June 20, 2012 Articles

CDOs: Bankruptcy-Remote, Not Bankruptcy-Proof

In-house counsel should always keep the risk of an involuntary filing in mind.

By Adam Lavine and Sunny Thompson – June 20, 2012

In a decision with significant implications for the distressed CDO (collateralized debt obligation) market, the U.S. Bankruptcy Court for the District of New Jersey has held that CDO issuers may, in fact, be debtors under the Bankruptcy Code. While the decision may come as a surprise to some investors, it serves as a reminder that there is a reason why these types of entities are characterized as “bankruptcy-remote” and not as “bankruptcy-proof.”

A CDO is an investment-grade security backed by a pool of assets, such as bonds or loans. CDOs are uniquely structured to represent different types of debt and credit risk. The different types of debt are often referred to as “tranches” or “slices” and have different maturities and associated risks—the higher the risk, the higher the payout. Typically, a CDO issuer issues various tranches of securities in the form of notes, and a contract called an indenture governs both the terms of the notes, including the interest rate and maturity date, and the respective rights of the various tranches of noteholders.

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