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Hoping for Failure!?

posted by Jason Kilborn

As if negotiating a confirmable reorganization plan weren't difficult enough already, apparently credit default swaps (CDS) are making it even more difficult. The March 7th issue of the Economist has a great sidebar article, aptly entitled "Burning down the house." The author helpfully analogizes CDS to fire insurance--if a corporate borrower defaults (i.e., the house burns down), the CDS seller pays the buyer for the loss. That seems like an acceptable hedge if the buyer of a CDS is the lender, but what if high-risk investors (speculators?) buy CDS, banking on a corporation's default (akin to "naked short selling" of a company's stock, a tactic also under attack of late).

This explosive situation comes to a head if the borrower company attempts a reorganization. Now you've got very dedicated and often aggressive investors hoping for your failure! If they have enough riding on the CDS paying out, one can easily imagine a CDS holder offering to buy a blocking position (34%) of the unsecured debt of a company attempting reorganization--which the CDS holder can probably do for a song in light of the pending reorganization (and the payout on the CDS will almost inevitably be more than a plan promises to unsecureds). I've heard lots of grousing among judges wanting to know how certain "creditors" voting unsecured claims came to own those claims--now I understand why these judges want that info and what scary info they might find if the question is answered. I presume the "not in good faith" votes of CDS holders voting down a reasonable reorg plan could be equitably subordinated or classified (rejected). What a nightmare for debtor's counsel! All that work to then have your plan fail because investors with no real skin in your game tank your deal so they can collect the equivalent of hazard insurance on your failure. 

It gets worse when national borders are involved. The Economist article mentions the Chapter 11 case of LyondellBasell, initiated in early January. Apparently, some CDS holders want to force the debtor's European parent to default, bringing in the complications of a cross-border reorganization. That would so complicate the case that the chance of a total meltdown--and a payout on the CDS--would spike, so DIP lenders have ponied up just to avoid that eventuality. The strategies of securing plan support are FAR more complex today in the CDS-influenced and cross-border complicated world of reorganization. I guess that's why the bankruptcy lawyers get the big bucks.

Comments

Now 11s are not my game but if a creditor is declared hostile in a 11(I can see the hassle in it) can't they be excluded from voting?

You mean Chapter 11 Bankruptcy Attorneys get the big bucks. Consumer Bankruptcy Attorneys get pennies when compared to 11 attorneys. You just need a few 11s to make your year. Consumer attorneys have to do volume (if they are not doing anything else) just to meet overhead. There is a ton of overhead for volume consumer bankruptcy Attorneys and there is very little empathy from 13 trustees on that subject. In my mind it's supposed to be a symbiotic relationship. Ya 13 trustees get salaries but damn! We have had (in the past before direct deposit) disbursement lost in the mail for 2-3 weeks! Trustees changing, at will disbursement dates etc... You think they care... not even! They don't care if you are depending on that check to make payroll, rent, etc... You have to pay for PACER.... and then your fees are set by a panel. All because our side are the bad guys, preying on hapless debtors. Hello? They make their living helping regular people who are in a financial crunch, not millionaires! (rant over)

It is great though to have the people you help come by the office (out of the blue) to bring you some of their harvest; make you tamales (just yesterday.. ohhh so good and homemade, like South Texas in the boonies homemade!); bring you doughnut etc... If you don't have a heart to help people, it's a miserable business.

Ok.. I have to share this. This couple, he is in a wheel chair she is ok... older couple, lived in the same home for the past 20 years, took out a Home Eq..etc.. The town they live in has like 200 people about 35 min out of town. The best tamales I have ever tasted in my life and that's saying something because before then my grandma held that title! I still have a dozen left! Our south Texans are very proud. When they appreciate you they find any means they can to let you know. I don't know of very many millionaires (period) who would bring over 4 dozen tamales just because.

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