Empty Debt Contracts – Why Windstream Provisions Are Ineffective Against Net-Short CreditorsPosted on Oct 25, 2021
A 2019 lawsuit between Aurelius, a distressed debt hedge fund, and Windstream Holdings, a telecom company, led to a major concern in the world of debt investments. Two years earlier, Aurelius sued to enforce a default from a completed Windstream spinoff transaction, leading many to theorize that Aurelius’ actions only made sense if they had a net-short position against the company. More broadly, Aurelius’ default enforcement led to fears of other potential net-short creditors taking similar actions, and concerns of how companies could protect themselves from such creditor action. The popular response was the addition of “Windstream Provisions,” contractual provisions designed to protect against net-short creditors. However, for reasons to be discussed below, these provisions and other methods of ex-ante protection ultimately fall short as a result of their reliance on voluntary disclosure.
I. Derivatives/Net-Short Creditors Generally
A net-short investor is an investor who has a larger short position than long position on one investment, meaning they are “net-short.” A short position is a bet that an investment’s value will decline and a long position is a bet it will go up. A net-short creditor is a creditor who has a bigger short position on a company’s debt than they do a long position, meaning their economic interest lies in default rather than repayment. Short investments in debt are often taken via derivatives.
A derivative is a financial contract whose value is tied to some underlying asset. A common type of derivative is a credit default swap (“CDS”). A CDS pays out in the event that the underlying debt defaults. Net-short creditors take CDS positions with economic value that outweighs the economic value of their interest in the underlying debt and utilizes their creditor rights to manufacture or enforce some event of default to cash in their CDS.
II. Explanation of Disqualified Lender Lists and Windstream Provisions
In response to the Windstream situation, a new class of contractual provisions, referred to as “Windstream provisions” became popular in contracts to protect against net-short creditors. Importantly, many of these provisions apply to creditors that have been identified or self-identify as being net-short. Common provisions include restricting voting rights and limiting access to company information. An example of a broader Windstream provision is the addition of a sunset provision, which limits when a creditor can enforce a default.
Another procedural safeguard against net-short creditors is disqualified lender lists, which can be utilized alone or in combination with Windstream provisions. Disqualified lender lists are what they sound like—a list of lenders who are not allowed to purchase a debt issuance. These lists can protect against net-short creditors because past known net-short creditors and potential future ones can be placed on the list; furthermore, the list can be updated to add creditors as they become a concern.
While these mechanisms may seem effective at first glance, they are actually less effective than intended.
III. Why They Fall Short
A. Disqualified Lender Lists
The first issue with disqualified lender lists is that it is hard to know who to add to the list. Net-short creditors very rarely, if ever, self-identify. Consequently, the list could be missing the key creditor, even if a company endeavors to ban potential net-short creditors like distressed investors. Additionally, there is a concern that increasing borrower protections can make debt unnecessarily unattractive to lenders. For example, locking out distressed investors may further reduce already constrained liquidity in the event of distress, which could scare off lenders.
Another issue is that disqualified lenders can use subsidiaries to circumvent the lists. In a recent dispute between Apollo and Serta Simmons, Apollo held debt in Serta Simmons even though they were a disqualified lender, and was nonetheless able to lend by purchasing the debt through a differently named subsidiary.
B. Windstream Provisions
The effectiveness of Windstream provisions is conditioned on successful identification and/or self-disclosure of net-short positions. However, the current regulatory landscape doesn’t make disclosure necessary, rendering proper identification difficult and unlikely. These provisions might even distort incentives and make companies even less likely to disclose a net-short position. Even Aurelius, the leading case of a net-short creditor, never officially disclosed such a position in Windstream.
Furthermore, the sunset provisions only solve a specific net-short problem—that of the creditor who has bought in after identifying a past event of default. Sunset provisions would be fairly toothless to net-short creditors who bought in to enforce an imminent default.
The current protections against net-short creditors make sense in theory, and would probably be quite effective in a world with perfect information sharing and mandatory disclosure of short positions. However, the current landscape does not require disclosure of these positions. Against this backdrop, perhaps the next stage of Windstream provisions should be focused on new methods to force disclosure of net-short positions.
 See U.S. Bank Nat'l Ass'n v. Windstream Servs., LLC, No. 17-CV-7857 (JMF), 2019 WL 948120 (S.D.N.Y. Feb. 15, 2019).
 Matt Levine, Maybe Companies Will Get Rid of CDS, Bloomberg (May 23, 2019), https://www.bloomberglaw.com/product/blaw/document/PRZ3MU6S9728?criteria_id=6455049f25a7b7f7452b44b5e2a802dc&searchGuid=c8c3482a-1f36-479f-84d0-6f5fcb46ce81. See Section I (“Derivatives/Net-Short Creditors Generally”) for an explanation on what a net-short creditor is.
 Joshua Feltman, et al., The Rise of the Net Short Debt Activist, Wachtell, Lipton, Rosen & Katz (Aug. 1, 2018), https://www.wlrk.com/webdocs/wlrknew/ClientMemos/WLRK/WLRK.26152.18.pdf.
 Todd Koretzky, Anti-Net Short Provisions in Syndicated Credit Facilities, Allen & Overy (Sept. 3, 2019), https://www.allenovery.com/en-gb/global/news-and-insights/publications/anti-net-short-provisions-in-syndicated-credit-facilities.
 Akhilesh Ganti, Net Short, Investopedia (July 12, 2021), https://www.investopedia.com/terms/n/netshort.asp. Generally, a short position is a bet that the asset’s value will decline and a long position is a bet it will go up.
 Eric M. Rosof, et al., Acquisition Financing: A Banner Year Behind, and New Opportunities in the Year Ahead 4, Wachtell, Lipton, Rosen & Katz (Jan. 11, 2018), https://www.wlrk.com/files/2018/AcquisitionFinancingBannerYearBehindandNewOpportunitiesintheYearAhead.pdf.
 PIMCO, Credit Default Swaps (Accessed on Oct. 1, 2021), https://www.pimco.com/en-us/resources/education/understanding-credit-default-swaps.
 Rosof, et al., supra Note 6.
 Christopher S. Auguste, et al., New Provisions Included in Credit Agreements to Sanitize the Vote of Net Short Lenders, Kramer Levin Naftalis & Frankel LLP (May 23, 2019), https://www.kramerlevin.com/en/perspectives-search/new-provisions-included-in-credit-agreement-to-sanitize-the-vote-of-net-short-lenders.html.
 Vincent Indelicato & Zachary R. Frimet, The Long and Short of It: Anti-Net Short Provisions in NDAs, Proskauer Rose LLP (Aug. 5, 2020), https://www.proskauer.com/pub/the-long-and-short-of-it-anti-net-short-provisions-in-ndas.
 Auguste, et al., supra Note 9.
 Auguste, et al., supra Note 9.
 David Griffiths, Barbarians at the Gate: Loan Syndicates and Trading Association Issues Market Advisory Regarding Disqualified Institutions Provisions for Blacklisted Lenders, Weil Restructuring Blog (Feb. 25, 2015), https://restructuring.weil.com/anti-assignment-clauses/barbarians-at-the-gate-loan-syndications-and-trading-association-issues-market-advisory-regarding-disqualified-institutions-provisions-for-blacklisted-lenders/.
 Id. (Discussing how the list can be updated).
 Koretzky, supra Note 4.
 Joshua A. Feltman, et al., Debt Default Activism: After Windstream, the Winds of Change, Harv. L. Sch. F. on Corp. Governance (Jun. 18, 2019), https://corpgov.law.harvard.edu/2019/06/18/debt-default-activism-after-windstream-the-winds-of-change/.
 Sally Bakewell, Apollo’s Debt-Lawsuit Defeat to Reshape Wall Street Risk Models, Bloomberg News (July 9, 2020), https://www.bloomberglaw.com/bloomberglawnews/private-equity/X763PP9S000000?bna_news_filter=private-equity.
 Koretzky, supra Note 4.
 Levine, supra Note 2.