The Fall and Rise of the Exit Consent

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ABSTRACT

Bond, issuers wanting to restructure their distressed debt often propose an exchange offer, in which the issuer persuades its bondholders to swap their present holdings for new bonds capable of being honored. To guard against nonparticipating bondholders, issuers may pair their exchange offers with an exit consent. A use of a bond's modification clause, an exit consent is a technique by which bondholders participating in the exchange also vote to impair the distressed bonds.

Use of the exit consent raises a contract question about the duty of good faith and fair dealing. For a quarter of a century, exit consents survived judicial scrutiny when they followed the Delaware case Katz v. Oak Industries Inc. Then, in a case emblematic of the recent Eurozone economic crisis, Assenagon Asset Management v. Irish Bank Resolution Corp., an English court found that the exit consent breached this doctrinal duty, seemingly upending Katz's position as the seminal case on exit consents. This Note argues that such concern is misplaced, concluding that Assenagon augments but does not replace Katz. It proposes reconciling the two cases in a manner that upholds the common values of each case in an effort to provide stable legal principles amid markets in flux.

If you have a 50 Dollar debt, you're called a scrounger.... Having a 50 million Dollar debt means you're a financial genius. And only a government can have a 50 billion Dollar debt.

--Anonymous (1)

INTRODUCTION

The year 2008 infamously saw many insolvent (2) household (3) and corporate (4) borrowers. Yet even in the year of "fundamental ... changes in business paradigms and the spectacular self-destruction of storied institutions," (5) few insolvencies threatened as many paradigms--or were nearly as spectacular--as that of Anglo Irish Bank (Anglo Irish). Barely one year after posting record profits of 1.2 billion [euro], (6) Anglo Irish disclosed heavy losses from investments in commercial real estate, subprime residential mortgages, and collapsed American and Icelandic banks. (7) Because of Anglo Irish's importance to the Irish economy, (8) the bank's financial tailspin "hurried the government into action," (9) first, to guarantee the bank's most precarious bonds, (10) and, eventually, to bail out and nationalize the bank. (11) Then, with the threat of systemic risk (12) seemingly contained, the government announced its plan for "appropriate burden-sharing." (13)

Burden sharing essentially meant the Irish government would lower its cost to operate Anglo Irish by persuading the fallen bank's bondholders to accept lower bond payments. Such restructurings occur through an exchange offer, in which a bond issuer encourages its bondholders to swap the bonds nearing default for new bonds that the issuer can honor. (14) A complication arises when some bondholders refuse to participate or hold out for a more favorable alternative. (15) Because the distressed (16) bonds continue to be valid contracts until surrendered, (17) holdouts can sue for full payment, upending an issuer's prime motivation for an exchange. (18) Thus, as a preventative measure against holdouts, many insolvent institutional debtors do as Anglo Irish did and pair their exchange offers with exit consents. A use of a bond's modification clause, (19) an exit consent provides that the bondholders agreeing to an exchange for new bonds, as a term of their acceptance, pledge their votes to impair the contract language of the old bonds. (20) The goal is to make the old bonds comparably unattractive and thereby incent would-be holdouts to participate in the exchange, or at least to render their recalcitrance toothless. (21)

Bondholders may challenge exit consents as a breach of the implied contractual duty of good faith and fair dealing. (22) Under the leading case on exit consents, Katz v. Oak Industries Inc., (23) an issuer meets this duty as long as its behavior is not "wrongfully coercive. …