Contractual Resolution of Bondholder-Stockholder Conflicts in Leveraged Buyouts

Abstract

L EGAL scholars and economists have long recognized that the interests of stockholders and bondholders often conflict. Since bondholders own fixed claims that are senior to the residual and limited liability claims of stockholders, the two classes of security holders often differ over corporate policies, including policies about cash distributions to stockholders, the issuance of additional debt, and the riskiness of investment projects.' Although bondholder-stockholder conflicts have been the source of much litigation during this century, U.S. courts generally have maintained that these conflicts should be resolved explicitly in bond contracts. For example, in 1981 in Broad v. Rockwell International Corp.,2 a federal court stated that it "will not rewrite a term of a [bond] contract by interpretation when that term is clear and unambiguous on its face." In Katz v. Oak Industries3 the Delaware Court of Chancery restated the common-law tradition: "Arrangements among a corporation, the under-