Virtually all corporate indentures have what are known as “change of control” provisions. In the event of a change of control of the issuer, noteholders have the right to compel the issuer to repurchase their notes, typically at 101% of face value. Often, a change of control is self-evident, as where the issuer is acquired by another entity. Sometimes, however, the occurrence of a change of control is unclear — and even hotly contested — and depends on interpretation of the definition of change of control, which is laden with terms borrowed from the federal securities laws. One such recent case, Wilmington Savings Fund Society, FSB v. Foresight Energy L.P. (Del. Ch. December 4, 2015), offers an instructive foray into the determination of beneficial ownership under Section 13(d) and Rule 13d-3 of the Securities Exchange Act of 1934.
Foresight Energy L.P., through subsidiaries, owned an array of coal assets, and like virtually all other coal companies, had come under severe stress in the current energy environment. In 2013, subsidiaries of Foresight issued $600 million principal amount of 7.875% notes due 2021. The indenture governing the notes contained a change of control provision with a relatively standard (other than the triggering threshold) definition of change of control. In relevant part, that definition defined a change of control as:
The consummation of any transaction … in one or a series of related transactions, the result of which is that any “person” (as that term is used in Section 13(d)(3) of the [Securities Exchange Act]), excluding [the then-current controller and his affiliates] becomes the Beneficial Owner, directly or indirectly, of more than 35% of the voting stock of [the general partner of the issuer] measured by voting power rather than by number of shares, common units or the like.
In turn, the indenture defined “voting securities” as securities having the power to vote for the election of the directors or managers of the general partner of Foresight or otherwise to control the general partner. “Beneficial ownership” is given the meaning under Rule 13d-3 of the Securities Exchange Act.
In March 2015, Murray Energy Corporation negotiated a deal to acquire control of Foresight. As originally structured, Murray Energy would pay $1.395 billion for an 80% voting interest in the general partner of Foresight, a 77.5% economic interest in the general partner and a mix of units in Foresight representing not more than 51% of the interests in that entity. This transaction would have constituted a change of control under the indenture, and the issuers solicited consent from noteholders to waive their put right for a fee. Unfortunately, the parties could not raise the required financing, and the deal was terminated in April 2015.
Later that month, the parties agreed upon a revised deal, whose economics were similar to the original transaction. The difference was that this time Murray Energy would pay $1.37 billion and receive only a 34% voting interest in the general partner, with an option to acquire an additional 46% voting interest for $25 million. Exercise of the option was subject to two conditions. First, Murray Energy had to provide 61 days’ advance notice before exercising the option, and second, before exercise of the option, Foresight must have refinanced the notes and its outstanding credit facilities, such that the exercise of the option would not trigger a change of control. In this manner Murray Energy hoped to avoid a change of control under the indenture. It would have less than 35% of the voting interests in Foresight, and under Rule 13d-3 it would not be deemed to have beneficial ownership of the shares subject to the option. Rule 13d-3 deems a right holder to have beneficial ownership of the underlying shares only if the right is exercisable within 60 days, and here 61 day's advance notice was required for exercise. Moreover, courts have held that beneficial ownership does not vest under a right if exercise of the right is subject to conditions outside the holder’s control, and here Murray Energy could not exercise without the cooperation of third parties.
Apart from the economics, the governance documents of Foresight and its general partner were amended to provide Murray Energy with various “negative control rights.” The general partner could not engage in a roster of activities without approval of Murray Energy, including replacing the CEO of the general partner, who was a designee of Murray Energy. Also, without the approval of Murray Energy, units in Foresight’s general partner could not be transferred. Finally, pursuant to a management services agreement, a subsidiary of Murray Energy provided the day-to-day management of the Foresight operating companies.
Against this backdrop, in May 2015 the trustee under the indenture filed suit. The trustee claimed that Murray Energy’s investment resulted in a change of control, as defined, and that the issuers had failed to offer to repurchase the notes as they were required to do upon such a change of control.
The Court’s Analysis
The trustee based its claim that Murray Energy was the beneficial owner of 35% or more of the voting units in the general partner on a number of provisions of Rule 13d-3, but the court found it necessary to address just two:
- under Rule 13d-3, shared investment power confers beneficial ownership; and
- an arrangement intended to divest beneficial ownership, and therefore evade the provisions of Rule 13d-3, will be ignored when determining the existence of beneficial ownership.
The court found that Murray Energy had investment power over interests in the general partner in excess of its 34% outright ownership by reason of its consent rights on the transfer of all other voting units. Citing treatise and SEC staff authority, the court held that this veto power was the equivalent of investment power for purposes of Rule 13d-3 and conferred on Murray Energy beneficial ownership of the additional units.
The court also addressed the anti-evasion language of Rule 13d-3. The court observed that the $25 million strike price of the option represented only 1.8% of the total purchase price, and found it preposterous that such a paltry sum would be sufficient consideration to acquire control of the general partner. The court therefore reasoned that, irrespective of the exercise of the option, Murray Energy had achieved de facto control of Foresight once the initial investment closed. The option was therefore an arrangement to divest beneficial ownership, which under Rule 13d-3 would not be given effect.
Foresight provides lessons both for interpreting common change of control provisions of indentures and other credit documents, and the beneficial ownership rules under the securities laws generally. Given the facts, one would not regard the court’s decision as unfairly contrary to the spirit of the indenture. However, the parties at the time of issuance were unlikely to have fully appreciated how the importation of securities law concepts into the indenture would drive its interpretation. The same could be true of other securities law concepts that worm their way into an indenture through the reference to Section 13(d) and Rule 13d-3. For example, the possibility of group formation often injects uncertainty into the application of indenture change of control provisions, because group contours under Section 13(d) can be murky. Also, if case law, legislation or rule-making of the SEC were to alter beneficial ownership concepts under the Securities Exchange Act, the change could have consequences for application of change of control provisions of indentures unforeseen at the time of issuance.
More broadly, the court’s decision raises important questions regarding beneficial ownership attribution rules under the securities laws that have yet to be squarely decided. Where is the line to be drawn between permissible and impermissible arrangements whose results deprive a holder of beneficial ownership? Does an option or other right that cannot be exercised except on 61 days’ advance notice, without more, violate the anti-evasion provisions of Rule 13d-3? And what of third-party approval rights to the exercise of an option that are patently designed to avoid vesting of beneficial ownership? These and other questions remain for another day.