102 Pages Posted: 3 Mar 2017 Last revised: 13 Jun 2017
Date Written: February 23, 2017
Bond workouts are a famously dysfunctional method of debt restructuring, ridden with opportunistic and coercive behavior by bondholders and bond issuers. Yet since 2008 bond workouts have quietly started to work. A cognizable portion of the restructuring market has shifted from bankruptcy court to out-of-court workouts by way of exchange offers made only to large institutional investors. The new workouts feature a battery of strong-arm tactics by bond issuers, and aggrieved bondholders have complained in court. The result has been a new, broad reading of the primary law governing workouts, section 316(b) of the Trust Indenture Act of 1939 (“TIA”), which prohibits majority-vote amendments of bond payment terms and forces bond issuers seeking to restructure to resort to exchange offers.
This Article exploits the bond market’s reaction to the shift in law to reassess a long-standing debate in corporate finance regarding the desirability of TIA section 316(b). Section 316(b) has attracted intense criticism, with calls for its amendment or repeal because of its untoward effects on the workout process and tendency to push restructuring into the costly bankruptcy process. Yet section 316(b) has also been staunchly defended on the ground that mom-and-pop bondholders need protection sharp-elbowed issuer tactics.
We draw on a pair of original, hand-collected data sets to show that many of the empirical assumptions made in the debate no longer hold true. We show that markets have learned to live with section 316(b)’s limitations, denuding the case for repeal of any urgency. Workouts generally succeed, so that there is no serious transaction cost problem stemming from the TIA; when a company goes straight into bankruptcy there tend to be independent motivations. We also show that workout by majority amendment will not systematically disadvantage bondholders. Indeed, the recent turn to secured creditor control of bankruptcy proceedings makes them all the more attractive to unsecured bondholders.
Based on this empirical background, we cautiously argue for the repeal section 316(b). Section 316(b) no longer does much work, even as it prevents bondholders and bond issuers from realizing their preferences regarding modes of restructuring and voting rules. We do not know what contracting equilibrium would obtain following repeal, but think that the matter is best left to the market. Still, we recognize that markets are imperfect and that a free-contracting regime may result in abuses. Accordingly, we argue that repeal of section 316(b) should be accompanied by the resuscitation of the long forgotten doctrine of intercreditor good faith duties, which presents a more fact-sensitive and targeted tool for policing overreaching in bond workouts than the broad reading of section 316(b).
Keywords: Corporations, Bankruptcy, Corporate Finance, Securities, Bonds, Financial Distress, Reorganizations, Debt Restructuring, Trust Indenture Act, Collective Action Clauses, Unanimous Action Clause, Creditor Coercion, Exit Consents, Intercreditor Duty of Good Faith
JEL Classification: G33, G38, K22
Suggested Citation: Suggested Citation
Bratton, William W. and Levitin, Adam J., The New Bond Workouts (February 23, 2017). U of Penn, Inst for Law & Econ Research Paper No. 17-9; European Corporate Governance Institute (ECGI) - Law Working Paper No. 356/2017. Available at SSRN: https://ssrn.com/abstract=2909186 or http://dx.doi.org/10.2139/ssrn.2909186