“Marriott Risk”: A New Model Covenant to Restrict Transfers of Wealth from Bondholders to Stockholders

Saturday, January 1st, 1994 at 12:00 am by F. John Stark, III, J. Andrew Rahl, Jr. and Lori C. Seegers
F. John Stark, III, J. Andrew Rahl, Jr. and Lori C. Seegers, “Marriott Risk”: A New Model Covenant to Restrict Transfers of Wealth from Bondholders to Stockholders, 1994 Colum. Bus. L. Rev. 593

Marriott Corporation issued $400 million of new senior notes in the spring of 1992 and then announced a spin-off in October. The Marriott Corporation spin-off represents a new extension of a trend of increasingly drastic, some would say outrageous, transactions which have unfairly transferred value from bondholders to stockholders. The trend which began with the leveraged buyout boom in the 1980s, and reached a peak with the RJR-Nabisco leveraged buyout, has now been revived and expanded again under the guise of the corporate spin-off. The authors label the new danger “Marriott risk.”

The Marriott experience proves that the end of the leveraged buyout boom does not in any way mean that expropriation risk, euphemistically termed “event risk,” has receded. Many bondholders who assumed that this kind of lightning would no longer strike their portfolios have already been hit more than once. In fact, this trend will surely continue as long as opportunities exist to expropriate value from bondholders.

The effects of the Marriott spin-off are virtually identical to the effects of a leveraged buyout (“LBO”): the Marriott transaction itself resulted in a massive transfer of value to stockholders and the debasement of Marriott’s outstanding public debt. Notes that were issued with an investment grade rating at par in April 1992, and which were trading as high as 110 in the fall of 1992, became junk bonds immediately following the announcement of the spin-off and traded as low as 80 by the end of October, without any change in Marriott’s underlying business. This dramatic fall in values reflects the market importance of adverse changes to an issuer’s capital structure.

Marriott’s willingness to attempt the spin-off is symptomatic of the weakness of the legal rights available to bondholders to prevent major expropriation events which put at risk their prospects for repayment. This article first describes the Marriott spin-off in the context of the history of other notorious “event risk” transactions. Second, it assesses the usefulness of the practical legal remedies now available to combat these risks and asserts that while some legal claims and remedies which curtail spin-offs do exist, it is apparent that bondholders need more legal protection than is available today. Third, the article evaluates standard bond indenture provisions in the context of the disappearance of public debt covenant protection and the status of event risk covenants today.

This article concludes with a three point proposal to address the Marriott risk: (i) adoption of a new model bond indenture covenant which restricts transfers of value from bondholders to stockholders in Marriott risk transactions; (ii) recognition that bondholders can effectively assert themselves in order to preserve the value they have bargained for; and (iii) judicial clarification and acceptance of the principle that bond indenture covenants are to be strictly construed in favor of bondholders.

Author Information

Stark (Senior Vice President, General Counsel and member of the Investment Management Committee of PPM America, Inc.); Rahl and Seegers (members of Anderson Kill Olick & Oshinsky, P.C., New York, NY)