Protecting Ma And Pa: Bond Workouts And The Trust Indenture Act In The 21st Century

Abstract

Revlon, the well-known cosmetics manufacturer, has labored under a massive debt load since the 1980s, when it was the subject of a classic hostile takeover battle. As with many recent distressed firms, it decided to address its debt not through the Bankruptcy Code and chapter 11, but rather in an “exchange offer.” That is, it offered to buy its old bonds back with an offer of new securities. One implication of its decision to proceed this way was that it was able to pay its retail bondholders much less than its institutional bondholders.

The Trust Indenture Act of 1939 was supposed to protect small bondholders from abuse by issuers and their fellow bondholders. Nevertheless, recent exchange offers have become more aggressive than ever. And academic scholarship has argued that the Trust Indenture Act should be repealed, because allegedly there are very few individual bondholders anymore.

Leaning against this ancient and illustrious literature, I instead argue that today we need the Trust Indenture Act, and section 316(b) thereof, more than ever. Indeed, I argue for an expansion of the Trust Indenture Act to provide more robust protection for small bondholders, the disappearance of which I submit has been seriously overstated.

I argue that the Trust Indenture Act should be viewed as a floor, from which SEC rulemaking can further develop to animate the spirt of the Trust Indenture Act. In particular, by adapting key concepts from equity tender offers – like the “best price” and “all holders” rules – exchange offers can be made more equitable. In addition, I propose a new a two-stage process for exchange offers, which exposes tendering bondholders to some chance that their bonds will not be accepted in the tender, and thus they will have to live with a bond modified by the exit consents which feature so prominently in modern offers.

Keywords: Trust Indenture Act; exchange offers; chapter 11; bond workouts; bond indentures; Revlon; Peabody