Academic journal article Texas Law Review

A Renewed Need for Collective Action: The Trust Indenture Act of 1939 and Out-of-Court Restructurings *

Academic journal article Texas Law Review

A Renewed Need for Collective Action: The Trust Indenture Act of 1939 and Out-of-Court Restructurings *

Article excerpt

I. Introduction

Spurred on by near-zero interest rates, U.S. companies have issued corporate bonds at a record pace.1 The amount of outstanding corporate debt now exceeds $8.2 trillion, marking a 50% increase since the subprime mortgage collapse.2 As U.S. policy makers intended, the corporate-bond market grew to meet the capital needs of the U.S. economy.3

Unfortunately, the statute that governs the issuance of corporate bonds, the Trust Indenture Act of 1939 (TIA), may inadvertently raise the cost of borrowing for corporate-bond issuers. In particular, § 316(b) of the TIA limits how corporate issuers can renegotiate with bondholders,4 which may needlessly push some financially distressed companies into Chapter 11 bankruptcy. Since it is difficult to predict which companies will run into financial trouble, this leads bondholders to demand higher rates of interest from all corporate issuers.

To see the problem, it is important to recognize that many financially distressed companies are able to avoid bankruptcy altogether. In fact, a considerable number manage to privately restructure their obligations without ever going to court. This is called a "workout": a company with a temporary shortage of cash, for example, might offer to make larger payments to its bondholders in the future in exchange for not having to pay anything now.5 And its bondholders might take that deal to avoid the hassle of a default. When these negotiations are successful, workouts provide a relatively quick and inexpensive solution.

Granted, for complex financial problems Chapter 11 bankruptcy may be the only solution.6 In these challenging cases, the troubled corporate issuer files a bankruptcy petition, and once the petition is filed, a court will oversee the entire process and scrutinize every step of the reorganization in accordance with the U.S. Bankruptcy Code.7 But Chapter 11 bankruptcy is generally regarded as a lengthy, expensive process-one that issuers and bondholders want to avoid; the average bond workout, for instance, takes three months, "while a bankruptcy reorganization typically takes two or three years."8

So it is troubling that the TIA favors Chapter 11 bankruptcy by placing restrictions on how workouts can be negotiated. Under § 316(b), specifically, corporate issuers cannot restructure their obligations by obtaining the approval of a majority of their bondholders.9 Rather, they must obtain the consent of each bondholder individually.10 This makes renegotiating with bondholders as a class quite challenging.

Moreover, these restrictions appear to be almost unique in modern corporate law. A majority of shareholders can approve an amendment to a corporation's certificate of incorporation and bind all owners of the corporation.11 Similarly, a two-thirds majority of creditors, which includes bondholders, can "cramdown" a reorganization plan under Chapter 11 bankruptcy, overriding the minority's claims.12 But a majority of bondholders cannot alter the interest and principle owed under an indenture; § 316(b) bars collective action.13

Nonetheless, the TIA has not stopped workouts altogether. In the last several years, numerous issuers have restructured corporate debt outside of bankruptcy because enterprising lawyers and bankers have developed suit5. able, although less efficient, alternatives.14 But despite their efforts, they likely have not overcome the statutory bias against out-of-court restructurings.

Recent developments in the case law have likely made the problem worse. Two federal district court decisions-Marblegate Asset Management v. Education Management Corp.15 and MeehanCombs Global Credit Opportunities Funds, LP v. Caesars Entertainment Corp.16-have further curtailed the use of workouts, which raises the question: Are workouts still a viable means of restructuring? Congress may need to finally amend § 316(b) of the TIA to allow for reorganizations through collective action.

In this Note, I argue that Congress should repeal § 316(b). …

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