State Contract Law and Debt Contracts

This paper examines the relationship between debt contracts and state contract law. We first develop an index to evaluate whether each state’s law is favorable or unfavorable to lenders. We then analyze how the contract terms, the frequency of covenant violations, and the repercussions of covenant v...

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Bibliographic Details
Published in:The Journal of law & economics 2014-11, Vol.57 (4), p.1031-1061
Main Authors: Honigsberg, Colleen, Katz, Sharon, Sadka, Gil
Format: Article
Language:English
Subjects:
Contract enforcement
Contract law
Contracts
Correlation analysis
Covenants
Debt
Debt contracts
Lenders
Litigation
State laws
State legislation
Studies
Sufism
Violations
Yield curves
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Summary:This paper examines the relationship between debt contracts and state contract law. We first develop an index to evaluate whether each state’s law is favorable or unfavorable to lenders. We then analyze how the contract terms, the frequency of covenant violations, and the repercussions of covenant violations vary across states. We find that cash collateral is most likely to be used when the contract is governed by law that is favorable to debtors and that out-of-state borrowers who use favorable law pay higher yield spreads. In addition, when the law is favorable to lenders, there are significantly fewer covenant violations, and the repercussions of covenant violations—measured as changes in the borrower’s investment policy—are more severe. We also compare the characteristics of relevant parties across states, and the results provide support for the theory that there is a market for contracts similar to the market for incorporations.
ISSN:0022-2186
1537-5285
DOI:10.1086/680934