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A Note on Senior Debt

posted by Stephen Lubben

Many of the comments and emails I have received regarding my Forbes commentary lead me to believe that there is a general lack of understanding about how senior debt -- like that at issue in Chrysler -- differs from traditional bond debt. Both are typically freely traded, but the similarities start to break down after that.

An indenture trustee appointed under the Trust Indenture Act is typically a passive sort, who collects bulk payments from the issuer, distributes them on to the individual bondholders, and lets the holders know when said payments have not been forthcoming. Under a typical senior debt agreement, however, the lead lender is typically vested with broad and irrevocable authority to act for all other lenders in the loan, including the successors to original lenders in the loan, particularly upon default.

In addition, senior loan agreements typically prohibit individual action by lenders that would thwart the decisions of the lead lender or "agent" bank. This is the so called "collective action" clause. Thus, while senior debt agreements often mirror bonds issued under the TIA in requiring unanimous consent before key terms of the loan can be amended, in the case of senior debt most other decisions are subject to the discretion of the agent bank, as directed by a majority of the lenders.

In the specific case of Chrysler, all voting requirements in the loan agreement and the collateral trust agreement, which outlines the terms under which the collateral agent will hold the liens for the benefit of all lenders, are set at 50% -- hence my "majority rule" comment in the Forbes article. And under section 6.12 of the Chrysler collateral agreement, the agent has the power to release the liens granted under the loan agreements. Indeed, upon default the agent has full control over any "Collection Enforcement Action," defined to include "exercising any other right or remedy under the [UCC] . . . or under any Bankruptcy Law or other applicable law."  In short, there is a lot the agent, acting with the consent of a majority of the lenders, can do that falls well short of a formal amendment to the loan agreement.

Thus, when people like the Indiana Pension Funds complain that their rights as a secured creditor have been violated, it is not unlike a condo owner saying that the condo board interferes with the owner's "property rights."  Yes, but isn't that what you agreed to when you bought the place? Indeed, that is the very nature of this kind of debt agreement, which by design mediates among the competing interests of individual lenders.

Judge Gonzalez provides further insight into this issue at pages 24-29 of his opinion, which I previously posted here.

Comments

ummmmm, I think I made this point last week sometime, in response to one of the comments on one of Steve's previous blog posts. Except I hadn't had the benefit of reviewing the senior secured debt instrument.

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