In 1987 RJR Nabisco, the food and tobacco giant, had $5 billion of A-rated debt outstanding. In that year the company was taken over, and $19 billion of debt was issued and used to buy back equity. The debt ratio skyrocketed, and the debt was downgraded to a BB rating. The holders of the previously issued debt were furious, and one filed a lawsuit claiming that RJR had violated an implicit obligation not to undertake major financing changes at the expense of existing bondholders.
1. Why did these bondholders believe they had been harmed by the massive issue of new debt?
2. What type of explicit restriction would you have wanted if you had been one of the original bondholders?