Chrysler LLC -- battered for the past two years by disappearing global auto sales and the credit crisis -- filed for bankruptcy on Thursday and announced an industry-changing deal with Fiat after talks to restructure its debt broke down.

Despite weeks of intense negotiations, Chrysler failed to gain the full support from its lenders to avoid the first-ever bankruptcy filing by a major U.S. automaker.

The move was hailed by President Barack Obama as a critical step in saving 30,000 jobs at Chrysler, majority-owned by Cerberus Capital Group , and hundreds of thousands more jobs at affiliated suppliers and dealers.

At the same time, Chrysler as expected entered into an alliance with Italian automaker Fiat SpA where it sold a stake starting at 20 percent and in which Fiat can become the majority owner once the government loans are repaid.

The Chapter 11 filing, in U.S. Bankruptcy Court in Manhattan, sent shock waves through the entire industry -- including Chrysler's rivals and suppliers.

As part of the filing, the U.S. government will provide up to $3.5 billion in debtor-in-possession (DIP) financing and up to $4.5 billion in exit financing. Obama said he hopes the entire process will take only 30 to 60 days.

Some of Chrysler's 3,600 U.S. dealers are expected to close, and Chrysler Financial will stop providing loans for new cars and trucks. Instead, GM's financing arm, GMAC, will provide loans to Chrysler dealers.

The legal proceedings will be overseen by Judge Arthur Gonzalez, the same jurist who oversaw the Enron Corp and WorldCom Inc bankruptcies.

The bankruptcy marks a key transition for the automaker -- founded in 1925 by Walter P. Chrysler. Three years later, the company laid the cornerstone for the Chrysler Building, briefly the world's tallest building and still a landmark on the Manhattan skyline.

FIGHTIN' WORDS

The bankruptcy signals that Obama is prepared to play hardball with holdout lenders rather than knuckle under to their demands and will likely set the tone for similar discussions with bondholders of General Motors Corp -- which is now on the clock to restructure its operations by the end of May.

While Obama voiced his support for Chrysler and the deal with Fiat, he was pointed in his criticism of the investors who did not agree to this deal.

I don't stand with them. I stand with Chrysler's employees and their families and communities, the president said. I don't stand with those who held out when everybody else is making sacrifices. That's why I'm supporting Chrysler's plans to use our bankruptcy laws to clear away its remaining obligations.

This is not the first major government action with Chrysler. In 1980, U.S. President Jimmy Carter signed a bill providing Chrysler with more than $1 billion in loan guarantees.

Once again, the state of Michigan -- and in particular the Detroit area -- will be disproportionately hurt by the auto industry's woes.

The industry's current crisis, with the potential for bankruptcy or consolidation, represents a fundamental shift in the state's economic base, rather than a simple cyclical downturn, Moody's said in a recent report.

Bankruptcy is what they have been headed for in the past several months, said Mirko Mikelic, portfolio manager at Fifth Third Bank. The biggest concern now is that the different stakeholders will be able to make the tough decisions they need to make.

Chrysler Chief Executive Robert Nardelli will leave the automaker following the emergence from bankruptcy. The U.S. government will place six members on the new company's board and Fiat will appoint three.

Investors reacted positively to the news. GM shares were up 7.7 percent and Ford Motor Co was up 7.5 percent in midafternoon trading on the New York Stock Exchange.

FIAT: A DONE DEAL

The bankruptcy filing did not stall the Fiat deal.

Chrysler has been seeking a rescue deal from the Italian automaker while also trying to finalize its debt agreement.

It's a partnership that will give Chrysler a chance not only to survive, but to thrive in a global auto industry, Obama said. Fiat has demonstrated that it can build the clean, fuel-efficient cars that are the future of the industry.

The debt-restructuring talks have been spearheaded by the Obama administration's autos task force and former investment banker Steve Rattner.

In a bid to win over three fund firms that had spurned an offer to accept $2 billion in cash in exchange for writing off all of Chrysler's $6.9 billion in secured debt, U.S. officials sweetened the terms by throwing in another $250 million, people familiar with those discussions said.

Chrysler has been among the car industry's laggards, but its plight reflects a slump in demand facing an industry whose $2.6 trillion annual revenue is equivalent to the GDP of France and which employs more than 9 million people.

(Reporting by Poornima Gupta and John Crawley, additional reporting by Kevin Krolicki, Soyoung Kim, David Bailey, Nick Carey, Jui Chakravorty, Jeff Mason and Giselda Vagnoni; writing by Jo Winterbottom and Patrick Fitzgibbons; Editing by Matthew Lewis)

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