wordpress-themes.org wordpress themes wordpress themes

SECURED CLAIMS IN BANKRUPTCY: Reduced Use of Covenants

Reduced Monitoring by Secured Lenders Under Full Priority
A potentially large efficiency cost of according foil priority to secured claims is that foil priority reduces the incentive of the secured creditor to “monitor” the debtor, that is, attempt to prevent the debtor from engaging in value-wasting activities, known as “misbehavior.” The intuition here is simple: to the extent the secured creditor is insulated from risk of loss because it has full priority in the collateral subject to the security interest, it has less incentive to monitor the borrower for misbehavior.

Full priority is likely to have two distinct effects on a secured creditor’s incentive to monitor the borrower: (1) full priority will reduce the secured creditor’s incentive to incorporate additional covenants into the loan agreement, for example, provisions aimed at preventing the borrower from engaging in certain types of undesirable behavior and (2) even if full priority does not reduce the secured creditor’s incentive to incorporate additional covenants into the loan agreement, it will reduce the secured creditor’s incentive to attempt to enforce the covenants it has incorporated into the loan agreement, as well as whatever creditor rights state debtor-creditor law provides.

Reduced Use of Covenants
When a borrower and a creditor have adopted a security interest, full priority makes it less likely that the two will include in their arrangement a set of covenants that would be efficient for them to adopt. This problem may arise even if the security interest giving the creditor full priority adds value to the arrangement. The point is that the arrangement would be even more value-adding if it also included the covenants that, as a result of full priority, the arrangement does not incorporate. ace payday loan

This post was written by , posted on August 26, 2014 Tuesday at 3:58 pm