Now that the housing bubble has burst many debt vultures are focusing on what’s being described as the bankruptcy exchange. Many entities looking to make a quick and “easy” buck are buying up heavily discounted debt during a company’s bankruptcy and then using their leverage as a creditor to mold the company’s Chapter 11 bankruptcy reorganization plan to their benefit while working hard to disclose as little of their activity as possible.
To some in the bankruptcy bar, the investors’ tactics are an affront to a tradition meant to nurse companies back to health and save jobs. At worst, say critics, the involvement of distressed-debt investors can turn a bankruptcy case into an insiders’ game, putting at a disadvantage other creditors and even the judge who is trying to guide an outcome that best serves the company and the wide array of those it owes.
A perfect example of how these “investors” work is the Six Flags Chapter 11 bankruptcy. A hedge fund that had purchased discounted debt was able to swing the company’s reorganization in their favor and then dumped the bonds afterwards. This is not what companies are looking for when they file Chapter 11 bankruptcy and seek out investors in their company. Chapter 11 bankruptcy companies are searching for creditors who are willing to work with them over the haul and take steps to insure the long-term health and viability of their company. Short-term, “buy and dump” investors should not be able to heavily influence the bankruptcy reorganization of a company because they have no incentive to look out for the company’s long-term best interests.