Companies that have issued bonds in the US capital markets need to consider a variety of US securities law issues when contemplating a restructuring transaction with its bondholders. Company’s restructuring choices depend to some extent on whether or not the company has access to cash.
Where cash is available, either from internal funds, new financing, or both, a company can consider an optional redemption, open market purchases or a cash tender offer. Without cash, the most likely alternative is an exchange offer of new securities for the existing securities.
In the case of either a cash tender offer or an exchange offer, companies also often engage in a concurrent consent solicitation to modify the terms of the agreement governing the existing bonds, typically an indenture. If only a waiver or amendment of existing terms is required, a stand-alone consent solicitation may be the answer.
Options for Companies with Cash
If the indenture permits the company to redeem the bonds prior to maturity, then it can consider an optional redemption. However, many indentures restrict optional redemptions in the early years of the bond — the so-called “non-call period” — and in later years the exercise of the redemption feature may be subject to the payment of a premium which may be unattractive. Some indentures allow redemptions at any time subject to optional payment of a “make-whole” premium based on the recuperation of the yield through maturity, a price that is usually quite high. Where the bonds are trading in the market at a discount to par value, these options will be particularly unappealing.
Most indentures do not restrict the company from repurchasing its own bonds in the open market. If no such restrictions exist, and assuming there are no other applicable contractual or regulatory prohibitions binding on the company, then cash repurchases in the open market can be made through privately negotiated transactions with individual holders, either directly or through the intermediation of a broker.
Most open market debt repurchases can be structured in a manner to avoid the application of the “tender offer” rules under the Securities Exchange Act of 1934 (the “Exchange Act”), but counsel should be consulted prior to undertaking any such program to ensure that such purchases do not amount to a tender offer. Repurchases that might be recharacterized as a non-compliant tender offer could expose the company to liability and sanctions.
What constitutes a “tender offer”? Neither the US securities laws nor the US Securities and Exchange Commission (“SEC”) has defined the term “tender offer,” and there is not much case law or SEC commentary on the topic. Eight factors have generally been cited as evidence of a tender offer but not all of them have to be present. The eight factors are 1) active and widespread solicitation of holders, 2) solicitation for a substantial percentage of the outstanding debt, 3) the offer is made at a premium over the prevailing market price, 4) the terms of the offer are firm and not negotiable, 5) the offer is contingent on a minimum number of tendered securities, 6) the offer is open only for a limited period, 7) the offeree is subject to pressure to sell the securities, and 8) the public announcement of a purchasing program precedes or accompanies rapid accumulation of the securities.
The best way to avoid inadvertently making a tender offer is to solicit only a limited number of holders, preferably sophisticated investors, stretch the repurchases over a long period of time, without deadlines or other pressures, purchase on separately-negotiated terms and prices from different holders, and consider limiting the total amount of securities purchased in the open market. If both a repurchase program and an overt tender offer are contemplated, the company should consider undertaking them separately and having some period of time elapse between the two events to avoid the repurchases being considered part of the tender offer.
Indentures typically provide that bonds that the trustee knows are held by the company or an affiliate will not be considered to be “outstanding” for purposes of tabulating votes required for taking action under the indenture such as waivers, consents and amendments. Companies and their affiliates (particularly controlling persons) should be conscious of this limitation if there is any intent to influence the outcome of a vote by acquiring outstanding bonds in the open market or otherwise.
PRACTICE POINT: It is often difficult for the trustee of the bonds to determine whether or not bonds are in fact held by the company or an affiliate. Indentures often provide that unless the trustee has actual knowledge of a holding by the company or affiliates, it is entitled to assume that the bonds are held by non-affiliates. This issue can often be a sore point for bondholders in circumstances where the consents are being sought in the context of a troubled debt restructuring. Foreign companies that have issued bonds in the U.S. market have encountered difficulties with this issue in many recent out-of-court restructurings.
Finally, a company may wish to make a cash tender offer to all holders of their bonds. Cash tender offers for debt securities are regulated by section 14(e) of the Exchange Act and Regulation 14E thereunder. These rules generally prohibit fraudulent and manipulative activity and require that the tender offer be kept open for a minimum of 20 business days from commencement and 10 business days from notice of a change in either the percentage of securities sought, the consideration offered or the dealer’s soliciting fee.
Since it is often impractical to leave a debt tender offer open for such a long period, the SEC has issued a series of “no-action” letters exempting certain tender offers for investment-grade securities from the 20-business-day rule, subject to certain conditions. Pricing formulations vary, but since the “equal treatment” rules for tender offers of equity securities do not apply to non-convertible debt securities, alternative pricing mechanisms such as Dutch auctions and fixed-spread pricing are available. There are also certain structural features to the offer that can be implemented to incentivize holders to tender early, such as “early bird” premiums to holders who tender before a certain date, thus providing greater certainty to the company as to results prior to the expiration of the offer.
The Exchange Act rules do not require the filing of any offering document with the SEC and there are no specific disclosure requirements that apply. However, an offer-to-purchase document is customarily prepared, and it should be materially accurate and not misleading to avoid liability. If the targeted debt securities are listed or quoted on a securities exchange, then the rules for such exchange must also be considered to determine whether any specific disclosure or procedural requirements apply.
Whether the company engages in open market purchases or conducts a cash tender offer, often the most significant legal issue is avoiding liability under the anti-fraud provisions of the securities laws, including Rule 10b-5 under the Exchange Act. This rule generally prohibits the use of materially misleading statements or omissions in connection with the purchase or sale of a security and otherwise prohibits the use of manipulation or deceptive devices to purchase or sell a security.
The application of Rule 10b-5 in the context of open market purchases of bonds is not entirely clear under existing case law. If the company makes statements in the context of a purchase that are materially misleading or inaccurate, then the seller may have a Rule 10b-5 claim against the company. Where no statements are made but where the company has inside information and the purchases are made through a broker, the result is even less clear because Rule 10b-5 only imposes liability for omissions where the buyer has a duty to disclose and has failed to do so. Recent decisions have held that companies that are solvent have no fiduciary duties to holders of their debt securities and, thus, assuming current public disclosures by the company are correct, there would be no duty to disclose material non-public information in the context of a repurchase of bonds. However, not all courts might agree with this position and there are other theories, such as common law fraud, that might be used to infer a duty to disclose even in the absence of a fiduciary duty.
Options for Companies Without Cash
A company may not want to use cash or may otherwise need to make an offering of new securities with different terms to its existing holders. Most indentures provide that a unanimous consent is required to change fundamental economic terms of the securities (such as maturity, interest rates or mandatory redemption events). Obtaining such consents is often quite difficult so the only alternative for the company is to conduct an exchange offer.
PRACTICE POINT: The U.S. Trust Indenture Act of 1939 applies to registered bond offerings and prohibits inden-ture provisions that would allow companies to modify essential economic terms without the consent of each holder affected thereby. Although nothing would prevent such a “collective action clause” from being in-cluded in a purely private bond offering, the U.S. market (as opposed to the practice under English law which customarily provides for these clauses) has historically resisted collective action clauses in indentures, except for sovereign or quasi- sovereign issuers.
Any exchange of newly-issued bonds or equity securities for outstanding bonds is considered an offer of securities under the Securities Act of 1933 (the “Securities Act”) and, thus, it must be registered with the SEC unless an exemption from registration is available. The most common exemptions are the section 3(a)(9) exemption and the so-called “private placement” or section 4(2) exemption. Exchange offers are also considered tender offers and, thus, the Exchange Act rules for tender offers discussed earlier also apply.
Although there is no legal requirement for the company to use the services of an intermediary to solicit exchanges, it is customary in most situations to appoint a dealer-manager for an exchange offer. In that event, due to liability concerns that arise in any new offering of securities, dealer-managers customarily perform due diligence on the company and request third-party assurances on whatever offering document is prepared, including auditors’ comfort letters and lawyers’ negative assurances or “10b-5 letters.”
Section 3(a)(9) of the Securities Act allows a company to offer and sell new securities to existing holders of its own securities without registration, subject to certain conditions. The offering must be made exclusively by exchange with its existing holders and the issuer of the new securities must be the same issuer as the issuer of the old securities, a requirement that can present structural challenges if there are parent or subsidiary guaranties involved. In a section 3(a)(9) exchange offer, similar to registered exchanges, there is no restriction on general solicitation or advertising, thus allowing unrestricted publicity, and there are no restrictions on the nature of the offerees.
One of the most problematic requirements of section 3(a)(9) is that the company cannot pay the dealer-managers a fee to solicit tenders that is conditional on the success of the exchange offer. The SEC has issued a series of no-action letters that permit a financial adviser to undertake certain administrative activities in connection with the exchange, including pre-launch discussions with sophisticated holders of bonds, so long as there is no success fee involved. Unconditional fixed fees are permitted but this solution may not be attractive for the company. The restriction on these fee arrangements where active solicitation may be required in an exchange often leads companies to select another form of exchange offer.
Another exemption available for an exchange offer is the so-called “private placement” exemption under section 4(2) of the Securities Act. With this structure, the offer and sale are made only to accredited investors such as large institutional holders; non-US persons are often solicited in reliance on the separate exemption provided by Regulation S of the Securities Act. Historically, one important limitation of this exemption is that there can be no general solicitation or advertising, a restriction on publicity that needs to be taken into account when considering this alternative. Recent legislation passed by the US Congress mandates the SEC to amend its rules relating to this restriction in the context of private offerings so this limitation may ultimately disappear. The section 4(2) exemption does not impose any restrictions on fees for the dealer-manager, so there is more flexibility on that issue as well.
Because of the limitation on the nature of the offerees, the offering document cannot simply be distributed to all existing holders. Holders must pre-qualify through an eligibility questionnaire before receiving an offering document. In most exchange offers for outstanding bonds, there is little if any non-accredited investor participation and, thus, this pre-qualification process mostly affects timing since the offer takes more time to implement.
Another option is a registered exchange offer. A company can file a registration statement on Form S-4 with the SEC to register the offer and sale of the new bonds or equity securities to the holders of its existing bonds. Form F-4 must be used if the company is a foreign private issuer.
In a registered exchange offer, there are no structural restrictions or fee limitations as there may be in a section 3(a)(9) exchange and dealer-managers can freely solicit tenders and all holders can participate, including retail investors. However, companies cannot generally use existing “shelf” registration statements to conduct an exchange offer and the SEC may elect to review a new registration statement, a process that can be lengthy and unpredictable. Foreign companies that are not SEC reporting face additional disclosure hurdles and financial information issues. Companies are also subject to heightened liabilities under the Securities Act for disclosures and omissions in the registration statement and prospectus.
In order to encourage holders to tender their bonds in an exchange offer or cash tender offer, and to allow the company to avoid the application of restrictive covenants in the indenture for the bonds that the company is attempting to retire or repurchase, companies often seek “exit consents.” This refers to the practice of having tendering holders consent to amendments or waivers of covenants or other terms in the existing indenture as a condition to acceptance of the tender or exchange.
The amendments or waivers that are sought are typically those that can be adopted or granted with a simple majority vote of bondholders. Holders tendering their bonds for cash or new securities will generally not be concerned about the protections in the existing indenture and those refusing to tender or exchange their bonds will be left with an indenture without the same protections. In addition, if the tender or exchange is successful, non-tendering holders will be left holding bonds with a more limited trading market which is likely to affect trading prices for the old bonds adversely; this also acts as an additional incentive to participate in the tender or exchange.
Companies should consider the application of the “new security” doctrine if a consent to an amendment or waiver relates to fundamental terms of the securities. The SEC has taken the position that consents to amendments to existing debt securities that fundamentally alter the terms of debt securities have the effect of creating a new security, thus requiring analysis of the consent under the Securities Act similar to what occurs in an exchange offer. In addition, in the context of exit consents included as part of an exchange offer relying on the private placement exemption of section 4(2) of the Securities Act, one issue to be addressed is whether or not a consent is valid if not all holders are given an opportunity to consent. Certain New York case law has cast some doubt on this point. Because private placements exclude non-accredited investors, to the extent there are any such holders excluded, consideration needs to be given to restructuring the transaction to accommodate this concern: for example, by undertaking a separate consent solicitation outside of the exchange offer to afford all holders the opportunity to participate.
The tax implications of bond repurchases and exchange offers should be considered; they are usually disclosed to existing holders in any offering document. Although the application of the tax rules to a particular transaction is often fact specific, certain principles generally apply.
A company repurchasing bond at a discount will generally recognize “cancellation of indebtedness” income in an amount equal to the discount.
In an exchange offer for new securities, the company will generally recognize this income to the extent that the amount owed on the existing debt exceeds the fair market value of the new securities. In the case of new bond, if the fair market value of the new bond is less than the outstanding principal amount of the debt, there will likely be original issue discount that the holders of the new bond will be required to treat as income (with a corresponding interest deduction for the company over the life of the new bond).