IT is a sad reflection of the state of Fiat Auto that General Motors preferred to pay $2bn rather than buy the company.

The two had been locked in negotiations since GM signalled its desire to dissolve its five-year relationship with the Italians.

Under the terms of the deal, GM will return its ten per cent stake in Fiat Auto, although the two groups will continue to co-operate in areas where a liaison is mutually beneficial, such as work on a new range of diesels.

General Motors can ill-afford such a costly divorce - its finances are already under stress from stagnant sales, costly incentives and pensions costs - but the alternative was even less palatable to the top brass in Detroit.

Under the terms of the original deal, brokered in 2000, GM acquired 20 per cent of Fiat with an option to buy the rest of the company.

Things were complicated by terms in the agreement that meant Fiat could force GM to go the whole nine yards within a certain time frame.

Known as a "put option", this meant GM would have been forced to acquire Fiat Auto and the Italian group's near $10bn debt mountain.

Announcing the agreement, GM chairman and chief executive officer Rick Wagoner said that it was in the best interests of both companies and shareholders.

"This is a good resolution to what was a challenging set of issues," he said.

"We have come to a solution that obviously satisfies both parties."

The solution is a costly but quick divorce. GM and Fiat will dissolve two joint ventures involving their European purchasing and power-train activities.

But the tie-up has not been all bad. Joint ventures have generated $2bn in savings - which was welcome, but not enough.

Initially, neither party talked of the put option, but Fiat first raised the spectre of a forced buyout last year as the group's financial situation worsened.

GM - already losing money on its European operations and unwilling to take on more problems - bristled at the suggestion.

It said a refinancing package at Fiat had effectively nullified the original deal as it reduced GM's stake from 20 per cent to only ten.

But the possibility of a lengthy legal battle had an impact on GM's shares. Standard and Poor wrote down the value of the company to one level above junk status - a humiliation for the world's biggest auto-maker. AlthoughStandard and Poor is due to review the position later this year, the influential group said it saw GM's get out as a neutral development. A legal war would have had a negative impact.

As Fiat chairman Luca di Montezmolo admitted: "If we had not reached the agreement, we would have had a long legal battle."

The $2bn settlement will give Fiat breathing space (it is losing about $1bn a year) and allow it to bring some of the 22 new models it has planned to the market.

Among these cars will be a replacement for the Punto - a critical model for the company - and a number of Alfa Romeos.