A Board Can Legally Take From Bondholders to Help Shareholders
The $30 billion Harrah's buyout left $4.5 billion of old bonds stranded at eight times leverage, because no one had bargained for protection.
The Wall Street Skinny · Private Equity Knows Something Private Credit Doesn't | This $30B LBO Holds the SecretWhen buyout firms Apollo and TPG bought the Harrah's casino company for $30 billion in 2008, holders of $4.5 billion of old Harrah's bonds woke up owning a different risk than the one they had bought.
In the view of Kristen, a former Morgan Stanley banker who worked on buyouts, that moment shows a hard rule about corporate debt. Bondholders are treated as outside lenders who must protect themselves in their contracts, while the board must try to maximize value for shareholders, who after a buyout are the private equity owners.
The old bonds lacked change of control protection, a promise that lenders get repaid or get new terms if the company is sold or piles on debt. After the buyout, leverage jumped to about eight times annual cash flow, and those once relatively safe lenders were pushed to the bottom of a much riskier pile. Debt, in this account, is only the rights written in the paperwork, so directors can favor shareholders if lenders failed to bargain for safeguards. Courts can still undo transfers that count as fraudulent conveyance, which is a separate legal fight.
Normally a buyout is funded mostly with debt backed by the company's own cash, and if the company cannot pay, lenders take control through bankruptcy. Kristen calls what Apollo did instead shenanigans to buy time and shift value from creditors, and Caesars later went bankrupt after a struggle.
She treats the episode as the start of creditor on creditor violence, in which lenders at the same level get treated differently by a deal that helps some of them at the expense of others. She also ties this to why debt and equity differ, since a lender gets interest and then repayment at face value and no more, while an owner can lose everything or can gain a great deal in a recovery.
Questions people ask
What is a covenant or change-of-control protection?
A covenant is a rule written into a loan that requires the borrower to do or avoid certain things, like staying below a debt limit or filing financial reports. A change-of-control clause says that if the company is sold, lenders can demand to be repaid immediately or renegotiate. Without it, new owners can load the company with additional debt and leave old lenders junior to the newcomers.
Why does a board owe its duty to shareholders and not bondholders?
Under U.S. corporate law, directors are elected by shareholders and must act in their best financial interests. Bondholders are treated as outside contractors who are expected to protect themselves through negotiation. Courts generally enforce that split unless directors loot a nearly insolvent company or commit fraud.
What is fraudulent conveyance?
It is a legal claim that a company moved assets or took on obligations to unfairly put property beyond creditors' reach, especially when insolvent. If proven, a court can undo the transfer. In buyout fights, bondholders often argue that shifting good assets to a new entity or paying owners while creditors go unpaid crossed that line.
What does creditor on creditor violence mean?
It describes restructurings where some lenders cut a deal with the borrower or sponsor that improves their own position while harming other lenders at the same level. Common tools include moving collateral to back new loans or rolling favored lenders into senior debt. Losing lenders often sue, arguing their contracts were exploited through loopholes.