In the jargon of the secondary bank loan market, loans beneficially owned by participation may be "elevated" to direct assignments once requisite administrative agent and/or borrower consent is obtained. Such "elevations" customarily have been viewed as straightforward transactions -- when completed, the participant simply stands in the shoes of the grantor and becomes the lender of record of the loan on the books of the administrative agent.

Years ago, second lien lenders adhered to the truism about children -- they were seen but not heard. As our children have grown more vocal in recent years, so too have second lien lenders. A spate of recent bankruptcy cases demonstrate that second lien lenders have been both seen and heard at many critical junctures in the chapter 11 timeline -- at the sale of the debtor’s assets under section 363 of the Bankruptcy Code,1 in seeking the appointment of an examiner,2 when voting on a chapter 11 plan,3 and in connection with the confirmation hearing.4

The trading rules and conventions of the loan market are well known to its participants. Similarly, the laws and practices governing equity securities trading in the U.S. are quite familiar to securities market professionals. The opportunity for confusion may arise, however, when these two markets quickly converge—for example, when the loans of a reorganized borrower are converted into or satisfied by the issuance of equity securities.

Does this sound familiar? A newly formed entity purchases distressed bank debt after the debtor has proposed a reorganization plan. The purchaser obtains a blocking position and uses its negotiating leverage to obtain control of the plan process and ultimately the borrower’s assets, which have strategic importance to the purchaser.

On April 25, 2011, as widely expected, a group of Lehman creditors holding claims arising from terminated derivatives transactions filed a competing plan of reorganization and related disclosure statement in the Debtors' chapter 11 cases. As a result of the new filing, there are now three competing plans – (1) the Debtors’ Plan, (2) the Ad Hoc Group’s Plan (filed by a group of bondholder creditors) and (3) the Non-Consolidation Plan (filed by the derivative claimants) - in the Lehman bankruptcy proceedings.

On April 27, 2011, the United States Supreme Court approved certain amendments to Bankruptcy Rule 2019 requiring disclosures by certain creditors and equity holders in Chapter 11 cases. We expect that amended Rule 20191 (“Amended Rule 2019”) will take effect as a matter of law on December 1, 2011 unless in the interim Congress enacts legislation to reject, modify, or defer the rules, which we view as unlikely.

On January 25, 2010, United States Bankruptcy Court Judge James M. Peck issued a decision that limited the ability of parties to swap transactions to enforce certain of their contractual rights against a counterparty that has filed for bankruptcy. See Lehman Brothers Special Financing Inc. v. BNY Corporate Trustee Services Ltd.1 (the “BNY Decision”).

An important battle about the place of secured lending in the United States economy is set to begin. When the battle ends, fundamental assumptions about the expected recovery rates for defaulted secured loans may change.

It has not taken long for another bankruptcy court to question the propriety of allowing secured creditors to credit bid their loans. You may recall that in the case of Fisker Automotive Holdings, Inc., et al. a Delaware bankruptcy court limited a creditor’s ability to credit bid based on self-serving testimony from a competing bidder that it would not participate in an auction absent the court capping the secured creditor’s credit bid.

In a recent decision that has captured the attention of the U.S. secondary loan market, the United States District Court for the Western District of Washington starkly concluded that hedge funds “that acquire distressed debt and engage in predatory lending” were not eligible buyers of a loan under a loan agreement because they were not “financial institutions” within the Court’s understanding of the phrase.