The syndicated loan market is cheering a rule change that lets stakeholders in a Chapter 11 bankruptcy withhold certain information about their holdings.
The change to federal bankruptcy procedures, a Supreme Court order that took effect Dec. 1, is expected to put an end to litigation that has complicated some of the biggest workouts of the past four years, beginning with Northwest Airlines in 2007.
Though the revision increases the number of parties required to disclose information about their holdings, syndicated lenders and other investors no longer have to disclose the price they paid for their holdings or the date the holdings were acquired.
The old rule, which had been in effect since the late 1930s, clearly required stakeholders to reveal what they paid for their interests and when these interests were acquired. It was murkier about who had to disclose this information.
For years, it was largely ignored. Before senior loans became widely syndicated among institutional investors, the major stakeholders in most bankruptcy cases consisted of a company's commercial bank lenders, the holders of its high-yield bonds, its trade creditors and shareholders.
It wasn't until Northwest Airlines filed for bankruptcy before some parties began to use the rule to discourage stakeholders from joining forces to influence the outcome of a restructuring.
By this time, senior loans had attracted a new class of investors and a secondary market for all kinds of distressed claims had developed. Traders of these claims, many of them hedge funds, often joined forces, pooling their resources to promote common interests, making them major players in the bankruptcy process.
In the case of Northwest Airlines, equity holders, not creditors, banded together. "The issue was that equity got crammed down, it had no value," says Elliot Ganz, the general counsel of the Loan Syndication and Trading Association. "They wanted to form a committee and were making a lot of trouble. … Some enterprising lawyer actually read what Rule 2019 says: Each member of committee must file individually what each member holds, including the price it's held at and the dates they bought it."
Judge Allan Gropper of the U.S. Bankruptcy Court for the Southern District of New York in February 2007 ruled that the ad hoc equity committee had failed to comply with the disclosure requirements and ordered the committee to file a modified disclosure statement stating what each member owned, when the interest had been acquired and at what price.
Hedge funds are notoriously reluctant to provide information that might reveal something about their investment strategy, and pressing judges to require disclosures by ad hoc groups became a common way for other stakeholders to try to change the course of bankruptcy cases, including Lehman Brothers, Washington Mutual and Six Flags. Complicating matters further, judges in different circuits took different views of how to apply the rule.
The LSTA and the Securities Industry and Financial Markets Association lobbied the Committee on Rules of Practice and Procedure of the Judicial Conference to review the rule. Initially, Ganz says, their effort backfired.
Judge Robert E. Gerber, also of the Bankruptcy Court for the Southern District of New York, and others sought stronger disclosure requirements. The initial proposed revision, which Ganz calls "brutal," did just that.
Still, the two trade groups managed to convince the committee that, while they acknowledged the need for disclosure of interests, it was not necessary to detail the prices and dates. "In bankruptcy it's not important where you bought the asset, what's important is where it sits in the capital structure. If you have a senior, secured claim, it's still a senior, secured claim whether you paid 5 cents on the dollar or 100 cents," Ganz says.
The compromise is expected to discourage the kind of "frivolous litigation" that has characterized many bankruptcy cases, Ganz says.