Enron Debtholder Ruling Raises Hackles

''It was not a risk they could have avoided even if they did do due diligence,'' argues one critic of a bankruptcy court ruling.
Stephen TaubDecember 12, 2005

A ruling that would subordinate claims of certain Enron debtholders is drawing criticism from a trio of trade groups.

Loans that were made to Enron by banks the company maintains committed fraud, and that were then sold by the banks to investors, should be subordinate to all other claims, ruled U.S. Bankruptcy Judge Arthur Gonzalez, according to Credit Investment News. Buyers of bonds and credit default swaps should be treated similarly, he reportedly added.

Judge Gonzalez reportedly asserted that his ruling would make it easier for the debtor, which wouldn’t need to sue the banks in question to recover its losses, and harder on wrongdoers, which wouldn’t be able to trade claims to avoid their being subordinated.

The ruling doesn’t sit well with the Loan Syndications and Trading Association, the International Swaps and Derivatives Association, and the Bond Market Association. The LSTA, ISDA, and BMA argue that the ruling is “tantamount to saying the claims have no value,” and reportedly they have filed an amicus brief in support of an appeal by investors.

According to Credit Investment News, the judge showed little sympathy to investors who bought Enron bankruptcy claims, asserting they should understand the risks involved, including the possibility that the claims would be subordinated.

LSTA executive vice president and general counsel Elliot Ganz responded that it is impossible for investors to determine whether the party they bought claims from was guilty of wrongdoing, added the News. “They should be aware of the risks,” he reportedly said. “But there is no way to determine whether the seller engaged in bad acts. The lawsuit was filed after they bought the loans. It was not a risk they could have avoided even if they did do due diligence.”

Craig Goldblatt, counsel for the ISDA, reportedly added that it would be very difficult to determine whether those accused of wrongdoing in the Enron bankruptcy had committed fraud since many of them are banks, and “you can’t do due diligence on a major financial institution.”

The judge’s decision “will definitely affect what people are willing to pay for bonds of bankrupt companies,” argued BMA senior vice president and regulatory counsel Marjorie Gross, according to the report.