VideoOne reason it might matter is that corporations are offered derivative-based contracts more often these days, and not just for simple interest-rate or FX swaps. "Financial markets have become incredibly reliant on a wide range of derivatives, including, most recently, credit derivatives," notes Goodwin Procter's Nolan. "There are a lot of transactions that are done synthetically with derivatives that five years ago would have been done by traditional loans."
Most companies, of course, don't enter into financial contracts thinking about what will happen if they default. "I don't think these changes to the bankruptcy code are going to surface in a CFO's mind as he is negotiating a transaction," says Campbell. But what happens once a company is in financial distress? In the past, he notes, it might take a bank 30 to 90 days after a Chapter 11 filing to get permission to unwind its transaction. That not only gave CFOs of troubled companies some wiggle room but also made banks more likely to come to their aid.
"But when you have a relationship that deals with these kinds of instruments, the bank will be able to pull the plug on the first day," Campbell says. "So now, as the CEO and CFO think through their options, one of those options has changed."
A case in point was the 2003 bankruptcy of Atlanta-based energy firm Mirant Corp. Although the case predates the recent bankruptcy act, the bankruptcy code allowed safe-harbor netting for the various types of derivative contracts that Mirant relied on for the delivery of gas and energy. On the day it filed, Mirant petitioned the court to approve a package of assurances and incentives demanded by its counterparties. Without them, Mirant told the court, "there is a high likelihood that many of the counterparties to [Mirant's] trading contracts would exercise their rights under the safe-harbor provisions of the bankruptcy code to terminate and liquidate the contracts, . . . jeopardizing the ability of the debtors to continue the trading activities that are necessary and prudent to ensure the continued operation of their power plants."
Mirant warned that without the court's help, "the reliability of the electric power grid may be threatened." And, ironically, Mirant warned that its "inability to continue at or near historical levels of operations could cause a domino effect within the fragile energy sector, triggering other financially distressed energy merchants to fail." In other words, the same safe-harbor provisions intended to prevent a systemic failure in the financial sector very nearly caused one in the energy sector.
Tim Reason is a senior editor at CFO.
Securitization Still Lacks a Safe Harbor
True or False?
Despite years of maneuvering, the financial industry ultimately abandoned efforts to get a safe-harbor provision for asset-backed securitization into the new bankruptcy law. Such a provision would have guaranteed that the transfer of receivables or other assets in a securitization was a "true sale" and shielded it from creditor challenges or bankruptcy court review.
While safe-harbor netting provisions for derivatives encountered little resistance other than philosophical objections, the securitization safe harbor became a lightning rod after LTV Steel tried to reclaim its securitized assets in bankruptcy in 2001. That got the attention of the AFL-CIO. "In the interest of getting the larger bill done, particularly the netting provisions," proponents scrapped the securitization safe harbor, says Mike Williams, the Bond Market Association's vice president for government affairs.
Ironically, the bankruptcy act still may be a boon to the securitization world, says Jack Williams, director of BDO Seidman Financial Recovery Services and a law professor at Georgia State University in Atlanta. "At worst, it's neutral for the securitization market. At best, it may be quite favorable," he says. That's because the new consumer provisions push individual debtors away from Chapter 7, which used to absolve them of debt, and into a revamped Chapter 13, which requires that they dedicate their disposable income to pay off creditors over a five-year period. Williams expects credit-card companies in particular will bundle up those payment streams and — you guessed it—securitize them. "From an academic perspective," he says, "it's a wonderful thing. Rarely do you get to see a new financial asset created." — T.R.
Cutting energy company Mirant's contracts under safe-harbor rules might have caused:
- An inability to fuel or operate "must run" plants in California
- Blackouts or brownouts in San Francisco and other major cities
- Failure of other distressed energy merchants
- Energy-market liquidity and power shortages
Source: Affidavit of Mirant chief risk officer Cameron Bready, July 2003
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