After surviving for months on government loans, America's third largest car manufacturer filed for Chapter 11 bankruptcy protection and at the same time announced a partnership with Italian automaker Fiat.
President Barack Obama wants Chrysler to get a new lease of life.
American carmaker Chrysler has become the first of the Big Three US automakers to be forced into bankruptcy protection to help it form an alliance with Fiat and create the 6th largest global car manufacturer.
If approved by a bankruptcy court, the plan would create a new company controlled by the United Auto Workers trade union and Fiat, with small stakes held by the US and Canadian governments.
The US and Canadian governments will provide billions of dollars in funding to support the company's operations during the transition.
Chrysler says it will close all its plants on Monday, and keep them closed until the company has come out of bankruptcy.
Convincing Chrysler's creditors to forgive most of the loans the carmaker owes them was crucial to save the company from bankruptcy but lenders resisted Washington's pressure.
In 2008, Chrysler had an $8 billion loss, and US sales fell 30 percent to 1.45 million vehicles.
US President Barack Obama said the "necessary steps" had been to taken to "to give one of America's most storied automakers, Chrysler, a new lease on life."
"I have every confidence that Chrysler will emerge from this process stronger and more competitive," Obama said.
The announcement came less than 24 hours before the expiry of a 30-day deadline set by the Obama administration for Chrysler to come up with a recovery plan.
Chrysler hopes a new alliance with FIAT will reverse its bad fortune.
Deal with Fiat
Fiat will initially take a 20 percent stake in the firm that would rise to 35 percent and could reach 51 percent as early as 2013 if Chrysler is able to repay its government loans.
Autoworkers have voted to approve a new contract with Chrysler and Fiat, agreeing to concessions designed to secure the survival of the number three US automaker.
Fiat, which is looking to buy into Chrysler, has also shown an interest in taking over German carmaker GM. Fiat reportedly needs to expand in order to survive the economic downturn.
In May 2007 Germany's Daimler ended its nine-year-old merger with Chrylser, selling its stake in the loss-making company to US investor Cerberus for 5.5 billion euros.
Under the new restructuring plan Daimler will give up its 19 percent equity interest and pay $600 million to Chrysler's pension funds. It will also waive its share of Chysler's $2 billion of second lien debt.