on a timeline that will meet their individual near term funding needs," Treasury spokeswoman Brookly McLaughlin said in a statement.

GMAC has not said publicly how much it was requesting from the $700 billion bank bailout fund. CreditSights analyst Richard Hoffman estimated in a research note Friday that GMAC "could have applied for up to about $6.3 billion."

The Fed order says GM will reduce its stake to less than 10 percent of the voting and total equity interest of GMAC. GM's remaining equity interest in GMAC will be transferred to an independent government-accepted trustee who must dispose of the equity held in the trust within three years of the trust's creation.

Cerberus, which led an investment group that bought a 51 percent stake in GMAC from the automaker for $14 billion in 2006, will reduce its stake in GMAC to no more than 33 percent of total equity.

In afternoon trading, GM shares fell 27 cents, or 7.4 percent, to $3.39.

Associated Press Economics Writer Christopher S. Rugaber in Washington contributed to this report.

Copyright 2008 Associated Press. All rights reserved. This material may not be published broadcast, rewritten, or

Harvard professor hopes to torpedo the music industry's lawsuits against online song-swappers BOSTON (AP) -- The music industry's courtroom campaign against people who share songs online is coming under counterattack.A Harvard Law School professor has launched a constitutional assault against a federal copyright law at the heart of the industry's aggressive strategy, which has wrung payments from thousands of song-swappers since 2003

The professor, Charles Nesson, has come to the defense of a Boston University graduate student targeted in one of the music industry's lawsuits. By taking on the case, Nesson hopes to challenge the basis for the suit, and all others like it.

Nesson argues that the Digital Theft Deterrence and Copyright Damages Improvement Act of 1999 is unconstitutional because it effectively lets a private group -- the Recording Industry Association of America, or RIAA -- carry out civil enforcement of a criminal law. He also says the music industry group abused the legal process by brandishing the prospects of lengthy and costly lawsuits in an effort to intimidate people into settling cases out of court.

Nesson, the founder of Harvard's Berkman Center for Internet and Society, said in an interview that his goal is to "turn the courts away from allowing themselves to be used like a low-grade collection agency."

Nesson is best known for defending the man who leaked the Pentagon Papers and for consulting on the case against chemical companies that was depicted in the film "A Civil Action." His challenge against the music labels, made in U.S. District Court in Boston, is one of the most determined attempts to derail the industry's flurry of litigation.

The initiative has generated more than 30,000 complaints against people accused of sharing songs online. Only one case has gone to trial; nearly everyone else settled out of court to avoid damages and limit the attorney fees and legal costs that escalate over time.

Nesson intervened after a federal judge in Boston asked his office to represent Joel Tenenbaum, who was among dozens of people who appeared in court in RIAA cases without legal help.

The 24-year-old Tenenbaum is a graduate student accused by the RIAA of downloading at least seven songs and making 816 music files available for distribution on the Kazaa file-sharing network in 2004. He offered to settle the case for $500, but music companies rejected that, demanding $12,000.

The Digital Theft Deterrence Act, the law at issue in the case, sets damages of $750 to $30,000 for each infringement, and as much as $150,000 for a willful violation. That means Tenenbaum could be forced to pay $1 million if it is determined that his alleged actions were willful.

The music industry group isn't conceding any ground to Nesson and Tenenbaum. The RIAA has said in court documents that its efforts to enforce the copyright law is protected under the First Amendment right to petition the courts for redress of grievances. Tenenbaum also failed, the music group noted, to notify the U.S. Attorney General that that he wanted to contest the law's constitutional status.

Cara Duckworth, a spokeswoman for the RIAA, said her group's pursuit of people suspected of music piracy is a fair response to the industry's multibillion-dollar losses since peer-to-peer networks began making it easy for people to share massive numbers of songs online.

"What should be clear is that illegally downloading and distributing music comes with many risks and is not an anonymous activity," Duckworth said.

Still, wider questions persist on whether the underlying copyright law is constitutional, said Ray Beckerman, a Forest Hills, N.Y.-based attorney who has represented other downloading defendants and runs a blog tracking the most prominent cases.

One federal judge has held that the constitutional question is "a serious argument," Beckerman said. "There are two law review articles that have said that it is unconstitutional, and there are three cases that said that it might be unconstitutional."

In September, a federal judge granted a new trial to a Minnesota woman who had been ordered to pay $220,000 for pirating 24 songs. In that ruling, U.S. District Judge Michael J. Davis called on Congress to change copyright laws to prevent excessive awards in similar cases. He wrote that he didn't discount the industry's claim that illegal downloading has hurt the recording business, but called the award "wholly disproportionate" to the industry's losses.

In the Boston case, Nesson is due to meet attorneys for the music industry for a pretrial conference on Tuesday, ahead of a trial set for Dec. 1.

Entertainment attorney Jay Cooper, who specializes in music and copyright issues at Los Angeles-based Greenberg Traurig, is convinced that Nesson will not persuade the federal court to strike down the copyright law. He said the statutory damages it awards enable recording companies to get compensation in cases where it is difficult to prove actual damages.

The record companies have echoed that line of defense. In court filings in Tenenbaum's case, they contend that the damages allowed by the law are "intended not only to compensate the copyright owner, but also to punish the infringer (and) deter other potential infringers."

But are these lawsuits the only way the record industry could deter piracy? Nesson believes the industry could develop new ways to prevent copyright material from being shared illegally. One idea would be to bundle music with ads and post it for free online, he says.