Bondholder litigation trends - How to spot the innovation opportunities?

If the 08/09 financial crisis is any guide, we can expect there to be an uptick in high stakes cross border bondholder disputes in coming months.

How can financial innovators help to avoid future disputes? If we look at the leading bondholder litigation cases certain innovation opportunities emerge.

 Governance frameworks

What is interesting for innovators is that although bond trustee duties differ between jurisdictions, the cases indicate that transactional frictions are consistent.

This consistency is despite some jurisdictions impose broad fiduciary duties pre- and post-default and others only apply them post-default.

Between jurisdictions that impose fiduciary duties pre-default, some focus on protecting collateral, others on covenant monitoring.

Innovation opportunities

It has been said that if you are in the lending game, you are also in the enforcement game. Thus the collateral focus intuitively makes sense.

What is interesting is we know that use of secured arrangements has actually decreased in some jurisdictions, while it remains more important in others.

Covenant monitoring and calling defaults are expensive and complex tasks. Can financial innovation help to bring value to these critical governance components?

USA market

Consider the landmark 80’s case of Washington Power. The deal involved construction of several nuclear power plants. Cost overruns and low electricity demand resulted in project’s collapse.

Local government issuer claimed ‘diplomatic immunity’ and refused to repay the huge outstanding sums to investors (ie claimed issuance was ultra vires and thus it had no liability!)

UK market

In Elektrim a UK court addressed issues of the suspension of a ‘bondholders director’ and disposal of collateral. Acceleration was ultimately approved by the court, but litigation in various courts dragged on for years.

Australia and New Zealand market

Australian and NZ courts have grappled with a number of recent bondholder disputes. Some resulted in settlements (ie. Provident Capital, Smith’s case and LDC Finance). Kerr’s case resulted in trustee being found guilty for improper release of collateral.

Trustee duties

US and UK laws broadly expect the indenture trustee / bond trustee to serve in an administrative capacity pre-default and fiduciary capacity post default.

Whereas, Australia and New Zealand debenture trustees / bond supervisors have substantial monitoring duties pre- and post-default.

The cases seem to suggest that financial innovators should focus on the pre-default space to help stakeholders avoid costly transactional frictions.

Problems to be solved

Consider the impact of deep, comparative and up to the minute data insights into collateral value and enforceability. Applying new technologies in the major common law jurisdictions would revolutionize bondholder risk and invigorate secondary markets.

In a post-COVID era we can expect there to be strong demand for sophisticated private credit solutions that combine traditional trustee governance with powerful data driven insights to address collateral and enforcement frictions.