Several people have asked me why Obama can't simply order a restructuring plan for the auto makers. As I've explained, his ability to do so depends on the company: he can't dictate terms to GM, but Chrysler he can fix by fiat.
A Richmond Times-Dispatch reporter, Emily Dooley, called me yesterday and clued me into an interesting story from the bankruptcy of LandAmerica, the Virginia based title insurance company that is in chapter 11. Her story is here, and Credit Slips readers will want to give it a look. It presents a twist on the usual story about bankruptcy claims trading.
LandAmerica had a subsidiary called LandAmerica 1031 Exchange Services, Inc., which would hold the cash earned from a real estate sale until it could be exchanged for reinvestment in property similar to the one sold. By reinvesting the cash in similar real property, U.S. tax law allows the seller to defer any tax owed from the sale profits. Continued rollovers could indefinitely defer the tax consequences. It's all governed by section 1031 of the U.S. Internal Revenue Code, which explains the name of the subsidiary.
Customers of LandAmerica 1031 Exchange Services were left holding the bag when the company joined its parent in a bankruptcy filing and are owed an estimated $419 million. A company has offered to buy their claims for 15 cents on the dollar, down from 20 cents on the dollar after an unfavorable court ruling. Bankruptcy claims trading can be a legitimate financial tool. Creditors get a certain, upfront cash payment rather than an uncertain payment at the end of a lengthy bankruptcy case. The purchaser of the claim can use its expertise and the power that comes from aggregating a bunch of small claims to maximize the recovery from the case. It could be a win-win.
Bankrutpcy claims trading, however, is almost wholly unregulated. The companies that purchase bankruptcy claims are sophisticated investors that often have a huge informational advantage over the creditors from whom they purchase claims. Although the bankruptcy court might have some tools to fix egregious misconduct, it often will not ever learn of abusive claims purchasing. From a policy perspective, the paradigmatic cases are small businesses or other trade creditors who do not have the financial sophistication to make an informed decision about whether to sell a claim in a bankruptcy case. In the LandAmerica case, however, the potential sellers principally appear to be consumers and hence maybe even at a bigger disadvantage than is true in the typical case.
None of this is to say that the claims trader in the LandAmerica case is not acting in good faith. Indeed, by the statements on its own web site, it tries to portray itself as one of the good guys in the industry. The point is, however, that the LandAmerica case provides a strong example of the need for some regulatory solution, perhaps with a uniform set of disclosures that need to be provided to the potential sellers of bankruptcy claims. A disclosure requirement of a good faith estimate of the potential recovery in the case would be a start. Until a regulatory regime becomes reality, there are players in the system who can play a constructive role. The U.S. Trustee, for example, strikes me as an entity that could do some good here, providing some basic guidance to the consumer creditors in the LandAmerica bankruptcy and ensuring that it does not become yet another situation where consumers lose out to another financial industry Goliath.
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