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I have some questions about Bond seniority and bankruptcy, with regard to defaults and the procedural rights of bond holders. I’ll try and frame some of them—the best I can—in the hope that someone out there might be patient enough to try and help reduce my ignorance, LOL. I’ll apologize in advance for mistakes in nomenclature/ terminology...

If a bond defaults, what events go into motion? Does that differ, if the event happens at maturity, versus simply missing a coupon payment? Does it depend on whether or not the instrument is a secured bond, versus a note?

To frame the question better, I’ll be specific. Let’s take the case of Ford. Ford has a large amount of debt, as everyone is well aware. They’re also in the midst of a special tender for a portion of that debt. Their debt structure is also complicated. They have a number of preferreds: One junior subordinate trust. One exchange traded trust holding senior unsecured trust. They also have several secondary trusts, administered by financial institutions, that hold senior unsecured debt.

They also have a large amount of senior unsecured debt structured in bonds. Some of these issues are participating in the tender offer. Some are not. Finally, Ford has a large amount of senior secured debt. I believe that when this was issued, the credit revolver that they have now completely drawn down, was estimated to be approximately the value of Ford Motor assets. So, liquidation value would essentially only cover that senior secured debt.

My question is what actually happens when a bond defaults? Everyone always says, “that would trigger bankruptcy”. But, procedurally what actually happens? Nothing involving lawyers ever proceeds quickly...

I presume that the company would have to formally indicate to holders their inability to pay. I also expect (wrongly?) that default on a coupon payment would be less damaging than failure to pay principal at maturity. I presume that bondholders would need to execute legal action to initiate the process, and that if granted, chapter 11 would put the status of those bonds in legal limbo. As a secondary issue, does the ability of a creditor to initiate a chapter 11 complaint depend on their position in the capital structure (unsecured v. secured)?

I’ll go back to Ford’s case to explain myself. Let’s take for example, Ford’s Capital B V, 9.5% notes (CUSIP: 345220AB3). I pick these because they mature in June of 2010, so they’re realistically in danger of default on principal. They’re also senior unsecured debt (to my knowledge); they’re not secured by assets. I presume that if they default, institutional holders would begin chapter 11 proceedings against Ford. So, what procedurally occurs at that point?

Can the company begin negotiations with holders on a tender offer to avoid bankruptcy, or is it too late for this? Could the company negotiate a debt for equity exchange post default, or is it too late for this? I guess what I’m asking is whether or not default is the end game and signals irreversible entry to chapter 11. How do these things proceed? Can the institutional parties still negotiate once a complaint has been negotiated? Would holders wait to file the complaint, and seek to negotiate before filing? I presume all of this would be driven by institutional holders, and that retail holders would sit on their hands while the big boys sort out the details? I know these are lots of questions; poorly framed in some cases. But, I’ve seen that some of you have lots of patience and explain things well. I’m hoping someone can help fill in the gaps. Thanks in advance.
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