Word count: 1921
The general assertion that creditors can adequately safeguard their interests solely through
contract overlooks the nuanced landscape of creditor protection, particularly regarding the
differing risks faced by the diverse classes of creditors. This essay challenges this assertion,
seeking to demonstrate that a comprehensive approach is most effective, incorporating
proprietary rights and legal intervention to protect both adjusting and non-adjusting
creditors in solvency and insolvency.
This essay will first provide an overview of the different classes of creditors and the risks
they each wish to mitigate, before examining the effectiveness of creditors’ self-protection
through contract, including those affording proprietary interests on the creditor. This will
then be compared to the protection provided by law, considering whether it resolves the
problems unresolved by contract, leading to the conclusion that both frameworks are
necessary.
Overview of creditor classes and risks
Creditors need protection when lending or advancing credit due to the risk of loss of return,
particularly when counterparties face insolvency or restructuring.1 Whilst this is the main
concern considering the “typically tight relationship between breach of a loan agreement
and insolvency”,2 creditors also need protection during solvency. Corporate creditors face
issues caused by their conflict of interests with shareholders, opening them up to risks of
shareholder opportunism such as asset diversion, changes to the company’s investment
profile and claim dilution. 3
1
Louise Gullifer and Jennifer Payne, Corporate Finance Law : Principles and Policy (Bloomsbury Publishing Plc
2020) <http://ebookcentral.proquest.com/lib/durham/detail.action?docID=6934137>.
2
Barry E Adler and Marcel Kahan, ‘The Technology of Creditor Protection’ (2013) 161 University of
Pennsylvania Law Review 1773, 1780.
3
Gullifer and Payne (n 1).
, Word count: 1921
Given the disparity in foresight and bargaining power between adjusting and non-adjusting
creditors, some argue that the law should accord this “heterogeneous group” 4 with different
protections.5 It seems obvious that creditors who have various risk appetites, credit
portfolios, time horizon priorities and repayment schedules face different risks and
ultimately have a different relationship with the borrower company. 6 Nonetheless, English
law has historically prioritised the protection of competent voluntary creditors, particularly
after the introduction of limited liability.7 But given this small group only concerns
established financial institutions able to self-protect through contract because they have
greater informational resources and negotiation leverage in transactions, this approach is
not compatible with modern practice. If fails to recognise involuntary or non-adjusting
creditors such as tort victims and employees who are disadvantaged not only due to a lack
of ability to contract in advance to avoid uncompensated risk (since their harm is
unforeseeable),8 but by their ranking below secured creditors with a fixed charge on the
payment hierarchy of the Insolvency Act 1986.
Contractual (and proprietary) protection
This paper does not dispute that contractual protection is effective: they are varied and can
be enforced against both borrowers and third parties, and their flexibility is particularly
attractive to established corporate creditors. Under the umbrella of contractual protection
there are three main forms of self-help which will be discussed in turn: 9
4
Peter O Mulbert, ‘A Synthetic View of Different Concepts of Creditor Protection, or: A High-Level Framework
for Corporate Creditor Protection’ (2006) 7 European Business Organization Law Review 357, 372.
5
Ezra Ripleu, ‘Concluding Remarks on Creditor Protection’ (2006) 1 European Business Organization Law
Review 465.
6
Mulbert (n 4) 372.
7
Ripleu (n 5).
8
ibid.
9
Mulbert (n 4) 375.
The general assertion that creditors can adequately safeguard their interests solely through
contract overlooks the nuanced landscape of creditor protection, particularly regarding the
differing risks faced by the diverse classes of creditors. This essay challenges this assertion,
seeking to demonstrate that a comprehensive approach is most effective, incorporating
proprietary rights and legal intervention to protect both adjusting and non-adjusting
creditors in solvency and insolvency.
This essay will first provide an overview of the different classes of creditors and the risks
they each wish to mitigate, before examining the effectiveness of creditors’ self-protection
through contract, including those affording proprietary interests on the creditor. This will
then be compared to the protection provided by law, considering whether it resolves the
problems unresolved by contract, leading to the conclusion that both frameworks are
necessary.
Overview of creditor classes and risks
Creditors need protection when lending or advancing credit due to the risk of loss of return,
particularly when counterparties face insolvency or restructuring.1 Whilst this is the main
concern considering the “typically tight relationship between breach of a loan agreement
and insolvency”,2 creditors also need protection during solvency. Corporate creditors face
issues caused by their conflict of interests with shareholders, opening them up to risks of
shareholder opportunism such as asset diversion, changes to the company’s investment
profile and claim dilution. 3
1
Louise Gullifer and Jennifer Payne, Corporate Finance Law : Principles and Policy (Bloomsbury Publishing Plc
2020) <http://ebookcentral.proquest.com/lib/durham/detail.action?docID=6934137>.
2
Barry E Adler and Marcel Kahan, ‘The Technology of Creditor Protection’ (2013) 161 University of
Pennsylvania Law Review 1773, 1780.
3
Gullifer and Payne (n 1).
, Word count: 1921
Given the disparity in foresight and bargaining power between adjusting and non-adjusting
creditors, some argue that the law should accord this “heterogeneous group” 4 with different
protections.5 It seems obvious that creditors who have various risk appetites, credit
portfolios, time horizon priorities and repayment schedules face different risks and
ultimately have a different relationship with the borrower company. 6 Nonetheless, English
law has historically prioritised the protection of competent voluntary creditors, particularly
after the introduction of limited liability.7 But given this small group only concerns
established financial institutions able to self-protect through contract because they have
greater informational resources and negotiation leverage in transactions, this approach is
not compatible with modern practice. If fails to recognise involuntary or non-adjusting
creditors such as tort victims and employees who are disadvantaged not only due to a lack
of ability to contract in advance to avoid uncompensated risk (since their harm is
unforeseeable),8 but by their ranking below secured creditors with a fixed charge on the
payment hierarchy of the Insolvency Act 1986.
Contractual (and proprietary) protection
This paper does not dispute that contractual protection is effective: they are varied and can
be enforced against both borrowers and third parties, and their flexibility is particularly
attractive to established corporate creditors. Under the umbrella of contractual protection
there are three main forms of self-help which will be discussed in turn: 9
4
Peter O Mulbert, ‘A Synthetic View of Different Concepts of Creditor Protection, or: A High-Level Framework
for Corporate Creditor Protection’ (2006) 7 European Business Organization Law Review 357, 372.
5
Ezra Ripleu, ‘Concluding Remarks on Creditor Protection’ (2006) 1 European Business Organization Law
Review 465.
6
Mulbert (n 4) 372.
7
Ripleu (n 5).
8
ibid.
9
Mulbert (n 4) 375.
