Can the issuer buy back its bonds?
The first thing to do is to look at the relevant contractual documentation (normally the bonds’ terms and conditions and the trust deed) to see whether the issuer is expressly permitted to buy back its bonds, or expressly prohibited from doing so. The most important first step is to look carefully at the contractual documentation.
Most bond issues will expressly permit the issuer or any of its subsidiaries to buy back bonds. The documentation will also regulate:
- how this needs to be done: most often this is permitted at any price, in the open market or otherwise – but there could be restrictions imposed on the method of purchase (eg by tender); and
- what the issuer can/must do with the bonds repurchased: some issues will provide that the bonds must be surrendered to the paying agent for cancellation, while others will give the issuer the choice of cancelling the bonds or holding them and/ or selling them on.
Some bond issues will expressly prohibit the issuer from buying back any of its bonds, although this would be unusual. If there is an express prohibition look carefully at its scope as there may be ways to structure round the prohibition. For example, would it prohibit a subsidiary or an associated company of the issuer, or an orphan offbalance SPV that is not a subsidiary, from buying bonds? How is subsidiary defined – is a companies legislation test used or a balance sheet test? Consider also whether you can avoid any prohibition on issuer buy-backs by structuring a synthetic buy-back between the issuer and a third party via the use of a total return swap or a sub-participation, whereby the issuer can achieve the economic effect of a buy-back without any physical repurchase of bonds.
No express permission and no express prohibition What is the situation if the contractual documentation neither expressly permits nor expressly prohibits a buyback of bonds by the issuer? There is no general rule of English or Hong Kong law that says that an issuer can only buy back bonds if expressly permitted by the documentation. So if there is no express permission and no express prohibition in the documentation, you need to look at the documentation very carefully to see if there are any indications as to whether the parties’ intention was that the issuer should (or should not) be permitted to buy back its bonds. There may be clues in other parts of the documentation. But having done that, if there is nothing to suggest a prohibition on issuer buy-backs, then the issuer should be permitted to buy back its bonds.
Effect of a buy-back
If the issuer is permitted to buy back bonds, the next question is: what is the effect of the buy-back?
- Can the issuer vote bonds it holds? Again, you need to look at the contractual documentation. However, this will normally provide that bonds held by or on behalf of the issuer or any of its subsidiaries: cannot vote at bondholder meetings; are not to be counted towards the quorum for bondholder meetings; and are not to be treated as ‘outstanding’ for those provisions of the bonds that refer to actions being taken by a stated percentage of the ‘outstanding’ bonds (eg the normal 25 per cent of ‘outstanding’ bonds required to direct the trustee to accelerate the bonds after an event of default).
- What must the issuer do with repurchased bonds? Again, this will be dealt with in the terms and conditions – as noted above often the issuer will be expressly obliged to surrender the bonds for cancellation, but will sometimes have the option either to surrender the bonds for cancellation or to hold them and/or subsequently sell them on. Note that where a borrower buys back its own loan debt, as a matter of English and Hong Kong law the loan debt is likely extinguished (as you can’t owe yourself money). However, the position is different with bonds because they are negotiable instruments and (provided there is no prohibition in the contractual documentation) an issuer can buy back and hold its bonds before their maturity without any automatic cancellation/ extinguishment of the bonds bought back.
Other relevant factors
You will always need to consider whether there are other relevant provisions in the bond documentation (or other documentation binding on the issuer) that will restrict the issuer’s ability to buy back bonds. For example the issuer will use cash to repurchase bonds, and the following questions arise.
- If the issuer wishes to borrow cash to fund the buyback, will that borrowing be permitted under any borrowing covenants binding on the issuer under the bonds or any of its other financings or other contractual documentation?
- If the issuer wishes to use its own cash reserves to fund the buy-back, is that use of cash permitted under the bonds or any of its other financings or other contractual documentation (eg are there any restrictions on the use of cash by the issuer and its group or on acquisitions by the issuer and its group)?
Stock exchange rules
Remember, if shares in the issuer and/or the bonds are listed on a stock exchange, it will be necessary to ensure full compliance with any relevant stock exchange rules, including those relating to:
- the content and timing of announcements by the issuer of the buy-back (including whether any announcements need to be made beforehand);
- the timing of the buy-back;
- the manner in which the buy-back can be implemented; and/or
- discloseable and/or major transactions (unlikely, but will depend on the size of the buy-back).
In the case of convertible bonds, you should also check (where relevant) that the buy-back will constitute an ‘exempt share repurchase’ for the purposes of the Hong Kong SFC’s Code on Share Repurchases.
Remember to consider the rules relating to inside information, insider dealing and closed periods. These will vary depending on the jurisdictions and stock exchanges involved, but some rules of thumb would be:
- an issuer should not buy back bonds when it is in possession of price-sensitive information that has not been disclosed to the market; and
- whether or not it is in possession of price-sensitive information, an issuer should avoid buying back bonds during any closed period (for example in the one month period before announcing its half- and full-year results).
As noted above, this note assumes Reg S bonds governed by English or Hong Kong law. US law considerations regarding avoiding a ‘creeping tender offer’, disclosure, insider trading, transaction size and manner in which the repurchases are made would apply if the bonds were listed on a US exchange or sold into the US under Rule 144A or another exemption from registration. Our US securities team would be happy to help with questions about any such issues.