Judge Overturns Distressed Commercial Debt Ruling

A judge in New York this week overturned a March 2006 decision concerning commercial bankruptcy that sent the distressed-debt trading market into confusion, according to reporting in The Wall Street Journal today.

U.S. District Judge Shira Scheindlin ruled Monday against a previous court finding that buyers of claims against bankrupt companies could find the purchases disallowed if the seller didn’t act legally.

The original ruling from U.S. Bankruptcy Judge Arthur Gonzalez concerned buyers of claims against the bankrupt Enron Corp. In that case, Citibank and other major banks joined to make a $1.7 billion loan to Enron and sold a $5 million portion of the claim to Springfield Associates LLC following Enron’s bankruptcy, according to the Journal.

Enron sued Citi, claiming it had contributed to its collapse, and sued Springfield, saying that its $5 million claim should be disallowed because of Citi’s alleged misconduct. Gonzalez ruled in Enron’s favor.

The ruling caused trading in certain claims to shut down, severely impacting the $500 billion business, according to Merrill Lynch and influential trade groups like the Bond Market Association. They asked Judge Scheindlin to review the Gonzalez decision.

Scheindlin found that “good faith” purchasers of claims that believed the seller acted within the law cannot be penalized if the seller has acted in an unethical or illegal manner. However, a purchaser that knew of the seller’s misconduct would not be protected by commercial bankruptcy law.