Complexity in Loan Contracts

Abstract

Using novel data on 1,240 credit agreements from the leveraged loan market, we propose simple measures of contractual complexity based on clauses qualifying negative covenants. We document a high average level of contractual complexity and significant heterogeneity. Sophisticated borrowers, and larger non-bank funding of a loan, are associated with more complex contractual terms. The 2017 J.Crew debt restructuring, a high-profile case involving a complex contract, corresponds to a market-wide value transfer from lenders to equity holders for borrowers with complex loan contracts. Contractual complexity in lending thus appears to have important economic implications consistent with weaker control rights for lenders.

Keywords: Leveraged Loans; Loan contracts; Covenants; Carve-out; Basket; Creditor Governance; LBO

JEL Classification: G14, G23, G32