Evan Rocher

The recent decision in U.S. Bank National Ass'n v. Windstream Services, LLC, No. 17-CV-7857 (JMF), 2019 WL 948120 (S.D.N.Y. Feb. 15, 2019) is the subject of much heated commentary. However, little ink has been spilled about defensive changes in debt contracts after Windstream (“Windstream covenants”).

It might make sense that Windstream covenants haven’t gotten much attention. A contract failed, with unexpected and disastrous consequences (a “contract catastrophe”), and lawyers—seeing this disaster—patched this problem in their new contracts. That is how it is supposed to work![1] However, as the empirical literature on contract evolution demonstrates, it almost never works that way.[2] Instead, lawyers modify contracts haphazardly, often failing to correct obviously dangerous terms or absences. This blog post reviews the literature on contract evolution and suggests a possible reason why Windstream covenants are now commonplace, even though contracts typically do not evolve in response to contract catastrophes.

But first, a brief refresher on Windstream, which was decided in February 2019. Windstream is a telecommunications company that issued bonds. In one issuance, they promised not to engage in certain sale-leaseback transactions.[3] They allegedly engaged in those transactions (though many prominent observers feel that their conduct was comfortably within the letter of the contract),[4] but bondholders seemed not to mind. No bondholder objected until, years after the breach, a hedge fund noticed Windstream’s behavior and purchased enough bonds to call a default.[5] Allegedly, the fund did so because they owned derivatives that paid off in the event of Windstream’s default.[6] Seeking to avoid a default that would cost them dearly[7] (and did cost them dearly)[8], the vast majority of bondholders tried to excuse Windstream’s breach, but this failed for complex legal reasons.[9] A court found Windstream in default,[10] which immediately accelerated all of Windstream’s bond obligations and led rapidly to bankruptcy.[11]

The bond market widely condemned this decision that allowed a net-short bondholder to bankrupt a company by calling a default.[12] This was a contract catastrophe—a better contract would deny this power to net-short bondholders. A general consensus developed that this should not happen again, and a variety of anti-Windstream covenants were added to debt contracts.[13] These covenants include:

  • A shortening of the notice period to call a default.
  • An increase in the percentage of bonds required to call a default.
  • A ban on voting by “net-short” bondholders.

Within months it seemed as if all was well again in the bond market. An opportunistic hedge fund had taken advantage of a weakness in a contract and caused a catastrophe, and that weakness was patched. But clear contractual weaknesses, even those that cause contract catastrophes, are often not fixed. Examples include:

  • Pari passu clauses in sovereign debt indentures, despite their crippling impact on Argentinian and Peruvian bonds in the early 2000s and beyond.[14]
  • Choice-of-law terms, which occasionally are ignored and lead to contract catastrophes due to changing interpretative norms, even though simple changes could prevent the contract catastrophes.[15]
  • IP protection covenants, which could protect critical IP from being removed from the debtor in financing transactions.[16]

This almost begs a question: if contract drafters failed to fix these key contract failures, even after they cost millions of dollars, why did Windstream covenants quickly take hold? I argue that Windstream covenants have three attributes that make their evolution likely: they cover negotiable terms, they are understandable, and they are mutually advantageous.

  • Windstream covenants cover negotiable terms: By negotiable terms, I mean terms that are expected to be negotiated or altered in a normal transaction. Pari passu clauses (because of their mysterious nature)[17] and choice-of-law terms (because they are seen as boilerplate not to be negotiated)[18] are nonnegotiable. When a party attempts to negotiate a nonnegotiable term, it raises the suspicions of their counterparties—why are they bothering to change this? Are they pulling a fast one on us?—and it may open the whole contract up for debate. Windstream covenants avoid these problems by only altering obviously negotiable terms like the notice period.
  • Windstream covenants are understandable: Many contract terms are not understandable, either to the lawyers[19] or to the non-legal professionals involved in the deal.[20] (Pari passu clauses, seen as deeply mysterious, are a great example of this.) This makes their evolution tricky because parties will be deeply concerned by a change they do not fully understand. Similarly, if parties cannot predict the consequences of their new covenants with a high level of certainty (as may be the case with IP protection covenants),[21] they may be very hesitant to change them. Windstream covenants like the ones discussed above are, by contrast, easy to understand.
  • Windstream covenants are mutually advantageous: These contract catastrophes are sometimes hugely advantageous to one of the parties,[22] like IP protection catastrophes that allow debtors to move key assets out of the reach of creditors, making contract evolution a complex negotiation. By contrast, when the contracting parties all benefit from new covenants, they are more likely to be inserted. Windstream covenants, which protect the company and the initial bond purchasers, who are likely net-long, fit cleanly in this mode.

The empirical literature has repeatedly demonstrated that real-life contracting practice does not reflect our assumptions. Windstream covenants, however, provide an interesting counterexample to this and exemplify a rare case where real-life contracting works like we think it should, and therefore, deserve further explanation. The combination of mutual advantageousness, understandability, and negotiability of Windstream covenants may explain why they bucked the trend of leaving terms that led to contract catastrophes uncorrected.



[1] Mitu Gulati & Robert E. Scott, The Three and a Half Minute Transaction: Boiler Plate and the Limits of Contract Design, 10 (2013) (describing the traditional view that contract attorneys are sophisticated individuals in attentive markets and therefore rapidly edit their contracts in response to legal events).

[2] Id. at 10–11; John F. Coyle, Choice-of-Law Clauses in US Bond Indentures, 13 Cap. Mkts. L.J. 2, 156 (2018), available at: https://academic.oup.com/cmlj/article/13/2/152/4934140 (describing how only 7% of bond indentures responded to changes in New York choice of law rules).

[3]  Windstream Corporation, January 23, 2013 Indenture, https://www.sec.gov/cgi-bin/browse-edgar?company=Windstream&owner=exclude&action=getcompany.

[4] Matt Levine, Opinion, Aurelius Wins Against Windstream, Bloomberg (Feb. 19, 2019), https://www.bloomberg.com/opinion/articles/2019-02-19/aurelius-wins-against-windstream.

[5] Sujeet Indap & Robert Smith, Contentious Legal Ruling Puts Windstream at Risk of Bankruptcy, Fin. Times (Feb. 17, 2019), https://www.ft.com/content/d1208cd0-3289-11e9-bd3a-8b2a211d90d5.

[6] Id.

[7] Matt Levine, Opinion, Aurelius Broke Windstream’s Bonds to Save Them, Bloomberg (Feb. 27, 2019), https://www.bloomberg.com/opinion/articles/2019-02-27/windstream-bankruptcy-will-destroy-value-eliminate-profits.

[8] Windstream SVCS 2023, Mkt. Insider, https://markets.businessinsider.com/bonds/windstream_services_llc-bond-2023-us97381waz77.

[9] Levine, supra note 4.

[10] Aurelius Responds to Windstream’s Statement Regarding Court Decision, PRNewswire (Feb. 19, 2019), https://www.prnewswire.com/news-releases/aurelius-responds-to-windstreams-statement-regarding-court-decision-300798014.html.

[11] Windstream Files for Chapter 11 Bankruptcy after Court Ruling, Reuters (Feb. 25, 2019), https://www.reuters.com/article/us-windstream-hldg-bankruptcy/windstream-files-for-chapter-11-bankruptcy-after-court-ruling-idUSKCN1QE2CL.

[12] Sujeet Indap, Windstream Debt Battle Opens up ‘Pandora’s Box’ for Hedge Funds, Fin. Times (Feb. 22, 2019), https://www.ft.com/content/fe394284-35ae-11e9-bd3a-8b2a211d90d5; William D. Cohan, Opinion, What Hedge Funds Consider a Win is a Disaster for Everyone Else, N.Y. Times (May 12, 2019), https://www.nytimes.com/2019/05/12/opinion/windstream-bankruptcy-cds.html; Carl N. Wedoff & Michael K. Ballew, Jr., Outrageous Fortune: Making Money by Engineering Defaults, 38 Am. Bankr. Inst. J., no. 7, July 2019, available at: https://jenner.com/system/assets/publications/19107/original/Wedoff%20ABI%20July%202019.pdf?1562626980.

[13] Joshua A. Feltman, Emil A. Kleinhaus & John R. Sobolewski, Debt Default Activism: After Windstream, the Winds of Change, Harv. L. Sch. F. on Corp. Governance & Fin. Reg. (June 18, 2019), https://corpgov.law.harvard.edu/2019/06/18/debt-default-activism-after-windstream-the-winds-of-change/.

[14] Gulati & Scott, supra note 1, at 61–72 (documenting that these clauses are still common). However, in 2014—many years after the events at issue—pari passu modifications became common. Stephen J. Choi, Mitu Gulati & Robert Scott, The Black Hole Problem in Commercial Boilerplate,  67 Duke L.J. 1 (2017), available at: https://dlj.law.duke.edu/article/the-black-hole-problem-in-commercial-boilerplate-choi-vol67-iss1/.

[15] Coyle, supra note 2, at 159–60 (noting that the overwhelming majority of forum selection clauses in bond indentures were deficient and unreliable).

[16] Katherine Doherty, Distressed Daily: J. Crew Blockers Appear in Just 17% of Loans, Bloomberg Law (Sept. 26, 2019), https://news.bloomberglaw.com/bankruptcy-law/distressed-daily-j-crew-blockers-appear-in-just-17-of-loans.

[17] Gulati & Scott, supra note 1, at 46.

[18] Coyle, supra note 2, at 163–65.

[19] Choi et al., supra note 14, at 18; Gulati & Scott, supra note 1, at 46.

[20] Jeffrey Manns & Robert Anderson IV, The Merger Agreement Myth, 98 Cornell L. Rev. 1143 (2013) available at: https://scholarship.law.cornell.edu/clr/vol98/iss5/3/; Gulati & Scott, supra note 1, at 80–81.

[21] Justin Smith, J Crew Blocker: Don’t Believe the Hype, Debtwire (May 11, 2018), https://www.debtwire.com/info/j-crew-blocker-don’t-believe-hype.

[22] Jonathan Schwarzberg, Investors Tighten Loan Documents with J Crew Blocker, Reuters (May 3, 2018), https://www.reuters.com/article/jcrew-blocker-idUSL1N1SA1W8.