Bounties For Errors: Market Testing Contracts

36 Pages Posted: 26 Sep 2019

See all articles by Robert K. Rasmussen

Robert K. Rasmussen

University of Southern California Gould School of Law

Michael Simkovic

University of Southern California Gould School of Law; University of Southern California - Marshall School of Business

Date Written: September 26, 2019

Abstract

Many scholars and courts have championed a plain meaning approach to interpreting commercial contracts between sophisticated parties. These parties are assumed to carefully draft contracts to make their rights and obligations clear and knowable if the language is enforced as written. However, recent events in the commercial lending arena have raised questions about the efficacy of this approach. Aggressive parties have combed through reams of complex documents looking for ways around seemingly clear contractual barriers. For example, Hovnanian promised to intentionally default on a debt payment to one of its wholly-owned subsidiaries in exchange for favorable financing from a hedge fund whose substantial CDS short position would have otherwise become worthless. In another case, J.Crew, faced with financial distress, found a way to divert the crown jewels from the collateral package pledged to its lenders, and instead use this value to prevent a default on unsecured notes that were coming due. Both of these transactions upended the expectations of those who put the original deals together. They raise the question: how can systems that depend on clear rules evolve, correct problems and reduce unintended consequences without resorting to a subjective standard? One approach is to crowdsource error-checking to market-participants by paying bounties to those who detect and publicize flaws in rules-based systems so that problems can be diagnosed and corrected (or, at least, their consequences mitigated) by subsequently revising the rules. This article considers such an iterative approach in the context of the Credit Default Swaps Market and the syndicated loan market.

Keywords: contract, plain meaning, rule, standard, credit default swap, syndicated loan, covenant, hovnanian, engineered default, credit event, j.crew, collateral, basket, error-checking

JEL Classification: K12, K22, M21

Suggested Citation

Rasmussen, Robert K. and Simkovic, Michael, Bounties For Errors: Market Testing Contracts (September 26, 2019). Harvard Business Law Review, Vol. 10, 2019. Available at SSRN: https://ssrn.com/abstract=3459838

Robert K. Rasmussen

University of Southern California Gould School of Law ( email )

699 Exposition Boulevard
Los Angeles, CA 90089-0071
United States
213-740-6473 (Phone)
213-740-5502 (Fax)

Michael Simkovic (Contact Author)

University of Southern California Gould School of Law ( email )

699 Exposition Boulevard
Los Angeles, CA 90089
United States

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA 90089
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
13
Abstract Views
65
PlumX Metrics