Wednesday, May 27, 2009

Political restructuring of creditor rights - it's not just the interest rates

The point has been repeatedly and correctly made many times that the Obama administration’s political - ‘extralegal’? - pressures to force secured and senior creditors to take lesser positions than that to which they are otherwise legally entitled for the benefit of politically-favored labor unions has the effect, other things equal and most likely even other things not, of raising the interest rates that secured or senior creditors will charge similar unionized enterprises in the future.

What has been less discussed, at least so far as I‘ve seen, is the effect the administration’s moves will have on how bond covenants might be drafted into the future, in order to address the uncertainties created by these moves. For example, might we see a bond covenant in the future (analogous to existing and ubiquitous poison put provisions in favor of creditors) that would allow senior or secured creditors to put the bonds back to a corporate borrower, forcing repayment of principal plus interest, if unionization occurred at all or part of the corporation’s operations?

I can imagine litigation over the question of whether this would be a violation of unionization rights, but at first blush, it is a provision directed at the corporation, at a risk that the corporation might suffer, and the corporation’s own actions are not relevant to that risk. Why should the parties not be able to bargain in advance over who suffers the loss in the case of government interference in credit ordering? Or in the unionization that might lead to that kind of political risk? I suppose we might have a whole special section of covenants covering these risks, perhaps under the title, “Rule of Law Failure Risks” or “Favored Political Constituency Risks.”

There are lots of possibilities for covenants and other moves seeking to lessen the uncertainties. But they would have the effect of reducing the ultimate interest rate only insofar as they were taken seriously. That is, if the market did not believe that the covenants would be enforceable, because it did not trust the administration or the courts to enforce them, either those in particular or a more generalized belief that the rule of law had been impaired (imagine you are a foreign government thinking of investing in US corporate debt - is it conceivable, watching events, that you would not at a minimum think that legal rules in investor protection law had been at least somewhat impaired by these events?) then interest charged as a risk premium would not be reduced.