By Mark J. Roe, Harvard Law School
The Trust Indenture Act of 1939 bars binding bondholder votes on core payment terms. The inability of deal proponents to get a binding vote can lead the debtor to file for an otherwise unnecessary bankruptcy. To get a deal done when there are economically-important holdouts, deal proponents often seek exit consents to induce enough holdout bondholders to reluctantly tender into a deal they don’t otherwise like, by stripping the bond indenture of those covenants on which bondholders can vote.
Exit consent transactions have generally been upheld, despite that in analogous corporate settings such distortions induce doctrinal and deal structure issues. Recent decisions indicate that exit consents that oust the bondholders from an effective individual choice ran afoul of the Trust Indenture Act, which may well have been the intent of the 1930’s drafters of the law.
Regardless, the anti-voting provision is anachronistic. It was passed when bankruptcy law did not respect bondholder votes without a judge’s substantive approval of the deal, but the Code was updated in 1978 to allow binding votes. Bondholders should also be free to agree in advance to a binding vote in an out-of-court workout. More restructurings will succeed and avoid bankruptcy. And proponents will have less reason to resort to arm-twisting with exit consents. Similar individualized consent difficulties and holdout issues have hobbled sovereign debt restructurings, with sovereign debt issues moving in recent years to include majority vote provisions.
For my analysis of the incentives and structure of bond restructurings in light of the TIA, see 97 Yale L.J. 232 (1987).