Covenants and Third-Party Creditors (eBook)

Empirical and Law & Economics Insights Into a Common Pool Problem

Daniela Matri (Autor)

eBook Download: PDF

2017 | 1st ed. 2017
XVII, 265 Seiten
Springer International Publishing (Verlag)
978-3-319-62036-7 (ISBN)

Infos

This book adds to the debate on the effects of covenants on third-party creditors (externalities), which have recently become a focus of discussion in the contexts of bankruptcy law, corporate law and corporate governance. The general thrust of the debate is that negative effects on third-party creditors predominate because banks act in their own self-interest.

After systematising the debated potential positive and negative externalities of covenants, the book empirically examines these externalities: It investigates the banks' factual conduct and its effects on third-party creditors in Germany and the US. The study's most significant outcome is that it disproves the assumption that banks disregard third-party creditors' interests.

These findings are then interpreted with the tools of economic analysis; particularly, with the concept of common pool resources (CPRs). Around the aggregated value of the debtor company's asset pool (as CPR) exists an n-person prisoner's dilemma between banks and third-party creditors: No creditor knows when and under what conditions the other creditor will appropriate funds from the debtor company's asset pool. This coordination problem is traditionally addressed by means of bankruptcy law and collaterals. However, the incentive structure that surrounds the bilateral private governance system created by covenants and an event of default clause (a CPR private governance system) is found to also be capable of tackling this problem.

Moreover, the interaction between the different regulation spheres - bankruptcy law, collateral and the CPR private governance system − has important implications for both the aforementioned discussions as well as the legal treatment of covenants and event of default clauses. Covenants alone cannot be seen as an alternative to institutional regulation; the complete CPR private governance system and its interaction with institutional regulation must also be taken into consideration. In addition, their function must first find more acceptance and respect in the legal treatment of covenants and event of default clauses: The CPR private governance system fills a gap in the regulation of the tragedy of the commons by bankruptcy law and collateral. This has particularly important implications for the German § 138 BGB, § 826 BGB and ad hoc duties to disclose insider information.

Inhalt

Acknowledgements 5
Contents 6
List of Abbreviations 12
List of Figures 14
List of Tables 15
Part I: Theoretical Framework and Development of Research Question 16
Chapter 1: Introduction: Covenants and Third-Party Creditors 17
1.1 Covenants and Creditor Protection 17
1.2 Relevance of Third-Party Creditor Protection 19
References 23
Chapter 2: Self-Help Devices of Creditor Protection 26
2.1 Credit Risk 26
2.1.1 Risk of False or Lacking Information 28
2.1.2 Risk of Bankruptcy 28
2.1.3 Risk of Loss 30
2.1.4 Corporate Groups as a Special Case 30
2.2 Mechanisms of Creditor Protection 30
2.2.1 Proprietary Devices 31
2.2.2 Covenants and Other Contractual Devices 32
2.2.2.1 Other Contractual Devices 33
2.2.2.2 Covenants 33
2.2.2.3 Mechanisms Suitable for Specific Creditor Types 34
2.2.2.3.1 Institutional Lenders 35
2.2.2.3.2 Bondholders 35
2.2.2.3.3 Trade Creditors 36
2.2.2.3.4 Customers 37
2.2.2.3.5 Employees 37
2.2.2.3.6 Tort Creditors 38
References 38
Chapter 3: Covenants and Bilateral Creditor Protection 43
3.1 Protection Against the Risk of False or Lacking Information 43
3.2 Protection Against the Risk of Bankruptcy 44
3.2.1 Financial Covenants 44
3.2.1.1 Framework of Financial Covenants 45
3.2.1.1.1 Setting of Financial Covenants 45
3.2.1.1.2 Inclusion of Subsidiaries 46
3.2.1.1.3 Compliance with Financial Covenants 46
3.2.1.2 Interest Coverage Ratio Covenant 46
3.2.1.3 Leverage Ratio Covenant 47
3.2.1.4 Tangible Net Worth Covenant 47
3.2.1.5 Gearing Covenant 47
3.2.1.6 Current Ratio Covenant 48
3.2.2 Negative Covenants 48
3.2.2.1 No Disposal Clause 48
3.2.2.2 No Merger Clause 49
3.2.2.3 No Change of Business/Management Clause 49
3.2.2.4 Other Negative Covenants 50
3.3 Protection Against the Risk of Loss 50
3.3.1 Affirmative Covenants 50
3.3.2 Negative Covenants 51
3.3.2.1 Negative Pledge Clause 51
3.3.2.2 CAPEX Covenant 52
3.3.2.3 Dividend Restrictions Clause 52
3.3.3 Financial Covenants as Supplements 52
3.4 Clauses That Ensure the Enforcement of Covenants 53
3.4.1 Information Undertakings 53
3.4.2 Pari Passu Clause 54
3.4.3 Event of Default Clause 55
3.4.4 Cross-Default Clause 57
3.4.5 MAC Clause 58
3.4.6 Performance Pricing Clause 58
3.5 Creating a Bilateral Private Governance System 59
References 62
Part II: The Systematisation of Third-Party Creditor Effects of Covenants: Preliminary Framework 65
Chapter 4: Academic Discussion and the Relevance of Third-Party Creditor Protection 66
4.1 Covenants Creating a Bilateral Private Governance System with Externalities 66
4.1.1 The Law and Economics Term of Externalities 67
4.1.2 Covenants and Externalities 67
4.2 The Relevance of Externalities 68
4.2.1 Covenants as an Alternative to Institutional Creditor Protection 68
4.2.1.1 Company Law 69
4.2.1.2 Bankruptcy Law 71
4.2.2 Rethinking Corporate Governance 72
4.3 Summary 73
References 74
Chapter 5: Potential Externalities of the Bilateral Governance System 77
5.1 Banks as Monitoring Agents for Third-Party Creditors 77
5.2 Potential Positive Externalities 78
5.2.1 Information Production 78
5.2.1.1 Direct Information About a Covenant Default 79
5.2.1.1.1 Privately Held Companies 79
5.2.1.1.2 Publicly Traded Companies 81
5.2.1.1.2.1 German Law 81
5.2.1.1.2.2 US Law 83
5.2.1.2 Indirect Information Through the Bank´s Reaction 84
5.2.1.3 Value of Information for Third-Party Creditors 85
5.2.2 Disciplinary Effect: Reducing the Shareholder-Creditor Conflict 86
5.3 Potential Negative Externalities 88
5.3.1 Influencing the Management Not in the Interest of All Creditors 88
5.3.2 Reducing the Pool of Assets 89
5.3.3 Unnecessary Bankruptcy and the Domino Effect 90
5.4 General Limits 91
5.5 Scale of Positive and Negative Effects Depends on the Covenant-Secured Creditor´s Conduct 92
References 93
Chapter 6: The Self-Interested Behaviour of Banks and Its Legal Limits 97
6.1 The Self-Interested Behaviour of Banks 97
6.2 Legal Limits of Bank´s Self-Interested Conduct 98
6.2.1 Acceleration Based on Covenant Default 99
6.2.1.1 German Law 100
6.2.1.1.1 Validity and Enforceability of Event of Default Clause 100
6.2.1.1.2 Treu und Glauben in Case of Acceleration 103
6.2.1.2 US Law 104
6.2.1.2.1 Validity and Enforceability of Event of Default Clause 104
6.2.1.2.2 Duty of Good Faith in Case of Acceleration 105
6.2.1.3 Conclusion 106
6.2.2 Additional Collateral Followed by Bankruptcy 106
6.2.2.1 German Law 107
6.2.2.1.1 Avoidable Preference 107
6.2.2.1.2 Nullity Under § 138 BGB 109
6.2.2.1.3 Treuepflicht of the Controlling Bank to Third-Party Creditors 111
6.2.2.1.4 Liability Under § 826 BGB 112
6.2.2.1.5 Liability as a Faktisches Organ 113
6.2.2.2 US Law 113
6.2.2.2.1 Avoidable Preference 114
6.2.2.2.2 Fiduciary Duty of the Controlling Bank to Third-Party Creditors 115
6.2.2.3 Conclusion 117
6.3 High Probability of Self-Interested Behaviour of Banks 117
References 118
Part III: Empirical Research: Results and Re-evaluation of Preliminary Theory 122
Chapter 7: Design and Methodology 123
7.1 Research Objective: The Factual Behaviour of Covenant-Secured Creditors and Its Effects on Third-Party Creditors 123
7.2 Research Object: Banks and Their Behaviour After a Covenant Default Under Bank Loans 124
7.3 Expert Interviews 125
7.4 Data Collection and Assessment 126
7.4.1 Conducting the Interviews 126
7.4.2 Transcription and Coding 127
7.4.3 Limitations and Bias 128
References 129
Chapter 8: Results: Covenants as a Reciprocal Private Governance Creditor Protection System 131
8.1 Private Governance: Enforcement Out of Court 131
8.1.1 Motivation for Private Enforcement 132
8.1.2 Method of Private Enforcement: Self-enforcing Agreements 133
8.1.3 Discussion 134
8.2 Negative Effects on Third-Party Creditors 135
8.2.1 Influencing the Management Not in the Interest of All Creditors 135
8.2.1.1 Debtor Company Pays Bank First or Only Pays Bank 136
8.2.1.2 Additional Risk Premiums 136
8.2.2 Unnecessary Bankruptcy and the Domino Effect 138
8.2.3 Discussion 140
8.3 Positive Effects on Third-Party Creditors 142
8.3.1 Disciplinary Effects 142
8.3.1.1 Similar Rights for Third-Party Creditors 142
8.3.1.2 Ensuring a Larger Pool of Assets 144
8.3.1.3 Keeping the Debtor Company Solvent 144
8.3.2 Information Sharing 146
8.3.2.1 Information Shared by the Debtor Company 146
8.3.2.2 Informal Exchange Between Creditors 146
8.3.2.3 Information Provided by Third Parties 148
8.3.2.4 Discussion 148
8.4 Influence of Third-Party Creditors on the Bilateral Private Governance System 149
8.4.1 Linked Contracts 149
8.4.2 Banks as Third-Party Creditors in a Small Community 150
8.4.3 Third-Party Creditors That Are Essential for Operational Business 150
8.4.4 Sense of Responsibility 151
8.4.5 Discussion 151
8.5 Conclusion 152
References 153
Chapter 9: Re-evaluation: Collectivisation of Creditor Protection Through Private Governance 155
9.1 Common Pool Resources 155
9.2 Aggregated Value of the Debtor Company´s Pool of Assets as a CPR 156
9.3 Mechanisms to Reduce the Coordination Problem 158
9.3.1 State Regulation: Bankruptcy Law 159
9.3.2 Privatisation of Rights: Collateral 161
9.3.3 Self-governing CPR Institutions 163
9.3.3.1 Clearly Defined Boundaries 164
9.3.3.2 Congruence Between Appropriation, Provision Rules and Local Conditions 165
9.3.3.3 Collective-Choice Arrangements 165
9.3.3.3.1 Linkage of Contracts 165
9.3.3.3.2 Linkage of Interests 166
9.3.3.4 Effective Monitoring 167
9.3.3.5 Graduated Sanctions 167
9.3.3.6 Conflict-Resolution Mechanisms 168
9.3.3.7 Minimal Recognition of Rights to Organise 168
9.4 Collectivisation of Creditor Protection Through the CPR Private Governance System 169
References 170
Chapter 10: Consequences for Legal Discussion 174
10.1 Covenants as a Supplement to Bankruptcy Law 175
10.2 Covenants as a Supplement to Capital Requirements 175
10.3 Creditors as Part of Corporate Governance 177
10.4 Fostering the CPR Private Governance System in Germany 178
10.4.1 Legal Treatment of Covenants: § 138 v. § 826 BGB 178
10.4.2 More Mandatory Disclosure 178
10.5 Summary 180
References 181
Part IV: Summary and Outlook 183
Chapter 11: Summary 184
Chapter 12: Outlook 190
References 192
Appendices: Empirical Research 194
Appendix 1: Interview Guideline 194
Appendix 2: Results 198
1 Private Governance: Enforcement Out of Court 198
1.1 Reasons for Enforcement Out of Court 199
1.2 Through Self-Enforcing Agreements 203
1.3 Limits of Private Governance via Covenants 207
2 Negative Effects on Third-Party Creditors 209
2.1 Debtor Pays Bank First or Only It 209
2.1.1 Not Likely 209
2.1.2 Likely 210
2.2 Exploiting Third-Party Creditors 211
2.2.1 Not Likely 211
2.2.2 Likely 214
2.3 Domino-Effect 218
2.3.1 Not likely 218
2.3.2 Likely 222
3 Positive Effects on Third-Party Creditors 226
3.1 Similar Rights for Third-Party Creditors 226
3.1.1 Not Likely 226
3.1.2 Likely 229
3.2 Ensuring a Larger Pool of Assets 233
3.2.1 Not Likely 233
3.2.2 Likely 235
3.3 Keeping the Debtor Solvent 236
3.3.1 Not Likely 236
3.3.2 Likely 238
3.4 Information Sharing 245
3.4.1 Not Likely 245
3.4.2 Likely 247
4 Influence of Third-Party Creditor on the Bilateral Private Governance System 255
4.1 Not Likely 255
4.2 Likely 257
Table of Cases 266
1 German Case Law 266
1.1 Supreme Court of the (German) Reich 266
1.2 German Federal Supreme Court 266
1.3 Higher Regional Court 268
1.4 Regional Court 268
2 European Union Case Law 268
3 US Case Law 268
3.1 US Supreme Court 268
3.2 State Supreme Courts 269
3.3 Courts of Appeal 269
3.4 District Courts 270

Produkt-Details

• Erscheint lt. Verlag: 17.10.2017
• Zusatzinfo: XVII, 265 p. 7 illus., 4 illus. in color.
• Verlagsort: Cham
• Sprache: englisch
• Themenwelt: Recht / Steuern ► EU / Internationales Recht
• Themenwelt: Recht / Steuern ► Wirtschaftsrecht
• Themenwelt: Wirtschaft ► Betriebswirtschaft / Management ► Finanzierung
• Schlagworte: Banking Law • Bankruptcy • Collateral • Common Pool Resources • Corporate Governance • Corporate Law • Covenants • CPRs • Credit law • Creditor protection • Creditors • Debtor • Externalities • Externality • Insider information • Insolvency law • law and economics • Third-party-creditors • Tragedy of the commons
• ISBN-10: 3-319-62036-3 / 3319620363
• ISBN-13: 978-3-319-62036-7 / 9783319620367