Debt Textualism and Creditor-on-Creditor Violence: A Modest Plea to Keep the Faith

Abstract

Although debt finance and restructuring rarely command headlines, they collectively comprise some of the most heated corporate battles in recent history. The field’s contemporary participants, including private equity sponsors, banks, and distressed debt investors have increasingly become embroiled in cantankerous conflicts over the division of assets and cash flows of distressed firms. Many of those battles resemble multiplayer chess matches, with parties scouring debt contracts for loopholes and landmines that either enrich themselves or undercut their rivals. The costs of these battles have grown precipitously, even as their outcomes have become less predictable—resulting in undesirable consequences for borrowers, lenders, intermediaries, stakeholders, and the economy at large. In this paper, we advance the thesis that much of our ongoing corporate credit conundrum has been aided and abetted by an unlikely co-conspirator: contract law. In particular, we highlight and document courts’ progression over fifty years towards a sweeping embrace of textualism to interpret credit agreements, and their concomitant rejection of other interpretive schema. Whatever its merits might have been a half century ago, “debt textualism” has catalyzed and fueled an onslaught of inter-creditor warfare, rendering its continued justification questionable. We propose several prescriptions for addressing the current state of play, ranging from doctrinal reform, to legislative/regulatory intervention, to private contractual innovation. If such measures prove unable to dislodge debt textualism from its entrenched perch, however, we also suggest strategies for marshaling it for the greater good, spotlighting the role that debt textualism might play in securing more credible corporate commitments on decarbonization and climate change.

Keywords: Creditor-on-Creditor Violence; Capital Structure; Distressed Debt; Private Equity; Contracts

JEL Classification: K00, K12, K22