Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Operational versus financial creditors redux

A month back when I blogged about Creditor versus Creditor and Creditor versus Debtor, I talked about the potential for conflicts between operational and financial creditors, but did not have any good examples of such battles. I am able to remedy that gap now thanks to the fading fortunes of shale oil producers in the United States. A couple of days ago, Reuters carried a story about three instances where operational creditors had initiated involuntary bankruptcy proceedings against large energy producers to avoid being outmanoeuvred by financial creditors:

Involuntary bankruptcy gives vendors some say over how an energy producers’ dwindling funds are managed, and vendors can use it to try to stop a company from cutting deals that favor lenders or investors.

Such cases also allow creditors to choose the court, and all three of the recent cases have been filed outside the busy bankruptcy court in Wilmington, Delaware. Bankruptcy lawyers in Texas said that may suggest suppliers are worried the court is too eager to approve quick sales of businesses, which tend to favor secured creditors.

A lawyer for the creditors … said the involuntary bankruptcy prevented the Gulf of Mexico producer from being stripped of all of its value in favor of the company’s owners.

If the facts stated in the story are correct, then standard theory (governance rights vest with residual rights) would imply that the operational creditors should indeed be in charge of the bankruptcy process.

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