Hybrid | The New Incentives of Senior Lenders in Financial Distress

Speaker: Professor Sarah Paterson (LSE)

Chair: The Right Hon Lord Richards of Camberwell (Justice of the Supreme Court)

About the lecture

This lecture will address a new problem: the problem that both modern private equity firms and senior lenders to financially distressed large private equity portfolio companies have incentives to avoid a formal restructuring. Shareholders have always had the incentive to avoid a formal restructuring, but their ability to do so has historically been constrained by senior lenders who have had both the motive and the means to insist on a restructuring in appropriate circumstances. The core claim in the lecture will be that the incentives of senior lenders to private equity portfolio companies have changed and that this creates risks for suppliers, customers, employees, and government agencies and even for wider society. The goal of the lecture is to unpack the problem and ask what, if anything, UK corporate, corporate insolvency, and restructuring law can and should do about it.

Modern finance theory posits that senior lenders to a firm with too much debt have the incentive to drive a restructuring of their financially distressed borrower. This is because the senior lenders’ claims will be more likely to be paid if junior debt and equity claims are written down or written off and the borrower returns to profitability. Shareholders do not share this incentive because they risk losing their equity investment in a restructuring transaction. Until comparatively recently, senior lenders addressed this misalignment of incentives through contractual terms; monitoring; and renegotiation. However, securitisation vehicles known as collateralised loan obligations (CLOs) have become significant holders of senior loans to private equity portfolio companies. In the lecture, I will argue that CLOs lack the incentive to drive a restructuring transaction. I will examine why private equity portfolio companies may take on more debt in financial distress as a result; the risk that the firm’s other stakeholders then find that they rank behind even more debt in a firm which is difficult or impossible to save; and the risk that this contributes to the zombie company phenomenon in which firms weighed down by too much debt cannot invest or grow employment. In the lecture I will explore whether corporate, corporate insolvency, and restructuring law can or should intervene to address these socially costly consequences of the new incentives of senior lenders in financial distress.

About the speaker

Sarah Paterson is a professor of law.  Her main areas of research are corporate reorganization and insolvency. Before joining LSE she was a partner in Slaughter and May in London, with whom she retains a consultancy.

About Current Legal Problems

The Current Legal Problems (CLP) lecture series and annual volume was established over fifty five years ago at the Faculty of Laws, University College London and is recognised as a major reference point for legal scholarship.

Book your place

You can attend this event in-person at UCL Faculty of Laws (Bentham House, 4-8 Endsleigh Gardens, London WC1H 0EG) or alternatively you can join via a live stream.

Please make sure you choose the correct ticket when booking your place.

Book your place

Image by Gerd Altmann from Pixabay