In Recent Years, Hedge Funds Have Engaged in So-Called "Loan-To-Own

question 28

Essay

In recent years, hedge funds have engaged in so-called "loan-to-own" pre-bankruptcy investments in which they acquire debt from distressed firms at a fraction of face value. Subsequently, they move the company into Chapter 11 intent upon converting the acquired debt to equity in a firm with sharply reduced liabilities. The hedge fund also provides DIP financing to further secure its interest in the business. The emergence from Chapter 11 is typically accomplished under section 363 (k) of the bankruptcy code which gives debtors the right to bid on the firm in a public auction sale. During the auction, the firm's debt is valued at face rather than market value, effectively discouraging any other bidders other than the hedge fund which acquired the debt prior to bankruptcy at distressed levels. Without competitive bidding, there is little chance of generating additional cash for the general creditors. How might this be viewed as an abuse of the Chapter 11 bankruptcy process?

Recognize exceptions to the perfect tender rule and how they impact the rigidness of the rule.

Define the terms "honesty in fact," "reasonable commercial standards of fair dealing," and "good faith" within the context of the UCC.

Comprehend the significance of the substantial-impairment requirement and its application.

Understand the implications of accepted goods and limitations on revoking acceptance.

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Definitions:

Debt-Equity Ratio

The debt-equity ratio is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets.

Pre-Tax Cost

The expense or cost that a company incurs which is calculated before any taxes are applied.

Return on Assets

A financial metric that indicates how profitable a company is relative to its total assets, demonstrating how efficient a company is at using its assets to generate earnings.