From Salon

Here's how it works: A lender buys the bonds of a company -- let's say General Growth, the huge mall operator that declared bankruptcy this week. But then, hoping to hedge against the risk that General Growth might default on its bond obligations, the lender purchases a credit default swap protecting against that event from another party, in effect buying insurance against the chance that those bonds will go bust.

But the kicker is that owning a credit default swap on General Growth bonds turns out to make the lender less willing to cut a deal that would allow General Growth to avoid bankruptcy, because the lender can get paid in full in the event of that bankruptcy by collecting on the insurance policy. So it's better for the lender to force the company to its knees rather than come to a less disastrous arrangement.

"We have seen CDS becoming a significant factor" when negotiations on out-of-court restructurings fail, said Alan Kornberg, the partner in charge of the bankruptcy practice at Paul, Weiss, Rifkind, Wharton & Rice, speaking generally. "We used to talk about the practice theoretically but now we see cases where it is hard to get lenders to agree to tender or to compromise and then you find out that these holdouts had significant CDS protection."