DURING THE PAST YEAR, many investors in the distressed debt market have received postreorganization private equity1 either through a confirmed plan of reorganization or through participation in a rights offering. Unlike publicly traded equity, each new issuance of postreorganization equity leaves recipients, issuers, and agents potentially facing uncharted territory in terms of how the instrument is to trade and settle. While there are many legal considerations related to trading and transferring post-reorganization equity and to the post-reorganization corporate governance of the reorganized debtor,2 there are some logistical considerations that may affect the liquidity of post-reorganization securities and lead to significant settlement delays.
The specifics of the terms of the equity security pursuant to the entity’s governing documents (i.e., certificate of incorporation, by-laws, or stockholders’ agreement) can also cause unexpected delays. For example, the recipients are often required to become a party to a stockholders’ agreement, which may contain additional hurdles to future transfers by requiring, among other things, an opinion of counsel to the selling party and/or board consent to the proposed transfer, or by providing restrictions limiting the number of shares significant holders may transfer at one time without triggering tagalong rights for non-transferring holders.
In addition, as the post-reorganization equity will be issued only to record holders, the beneficial holder’s receipt of the post-reorganization equity may be subject to the completion of intermediate trades between it and the record holder. It is possible for there to be multiple trades after the record date such that the actual beneficial holder could be several levels “downstream” from the record holder and, each transfer between intermediate trade parties can be delayed for myriad reasons.
In short, transfers of post-reorganization private equity often take longer than expected and, as with distressed loans and claims, consideration should be given to the potential for settlement delays and the distinction between trading liquidity and settlement liquidity.3
Possible Causes of Delay
- Parties are unaccustomed to settling equity trades or are unfamiliar with the specific terms of the instrument being transferred;
- Lack of clear market consensus on how a post-reorganization equity instrument will trade, on what documents such equity will be traded, or even what rights need to travel with the shares. For instance, some issuers require an opinion of counsel for the selling party stating, among other things, that the transfer is not subject to securities laws, whereas some issuers require only a seller’s certification to that effect, and some issuers require no opinion or certification; or
- The transfer agent and issuer may disagree on what form and type of documentation requirements and applicable procedures are to be followed to transfer the post-reorganization equity