Credit derivatives and the future of chapter 11

American Bankruptcy Law Journal

Volumn 81, Issue 4, 2007, Pages 405-430

  Lubben, Stephen J ^a  

^a University School of Law   (United States)

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EID: 38949098173     PISSN: 00279048     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (156)

1. Address at the Bond Market Association (May 18, 2006),
2. quoted in Caroline Salas, Derivatives, Not Bonds, Show What Pimco, TIAA-CREF Really Think, Bloomberg.com (May 31, 2006), http://quote. bloomberg.com/apps/news?pid=10000103&sid=aE6mQtSp402w&refer=news_index.
3. See Lehman Brothers, Default Swaps, http://www.lehman.com/fi/sct/ def_default_swap.htm (last visited Oct. 15, 2007). Credit default swaps are contracts in which one party (the "Buyer" of protection) pays a premium to a second party (the "Seller" of protection) for taking on the default risk related to a particular debt security (the "Reference Security").
4. Id. If the Reference Security is the subject of a "credit event," typically a significant default, then the Seller of protection pays the loss on the Reference Security to the Buyer.
5. Id. Essentially a credit default swap is a kind of insurance policy, although there is no requirement that any party actually own the underlying Reference Security.
6. See infra Part I.
7. T. Bowler & J. Tierney, Credit Derivatives and Structured Credit: A Survey of Products, Applications and Market Issues (1999), available at http://www.fonet.co.kr/bbs/aca208/145overview.pdf.
8. Notional amount as of December 2006. ISDA, 2006 YEAR-E ND MARKET SURVEY, available at http:/ /www,isda.org/(select "Survey & Market Statistics," then select "Summaries of Market Survey Results," then select "2006 Year-End". ISDA is the key trade association for the derivatives industry.
9. See generally Sean M. Flanagan, Student Article, The Rise of a Trade Association: Group Interactions Within the International Swaps and Derivatives Association, 6 HARV. NEGOT. L. REV. 211 (2001).
10. That is, swaps involving the risk of a default by a single debtor.
11. See infra Part I for a fuller description of the features of the credit derivative market. A synthetic product uses derivatives to stand in for an underlying asset. For example, while a collateralized debt obligation (CDO) would normally involve a pool of debt instruments, a synthetic CDO would involve a pool of derivatives. A squared product involves two layers of derivatives: for example, a squared CDO would involve a pool of CDOs.
12. Id.
13. For exceptions, see Paul M. Goldschmid, Note, More Phoenix Than Vulture: The Case For Distressed Investor Presence In The Bankruptcy Reorganization Process, 2005 COLUM. BUS. L. REV. 191, 233-34;
14. Frank Partnoy & David A. Skeel, Jr., The Promise And Perils Of Credit Derivatives, 75 U. CIN. L. REV. 1019, 1048-50 (2007).
15. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, 119 Stat. 23;
16. see Shmuel Vasser, Derivatives in Bankruptcy, 60 BUS. LAW. 1507, 1511 (2005).
17. The financial community is unquestionably aware of the problem. As noted in a recent report on derivatives: one of the great strengths of the financial system has been its capacity to organize and execute restructurings for troubled but viable companies and countries. Such restructurings typically occurred through groups of primary creditors having a major financial interest in the outcome. To the extent such primary creditors now use the credit default swap market to dispose of their credit exposure, restructuring in the future may be much more difficult.
18. COUNTER PARTY RISK MANAGEMENT & POLICY GROUP II, TOWARDS GREATER FINANCIAL STABILITY: A PRIVATE SECTOR PERSPECTIVE 9 (July 27, 2005), available at http://www. crmpolicygroup.org/ docs/CRMPG-II.pdf.
19. 11 U.S.C. § 1121 (2006);
20. Richard Levin Sc Alesia Ranney-Marinelli, The Creeping Repeal of Chapter 11: The Significant Business Provisions of the Bankruptcy Abuse Prevention and Consumer Protection Act 0/2005, 79 AM. BANKR. L.J. 603, 631 (2005).
21. 11 U.S.C. § 1126(c) (2006).
22. 11 U.S.C. §§ 303, 361, 362(d), 1104, 1112 (2006).
23. See In re Enron Corp., 328 B.R. 58 (Bankr. S.D.N.Y. 2005);
24. In re Worldcom, Inc. Sec. Litig., 346 F. Supp. 2d 628, 651-52 (S.D.N.Y. 2004);
25. see also Henny Sender, Spotlight Put on Credit-Derivatives Market, WALL ST. J., Dec. 3, 2001, at C15 (noting that the Enron bankruptcy brought attention to the market).
26. But see Franklin Allen & Elena Carletti, Credit Risk Transfer And Contagion, 53 J. MONETARY ECON. 89, 93 (2006) (arguing that credit derivatives might reduce overall welfare through increased risk of contagion).
27. FRANKLIN ALLEN, RICHARD A. BREALEY, & STEWART C. MYERS, PRINCIPLES OF CORPORATE FINANCE 727 (8th ed. 2006).
28. Norman Menachem Feder, Deconstructing Over-the-Counter Derivatives, 2002 COLUM. BUS. L. REV. 677, 682-83.
29. See, e.g., ADOLF A. BERLE, JR., STUDIES IN THE LAW OF CORPORATION FINANCE 133 (1928);
30. Frank Partnoy, The Shifting Contours of Global Derivatives Regulation, 22 U. PA. J. INT'L ECON. L. 421, 424-28 (2001).
31. See Bank One Corp. v. Comm'r, 120 T.C. 174, 186 (2003) ("The origin of the swaps market is generally traced to a currency swap negotiated between the World Bank and IBM in 1981. That transaction involved an exchange of payments in Swiss francs for payments in deutschmarks. The first interest rate swap was negotiated with the Student Loan Marketing Association in 1982.").
32. Interbulk v. Louis Dreyfus Corp. (In re Interbulk, Ltd.), 240 B.R. 195, 201 (Bankr. S.D.N.Y. 1999).
33. Desmond Eppel, Note, Risky Business: Responding to OTC Derivative Crises, 40 COLUM. J. TRANSNATL L. 677, 680-81 (2002).
34. ALLEN ET AL., supra note 13, at 735-37;
35. Louis Vitale, Note, Interest Rate Swaps under the Commodity Exchange Act, 51 CASE W. RES. L. REV. 539, 547-59 (2001).
36. Thrifty Oil Co. v. Bank of Am. Nat'l Trust, 322 F.3d 1039, 1042 (9th Cir. 2003).
37. This is the rate of interest at which banks can borrow funds from other banks in the London interbank market. It is commonly used as a reference floating interest rate in swaps. See http:// www.bba.org.uk/bba/jsp/ polopoly.jsp?d=141.
38. Because swaps typically have net present values equal to zero at inception-that is, the swap is balanced and no payment is owing in either direction-the example implies a LIBOR rate of 2.5%. 0.01% = 1 basis point. See Linda M. Beale, Book-Tax Conformity and the Corporate Tax Shelter Debate: Assessing the Proposed Section 475 Mark-To-Market Safe Harbor, 24 VA. TAX REV. 301, 389-90 (2004).
39. For simplicity, I assume all payments are made annually, but actual practice various by jurisdiction. In the United States fixed payments are often made semi-annually and floating payments are made quarterly. The numbers in the example also do not take into account date conventions. For example, in the United States many swaps trade under an actual/360 day count convention.
40. Conversely, if the LIBOR rate fell below 2.5%, so that the floating payment was less than 4% in total, FIXED would make payments to FLOATING equal to the difference in the two rates.
41. Of course, the risk of the floating rate payer's default is only important if the swap becomes valuable from the fixed rate payer's perspective.
42. For example, the University of Texas policy on swaps requires collateral in all transactions where the University has more than $30 million of exposure to the counterparty's default and provides that the collateral "will consist of cash, U.S. Treasury securities, and Federal Agency securities guaranteed unconditionally by the full faith and credit of the U.S. Government." UNIVERSITY OF TEXAS SYSTEM, RULES AND REGULATIONS OF THE BOARD OF REGENTS, INTEREST RATE SWAP POLICY § 6.2 (last amended Aug. 23, 2007), available at http://www.utsystem.edu/bor/rules/70000series/70202.pdf.
43. ISDA, 2007 MARGIN SURVEY, available at https://www.isdadocs.org/c_and_a/pdf/ISDA-Margin-Survey-2007.pdf.
44. See generally OFFICE OF THE COMPTROLLER OF THE CURRENCY (OCC), OCC BULLETIN 96-43 (Aug. 12, 1996), available at http://www.occ.treas.gov/ftp/bulletin/96-43.doc.
45. SATYAJIT DAS, CREDIT DERIVATIVES: CDOs & STRUCTURED CREDIT PRODUCTS 6 (3d. ed. 2005) ("Credit derivatives are defined as a class of financial instruments, the value of which is derived from an underlying market value driven by the credit risk of private or government entities other than the counterparties to the credit derivative transaction.")
46. ISDA, 2001 MID-YEAR MARKET SURVEY, available at http://www.isda.org/(select "Survey & Market Statistics," then select "Summaries of Market Survey Results," then select "2001 Mid-Year").
47. ISDA, 2005 MID-YEAR MARKET SURVEY, available at http://www.isda.org/ (select "Survey & Market Statistics," then select "Summaries of Market Survey Results," then select "2005 Mid-Year"). The striking increase is undoubtedly largely the result of the growth of index swaps.
48. Paul J. Davies, Interest Grows For Credit Default Swaps, FIN. TIMES, March 7, 2006, at 41.
49. OCC, "Financial Performance of National Banks," 24-4 Q.J. 85 (Dec. 2005), available at http:// www.occ.treas.gov/qj/qj24-4/qj24-4.pdf. As of September 2005, national banks held $2.4 trillion of credit derivatives as protection sellers and $2.7 trillion held as protection buyers.
50. Id.
51. B. Gerard Dages et al., Fed. Reserve Bank of N.Y., An Overview of the Emerging Market Credit Derivatives Market (2005), available at http://www.bis.org/publ/cgfs22fedny4.pdf. The authors explains: "The market encompasses roughly under 700 underlying credits, of which some 170 are considered liquid. Roughly 30 of the underlying reference entities are emerging market sovereigns."
52. Id.
53. See DAS, supra note 31, at 2-3.
54. See generally Stephen J. Lubben, Beyond True Sales: Securitization and Chapter 11, 1 N.Y.U. J.L. & BUS. 89 (2004).
55. See Richard Beales, Exchanges Attempting To Offer Instruments That Align With OTC Credit Derivatives, FIN. TIMES, March 23, 2007, at 39.
56. Nomura Int'l plc v. Credit Suisse First Boston Int'l, 2 All E.R. (Comm) 56 (Q.B. 2003) (describing a credit default swap transaction, whereby "Nomura 'bought' from CSFB as 'seller' credit protection referable to Railtrack plc in a principal amount of US$10m. Nomura paid 0.47% of $10m per annum for the protection.").
57. At the start of 2006, the five most common reference entities or debtors were General Motors, Ford, DaimlerChrysler, Russia, and France Telecom. Alex Chambers & Mark Brown, Credit Derivatives: Fitch Says AIG Dominates Protection, EUROMONEY, Jan. 1, 2006, at 21.
58. Whether a credit event has occurred is sometimes subject to dispute, as when Argentina announced a debt exchange in 2001. Eternity Global Master Fund Ltd. v. Morgan Guar. Trust Co., 375 F.3d 168 (2d Cir. 2004);
59. see also Stephen J. Choi & G. Mitu Gulati, Contract as Statute, 104 MICH. L. REV. 1129, 1142-44 (2006).
60. ISDA, 2003 ISDA CREDIT DERIVATIVES DEFINITIONS § 4.2.
61. Id. § 4.5. "Failure to Pay" is defined, in part, as the failure of the reference entity to make "payments in an aggregate amount of not less than the Payment Requirement." "Payment Requirement" is a term that the parties can define, but otherwise defaults to obligations of at least $1 million.
62. Id. § 4.8(d).
63. Id. § 4.7. The restructuring must relate to debt in excess of the "Default Requirement," which is set at $ 10 million unless the parties agree otherwise.
64. Id. § 4.8(a). The definition of restructuring is not uniform among jurisdictions; for example, in the North American corporate market the definition is usually modified - and thus referred to as "Modified Restructuring"-by electing additional limitations on the maturity and transferability of the debt that can be delivered under the swap.
65. Id. § 2.32;
66. see also Frank Packer & Haibin Zhu, Contractual Terms and CDS Pricing, BIS Q. REV. (Mar. 2005) available at http:// www.bis.org/publ/qtrpdf/r_qt0503.htm.
67. ISDA, 2003 ISDA CREDIT DERIVATIVES DEFINITIONS § 4.6.
68. Outside of North America the guarantee provisions usually apply to all guarantees, not just those given to a subsidiary's creditors.
69. See supra notes 43-44.
70. See DAS, supra note 311, at 113.
71. INSOL INTERNATIONAL, CREDIT DERIVATIVES IN RESTRUCTURINGS 12 (2006). This might occur if the buyer used the credit default swap to hedge an illiquid debt, such as a bank loan with transfer restrictions, or simply because the buyer was making a speculative bet on the reference debtor's credit worthiness.
72. Cf. N.Y. INS. LAW § 3401 (McKinney 2007) ("No contract or policy of insurance on property made or issued in this state, or made or issued upon any property in this state, shall be enforceable except for the benefit of some person having an insurable interest in the property insured. In this article, 'insurable interest' shall include any lawful and substantial economic interest in the safety or preservation of property from loss, destruction or pecuniary damage.").
73. INSOL INTERNATIONAL, CREDIT DERIVATIVES IN RESTRUCTURINGS 11 (2006).
74. See generally ISDA, ISDA CREDIT DERIVATIVES PHYSICAL SETTLEMENT MATRIX (Apr. 18, 2006), available at http://www.isda.org/c_and_a/docs/Credit-Derivatives- Physical-Settlement-Matrix-20060418.xls. The Credit Derivatives Physical Settlement Matrix-which is updated periodically-sets out the most commonly used provisions by jurisdiction for credit default swaps.
75. Id. Parties can adopt these "market standard" terms by incorporating the Matrix into their transaction.
76. See ISDA, 2005 MATRIX SUPPLEMENT TO THE 2003 ISDA CREDIT DERIVATIVES DEFINITIONS (Mar. 7, 2005), available at http:// www.isda.org/publications/pdf/2005-Supplement-for- CDS-Matrix.pdf.
77. Cf. J. DAUCHEN & P. BINZEN, THE WRECK OF THE PENN CENTRAL 289-90 (2d ed. 1999) (noting the Nixon Administration's concerns about the effects of Penn Central's bankruptcy on the money markets).
78. According to one industry source, "the most liquid CDS is the five-year contract, followed by the three-year.... The fact that a physical asset does not need to be sourced means that it is generally easier to transact in large round sises with CDS." Dominic O'Kane, et al., Lehman Brothers, The Lehman Brothers Guide to Exotic Credit Derivatives 6 (2003), available at http://investinginbonds.com/assets/files/ LehmanExoticCredDerivs.pdf.
79. See generally Eduardo Porter, Auto Bailout Seems Unlikely, N.Y. TIMES, Apr. 14, 2006, at Cl.
80. A credit default swap spread is the cost per year for protection against a default by the referenced firm. Table 2 shows that a two year credit default swap on GM, purchased in late March, would have cost the protection buyer almost 12% (11.9932%) of the face amount of the swap.
81. As quoted by Markit Group Limited (www.markit.com).
82. This is referred to as "basis risk" in the derivatives community. There is also a related question of whether all triggering defaults will be publicly known, which is a problem that could be especially acute if the reference entity is not subject to SEC reporting obligations.
83. See Lubben, supra note 35, at 93-94. Stated at a very basic level, a securitization involves the sale of an asset or a group of similar assets to a separate but related legal entity that then borrows against those assets to pay the purchase price to the selling party. More formally, in a securitization transaction the owner of the assets (the "originator") transfers assets to a newly created subsidiary called a "special purpose vehicle" (the "SPV") that issues debt or comparable securities to the market, based on the cash-flows anticipated from the assets. The funds generated from the sale of these securities are used by the SPV to pay the originator for the purchased assets.
84. Id.
85. See DAS, supra note 31, at 181-201.
86. Index composition and price information can be found at http://www.markit.com/markit.jsp?jsp page=indices.jsp.
87. $800,000 = (1/125)($100 million)
88. See Richard Beales, equel Could Contain Many Plot Twists After A Tear Of Extraordinary Growth, There Is Still Plenty Of Room For Drama In The Credit Derivatives Market, FIN. TIMES, Jan. 6, 2006, at 37.
89. As explained on one industry web site: It's not hard to see why [leveraged loan credit default swaps have] attracted significant investor interest Buyers of protection, i.e. taking a short credit risk position, are able to hedge risk on loans without the borrower knowing, This is particularly important for bank portfolio managers... for whom managing client relationships is paramount.
90. Gavan Nolan, Markit, LCDS Forum Summary, www.markit.com/marketing/ lcds_summary.php (last visited Oct. 16, 2007).
91. Jenny Anderson, Derivatives May Put the Hew "York Fed Chief Through a Stress Test, N.Y. TIMES, Feb. 9, 2007, at Cl ("The so-called "assignment issue" was simple: credit derivatives were negotiated by two parties, say JPMorgan and Goldman Sachs. But banks were "assigning" the contracts out to others-like hedge funds-without telling each other. It was a little bit like lending money to a friend who is really rich who in turn lends it to her deadbeat brother and fails to mention it."). A substantial number of swaps also contain errors in their documentation, an issue that could present serious problems in the event of a major economic downturn.
92. See ISDA, ISDA 2006 OPERATIONS BENCHMARKING SURVEY 5 (2006) (reporting a 17% average error rate for credit derivative transactions), available at http://www.isda.org/ c_and_a/pdf.ISDA-Operations-Survey-2006.pdf.
93. Most of the derivatives in the global derivatives market are documented under ISDA documentation. The ISDA Master Agreement, the most current version of which is the 2002 ISDA Master Agreement, is a standard agreement, used in the industry, to provide a set of default terms for a series of derivative transactions between a set of counterparties. A "schedule" is attached to the Master Agreement to account for party-specific terms of the deal. The economic terms of individual derivative transactions are reflected in "confirmation" term sheets, which are deemed to be part of the single Master Agreement between the parties, somewhat like the schedules of equipment used in long-term equipment leases. Each confirmation will incorporate by reference a relevant set of ISDA definitions. In the credit derivatives context, this is typically the 2003 ISDA Credit Derivatives Definitions. Also commonly used are documents related to credit support, which are used when parties are of differing credit quality and provide for the lower credit quality party to provide collateral to reduce the credit risk associated with the transaction. See generally www.isda.org;
94. see also Ursa Minor Ltd. v. Aon Fin. Prods, Inc., No. 00 Civ. 2474 (AGS), 2000 U.S. Dist. LEXIS 10166, at * 6.8 (S.D.N.Y. July 21, 2000).
95. ISDA 2002 MASTER AGREEMENT § 7.
96. See Richard Beales, Popular Credit Market Still Too Opaque, FIN. TIMES, Jan. 6, 2006, at 21.
97. Richard Beales, Sign-ups Strong on New ISDA Practices, FIN. TIMES, Nov. 25, 2005, at 41 (The broad acceptance of the new procedures ?intended to streamline assignments, in which one party transfers its position in an existing trade to a third party - should help reduce one of the thorniest documentation problems for the fast-growing credit derivative market.").
98. See Greg Ip & Carrick Mollenkamp, U.S. and Britain Team Up to Test Financial Risk, WALL ST. J., Mar. 2, 2006, at C1;
99. see also Stacy-Marie Ishmael, Banking Staff Face Derivatives Backlog, FIN. TIMES, Oct. 25, 2007, at 27.
100. In re Delphi Corporation, et al., 05-44481 (RDD) (Bankr. S.D.N.Y. Oct. 8, 2005).
101. See Richard Beales, Uncertain Road Ahead For Delphi, FIN. TIMES, NOV. 8, 2005, at 45.
102. See Richard Beales, Credit Derivative Industry Set To Propose New Settlement Rules, FIN. TIMES, Jan. 31, 2006, at 30.
103. While traditionally these settlement procedures have been used only in conjunction with index prod-ucts, the process was recently extended to single name swaps. See Press Release, Creditex And Markit Announce Results Of Dura Credit Event Fixing For Defaulted Bonds (Nov. 28, 2006), available at http:// www.creditex.com/press/dura.pdf.
104. For example, in the Delphi Automotive chapter 11 case there was $28 billion in outstanding swaps, including $8 billion in single names, (on $5.2 billion in bond and bank debt) and $20 billion in indexes.
105. In re Southland Corp., 124 B.R. 211 (Bankr. N.D. Tex. 1991).
106. See generally Robert A. Jacobs, The Chapter 11 Corporate Tax Survival Kit or How to Succeed as Guardian Ad Litem of a Corporate Debtor's NOLS, 42 TAX LAW. 3 (1988).
107. For more background on these orders, see http://www.lsta.org/assets/ files/Standard_Documents/ Legal_Analysis-Regulatory_Matters/NewModelNOLOrder. doc.
108. See generally Stephen J. Lubben, Railroad Receiverships and Modem Bankruptcy Theory, 89 CORNELL L. REV. 1420 (2004).
109. Act of June 22, 1938, (the "Chandler Act"), ch. 575, 52 Stat. 840, repealed by Bankruptcy Reform Act of 1978 (the "Bankruptcy Code"), Pub. L. No. 95-598, 92 Stat. 2549.
110. See generally Charles J. Tabb, The Future of Chapter 11, 44 S.C. L. REV. 791 (1993).
111. See, e.g., Douglas G. Baird & Robert K. Rasmussen, The End of Bankruptcy, 55 STAN. L. REV. 751 (2002);
112. Stephen J. Lubben, The "New and Improved" Chapter 11, 93 KY. LJ. 839 (2005).
113. 11 U.S.C. § 1102(2006).
114. Courts and academics often proclaim, with little analysis, that the Bankruptcy Code prohibits nondebtor termination of contracts. A careful reading of sections 362 and 365 shows that this assertion is overstated. The Bankruptcy Code simply ensures that the non-debtor party will have to pay full breach damages if it terminates a contract solely because of the debtor's bankruptcy filing. In most cases paying damages is an unattractive option, since the debtor will likely incur substantial costs to cover. In short, the Code often effectively precludes termination by the non-debtor party, by making it prohibitively expensive, but there may be instances in which a party could advance sufficient "cause" to lift the automatic stay for purposes of breaching a contract.
115. 11 U.S.C. § 365(a), (f) (2006).
116. § 1121.
117. See Bankruptcy Abuse Prevention and Consumer Protection Act, Pub. L. No. 109-8, § 441 (2005) (adding a new paragraph to section 1121(d) that limits the debtor to a single 14-month extension of both the exclusivity and plan solicitation periods).
118. See generally Jay Lawrence Westbrook, The Control of Wealth in Bankruptcy, 82 TEX. L. REV. 795 (2004).
119. Douglas Baird & Robert Rasmussen, Chapter 11 at Twilight, 56 STAN. L. REV. 673, 675 (2003).
120. 11 U.S.C. § 506(b) (2006).
121. Sec supra notes 87-88.
122. represents 0.04% the total costs of brining the motion ($400,000) over the total unsecured claims ($900 million) and 0.04% of $50 million (the amount of this bondholder's claim) equals $22,222.
123. See 11 U.S.C. § 1103(c) (2006)
124. See Stephen J. Lubben, Some Realism About Reorganization: Explaining the Failure of Chapter 11 Theory, 106 DICK. L. REV. 267, 301-02 (2001).
125. See Lubben, supra note 81, at 849-56.
126. See In re Liberty Warehouse Assoes. Ltd. P'ship., 220 B.R. 546 (Bankr. S.D.N.Y. 1998).
127. 11 U.S.C. § 506(b).
128. 11 U.S.C § 506 (interest only accrues to the extent the collateral value "is greater than the amount of [the] claim.").
129. 11 U.S.C § 362;
130. see also United Sav. Ass'n of Tex. v. Timbers of Inwood Forest Assoes., Ltd. (In re Timbers of Inwood Forest Assoes., Ltd.), 484 U.S. 365 (1988) (holding that undersecured creditors are not entitled to compensation for the delay caused by the automatic stay in foreclosing on their collateral).
131. See, e.g., Daniel Keating, Pension Insurance, Bankruptcy and Moral Hazard, 1991 WIS. L. REV. 65, 67-68.
132. Even if there is no credit risk associated with the counterparty, differences in taxation will prevent perfect equivalence with government bonds.
133. In a transaction where the protection buyer settles the swap with the hedged debt, the g term essentially drops out of the equation (or equals zero).
134. See generally David A. Skeel, Jr., Creditors Ball: The "New" New Corporate Governance in Chapter 11, 152 U. PA. L. REV. 917 (2003).
135. This situation is unlikely to arise in reverse, as the protection buyer would have an incentive to disclose its superior information and avoid overpaying for the bonds.
136. See Viral V. Acharya & Timothy C. Johnson, Insider Trading in Credit Derivatives, 84 J. FIN. ECON. 110, 111-12 (2007).
137. Cf Chaim J. Fortgang & Thomas Moers Mayer, Trading Claims and Taking Control of Corporations in Chapter 11, 12 CARDOZO L. REV. 1 (1990).
138. See Deutsche Bank v. AMBAC Credit Prods., No. 04 Civ. 5594, 2006 WL 1867497 at *6-7 (S.D.N.Y. Jul. 6, 2006) (describing transaction in which Deutsche Bank intended to settle a CDS it had purchased with bonds received under a CDS that the bank had sold).
139. Since many of the large dealers have high credit ratings, they may be able to buy protection for less than the cost paid by the parties buying protection from them, leaving the dealer with gains equal to the spread.
140. The Loan Syndication and Trading Association (LSTA) has developed a series of standardized lending forms that allow for greater trading in bank loans. LSTA, Standard Documents and Publications, http://lsta.org/documents.asp (last visited Oct. 18, 2007). One practitioner advises that about "five years ago, banks began to refuse to include any limitation on transferability in their loan documents." Email from R. Michael Farquhar, Winstead Sechrest & Minick, to the author (Jun. 7, 2006, 12:53 p.m.) (on file with author). ISDA recently published model documents for use in credit default swap transactions where the reference obligation is a syndicated secured loan and the deliverable obligations are also syndicated secured loans.
141. See Syndicated Secured Loan Credit Default Swap Template (published June 8, 2006) (available at www.isda.org).
142. Apparently hedge funds can sell protection without recording a potential liability on their balance sheets, increasing the attractiveness of this approach.
143. See 11 U.S.C. § 303 (2006).
144. Cf. FED. R. BANKR. P. 2019(a) (requiring disclosures from creditor groups, including "the amounts of claims or interests owned by the entity, the members of the committee or the indenture trustee, the times when acquired, the amounts paid therefor, and any sales or other disposition thereof).
145. See Stephen J. Lubben, The Direct Costs of Corporate Reorganization: An Empirical Examination of Professional Fees in Large Chapter 11 Cases, 74 AM. BANKR. L.J. 509, 516 (2000).
146. Credit default swaps may also discourage participation in creditors' committees, especially by large financial institutions. Courts have repeatedly held that committee members owe fiduciary duties to the class of creditors they represent. E.g., Westmoreland Human Opportunities, Inc. v. Walsh, 246 F.3d 233, 256 (3d Cir. 2001). A large financial institution with an active trading arm already faces problems reconciling its dual roles in chapter 11, and the growth of swaps may convince these creditors to avoid problems by declining committee membership altogether.
147. See 11 U.S.C. § 1126(c) (2006).
148. Reorganization of Railroads Engaged in Interstate Commerce, Pub. L. No. 72-420, 47 Stat. 1474 (1933),
149. repealed by Bankruptcy Reform Act of 1978, Pub. L. No. 95-598,.92 Stat. 2549;
150. see Stephen J. Lubben, Out of the Past: Railroads & Sovereign Debt Restructuring, 35 GEO. J. INT'L L. 845, 850 (2004).
151. See Shaun Martin & Frank Partnoy, Encumbered Shares, 2005 U. ILL. L. REV. 775, 778-79.
152. Alexander Hamilton, Report on Public Credit (Jan. 9, 1790), in ALEXANDER HAMILTON: WRITINGS 531, 540-41 (Joanne B. Freeman ed., 2001).
153. See In re Pengo Indus., Inc., 962 F.2d 543, 550 (5th Cir. 1992).
154. See generally LYNN M. LOPUCKI, COURTING FAILURE: HOW COMPETITION FOR BIG CASES IS CORRUPTING THE BANKRUPTCY COURTS (2005).
155. See Lubben, supra note 72, at 1483.
156. See generally STEPHEN J. LUBBEN, ABI CHAPTER 11 PROFESSIONAL FEE STUDY (2007).