Accelratrion___Article_for_submission.docVIP

The Roles of Acceleration David Hahn* I. Introduction 1 II. Debt Covenants and Acceleration Clauses 4 A. Four Types of Covenants 5 B. Cross Defaults 7 C. Acceleration Clauses 8 III. The Collection Role of Acceleration 9 A. Means of Collection 9 B. The Limited Efficacy of Collection 10 IV. The Governance Roles of Acceleration 13 A. Governing Debtor Misbehavior 14 B. The Gate to Insolvency 18 C. Encouraging Inter-Creditor Arrangements 20 Abstract Acceleration clauses are found in most debt instruments. Upon the occurrence of predetermined triggering event, acceleration makes a creditors future claim due and payable. While debt covenants have been analyzed extensively in the academic literature, the role of acceleration has been overlooked. This paper examines the role of acceleration clauses and maintains that they play a critical role in debt financing. The paper argues that the prime role of acceleration is to perfect a complex set of governance mechanisms within the corporate setting. This governance role is comprised of three parts. First, acceleration is a complementary measure that supports debt covenants in mitigating ex ante the borrowers agency costs of self-interest actions. The other two parts of the governance mechanism function ex post, upon the debtors financial distress. Each deals with disciplining a different entity that may generate wasteful costs to the creditor. One entity that requires restraining is the debtor. Acceleration facilitates the commencement of the debtors bankruptcy and thus curtails any prospective losses to the creditors resulting from the borrowers continuous moral hazard. The other entity a creditor must worry about, which has been widely neglected by the financial literature, is other, self-interested, creditors who rush to dismantle the common debtor upon the latters financial distress. Cross-acceleration clauses place all creditors on equal footing, establish an inter-creditor balance of terror, and prevent the credito