Six Flags filed for bankruptcy last month, but don't blame it on the recession driving down attendance at its amusement parks. Don't blame the credit markets for impeding Six Flags' access to fresh capital, either. Both of those factored in the company's decline, but the biggest culprit in its Chapter 11 filing was its own creditors. They had nothing to lose. Several large Six Flags bondholders voted down an offer that would have kept the former AstroWorld operator out of bankruptcy and given them an 85 percent equity stake in the company. Now, unsecured creditors may get as little as 10 percent. The bondholders who stonewalled the settlement offer had a secret weapon credit-default swaps. Those same arcane financial instruments that played a central role in last fall's global economic meltdown now may redefine how companies resolve their own financial crises, forcing more them into bankruptcy. That means more equity investors may get wiped out in corporate reorganizations and more employees may lose their jobs as companies cut costs in Chapter 11. Credit-default swaps function like insurance for debt investors, essentially guaranteeing that they get paid even if the debtor Six Flags in this case defaults. So rather than taking 85 percent, the swaps-holding Six Flags creditors allowed the company to file for bankruptcy, knowing the swaps would ensure they recover all of their investment. Not much incentive 'With devices such as credit-default swaps, it has become quite easy for creditors to protect themselves against default of their borrowers,' said Henry Hu, a University of Texas law professor who specializes in banking and finance issues. 'The incentives of the creditor to help the company that it has lent money to stay out of bankruptcy can be weaker now.' The increasing use of swaps undermines a fundamental concept of our bankruptcy laws. They were written with the assumption that creditors want to keep struggling companies out of bankruptcy because they're likely to get a bigger recovery by negotiating with the troubled company. 'You have these traditional assumptions that really no longer hold,' Hu said. 'When creditors have access to credit-default swaps the incentive to work with a borrower may be much less.' 'Empty creditor' Hu even coined the phrase 'empty creditor' two years ago to describe investors who because of credit-default swaps have little economic exposure to borrowers, and therefore no stake in keeping them solvent. Empty creditors may have played a role in other recent Chapter 11 cases, too, including mall owner General Growth Properties in April and the government-arranged filing of General Motors. With default rates rising, Hu believes empty creditors could become a bigger problem. How big, though, remains anyone's guess. Because swaps trade in the dark corners of the market, outside of an exchange, companies usually don't know whether creditors have such an insurance policy in their back pocket. That can make negotiations more difficult. 'You don't really know what the incentive of your creditors are,' Hu said. Protected by swaps Sometimes, those incentives may be predatory. For example, investors such as hedge funds might scoop up a helping of a troubled company's debt, ladle on some credit-default swaps, then wait for the company to fail. Better disclosure of swap holdings would give businesses more insight into their creditors' motives, but addressing the empty creditor problem may require changes in bankruptcy laws or restructuring debt agreements to account for creditors' full economic exposure rather than just debt holdings. In the meantime, we're likely to see more companies like Six Flags careening into bankruptcy court like a runaway mine train. Creditors may be along for the ride, but, protected by their swaps, they aren't going to put on the brakes. After all, they have nothing to lose. loren.steffy@chron.com http://blogs.chron.com/lorensteffy/. 