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The rise of claims trading is one of the most important changes in bankruptcy practice over the past 30 years. Many critics contend that claims trading has made chapter 11 much harder to administer. Chapter 11 is built on the assumption that the debtor will have lengthy and contentious negotiations with creditors that ultimately culminate in a consensual settlement and a fully supported reorganization plan.
However, chapter 11 practice began to drift further and further away from this classic paradigm in the late 1990s, as, so the story goes, a robust secondary market developed in the debt and equity of chapter 11 debtors. Some creditors decided not to negotiate with debtors and instead sold their claims to a new type of investor that both helped to create the secondary market and grew along with it: distressed hedge funds that specialize in activist investing in chapter 11. Over the years, there have been many calls to change bankruptcy law or practice to accommodate what many see as a disruptive change, including an ABI Journal article.1
In a recent paper,2 the author conducted the first empirical study of the one of the largest markets for bankruptcy claims: trading in the corporate bonds issued by chapter 11 debtors. The study relied on the entire record of bond-trading for all chapter 11 debtors that filed for bankruptcy between 2002-12, which were then matched to important dates and case information from the court dockets. The data source used for the study has a key limitation, however.3
First, a note about the author's methodology. Consider a hypothetical trade of a small amount of a bond issued by a debtor prior to the debtor's bankruptcy. Assume that one hedge fund sells the right to receive $100 from the debtor to another investor for $10 (or 10 cents on the dollar) on March 1, 2005. In the dataset, the author observed the fact that a trade of $100 of the debtor's bond issue happened on March 1, 2005, with a sale price of $10. However, the author is unaware of the buyer or seller's identity. While this limits the empirical conclusions, the data can still be informative about bankruptcy claims-trading.
This article summarizes some of the study's main findings. As further explained herein,...