Bankruptcy

?Empty Creditors?

By mcbride

This is a term to describe a certain type of creditor which is better off when its debtor files chapter 11 than if it agreed to an out of court workout proposal.  While there have always been circumstances when a filing is actually advantageous to the lender, the new forms of financial instruments, i.e. credit default swaps (a form on insurance) has increased the number of these situations from years past.  This term was coined by Henry Hu, a professor at the University of Texas law school.

 In an article on Six Flags, it was noted that an out of court restructuring proposal was not getting past one of their larger lenders, likely a Fidelity Fund.  ?It’s unclear why Fidelity isn’t coming to the table. It could be because they believe the company might be able to make the interest payments. Or it could be because Fidelity, in this instance, is an empty creditor. The Post notes that one possible explanation for Fidelity’s behavior is that “the bondholder has a credit-default swap?essentially an insurance policy?that would pay it a higher sum than an out-of-court agreement.” Since credit-default swaps are triggered by formal bankruptcy filings?and not necessarily by out-of-court restructuring deals?bondholders who purchased insurance may feel they have more to gain from a traumatic filing than from an out-of-court settlement. The Financial Times reported last week (subscription required) that the logic of empty creditors may similarly have been a reason why General Growth Properties and paper company Abitibi-Bowater both ended up filing (here and here) for Chapter 11 on April 16.?  Here is a link to this article: http://www.slate.com/id/2216604/

Michael

Full post as published by Texas Lawyer Blog on April 27, 2009 (boomark / email).