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The Drama Over the Windstream Case: Boiled Down

posted by Mitu Gulati

One the most discussed and debated corporate finance/contracts cases of 2019 was Windsteam LLC v. Aurelius (SDNY 2019) (Stephen L posted on this here).  A couple of days ago, Elisabeth de Fontenay put up her article "Windstream and Contract Opportunism" on ssrn (here) that is one of first deep dives into the implications of what happened in the case.

I find this case especially interesting because it is about contract arbitrage. Cribbing from Elisabeth's superb narrative, the saga starts when the company in question, Windstream, does a sale-leaseback transaction in violation of its bond covenants (it claims it is not actually violating the covenant because it did the transaction through a subsidiary blah blah -- but as the judge points out, its attempt to elevate form over substance falls flat). As it turns out though, none of the bondholders seem to have either noticed or cared about the violation at the time it happened. The violation only bubbles to the surface when Aurelius, a notorious hedge fund, shows up two years later and demands that the trustee declare a default. At this point, I'd have expected that Windstream would have paid Aurelius greenmail to get them to disappear and everyone would have lived happily after.  But that doesn't happen.  Instead, Windstream officials and Aurelius fund managers get into a nasty battle of words in the press and (I'm guessing) both sides decide that they will fight this to the death.

At this point, Windstream tries to retroactively cure its covenant violation by getting the non-Aurelius creditors to say that they were okay with the transaction and do not want to call the company to the carpet. In theory this should have been doable via exit consents and other familiar corporate moves.  But, in a comedy of errors, Windstream manages to screw up the retroactive cure (and the judge wasn't willing to elevate substance over form on this side of the equation).  End result: Windstream loses and goes into bankruptcy.  That is, everyone loses, including the bondholders, because the value of their bonds goes into the toilet.


So, at first cut, it looks like both sides, Windstream and Aurelius, lost as a result of their contract shenanigans and their failure to cut a deal. However, the rumor is that Aurelius made a bundle here because it had purchased a bunch of CDS contracts betting that Windstream would tank.  As an aside, no one seems to actually know whether Aurelius lost big or won big. But almost everyone who tells the story does so under the assumption that Aurelius won big. I'd love to know the details, but Judge Furman didn't push Aurelius on this -- and probably wouldn't have gotten a straight answer (Justice Alito actually tried to get Aurelius to fess up to what their strategy was in a recent case involving Puerto Rico that also looked -- on its face -- to be a lose-lose situation for all the parties involved (here), but didn't succeed).  

The interesting questions have to do with the big picture implications.  A number of the folks who have written about this case use it as an illustration of what is often referred to as the "empty voting" problem. (e.g., here)  Elisabeth does talk about this in her article, but she sees a bigger and potentially more interesting problem.

That is the problem of judges taking an unrealistic view of how even the most sophisticated parties write contracts.  Judges in these sophisticated corp fin cases, according to Elisabeth, routinely view parties as being able to write complete contracts. That is, contracts that anticipate every contingency ahead of time.  But that view, even for the most sophisticated parties, is rubbish.  The product of the judiciary holding this unrealistic view though, Elisabeth explains, is the contracting parties keep trying to write more and more complete contracts. That then results in contracts growing longer and more complex.  End result: the contracts end up being rife with even more ambiguities and confusions than they were in the first place. And that is a recipe for contract opportunism. Absent strong norms against such behavior, we end up with cases like Windstream.  (For a fuller treatment of this dynamic, see Elisabeth's recent article in the Wisconsin Law Review, "Complete Contracts in Finance", also posted a couple of days ago, here).

So, what should be done?

There are some possible solutions. None particularly satisfactory.

First, private ordering.  The parties could try to fix the Windstream problem contractually by requiring disclosure of CDS holdings or putting a time bar on how long investors can wait before they assert covenant violations. There are rumors that this has been attempted, although I haven't seen any evidence as to whether it has succeeded (getting boilerplate contracts to change is difficult, to put it mildly). But even assuming that the attempt to add more language to the contracts succeeds, the endeavor plays right into the problem Elisabeth identifies.  Even more gibberish gets added to the contract. 

Second, judges could try to police opportunism more aggressively, using good faith duties and implied inter creditor obligations. I think that Elisabeth would say that that this is going to be inadequate. Judges already have these implied duty tools and choose not to use them.  Pointing out that they exist to judges who already know that they exist does nothing.

Third, we could try to persuade judges to change their behavior in these corporate contracting cases (yes, I'm suspending the reality that no judge is reading our articles about how they should behave). As Elisabeth points out in her Wisconsin article, judges have shown themselves to be able and willing to view contracts as incomplete in other areas of contract law (e.g., employment). So, maybe it is just a matter of educating judges about the reality of how these corporate contracts such as bond indentures are produced (that they are full of gaps and ambiguities). I'm skeptical though that judges will change their behavior if they gain a better understanding of the impossibility of drafting complete corporate bond indentures.  I suspect that the reason they rule the way they do in these cases is that they find them difficult to understand and they have other more pressing (and interesting) matters to deal with -- after all, who wants to read a hundred page corporate bond indenture? (One of the ironies here is that Judge Furman seems to have actually put in the effort to try to figure out what was going on; and he still managed to accrue an enormous amount of criticism).  

Bottom line: This is a fascinating case that flags a problem that is not going away anytime soon. 


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