Senior Lenders Research Articles

Private Debt and the Missing Lever of Corporate Governance

Traditional approaches to corporate governance focus exclusively on shareholders and neglect the large and growing role of creditors. Today's creditors craft elaborate covenants that give them a large role in the affairs of the corporation. While they do not exercise their rights in sunny times when things are going well, these are not the times that matter most. When a business stumbles, creditors typically enjoy powers that public shareholders never have, such as the ability to replace the managers and install those more to their liking. Creditors exercise these powers even when the business is far from being insolvent and continues to pay its debts. Bankruptcy provides no sanctuary as senior lenders ensure that their powers either go unchecked or are enhanced. The powers that modern lenders wield rival in importance the hostile takeover in disciplining poor or underperforming managers. This essay explores these powers and begins the task of integrating this lever of corporate governance into the modern account of corporate law.

Chapter 11 at Twilight

In The End of Bankruptcy we detailed the forces that have rendered obsolete traditional conceptions of corporate reorganization. In a response to our article, Lynn LoPucki asserts that our paper lacked empirical foundation. In this response, we draw on LoPucki's data set of the reorganization of large, publicly held entities to show the robustness of our claims, both empirical and theoretical. Looking in detail at the firms whose Chapter 11 cases ended in 2002, most of which concluded after we completed our original piece, we find that in over 80% of the cases the assets of the firm were either sold or the bankruptcy proceeding put in place a restructuring plan agreed to before bankruptcy was filed. The remaining firms evince little in the way of going-concern value. Moreover, equityholders are nearly always wiped out, and the board of directors is usually replaced. Today's bankruptcy practice reveals creditors, particularly the senior lenders, in control. They use their powers to remove managers in whom they have lost confidence, replace the board of directors, put the corporation on the auction block and terminate the interest of equityholders. This paper provides further evidence that issues of control rather than priority dominate modern reorganization practice.

Best practices in commercial real estate financing: essential issues in negotiating A/B note intercreditor agreements

AbstractIn this quarterly feature the nuts and bolts of loan document structuring and negotiations are investigated, as well as the closing process and loan administration. This issue's paper examines the most hotly negotiated legal issues between the senior and junior lenders in the context of A/B notes originated for the REMIC securitisation market, where both the senior (A) and junior (B) note share a mortgage interest in the same real property. The paper outlines the ways in which the holder of the B note may attempt to protect its interest in the face of actions by the A note holder that could otherwise modify or reduce the borrower's obligations to the B note holder, or eliminate the collateral for the B note. In each case, the author suggests typical compromise positions that should satisfy both the B note holder and the holders of all tranches of the securities backed by the A note. Copyright © 2002 Henry Stewart Publications

Layered Finance

The general objectives of subordinated debt in project finance transactions are to mitigate risk for senior lenders and to mobilize a higher aggregate level of project debt than is otherwise justified by the project9s underlying cash flows. This article focuses primarily on three purposes of debt subordination in project finance, 1) replacement by project sponsor or other “insider” of equity with debt, 2) provision by other “investors” of equity-like capital on a hybrid basis, and 3) promoting the participation of senior lenders by improving the margin of debt service coverage.

Monitoring and Structure of Debt Contracts

This paper presents a theory of optimal debt structure when the moral hazard problem is severe. The main idea is that the optimal debt contract delegates monitoring to a single senior lender and that seniority allows the monitoring senior lender to appropriate the full return from his monitoring activities. The theory explains (i) why debt contracts are prioritized, (ii) why short‐term debt is senior to long‐term debt, and (iii) why financial intermediaries usually hold short‐term senior debt whereas long‐term junior debt is widely held. Another implication of the theory is that covenant and maturity structures will be set to conform to the seniority structure.

Resolving Financial Distress By Way of a Contract: an Empirical Study of Small UK Companies

This paper provides an empirical study of the resolution of financial distress in England. The study is based upon a unique data set of 532 financially distressed UK companies, most of which are small and privately held. The data were assembled from the private records of three major commercial banks. The main focus of our investigation is a description and analysis of the process of rescue and the extent to which it leads to turnaround or insolvency. We find that the typical firm in our sample has a capital structure that is dominated by one senior lender (a bank) and dispersed trade creditors. The bank's loan is highly collateralised, it holds all the liquidation rights and controls the rescue process. Notwithstanding, we find an elaborate rescue process that contradicts claims that such a capital structure would lead to virtual automatic liquidation. Also, we find little evidence of co-ordination failures, especially among dispersed trade creditors. The paper provides strong evidence of how a contract driven bankruptcy procedure, with highly collateralised loans, will perform.

The Outer Fringes of Chapter 11: Nonconsenting Senior Lenders' Rights under Subordination Agreements in Bankruptcy

The Outer Fringes of Chapter 11: Nonconsenting Senior Lenders' Rights under Subordination Agreements in Bankruptcy