Playing both sides-CDS and restructuring

The traditional theory of corporate debt restructuring is based on the notion that major creditors want to protect their loans and will support a restructuring plan that saves the business and preserves their loan values or provides a better return than would result from the company entering liquidation. One challenge to this traditional view is that the ability of major creditors to use credit default swaps to obtain an economic benefit if a debtor defaults on their loans.

It is open to a distressed debt fund or special situations fund to buy up bonds or senior debt issued by a company in order to obtain a place at the restructuring table, while also buying up CDS which will protect the fund if the restructure fails.

On its face there is nothing exceptional about a major creditor seeking protection for their loans. However, there is no limit to the amount of CDS protection that can be obtained (aside from the willingness of swap counter parties to write CDS contracts). This means a party to a restructuring effort (whom other parties assume will have an economic interest in see the restructure succeed) may have an economic interest in seeing the restructure fail as the value of the CDS payments will exceed the payments on the face value of the loans.

The issue has come up in Australia with the proposed rescue of Arrium (the Australian steel maker, mining services and iron ore producer) by US distressed investment fund  GSO Capital Partners (part of the Blackstone Group). See further:

SMH article

GSO was involved in a dispute last year in New York regarding the restructure of a Norwegian company where it was alleged that it was ‘playing both sides’ by entering into CDS as well as buying up debt. See further:

NY Times article

Australia does not have specific disclosure laws relating to CDS positions held by secured creditors. It will be interesting to see how the Arrium restructuring plays out.

There are some useful articles on CDS and restructuring, see

Sarra, ‘Financing Insolvency Restructurings in the Wake of the Financial Crisis’ (2011) 29 Penn State International Law Review 581

Green, ‘The Impact of Credit Derivatives on Corporate Debt Restructurting’ (2008) 19 JBFLP 97


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