Chrysler's fate was in the hands of about 40 hedge funds that hold about 30 percent of its debt. Although four banks holding 70 percent of the debt had agreed to erase it for $2 billion, the hedge funds were holding out for a better deal.
To entice the hedge funds into going along with the banks, the government on Wednesday afternoon added $250 million to the $2 billion that the banks had settled for and gave the hedge funds a 6 p.m. (2200 GMT) deadline to work it out, two people briefed on the talks said.
Michigan Gov. Jennifer Granholm, speaking in Lansing at a news conference about the swine flu, had urged them to consider Chrysler's 54,000 employees.
"On behalf of Michigan, on behalf of the thousands of people who will be affected if this company is forced into bankruptcy, I am publicly asking these hedge funds to not be greedy but to do what the banks have done and what everyone else around the table has done take the concessions," she said.
But several of the funds came back with their own different counterproposals, leaving the Treasury Department to bargain with 46 funds, the person said. Treasury extended the deadline into the evening, but when it appeared there was no central authority to negotiate with, decided to end talks around midnight.
"This is the one shot when everybody had a chance to say yes or no," the person said. "You had 46 different people here, and they said no."
The collapse of the talks means Chrysler will almost certainly head for bankruptcy protection, unless a deal can be salvaged by the government's deadline of 11:59 p.m. Thursday (0359 Friday). Others briefed on the negotiations said that in order for Chrysler to get a deal without bankruptcy, it needs to get 100 percent of its creditors to sign on.
But bankruptcy doesn't mean the end of the company. The people said plan B is for Chrysler to file for bankruptcy with funding help from the government. Under the bankruptcy law that Chrysler would file under, a judge would decide how much creditors would get, but is likely to go with any settlement agreed to by the majority of the creditors, the people said.
If it files for bankruptcy, Chrysler would continue operating and Fiat would still sign on as a partner on Thursday, the people said. The government already has promised to back Chrysler's warranties in an effort to allay customers' fears that the automaker wouldn't be around to honor them.
The government in March rejected Chrysler's restructuring plan and gave it 30 days to make another effort, including a tie-up with Fiat. The company, which has borrowed $4 billion from the federal government and needs billions more, faces a Thursday night deadline to cut labor costs, slash debt and take on a partner if it wants more aid.
President Obama said Wednesday night while the lender talks were still ongoing that he was "very hopeful" that deals can be worked out to keep Chrysler LLC a viable automaker, and more hopeful than he was a month ago that the company will stay in business.
On Sunday, the Canadian Auto Workers ratified concessions to the automaker, and the United Auto Workers in the U.S. reached a tentative cost-cutting deal that members overwhelmingly ratified Wednesday night.
The UAW agreement, which will take effect May 4, meets Treasury requirements for continued loans to Chrysler Corp., and includes commitments from Fiat to manufacture a new small car in one of Chrysler's U.S. facilities and to share key technology with Chrysler.
"This has been a challenging time filled with anxiety and uncertainty for our membership," said UAW President Ron Gettelfinger. "Our members have responded by accepting an agreement that is painful for our active and retired workers, but which helps preserve U.S. manufacturing jobs and gives Chrysler a chance to survive."
Meanwhile, the Fiat partnership means Chrysler CEO Robert Nardelli could be out of a job. In an April e-mail to employees, he said that if the deal is finalized, Chrysler would be run by a new board appointed by the government and Fiat. The new board, Nardelli wrote, would pick a CEO "with Fiat's concurrence."
Sergio Marchionne, CEO of the Italian automaker, told reporters earlier this month that he could run Chrysler. Obama said Wednesday that Fiat's management "has actually done a good job transforming their industry."