Covenant Control: The Case for Treating Uptier Transactions as a Form of Corporate Control
Abstract
In recent years, uptier transactions have emerged as a novel way for distressed companies to restructure their debt obligations, resulting in unforeseen and inequitable outcomes for investors in corporate debt. Uptier transactions depend on provisions in credit agreements that permit debtholders with a majority stake in a class of debt to make decisions on behalf of all debtholders. Distressed companies take advantage of these provisions by colluding with a majority of debtholders to shift economic value from the remaining debtholders to themselves. As this Comment demonstrates, these transactions are likely to be value destructive and present an issue for capital markets. Unfortunately, the contractual solutions available to debtholders to prevent uptier transactions either are insufficient or impose substantial costs on parties.
Uptier transactions may be a recent innovation in restructuring, but they are an instance of investor opportunism that is present whenever there is common ownership in property—those with control over common property can exercise that control in a way that benefits themselves to the detriment of other owners. Corporate law has resolved this issue in the equity context by imposing a fiduciary duty of loyalty on controlling shareholders. This Comment proposes treating debtholder control over debt covenants as akin to the control that large shareholders wield over corporations by imposing a waivable fiduciary duty of loyalty on controlling debtholders. The controlling shareholder doctrine in Delaware corporate law provides a useful starting point to consider how courts could enforce a controlling debtholder fiduciary duty in a way that would provide adequate judicial oversight over the most concerning transactions while limiting disruption to productive transactions.