In Orchid Hill Master Fund Ltd. v. SBA Communications Corp. (2d Cir. July 2016), the Court of Appeals for the Second Circuit held that convertible noteholders who exercise their conversion rights just prior to maturity were not entitled to interest for the last payment period. The case is a reminder that market expectations sometimes fail when put to the judicial test.


The plaintiffs, Orchid Hill Master Fund and several other funds, owned two convertible notes issued by SBA Communications. Both notes matured in 2014 and were issued pursuant to substantially identical indentures. The plaintiffs converted their notes between the final record date and the maturity date and then sought to collect interest for the final interest period. The District Court denied their claim on a motion to dismiss, and the Second Circuit affirmed.

As is typical, the notes paid interest semiannually and provided for a record date two weeks prior to each interest payment date. Noteholders who converted following a record date but prior to an interest payment date were required to pay an amount equal to the “otherwise payable” interest. This provision was referred to in the case as the “wash clause,” since it washed away the interest payment that the holders would otherwise receive by virtue of their status as holders of record on the proceeding record date. There was one exception to the wash clause: No wash payment was required to be made with respect to conversions after the close of business on the final record date and prior to maturity date. This exception is referred to in the case as the “maturity exception.” The plaintiffs alleged that a market convention had developed around the maturity exception, allowing noteholders who wanted to convert just prior to the end of the final interest period to do so without forfeiting their interest. Essentially, according to plaintiffs, this would replicate their rights with respect to any other interest period, where noteholders could wait to receive their interest payment and convert immediately thereafter.

The Decision

The court opened with the usual introduction of how, under the governing New York law, the indentures are to be interpreted under the normal rules of contract interpretation. Pursuant to these rules, contracts are unambiguous if there is no reasonable basis for difference of opinion; words and phrases are to be given their plain meaning; and a contract should be interpreted “so as to give full meaning and effect to all of its provisions.” Applying these principles, the court agreed that there was no need for extrinsic evidence to interpret the indentures, and the plaintiffs were not entitled to put on a case.

The court then began its analysis with the observation that the final interest payment differed from all other interest payments under the indentures. With respect to the final interest payment — that is, interest payable on the maturity date — interest was to be paid to the person to whom the principal amount was paid. The identity of the noteholders on the final record date, therefore, was irrelevant for purposes of determining who would receive the final interest payment. Because the noteholders had converted their notes prior to maturity — under the terms of the indentures, the last opportunity for conversion was two business days prior to the maturity date — they were not noteholders on the maturity date and therefore were not entitled to receive interest.

Plaintiffs argued that the exception to the wash clause was intended to address the very circumstances in which plaintiffs now found themselves. If interest were not payable to noteholders who converted just prior to the maturity date, there would be no need for the maturity exception. Since there would be no interest “otherwise payable” to the noteholders, there clearly would be no reason for relieving a converting noteholder of its obligation to make a wash payment upon conversion.

The Second Circuit rejected this argument, reading the intent of the maturity exception differently from how the plaintiffs read it. The final interest payment had to be excepted from the wash clause because otherwise converting noteholders would have been required to make payment in the amount of the interest coupon, without getting it back when it otherwise would be payable to other holders. The court also observed that, in the plaintiffs’ reading, noteholders who converted in the final interregnum period between record date and payment date would receive interest plus the conversion stock, while noteholders who converted during any other interregnum period would get only their stock.

The plaintiffs also argued that while they surrendered their notes for conversion prior to the maturity date, the actual conversion occurred when they received their shares, which was on or after the maturity date. Moreover, because the amount of stock they received was dependent on the principal amount of the notes, they argued, they were effectively paid the principal on the maturity date and were therefore entitled to be paid interest as well. Again, the court did not find these arguments persuasive. The indentures stated that a conversion date occurs when the holder of notes satisfied certain requirements. These requirements included submission of a conversion notice, fulfillment of obligations under the wash clause (if applicable) and payment of any transfer taxes, which were all unilateral acts within the control of the noteholder. Accordingly, the notes were converted when the noteholders performed these acts — that is, when they submitted the notes for conversion, not on the later date when the shares were actually issued and delivered. Unsurprisingly, the court also rejected the argument that delivery of the conversion shares by the issuer was tantamount to the payment of principal, so that in fact the plaintiffs were not paid their principal on the maturity date.

Concluding Thoughts

In reading the decision, it is difficult to know whether the plaintiff funds were actually expecting to receive the final interest payment, or whether this was a case of “we have nothing to lose, so we might as well try.” Plaintiffs’ protestation that their gambit was based on “market expectations” obviously did not resonate either with the District Court or with the appellate reviewers. While the Second Circuit’s decision was based on a close reading of the indentures, there is also a sense that the appeals court was averse to allowing plaintiffs to have their conversion cake and eat it too. Not only are there no free lunches, but there are also no free desserts. Along the way, the decision provides useful precedent for the commonly accepted understanding that conversion of a convertible instrument occurs at the time of submission for conversion, and not when shares are actually received.