By William W. Bratton (University of Pennsylvania Law School)
Bond workouts are a dysfunctional method of debt restructuring, ridden with opportunistic and coercive behavior by bondholders and bond issuers. Yet since 2008 bond workouts have quietly started to work. A cognizable portion of the restructuring market has shifted from bankruptcy courts to out-of-court workouts by way of exchange offers made only to large institutional investors. The new workouts feature a battery of strong-arm tactics by bond issuers, and aggrieved bondholders have complained in court. A fracas followed in courts of the Second Circuit, where a new, broad reading of the primary law governing workouts, section 316(b) of the Trust Indenture Act of 1939 (“TIA”), was mooted in the Southern District of New York, only to be rejected by a Second Circuit panel.
In “The New Bond Workouts,” Adam Levitin and I exploit the bond market’s reaction to the recent volatility in the law to reassess the desirability of section 316(b). Section 316(b), which prohibits majority-vote amendments of bond payment terms and forces bond issuers seeking to restructure to resort to untoward exchange offers, has attracted intense criticism, with calls for its amendment or repeal. Yet section 316(b)’s staunch defenders argue that mom-and-pop bondholders need protection against sharp-elbowed issuer tactics.
Many of the empirical assumptions made in the debate no longer hold true. Markets have learned to live with section 316(b)’s limitations. Workouts generally succeed, so there is no serious transaction cost problem stemming from the TIA; when a company goes straight into bankruptcy, there tend to be independent motivations. But workout by majority amendment will not systematically disadvantage bondholders. Indeed, the recent turn to secured creditor control of bankruptcy proceedings makes workouts all the more attractive to them, as their claims tend to be unsecured. Accordingly, we cautiously argue for the repeal of section 316(b). Section 316(b) no longer does much work, even as it prevents bondholders and bond issuers from realizing their preferences regarding modes of restructuring and voting rules. The contractual particulars are best left to the market. Still, markets are imperfect, and a free-contracting regime may result in abuses. Accordingly, repeal of section 316(b) should be accompanied by the resuscitation of the long forgotten intercreditor good faith duties, which present a more fact-sensitive way to police overreaching in bond workouts than section 316(b).
The full paper is available here.
For previous Roundtable posts on Marblegate, section 316(b), and bond workouts, see “Second Circuit Rules on § 316(b) in Marblegate“; Liu, “Exit Consents in Debt Restructurings“; Roe, “The Trust Indenture Act of 1939 in Congress and the Courts in 2016: Bringing the SEC to the Table.”