Category: Debt Trading

  • New Book Alert: Delinquent

    Posted by

    Melissa Jacoby

    Cover ImageThe University of California Press has published Delinquent: Inside America's Debt Machine by Elena Botella. 

    Botella used to be "a Senior Business Manager at Capital One, where she ran the company’s Secured Card credit card and taught credit risk management. Her writing has appeared in The New Republic, Slate, American Banker, and The Nation."

    Here's the description from the publisher between the dotted lines below: 

    ——————

    A consumer credit industry insider-turned-outsider explains how banks lure Americans deep into debt, and how to break the cycle.

    Delinquent takes readers on a journey from Capital One’s headquarters to street corners in Detroit, kitchen tables in Sacramento, and other places where debt affects people's everyday lives. Uncovering the true costs of consumer credit to American families in addition to the benefits, investigative journalist Elena Botella—formerly an industry insider who helped set credit policy at Capital One—reveals the underhanded and often predatory ways that banks induce American borrowers into debt they can’t pay back.

    Combining Botella’s insights from the banking industry, quantitative data, and research findings as well as personal stories from interviews with indebted families around the country, Delinquent provides a relatable and humane entry into understanding debt. Botella exposes the ways that bank marketing, product design, and customer management strategies exploit our common weaknesses and fantasies in how we think about money, and she also demonstrates why competition between banks has failed to make life better for Americans in debt. Delinquent asks: How can we make credit available to those who need it, responsibly and without causing harm? Looking to the future, Botella presents a thorough and incisive plan for reckoning with and reforming the industry.

    ———————

    Looking forward to reading this book! Also expecting to see more from the University of California Press of direct interest to Credit Slips readers in the years ahead. 

  • Does Delaware Get the Final Say?

    Posted by

    Stephen Lubben

    I’ve been doing some reading on officer and director fiduciary duties to creditors, and I am surprised that how much the academic and practitioner consensus seems to have settled on the notion that, in light of the Delaware caselaw following Gheewalla, it is essentially impossible for creditors to bring a fiduciary action against a board. Namely, because Delaware caselaw has held that such claims are derivative (with all the procedural limits thereon) and have narrowed the duty to apply, if at all, to cases of actual insolvency, most claims will not be viable. Moreover, most authors implicitly assume that these claims are subject to the internal affairs doctrine (i.e., that they are subject to Delaware law no matter where the case is brought).

    That analysis seems right to me only if we are sure that these sorts of claims arise out of the corporate form. But if creditor fiduciary duty claims instead arise out the debtor-creditor relationship itself, then it is not clear to me Delaware gets to decide these issues. Indeed, more often New York would seem to provide the relevant law (if the debtor-creditor relationship is subject to New York law). Of course, some might argue that the debtor-creditor relationship is purely contractual, but it strikes me that the source of these claims is a greatly under-discussed issue.

  • J. Screwed – A Paper

    Posted by

    Mitu Gulati

    A number of months ago now, I listened to a fun podcast episode on Planet Money titled "J. Screwed" about contract shenanigans by J.Crew, as it was making its way into deep financial distress.  I'm fascinated by the exploitation of contract loopholes in debt contracts. So, of course, I wanted to know more. I went digging into the world of Google.  But I couldn't find anything good in the literature that explained to me the details of what was going on (the contract term in question, how widespread this problem was, how the market had reacted, etc., etc.). The best I found was a blog post that fellow slipster, Adam Levitin, kindly pointed to me.

    But now there is a wonderful article up on ssrn by the author of that post (a former student of Adam at Georgetown Law, I believe).  The appropriately titled article, "The Development of Collateral Stripping By Distressed Borrowers" by Mitchell Mengden, is here.

    The abstract reads as follows:

    In the past decade, private equity sponsors have taken a more aggressive stance against creditors of their portfolio companies, the most recent iteration of which has come in the form of collateral stripping. Sponsors have been using creative lawyering to transfer valuable collateral out of the reach of creditors. This Article delves deeper into the issue by examining the contract terms and litigation claims raised by these transactions.

    The lack of protective covenants and ease of manipulating EBITDA and asset valuations are key conditions that permit collateral stripping. Each of these conditions were present in the past decade, primarily due to the protracted expansionary stage of the credit cycle. Lenders, however, can protect themselves from collateral stripping by negotiating stricter covenants and tighter EBITDA definitions, as well as pursuing ex post litigation for fraudulent transfers, illegal distributions, and claims for breach of fiduciary duty.

    Contractual opportunism and creative lawyering will almost certainly continue to pervade credit markets. This Article provides a roadmap of ways that lenders can protect themselves from opportunism during contracting and throughout the course of the loan. As this Article concludes, ex post litigation claims are often an inadequate remedy, so lenders should seek to tighten EBITDA definitions and broaden protective covenants—even if to do so requires other concessions—to avoid litigation.

  • The Drama Over the Windstream Case: Boiled Down

    Posted by

    Mitu Gulati

    One the most discussed and debated corporate finance/contracts cases of 2019 was Windsteam LLC v. Aurelius (SDNY 2019) (Stephen L posted on this here).  A couple of days ago, Elisabeth de Fontenay put up her article "Windstream and Contract Opportunism" on ssrn (here) that is one of first deep dives into the implications of what happened in the case.

    I find this case especially interesting because it is about contract arbitrage. Cribbing from Elisabeth's superb narrative, the saga starts when the company in question, Windstream, does a sale-leaseback transaction in violation of its bond covenants (it claims it is not actually violating the covenant because it did the transaction through a subsidiary blah blah — but as the judge points out, its attempt to elevate form over substance falls flat). As it turns out though, none of the bondholders seem to have either noticed or cared about the violation at the time it happened. The violation only bubbles to the surface when Aurelius, a notorious hedge fund, shows up two years later and demands that the trustee declare a default. At this point, I'd have expected that Windstream would have paid Aurelius greenmail to get them to disappear and everyone would have lived happily after.  But that doesn't happen.  Instead, Windstream officials and Aurelius fund managers get into a nasty battle of words in the press and (I'm guessing) both sides decide that they will fight this to the death.

    At this point, Windstream tries to retroactively cure its covenant violation by getting the non-Aurelius creditors to say that they were okay with the transaction and do not want to call the company to the carpet. In theory this should have been doable via exit consents and other familiar corporate moves.  But, in a comedy of errors, Windstream manages to screw up the retroactive cure (and the judge wasn't willing to elevate substance over form on this side of the equation).  End result: Windstream loses and goes into bankruptcy.  That is, everyone loses, including the bondholders, because the value of their bonds goes into the toilet.

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  • Mick Mulvaney’s South Carolina Land Shenanigans All Under Seal

    Posted by

    Adam Levitin

    Last year the Washington Post covered Mick Mulvaney's South Carolina land deal gone sour. It was a pretty amazing case that is fantastic for teaching purposes. Mick's moves would have made some of the most sophisticated distressed debt funds (not to mention a real estate developer president) blush with shame (or green with envy).

    I've got an update on the case that appears quite troubling: it seems that the South Carolina court has put everything except the docket entry list under seal, including previously public available documents. If I am correct, this is really disturbing because would indicate a willingness by the South Carolina court system to accommodate Mick's desire to shield keep his business dealings from any public scrutiny, even though there is no legitimate reason that I can see for the court to turn seal all the documents in a public judicial proceeding about a commercial real estate foreclosure action. 

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  • Yadav on Dodgy Debt Buybacks

    Posted by

    Mitu Gulati

    I’ve long been fascinated by debt buybacks by issuers, in large part because they seemed to occupy a loophole in the securities disclosure laws.  A company could do a buyback of bonds and, because bondholders are not owed fiduciary duties by the company, there was no requirement for disclosure. That means that the company, to the extent it was in possession of secret information (the discovery of a gold mine, for example), could screw over the bondholders by buying back their securities before the news got out and the price went up.  Of course, the gold mine situation doesn’t occur all that often. But in the area that I do most of my research in, sovereign bonds, there are often large asymmetries of information between issuers and creditors. And yet, one rarely sees large scale buybacks of debt. (for the classic piece on sovereign buybacks, by Bulow and Rogoff, see here).

    For years though, I’ve thought that this topic was of interest to no more than the three or four people in the legal academy who found bonds interesting (Marcel Kahan, Bill Bratton and a couple of others).  But just a few days ago I came across a wonderful new article by Yesha Yadav on precisely this topic. The draft article, “Debt Buybacks and the Myth of Creditor Power” is available here.  Yesha argues that the dramatic increase in corporate debt buybacks in recent years (apparently in the trillions of dollars) should be concerning not just because of the aforementioned disclosure loophole, but because these buybacks undermine corporate governance (when they are done in order to strip covenants) and allow shady behavior by banks seeking to increase the value of their loans at the expense of bondholders.

    The story Yesha tells is more than plausible and she gives lots of vivid examples that support her arguments.  Since my particular interest is in flaws in the bond contract drafting process, the questions that her article raised for me have to do with why private contracting has not fixed the problem she identifies.  After all, the parties involved in these deals are super rich and sophisticated (with the fanciest of Wall Street law firms at their beck and call).

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  • Badawi & de Fontenay Paper on EBITDA Definitions

    Posted by

    Mitu Gulati

    I confess that, on its face, this did not strike me as the most exciting topic to read about (and that comes from someone who writes about the incredibly obscure world of sovereign debt contracts).  After all, who even knows what EBITDA definitions are?  Sounds like something from the tax or bankruptcy code.  But don’t let the topic be off putting.  This is a wonderfully interesting project; and elegantly executed (here).  By the way, EBITDA stands for earnings before interest, taxes, depreciation blah blah. Turns out it is especially important for young companies, where potential investors want to know about the cash flow being generated (Matt Levine has been writing about it recently in the context of the WeWork debacle – here). It is also very important because it generally ties into the covenants in the debt instrument and can impact whether or not the covenants are violated.

    Using machine learning techniques, Adam and Elisabeth look at the EBITDA definitions in thousands of supposedly boilerplate debt contracts.  And they find a huge amount of variation in this supposedly boilerplate term; variation that can end up making a big difference to the parties involved. (For those interested, there is a nice prior study by Mark Weidemaier in the on how supposedly boilerplate dispute resolution terms in sovereign bonds are often not really all that close (here); and John Coyle’s recent work on choice-of-law provisions in corporate bonds is also along these lines (here))

    The question that naturally arises here is whether the variation in these EBITDA definitions is the product of conscious and smart lawyering or just random variation that arises as contracts are copied and pasted over generations. (for more on this, see here (Anderson & Manns) and here (Anderson)). My understanding of the results is that these definitions are definitely not the product of random variation; instead, there seems to be a lot of sneaky lawyering to inflate the supposedly standard EBITDA measure.

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  • Why is Netflix Listing its European Bonds on the Isle of Guernsey?

    Posted by

    Mitu Gulati

    Netflix has long interested me as a company, not only because of shows like "Master of None" (Aziz Ansari and Alan Yang have delivered brilliantly), its darwinian management philosophy (very cool podcast on Planet Money), but because of its uncertain future. It is competing against rich giants like Amazon and Apple to deliver original content in a field that is getting increasingly crowded.  My guess is that it is having to spend more and more on content, but is unable to increase its prices very much. One solution for Netflix: borrow at a high interest rate from investors who are willing to bet on your future.  And that it has done, in spades. Most recently — a few days ago — it borrowed $1.6 billion (yes, billion). I was intrigued and trying to avoid doing my real work, so I went looking for its offering documents and while I didn't immediately find the current docs, I found the offering circular for the bond issue Netflix did a few months prior in Europe (Euro 1.3 billion) in an offering listed on the International Stock Exchange, which is an exchange licensed by the Bailiwick of Guernsey.  Yes, really. So, surely, at least some of you are asking the same questions I am. What? Where? Who?

    Guernsey, for those of you who are clueless like I am, is a British Crown "dependency" (not sovereign, but not independent, and not quite like a former colony like the British Virgin Islands or Bermuda (they are "British Overseas Territories")). Basically, a cynic might say: Perfect for a tax haven. But it is the stock exchange that interested me, especially since it seems to have been quickly rising in popularity for US and EU companies over the last couple of years.

    If I remember my basic corporate finance class (I don't), we were told that exchanges performed a monitoring and disciplinary role; they were "gatekeepers", as the fancy corporate types liked to say. So, is Netflix going all the way to the Isle of Guernsey to get extra special monitoring from the Channel Islanders? Curious, I went to the website for the Guernsey exchange, to see what it said. And it does say that it has wonderfully rigorous regulatory standards ("some of the highest regulatory standards globally"). But does it really?

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  • Venezuelan Debt: Call a Spade a Spade

    Posted by

    Mitu Gulati

    Adam Lerrick, of the American Enterprise Institute, has offered an intriguing approach to the Republic of Venezuela/PDVSA debt problem. Call a spade a spade. The distinction in the market between Republic of Venezuela and PDVSA bonds has always been artificial and the market has normally perceived it as such. Only recently have market participants begun trying to figure out which bonds — PDVSA or Republic of Venezuela — will be more likely candidates for a debt restructuring and therefore which should trade higher in the market.

    PDVSA accounts for 95 percent for the foreign currency earnings of the entire country. Without PDVSA, there is no credit standing behind Republic bonds.  At base, there is only one public sector credit risk in the country and Lerrick invites us to acknowledge this fact.

    He proposes that the Republic assume the indebtedness of PDVSA and proceed to restructure that debt as part of a generalized Republic debt workout. As part of this process — and to discourage potential holdouts from the Republic's offer to exchange PDVSA bonds and promissory notes — he suggests that the Government take back PDVSA's concession to lift and sell Venezuelan oil. This risk has always been prominently disclosed in the PDVSA offering documents and should not come as a surprise to anyone.

    Lerrick's proposal adds to the growing list of suggestions for how a future Venezuelan debt restructuring (and there almost certainly will be such a debt restructuring) may be accomplished without holdout creditors devouring the process. No one wants to repeat the experience of Argentina.

    Recently, in the context of trying to work out the knotty problem of how to restructure Venezuela’s promissory notes, Lee Buchheit and I made a similar suggestion along these lines. (our friends, Bob Lawless and Bob Scott, two gurus of this world of secured financing and contracts, were invaluable in helping us figure this structure out — all blame for errors is ours, of course).

    The structure we suggest differs from the Lerrick proposal mainly on the question of what should happen to the PDVSA oil assets, including receivables for the sale of oil.  We suggest that PDVSA pledge those assets to the Republic in consideration for the Republic's assumption of PDVSA bond/promissory note liabilities (as opposed to transferring title to the assets back to the Republic).  Such a pledge is expressly permitted by the terms of the PDVSA bonds and promissory notes and should operate to shield the assets from attachment by holdout creditors.

  • Could Giving the Rohingya Refugees a Debt Claim Ameliorate the Current Crisis?

    Posted by

    Mitu Gulati

    From Joseph Blocher & Mitu Gulati

    Just a couple of weeks ago, the plight of the Rohingya, a muslim minority group in Myanmar, who are being oppressed (to put it mildly–they have been called “the most friendless people in the world”) was front page news. But, as has often been the case with the plight of the Rohingya over the years, news of their plight quickly receded as other human drama and tragedy took over (hurricane in Puerto Rico, Las Vegas shooting, Catalan secession vote/violence, North Korean craziness etc.)

    We realize that we are likely engaged in a pointless task.  But we want to plead for the condition of the Rohingya, and indeed other refugees, not to be forgotten so quickly. As a threshold matter, we recognize that our government cannot be depended on to care much (if at all) about the plight of oppressed groups that are as far away, foreign and poor as the Rohingya. In other words, the top down mechanism isn’t going to work. The question then is whether, assuming that the oppression in question is clear and cognizable, there is some other solution—something bottom up–that the international legal system could provide to oppressed groups who are forced into refugee status that does not depend on other governments, such as the U.S., having a self interest in intervening.

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