Trends in Distressed Debt Investing: An Empirical Study of Investors' Objectives

Abstract

Increased creditor control in chapter 11 cases has generated considerable debate over the past several years. Proponents of creditor control argue that, among other things, it promotes efficiency in corporate reorganizations. Critics assert that it destroys corporate value and frequently forces otherwise viable entities to liquidate. The increasing involvement of professional distressed debt investors in chapter 11 cases has intensified this debate. In this article, I present and analyze empirical data regarding the investment practices and strategies of distressed debt investors. Based on this data and actual case reports, I reach two primary conclusions. First, although relatively few in number, activist distressed debt investors are well-financed and relatively successful in their attempts to influence change at or to acquire troubled companies. Second, unchecked creditor control by distressed debt investors or others has the potential to lead to creditor self-dealing, to the detriment of the debtor and its other stakeholders.

The Bankruptcy Code, as currently structured, presents opportunities not only for creditor control, but also for creditor self-dealing. In analyzing the survey data and actual case reports, I suggest one possible legislative change to create a more balanced, estate-focused chapter 11 process. This change would entail eliminating the concept of statutory committees and replacing it with an estate representative. The concept of an estate representative is just one proposal; certainly, alternative or complementary legislative changes could create a more balanced playing field in chapter 11 cases. I discuss a few of these prospective changes here. Moreover, the concept of an estate representative is a preliminary proposal. Further research and study is necessary to develop this and related concepts.

Keywords: activist investors, bankruptcy, chapter 11, creditor control, creditor conflict, creditors' committee, DIP loan, distressed debt, reorganization

JEL Classification: G33, G34, K29