How parties to a loan agreement or bond indenture can change the terms of their deal is an important, if frequently neglected, aspect of debt financing. Bonds and loans represent a company’s obligation to repay a debt, with interest, over time. But only a small fraction of what goes into an indenture or a loan agreement relates directly to the debtor’s financial obligations. Most of the material, by word count and complexity, consists of rules that bind the debtor while the debt is outstanding and which are designed to increase, relative to a naked promise to repay, the likelihood that the debtor will make good on its debt and that the investors will be able to recover otherwise if it doesn’t. The problems of incomplete contracting plague these supporting rules, however. Parties to a debt contract thus try to articulate sensible terms when they strike their agreement knowing full well that the world will change and might change in ways that undermine the initial terms’ commercial desirability. Sometimes it will make sense for the deal to change.

In recent years, long-settled understandings about how debtors pursue change have largely collapsed. Some of the world’s most elite law firms and financial advisors have made their marks devising novel approaches to consent solicitations. From the debtor’s perspective, the stimuli for these changes have been both “defensive” and “offensive.” On the defensive side, a seeming increase in activism by hedge funds specializing in distressed debt has induced companies to consider all available means to escape a threatened acceleration. On the offensive side, private equity-backed companies seeking to restructure unsustainable debt burdens without invoking Chapter 11 have proven willing to experiment with previously unthinkable techniques. The most talked-about development in leveraged finance and restructuring in recent years, sometimes described as “creditor-on-creditor violence,” is a story first and foremost of dashed expectations about how consent solicitations work. More than hyperbolic labels are at stake. The new methods have spurred numerous rounds of litigation, with disaffected debtholders challenging the validity of putative “majority” or “supermajority” results.

Read more at Harvard Law School Forum on Corporate Governance