18.9 In recent years, hedge funds engaged in so-called loan-to-own prebankruptcy investments, in which they acquired debt

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18.9 In recent years, hedge funds engaged in so-called loan-to-own prebankruptcy investments, in which they acquired debt from distressed firms at a fraction of face value. Subsequently, they moved the company into Chapter 11, intent on converting the acquired debt to equity in a firm with sharply reduced liabilities. The hedge fund also provided financing to secure its interest in the business. The emergence from Chapter 11 was typically accomplished under Section 363(k) of the Bankruptcy Code, which gives debtors the right to bid on the firm in a public auction sale. During the auction, the firm’s debt was valued at face value rather than market value, discouraging bidders other than the hedge fund, which acquired the debt before bankruptcy at distressed levels. Without competitive bidding, there was little chance of generating additional cash for the general creditors. Is this an abuse of the Chapter 11 bankruptcy process? Explain your answer. (Appendix)

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