Rarely is bankruptcy court a welcome detour, but more struggling banks may take it to overcome debtholders blocking their recapitalization efforts.

Bank lawyers had long talked about tapping the asset-sale procedures under section 363 of the bankruptcy code as a way to pressure the owners of pooled trust-preferred securities to give in and agree to deal.

Last month the $1.5 billion-asset AmericanWest Bancorp in Spokane, Wash., did it. Observers said the industry is taking note.

"I believe there are a meaningful number of distressed financial institutions giving serious consideration to the … bankruptcy alternative," said Christopher Zinski, a lawyer at Schiff Hardin. "This could work for banks that have a good core franchise and where the buyers want only the operating parts of the company. That is where the value is."

A prerequisite for this kind of structure is a commitment of fresh capital. In the case of AmericanWest, SKBHC Holdings LLC, a bank holding company backed by private-equity groups and other investors, was ready to pour $185 million into its bank unit. SKBHC was the stalking horse in the AmericanWest auction carried out by the U.S. Bankruptcy Court for the Eastern District of Washington. SKBHC paid $6.5 million for the bank.

To get that capital, the bank must have some redeeming value, but the company needs the cooperation of various stakeholders. Most of the players, from the Treasury Department to common shareholders, have been willing to take discounts or dilution as they believe the bank might fail without their cooperation. Holders of pooled trust-preferred securities, however, have been a harder sell — that's where the force of the bankruptcy court comes in.

"It forces the trust-preferred to come to the table," said Brad Williamson, the director of banks at the Washington Department of Financial Institutions. "For the past several years, investment bankers have been telling banks that it is highly unlikely that trust-preferred holders would approve any deal."

The decision to file for bankruptcy is not easy one.

Pat Rusnak, AmericanWest Bancorp's chief executive, said in an interview that the parent company searched for capital for two years before deciding on bankruptcy. Taking note of other companies' struggles with resolving impasses with holders of trust-preferred securities, officials concluded that carrying out an exchange was not a viable option, he said.

"You do it when it is clear that in either scenario the shareholders get zero," Rusnak said. "It is a tough pill to swallow to say conclusively that you've foreclosed all other opportunities."

Rusnak added that any companies considering the option should "carefully manage the amount of runway left with regulators."

Regulators would not say whether they backed the bankruptcy method, but Kenneth Kohler, a lawyer at Morrison Foerster, which represented AmericanWest, said the regulators were supportive. "They knew this was pending and were very cooperative ... just letting it move forward."

The problem with trust-preferred securities has been multifaceted. The architects of the collateralized debt obligations never developed a plan in case of a massive industry downturn.

"They were designed to be secure investments," said Michael Iannaccone, the president of MDI Investments in Chicago. "The failure rate of banks was so low that no one thought they needed to have a plan for a bank failing."

Holders have been stubborn. Groups like Hildene Capital Management, a vocal hedge fund that holds trust-preferreds, have mostly been unwilling to entertain discounted exchange offers. With AmericanWest, Hildene filed an objection to the bankruptcy. The court denied it, saying the debtholders were represented by the trustee, which had given consent.

Surprisingly, John Scannell, Hildene's chief operating officer, said his firm is not opposed to a bankruptcy process for the parents of banks facing failure. His firm's objection came from a concern that the process could have opened the door for other bidders for the bank.

"We are not opposed to bankruptcy for a bank that isn't going to make it, as long as it is a fair process," Scannell said.

Getting the trustee to act has been tough. Lawyers said that the trustee only acts when urged by at least a supermajority of the holders out of fear of litigation.

Bank of New York Mellon Corp., one of the most frequent trustees, said in a statement that, "in general, a trustee can take action on behalf of the holders only if directed by the requisite percentage of holders, which is outlined in the indenture. In addition, the indenture permits the trustee to receive indemnity before taking any action on behalf of the holders."

Collectively, those issues with trust-preferreds create a paralyzing situation that can lead to a bank failing, not because it couldn't find the money, but because it couldn't get all of its stakeholders to agree. That makes bankruptcy compelling, Williamson said.

"While we are never glad to see one declare bankruptcy, it is a much better scenario than having a bank fail," Williamson said. "We want banks that can be saved to be saved."

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