Template:M intro isda bankruptcy phase transition: Difference between revisions

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Created page with "Here is a scenario: {{quote|You are a credit officer in the commercial division of your local bank. It transpires your customer, who recently drew a £100 million fixed-rate term loan from you, is on the point of bankruptcy.}} What to do? ====The phase transition of bankruptcy==== {{drop|N|ow. In the}} jurisprudence of company law, formal insolvency is a “phase transition”: a company’s whole “legal context” ''changes'' upon its bankruptcy. Erstwhile ..."
 
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Here is a scenario:
[[The phase transition of bankrupcty|Here]] is a scenario:
{{quote|You are a [[credit officer]] in the commercial division of your local bank. It transpires your customer, who recently drew a £100 million fixed-rate [[term loan]] from you, is on the point of bankruptcy.}}
{{quote|You are a [[credit officer]] in the commercial division of your local bank. It transpires your customer, who recently drew a £100 million fixed-rate [[term loan]] from you, is on the point of bankruptcy.}}



Revision as of 19:00, 11 September 2024

Here is a scenario:

You are a credit officer in the commercial division of your local bank. It transpires your customer, who recently drew a £100 million fixed-rate term loan from you, is on the point of bankruptcy.

What to do?

The phase transition of bankruptcy

Now. In the jurisprudence of company law, formal insolvency is a “phase transition”: a company’s whole “legal context” changes upon its bankruptcy. Erstwhile certainties of contract vanish; in their place arise uncontrollable vagaries. An insolvency administrator is invested with wide, nightmarish discretions to do as she pleases, within reason, to ensure the right thing is done by the bankrupt’s creditors — one of whom is you — and its customers, employees and, if there is anything left, shareholders.

Creditors must fall upon her mercy. Outcomes are, thereby, uncertain. (You may recall from your first law lecture that legal systems don’t like not knowing what will happen. Financial services types have a particular aversion.)[1]

The administrator won’t care. She will quietly do what she can — and given her discretions, that is a lot — to stop precipitate creditors jumping her gun and swiping valuable assets. Hence, there is much fevered talk among legal eagles of voidable preferences and like magical notions.

The game is what demands certainty. The law recognises that when it is up, that imperative falls away. We are in exception territory: being too prescriptive is futile: it is best to let the administrator apply common sense.

In some jurisdictions, bankruptcy will operate to suspend creditor rights or stay the execution of legal processes. One may lose the right to call in a loan or close out Transactions, for example.

Bankers: meh

For a lender, this is not quite as drastic as it sounds. There are many ways of falling into bankruptcyeight at least, by ISDA’s reckoning — but to a lender it doesn’t much matter which of them applies: the bank’s position is more or less the same: munted.

Its goose is already cooked: suspending its right to claim from a borrower money that it does not in any case have is no great loss. Indeed, none of these discretions make much difference: the bank is owed 100 million pounds; it will get back significantly less than that. There is not much that an insolvency administrator can do to make that worse.

Derivatives counterparties: not so fast

Bankruptcy might not make much odds to a lender, but a derivatives counterparty is in a very different boat. How it manages its rights under the Transactions, and what exactly it is or is not allowed to do under the Master Agreement, makes an enormous difference.

  1. Which, yes, is highly ironic, seeing as the financial markets depend for their existence on uncertainty.