By Professor Jing-Zhi Huang, Professor Stefan Lewellen, and Professor Zhe Wang (Pennsylvania State University)
Bankruptcy is a high-stakes game of negotiation, and creditor coalitions have emerged as game-changers in Chapter 11 proceedings. Despite their growing influence, these coalitions remain largely unexplored in academic research. This study is the first to systematically investigate their role, addressing two critical questions: (1) what drives creditor coalition formation in bankruptcy, and (2) how do creditor coalitions affect key outcomes, such as recovery rates and delays in bankruptcy?
Creditor coalitions, especially ad hoc committees that are formed voluntarily and flexibly by creditors, serve as powerful vehicles for coordination in the face of fragmentation among creditors. This study uses a theoretical framework to predict that coalition formation is influenced by factors such as the debt size, creditor dispersion, creditor types, market liquidity, and the creditors’ prior interactions. For example, in cases involving larger classes, dispersed ownership, or illiquid debt, coalitions are more likely to form because they reduce trading costs and enhance bargaining power. Additionally, familiarity among creditors from past restructuring interactions encourages coalition formation, as trust and cooperation are easier to establish. Conversely, coalitions are less attractive when banks hold large portions of debt, as regulatory constraints often prompt these creditors to sell their defaulted claims quickly—typically at a discount—rather than participate in prolonged negotiations.
The study goes beyond theoretical predictions, providing empirical evidence to support its hypotheses. Leveraging novel data from court filings—especially Rule 2019 disclosures—on creditor holdings and coalition memberships in U.S. Chapter 11 cases, the study shows that coalition formation aligns with the drivers predicted by the theoretical framework. Furthermore, the study finds that coalition announcements are associated with increased bond prices, signaling that markets expect better recoveries when coalitions are involved. Importantly, empirical findings reveal that coalitions enhance recoveries not just for their own members but often for the firm as a whole, as demonstrated by significant positive returns for bonds across creditor classes following coalition announcements.
But coalitions are not just cooperative partners; they are also strategic actors. Using the landmark 2017 Peabody court ruling, the study shows how weakened within-class equality rules have shifted the incentives for coalition formation. Following Peabody, coalitions grew in size and influence, and class recoveries improved. However, the flip side was clear: larger coalitions amplified conflict, delayed case resolutions, and heightened litigation risks. This “creditor-on-creditor violence” underscores the double-edged nature of coalitions—they consolidate power for their members but can exacerbate inefficiencies in the restructuring process.
This research underscores the importance of a nuanced approach to creditor coalitions. Policymakers and practitioners must weigh their benefits—greater recoveries, improved coordination—against the risks of extended litigation and unequal outcomes among creditors. With creditor coalitions now becoming a dominant force in the restructuring process, understanding their economics and strategies is essential for navigating modern bankruptcy.
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