We really do live in interesting times. Over the last two years, most Americans have come to reduce or defer personal expenditures of one kind or another. Homeowners are sharply focused on the burden of mortgage payments, and record numbers of leased automobiles are showing up back at the dealerships. In short, Americans are rethinking and restructuring their personal balance sheets. Some by choice and others out of necessity. It's essentially the same for issuers. Thinking hard about balance sheet restructuring has become an imperative for a large proportion of issuers in the United States. The following discussion highlights a number of balance sheet restructuring approaches on which issuers currently are focused.
Repurchases for cash
- Redemptions – a purchase of outstanding debt securities for cash in accordance with the terms of the security;
- Repurchases – opportunistic repurchases of debt securities for cash, including privately negotiated and open market repurchases; and
- Tender offers – an offer made to all bondholders to repurchase outstanding debt securities for cash.
Tenders not involving cash
- Exchange offers, including:
- Private exchange offers – unregistered debt for debt exchanges pursuant to Section 4(2) usually made to qualified institutional buyers ("QIBs") as defined under Rule 144A under the Securities Act of 1933, as amended (the "Securities Act") and non-U.S. persons under Regulation S;
- Section 3(a)(9) exempt exchange offers – exempt debt for debt exchanges; and
- Registered exchange offers – public debt for debt exchanges registered with the Securities and Exchange Commission ("SEC") and subject to the tender offer rules.
Exchanges involving non-debt securities – exchanges of securities that are subject to the tender offer rules.
We also discuss related matters such as consent solicitations, both on a standalone basis and as "exit consents" in connection with an exchange offer.
Why consider repurchases, exchanges or tenders?
New bus iness and market realities . With the prolonged financial crisis resulting in market volatility, declining stock prices, ratings downgrades, asset write downs and modified earnings projections, this is the time for an issuery to recalibrate its debt/ equity mix.
Deleveraging efficiently. Many debt securities and hybrids are trading at significant discounts. An issuer may be able to effect an efficient repurchase/ tender given market conditions—optimize its balance sheet, reduce its interest expense, etc.
Tax considerations . Recent changes to the tax laws facilitate the repurchase of debt securities.
Investor perceptions . Investors may be more willing to consider exchange and restructuring opportunities. Investors may seek liquidity or appreciate the opportunity to move up in the capital structure.
Each restructuring transaction we discuss herein may have federal income tax consequences. We discuss below the general tax considerations applicable to these transactions as well as provide a more specific discussion of the tax consequences for each transaction.
Central to the tax considerations for an issuer restructuring its debt is the potential recognition of cancellation-of indebtedness ("COD") income. Under the Internal Revenue Code (the "Code"), taxpayers with outstanding debt are often subject to tax on COD income when all or a portion of such debt has been economically cancelled unless special exceptions apply (for example, in the event of bankruptcy or insolvency of the taxpayer). In addition, corporations that issue obligations with original issue discount ("OID") as part of their restructuring also must consider potential limitations on the deductibility of such discount. For corporations that issue certain high-yield obligations with significant OID ("AHYDOs"), a portion of such discount is treated as a nondeductible dividend under Section 163(e)(5) of the Code, while the remaining discount may not be deducted until actually paid.
Issuers should be aware that the American Recovery and Reinvestment Act of 2009 (the "Recovery Act"), signed into law on February 17, 2009, provides temporary relief from these COD and AHYDO rules. Generally, these provisions should make the refinancing and restructuring of existing corporate debt more attractive.
With respect to COD income, at the election of the taxpayer the Recovery Act defers the recognition of such income in connection with certain repurchases, modifications, and exchanges (referred to as "reacquisitions") of debt instruments after December 31, 2008 and before January 1, 2011. For reacquisitions in 2009, the deferral is five years; for reacquisitions in 2010, the deferral is four years. At the end of the deferral period, the taxpayer must include the COD income ratably over the next five years. Among other things, the deferral applies only to the debt of C corporations, and in the case of all other taxpayers, trade or business debts. Original issue discount on certain new debt instruments issued as part of, or in connection with, the reacquisition will not be deductible during the deferral period but will be deductible during the period in which deferred COD income is recognized. The death of, liquidation of, or other similar event with respect to a taxpayer will accelerate deferred COD income. If a taxpayer elects deferral, other possible exceptions to COD income in the Code may be unavailable. Special rules apply to pass-through entities, such as partnerships.
With respect to the AHYDO provisions, the Recovery Act suspends these rules for AHYDOs issued in exchange for non-AHYDOs of the same corporation between August 31, 2008 and January 1, 2010. The Recovery Act grants the Treasury the authority to extend the suspension and also expands the Treasury's ability to adjust the base rates used to determine whether an instrument is an AHYDO. The suspension does not apply to certain obligations with contingent interest determined, among other things, by reference to the income, value or dividends of the debtor (or a related person), nor does the suspension apply to obligations issued to related persons.
In part, the tax consequences to debtholders depend on whether the restructuring constitutes a "recapitalization" within the meaning of Section 368(a)(1)(E) of the Code. Generally, debt exchanges involving debt securities with terms longer than five years will qualify as recapitalizations. On the other hand, a repurchase of debt securities will result in gain or loss to the debtholder equal to the difference between the amount of cash received and the holder's adjusted tax basis in the debt security. If the holder acquired the debt security with market discount, a portion of any gain may be characterized as ordinary income.
Repurchases for Cash
An issuer may redeem its outstanding debt securities in accordance with their terms, assuming that the debt securities do not prohibit redemption. A credit line may prohibit prepayment; the debt securities may have absolute call protection and may not be redeemable. An issuer also may find that other debt securities have limited call protection, and may be redeemable following expiration of a certain period of time after issuance, often five or ten years. Specific kinds of debt securities also may be more or less likely to contain redemption provisions – for instance, zero coupon bonds generally are not by their terms redeemable.
Contractual and other approvals
Prior to deciding to redeem outstanding debt securities, an issuer must ensure that the redemption is permitted, not just under the terms of the debt security in question, but also under the issuer's other debt instruments. Many credit agreements limit an issuer's ability to redeem other outstanding debt. The usual areas of concern include definitions of, and restrictions on, "permitted indebtedness," "permitted refinancings," "permitted liens" and "restricted payments," as well as covenants regarding incurrence of indebtedness. An issuer should review carefully its existing debt instruments to ensure that a redemption is permitted and that a redemption would not trigger repayment obligations. There also may be other, non-financial agreements, such as lease agreements or even acquisition agreements, that may affect an issuer's ability to redeem its securities. In addition, redemption may require prior approval by the issuer's board of directors.
The process for redeeming an outstanding debt security is spelled out in the instrument governing the debt security, usually the indenture. Typically, an issuer must give holders not more than 60 and not less than 30 days' prior notice of redemption. This notice also may require that the issuer include other information, such as the redemption price, the redemption date, and identify the securities (if not all) which are being selected for redemption. If not all of the securities are being redeemed, the securities will be redeemed either on a pro rata basis or by lot; the process usually is determined by the trustee.
The terms of the debt securities, which were negotiated at the time of issuance, usually will specify the redemption price. The redemption price typically will reflect the holders' "yield to maturity" on the outstanding debt securities and debtholders will be made whole. The price typically will equal the face amount of the debt security, plus the present value of future interest payments. The effect of this is that the debt securities will be redeemed at a premium. For issuers with limited cash on hand, redemption may not be a viable option. In addition, as we discuss above, an issuer is required to provide at least 30 days' prior notice of redemption. If the issuer announces a redemption on fixed rate debt securities, it runs the risk that the proceeds it intends to use for the redemption, which at the time the notice was issued were at a lower cost, may have increased, and may even increase above the redemption cost.
Disclosure and other considerations
In connection with any redemption of outstanding debt securities, an issuer also must ensure that it has complied with securities law antifraud provisions. In particular, if in the offering documents an issuer has not adequately disclosed, for instance, that a specific series of debt securities may be redeemed, the issuer may be liable under Rule 10b-5 of the Securities Exchange Act of 1934, as amended (the "Exchange Act") for material misstatements or omissions in the prospectus as they relate to the redemption.1
As we discuss above, the terms of the indenture typically will require the issuer to distribute a redemption notice. In connection with delivery of this notice, an issuer often will announce via press release that it has decided to redeem the debt securities in accordance with their terms. An issuer should publicly disclose a redemption, to the extent that its broader impact on an issuer's financial condition would be viewed as material, prior to contacting debtholders. We discuss disclosure considerations below.
Privately negotiated and open market debt repurchases
An issuer that has cash, or can obtain it quickly, may determine that a privately negotiated or open market repurchase (or repurchases) of its debt securities is an efficient use of capital. In the context of a debt repurchase, an issuer also will need to review the terms of all of its outstanding debt instruments and other securities to determine that repurchases are permissible. The terms of the indenture will not dictate the purchase price payable by an issuer in connection with repurchases. As a result, an issuer may (and should) negotiate the purchase price with securityholders in order to achieve the best possible pricing.
How to choose among the various options?
Legal, accounting, ratings, regulatory capital and tax considerations should all be factored into the choice.
Cash? If the issuer has cash on hand, open market repurchases or a tender will be possible.
No cash? If the issuer does not have cash on hand, or a repurchase would not be considered a prudent use of resources, an issuer should consider an exchange.
Holders? The issuer will have to consider whether the securities are widely held and the status (retail versus institutional) of the holders.
Buying back a whole class of debt securities? Open market repurchases will provide only selective or limited relief. A tender may be necessary to buy all of a class of outstanding bonds.
Straight debt? Convertible debt? Hybrid? The issuer's options will depend on the structure of the outstanding security. A repurchase/tender for straight debt typically will be more streamlined.
Tender? Again, the structure and rating of the outstanding security will drive whether the issuer can conduct a fixed spread or fixed price offer.
Covenants. Is the issuer concerned about ongoing covenants as well as de-leveraging?
Part of a broader effort? The issuer should consider whether a buyback is only a precursor to a restructuring or recapitalization or whether an exchange offer/tender is only one element of a bigger process. The issuer should keep the bigger picture in mind.
Mix and match? Well, not really. It may be possible to structure a variety of transactions. However, an issuer should be careful to structure any liability management transactions carefully. Open market repurchases in contemplation of a tender may be problematic.
Benefits of a debt repurchase
Repurchases may be conducted with little advance preparation, they require limited or no documentation and generally can be conducted for little cost to the issuer (outside of the purchase price). Privately negotiated and open market purchases usually are most effective if the issuer is seeking only to repurchase a small percentage of an outstanding series of debt securities, or if the class of debt securities is held by a limited number of holders. Repurchases may be conducted in a number of different ways – the issuer may negotiate the purchase price directly with security holders; the issuer may purchase the debt securities on the secondary market; the issuer may engage a financial intermediary to identify holders, negotiate with holders and repurchase the debt securities; or the issuer may agree with a financial intermediary to repurchase debt securities that the financial intermediary purchases on a principal basis. If the issuer's debt securities are trading at a discount, a repurchase will be efficient. An issuer that repurchases its debt securities at a discount and cancels the debt securities will be able to improve its overall capital position. For a financial institution, the issuer may be able to increase its Tier 1 capital levels by doing so.
An issuer often may engage a financial intermediary to effect open market repurchases. This entity usually will be the same entity that acted as an underwriter for the initial issuance of the debt securities because the investment bank's sales force will have better knowledge regarding the secondary market for the issuer's debt securities, including the most appropriate pricing. The financial intermediary will be able to contact holders and easily negotiate the terms of the transaction.
In connection with a privately negotiated or open market repurchase, an issuer needs to ensure that it complies with all applicable laws, including those enacted under the Securities Act and the Exchange Act. Among other things, these rules and regulations affect the information that an issuer must provide to its securityholders in connection with debt repurchases.
Private negotiations with creditors, including debtholders, can trigger disclosure or other obligations under Regulation FD. In particular, concerns may arise when an issuer conducts discussions with one or more bondholder or lender groups to "test the waters" with respect to a particular repurchase plan. Regulation FD provides, subject to certain exceptions, that whenever an issuer, or any person acting on its behalf, such as a financial adviser, discloses any material nonpublic information regarding that issuer or its securities to market professionals or holders of the issuer's securities who may trade on the basis of such information, the issuer shall make public disclosure of that information either simultaneously, in the case of an intentional disclosure, or "promptly," in the case of a non-intentional disclosure. In the context of privately negotiated repurchases, the fact that an issuer is conducting these repurchases may be considered material nonpublic information in and of itself. A repurchase that is part of a restructuring, because of its broader impact on an issuer's financial condition and in many circumstances, its ability to operate, may be viewed as material. Disclosure of the repurchases to a debtholder may trigger a disclosure obligation on the issuer's part. However, the issuer may avoid the obligation to disclose such information if the person that receives the information is either under a duty of trust or confidentiality or such person expressly agrees to keep the information confidential. An issuer should consider whether to use a confidentiality agreement.
An issuer also should consider when it will disclose information regarding a repurchase to the public. If the issuer engages in private repurchases over time, it may not be appropriate to disclose each repurchase until the process ends. Similarly, negotiations over the terms of a restructuring (including a tender or exchange offer) may take time or may ultimately be fruitless. In those cases, debtholders may object to being kept out of the market for such an extended time, and may negotiate a specific time or event by which disclosure must be made public by the issuer or a determination made that the information is no longer material or current for any reason, including because of the occurrence of superseding events.
An issuer should consider the benefits of disclosing either in general terms or specific terms its restructuring goals, and giving up some negotiating flexibility for disclosure protection. The issuer may consider announcing the debt restructuring program (if there is a program, as opposed to opportunistic repurchases) with a press release and file the release as an exhibit to a Current Report on Form 8-K. The issuer may disclose its intentions in a periodic report, such as in its Annual Report on Form 10-K or a Quarterly Report on Form 10-Q. However, this may raise concerns about a "tender," which we discuss below. The disclosure need not be very detailed and may simply state that the issuer will repurchase its debt securities in the open market or in privately negotiated transactions if market conditions warrant. More specific disclosure may be problematic.
An issuer also should take care to avoid entering into discussions with debtholders that may rise to the level of an "offer" under the securities laws. If this occurs, the "offer" must: qualify as a bona fide private offer; be registered with the SEC, or be exempt from the registration requirements of the Securities Act by virtue of Section 3(a)(9).
Prior public disclosure
To avoid violating the antifraud provisions of the federal securities laws, particularly Rule 10b-5 under the Exchange Act, by purchasing a security and/or issuing a security at a time when the issuer has not disclosed material nonpublic information, whether or not related to the repurchase, the issuer should plan to disclose all material nonpublic information in advance. Examples of material information include unreleased earnings or an unannounced merger, both of which may need to be disclosed before purchasing securities from a debtholder. This can usually be done in an Annual Report on Form 10-K or a Quarterly Report on Form 10-Q but may also be accomplished by filing a Current Report on Form 8-K. In addition, if an issuer engages in privately negotiated or open market repurchases in advance of conducting a tender offer, it may be considered manipulative – the issuer will have prior knowledge of its intention to commence a tender that it did not disclose to holders from whom it is purchasing.
Regulation M and other considerations
Although Regulation M does not apply to investment grade non-convertible debt securities, it does apply to equity securities, non-investment grade and convertible debt securities. An issuer that is engaged in a distribution while effecting a repurchase program must ensure that it complies with Regulation M. Rule 102 under Regulation M makes it unlawful for an issuer or its affiliates "to bid for, purchase, or attempt to induce any person to bid for or purchase, a covered security during the applicable restricted period." This prohibition is intended to prevent an issuer from manipulating the price of its securities when the issuer is about to commence or is engaged in a distribution. A distribution may be deemed to take place in connection with a proxy mailing. In addition, issues under Regulation M arise when an issuer uses the proceeds from a new offering to repurchase outstanding debt securities. The new offering may be a distribution under Regulation M and any purchases under the buyback may be prohibited. An issue also arises if the debt repurchases are for debt securities that are convertible into the issuer's equity securities. Under certain circumstances, repurchases of convertible debt securities could be deemed a forced conversion and, therefore, a "distribution" of the underlying equity security for purposes of Regulation M.
Avoiding the tender offer rules
An issuer repurchasing its debt securities, either in privately negotiated transactions or in open market purchases runs the risk that it may inadvertently trigger the tender offer rules. The tender offer rules were adopted to ensure that issuers, and others, tendering for equity securities would be prohibited from engaging in manipulative practices in respect of those tenders. With equity securities, in particular, the market price is subject to manipulation as it fluctuates based on market pressures. However, debt securities are not subject to the same considerations as equity securities and therefore, a debt tender poses less risk than one for equity. For a debt tender, it is possible to structure the purchases to avoid the application of these rules.
Section 14(e) of the Exchange Act does not define "tender offer." Without a clear definition from the SEC, courts have provided a set of eight factors to help differentiate between a tender offer and other public solicitations. The eight-part test (and the case implementing that test) involved equity securities. It is likely, though, that any discussion on debt securities and tender offers would begin with the eight characteristics listed below. An issuer considering an open market or privately negotiated repurchase of its debt securities should review carefully the impact of the eight factors and structure the transaction to avoid the tender offer rules. Courts have found the following eight characteristics typical of a tender offer:
(1) active and widespread solicitation of public shareholders for the shares of an issuer;
(2) solicitation is made for a substantial percentage of the issuer's stock;
(3) offer to purchase is made at a premium over the prevailing market price;
(4) terms of the offer are firm rather than negotiable;
(5) offer is contingent on the tender of a fixed number of shares, often subject to a fixed maximum number to be purchased;
(6) offer is open only for a limited period of time;
(7) offeree is subjected to pressure to sell his stock; and
(8) public announcements of a purchasing program concerning the target issuer precede or accompany a rapid accumulation of large amounts of the target issuer's securities.2
These elements need not all be present for a transaction to constitute a tender offer, and the weight given to each element varies with the individual facts and circumstances.3 To ensure that a debt repurchase does not trigger application of these rules, it should be made for a limited amount of securities and to a limited number of holders, preferably sophisticated investors, should be made over an extended period of time (with no pressure for holders to sell), and prices should be privately, and individually, negotiated with each holder, with offers that are independent of one another.
How can an issuer benefit from a repurchase or exchange
of debt securities?
- Perception. A buy back may signal that an issuer has a positive outlook.
- Recording of accounting gains if securities are repurchased at a discount to par. The issuer will have to consider the structure of its buyback, exchange or tender.
- Reducing interest expense.
- Potential EPS improvement.
- Potential regulatory and ratings benefits.
- Alternative to more fundamental restructuring or potential bankruptcy.
In some cases, privately negotiated or open market repurchases of debt securities may not provide an issuer with the desired results, particularly if the issuer wishes to retire all or a significant portion of a series or class of outstanding debt securities. Privately negotiated or open market purchases may not be efficient for an issuer if the debt securities are widely held or the issuer plans a simultaneous consent solicitation. In those situations, a tender offer may be the most appropriate way to restructure the indebtedness. A tender offer allows an issuer to approach or make an offer to all of the holders of a series of its debt securities. Because tender offers do not have to close until specified (and disclosed) conditions are satisfied (including receipt of consents from the debtholders to modify the terms of the debt securities that remain outstanding, completion of any necessary financing for the tender offer and receipt of other necessary consents from third parties), it may be possible to conduct a tender offer and achieve the issuer's objectives.
Cash tenders for straight debt securities
Cash tender offers for straight debt securities may be completed more quickly and at a lower cost than other tenders because of the absence of specific disclosure or structuring requirements. In a cash tender for straight debt securities, an issuer typically will mail tender offer materials to holders describing the terms of the offer and providing them with material information. An issuer often will announce the commencement of a tender offer in a press release, and may even supplement that announcement by publishing notice of the tender in a nationally circulated newspaper.
Certain rules apply to tender offers. These rules were adopted in 1968 and are referred to collectively as the Williams Act. Regulation 14E and Rules 14e-1, 14e-2 and 14e-3 under the Exchange Act apply to all tender offers – both equity and debt. These rules do not apply to tenders or exchanges of securities that are exempt securities under Section 3(a) of the Securities Act. In addition, the SEC has provided no-action guidance that limits the applicability of some of these rules to tenders of investment grade debt securities. If the tender involves equity securities (which for purposes of the tender offer rules includes debt securities with equity components, such as convertible or exchangeable notes) additional rules apply. We discuss these rules below under "Cash tenders for convertible debt securities."
Rule 14e-1 sets forth certain requirements for tender offers generally.
- Offer Period – Rule 14e-1 provides that a tender offer must generally be held open for at least 20 business days from the date the tender offer commences.4 The offer must also stay open for at least ten business days from the date of a notice of an increase or decrease in: (1) the percentage of securities to be acquired pursuant to the tender (if the change exceeds two percent of the original amount); (2) the consideration offered, without any de minimis exception; or (3) any dealer-manager's solicitation fee, is first published or sent to the holders of the relevant securities. A tender offer subject only to Regulation 14E must remain open for a minimum of five business days for any other material change to the offer or waiver of a material condition.5
- Extension of Offering Period – Rule 14e-1 also provides that any extension of the offer period must be made by a press release or other public announcement by 9:00 a.m. Eastern time, on the next business day after the scheduled expiration date of the offer, and the press release or other announcement must disclose the approximate number of securities tendered to date.6
- Prompt Payment – The offeror must either pay the consideration offered or return the securities tendered promptly after termination or withdrawal, respectively, of the offer.
Under Regulation 14E, an issuer is not required to file tender offer documents with the SEC and the rules do not prescribe any form requirements. Any offer to purchase, and other tender offer documentation, is subject to the general antifraud provisions of the Exchange Act, notably Rule 10b-5 and Section 14(e), and, therefore, may not contain any material misstatement or omission.
While a cash tender for straight debt securities can be a relatively straightforward transaction, if a cash tender is combined with a consent solicitation, the process may become more complicated. Further, because cash tender offers for straight debt securities are not subject to the "best price" rules applicable to equity tender offers (discussed below), it is common practice to encourage participation in the tender by providing for an "early tender premium." Holders that tender early in the offering period, typically within the first ten business days, may receive the "total consideration." Holders that tender after the early tender period terminates will receive lesser consideration for their securities. The early tender feature benefits the issuer because it may have greater visibility regarding the success of the tender offer. An issuer needs to be mindful that the falling away of the "premium" may, under in certain circumstances, constitute a change in consideration that may require that the tender stay open for an additional ten days as discussed above.
Rule 14e-1 does not specifically require withdrawal rights. However, it is standard practice to provide holders with withdrawal rights for tender offers for straight debt securities. These withdrawal rights typically expire after an initial period, often after the first ten business days. An issuer also should consider whether it should reinstate limited withdrawal rights following the occurrence of any material change in the terms of the tender offer or the waiver of a material condition.
Rule 14e-2 requires that the issuer subject to a tender offer disclose to its securityholders its position with respect to the bidder's tender – whether it recommends it, expresses no opinion or is unable to take a position. Interestingly, Rule 14e-2 does not contain an explicit exemption for issuer tenders, though the subject issuer and the bidder would be the same entity. It is common for an issuer to include in its tender offer materials a statement that the issuer makes no recommendation as to the tender.
Rule 14e-3 contains an antifraud prohibition on activities of a person conducting a tender offer. If such person is in possession of material nonpublic information that he knows or has reason to know is nonpublic and knows or has reason to know was acquired from the offering person, the issuer or any of its directors, officers or employees, it is unlawful for that person to purchase or sell or cause to be purchased or sold any of the securities being tendered for. In the case of an issuer tender, an issuer must be careful not to conduct a tender at a time when it possesses material nonpublic information. This information may include unreleased earnings, a potential change in an issuer's credit ratings or an unannounced merger. The issuer should, to avoid any issues, disclose this information prior to commencing a tender offer.
Typically, in its tender offer documents, an issuer will specify the amount of securities it is seeking to purchase, as well as the price at which it will purchase these securities (or the method, as we discuss below, of calculating the purchase price). However, in some cases, an issuer may specify the amount of securities to be tendered, but may set the price using a modified "Dutch auction" pricing structure. In this structure, the issuer sets a cascading range of prices at which a holder may tender its securities. The purchase price will be the highest price at which the issuer is able to buy all of the securities for which it has solicited a tender (or a smaller amount, if not all the securities are tendered). This price is often referred to the "clearing price." The SEC has permitted tender offers to proceed without the issuer disclosing this range in the tender offer documents, so long as the aggregate amount of securities to be purchased is disclosed (and the range of securities to be purchased if the offer were fully subscribed).7 Usually the permitted price range is very narrow – often no more than 15% of the minimum price.
Challenges to consider
The issuer and its advisers should consider how to address potential holdouts—one approach may be to include a high minimum tender or exchange condition (such as 90% or higher).
Starting out with a timetable that complies with both contractual deadlines and tender offer rules is key to a successful process.
A bondholder committee may be helpful in the context of a broad restructuring or recapitalization. However, the interests of bondholders may not be aligned. For example, the interests of hedge fund holders of convertible debt may not be compatible with the interests of institutional investors that hold straight debt or hybrid securities. Disagreements among committee members can delay or prevent a successful tender or exchange offer.
Cash tenders for investment grade debt securities
The requirements of Regulation 14E may be limiting for an issuer conducting a tender offer. Specifically, if an issuer must keep the offer open for 20 business days or extend the offer period if there are any changes in the consideration or percentage sought, it can adversely affect the tender because the issuer is subject to market risk during this time. Most debt tender offers occur when interest rates are low – the issuer is trying to lower its cost of funds by retiring high interest rate debt securities with the proceeds from new securities issued at a lower rate, or a lower-interest rate credit facility. If interest rates decline during the offer period, an issuer will not retire as much debt and if rates increase, the retired debt will come at a higher price. Longer offer periods translate into increased uncertainty.
Because the SEC staff believes that issuer debt tender offers for cash for any and all non-convertible, investment grade debt securities may present considerations that differ from any and all or partial issuer tenders for a class or series of equity securities or non-investment grade debt, it consistently has granted relief to issuers of investment grade debt in the context of tenders for their debt securities. An issuer need not keep the tender open for 20 business days, provided the following conditions are met:8
- Offers to purchase were made for any and all of the investment grade debt, non-convertible debt of a particular series or class;
- The offer is open to all record and beneficial holders of that series or class;
- The offer is conducted so as to afford all record and beneficial holders of that series or class the reasonable opportunity to participate, including dissemination of the offer on an expedited basis in situations where the tender offer is open for a period of less than ten calendar days; and
- The tender offer is not being made in anticipation of or in response to other tender offers for the issuer's securities.
Following these no-action letters, investment grade debt issuers were no longer subject to the ten- and 20- business day requirements. In 1990, the SEC staff expanded this no-action relief for investment grade debt.
Salomon Brothers Inc. proposed to conduct an offer wherein the issuer would offer to purchase its debt securities from tendering holders at a price determined on each day during the offer period by reference to a fixed spread over the then - current yield on a specified benchmark U.S. Treasury security determined as of the date, or a date preceding the date, of tender. This is referred to as a "fixed-spread" tender offer. In connection with a fixed spread tender, the SEC staff required that the offer provide that information regarding the benchmark Treasury security will be reported each day in a daily newspaper of national circulation and that all tendering holders of that class will be paid promptly for their tendered securities after the securities are accepted, within the standard settlement period (now, three days).9
The SEC followed by expanding again the breadth of the no-action relief for tenders of investment grade debt securities. This relief applies to tenders for investment grade debt securities for which the nominal purchase price would be calculated by reference to a stated fixed spread over the most current yield on a benchmark U.S. Treasury security determined at the time the holder tenders, rather than by reference to a benchmark security as of the date, or date preceding the date, of tender. This is referred to as a "real-time fixed-spread" tender offer.
The SEC imposed the following additional requirements for a real-time fixed spread tender:
- The offer must clearly indicate the benchmark interest rate to be used and must specify the fixed spread to be added to that yield;
- The offer must state the nominal purchase price that would have been payable under the offer based on the applicable reference yield immediately preceding commencement of the tender offer;
- The offer must indicate the reference source to be used during the offer to establish the current benchmark yield;
- The offer must describe the methodology used to calculate the purchase price; and
- The offer must indicate that the current benchmark yield and the resulting nominal purchase price of the debt securities will be available by calling a toll-free phone number established by the dealer-manager.10
With the assistance of counsel, an issuer should be able to structure its tender offer for investment grade debt securities to fit within existing no-action letter guidance. Structuring within the guidance will relieve the issuer of the burden of complying with the ten - and 20-business day requirements.11
We believe the staff's no-action guidance will have particular importance over the next several years as financial institutions that have issued debt guaranteed by the Federal Deposit Insurance Corporation (the "FDIC") address the impending maturity dates of those government guaranteed debt securities. Under the terms of the FDIC's temporary liquidity guarantee program, the guarantee must mature no later than June 30, 2012.12
Investment Grade v. Non-Investment Grade Debt
Investment Grade Debt:
- Generally must remain open for 7-10 calendar days;
- Offer must be extended 5 calendar days for certain modifications to terms;
- Must be conducted to afford all holders the reasonable opportunity to participate, including dissemination of the offer material on an expedited basis (within two days after commencement); Able to price using a fixed-price spread or a real-time fixed price spread.
Non-Investment Grade Debt:
- Must remain open for 20 business days;
- Offer must be extended 10 business days for certain modifications to terms;
Cash tender offers for convertible debt securities
As we discuss above, certain provisions of the Williams Act, such as Rule 13e-4, are applicable only to tenders of equity securities, including tenders of convertible or exchangeable debt. If an issuer has a class of equity securities registered under the Exchange Act or is otherwise reporting under the Exchange Act, tenders for a debt security with equity features must comply with the provisions of Rule 13e-4. The obligation to comply with these provisions makes tender offers for convertible or exchangeable debt securities more complicated and time consuming, and subject the offer to SEC review, which could result in additional time delays.
We discuss below the principal additional requirements for a tender subject to Rule 13e-4.
Filing with the SEC – Rule 13e-4 requires that an issuer file a Schedule TO for a self tender for convertible or exchangeable debt securities on the day that such tender offer commences. Schedule TO has a number of specific disclosure requirements; disclosures must be made either in the Schedule TO itself or in the documentation sent to securityholders. Schedule TOs are subject to review by the SEC,13 and material changes in the information provided in the Schedule TO must be included in an amendment filed with the SEC. Rule 13e-4 also requires that all written communications regarding the tender offer be filed with the SEC.14 By reason of the Schedule TO filing obligation, the tender offer then becomes subject to the requirements of Regulation 14D, which governs the form and content of the Schedule TO.
Offers to all holders – Under Rule 14e-4, generally, tender offers must be made to all holders of the relevant securities.
Best price – The consideration paid to any securityholder for securities tendered in the tender offer must be the highest consideration paid to any other securityholder for securities tendered in the tender offer. Note that this does not prevent an issuer from offering holders different types of consideration as long as the holders are given an equal right to elect among each type of consideration, and the highest consideration of each type paid to any securityholder is paid to any other securityholder receiving that
type of consideration.
Dissemination – Rule 13e-4 provides alternative methods for disseminating information regarding an issuer tender offer. The most common method of dissemination is to publish a "tombstone" advertisement in The Wall Street Journal or other daily newspaper with national circulation.15
Withdrawal rights – Rule 13e-4 requires that the tender offer permit tendered securities to be withdrawn at any time during the period that the tender offer remains open. In addition, Rule 13e-4 specifically permits withdrawal after 40 business days from the commencement of the tender offer if the securities have not yet been accepted for payment.
Purchases outside the tender offer – Rule 13e-4(f)(6) provides that until the expiration of at least ten business days after the date of termination of the issuer tender offer, neither the issuer nor any affiliate shall make any purchases, otherwise than pursuant to the tender offer, of: (1) any security that is the subject of the issuer tender offer, or any security of the same class and series, or any right to purchase any such securities; and (2) in the case of an issuer tender offer that is an exchange offer, any security being offered pursuant to such exchange offer, or any security of the same class and series, or any right to purchase any such security.16
The requirements of Rule 13e-4 result in less flexibility for tenders for convertible or exchangeable debt securities compared to tenders for straight debt securities. A good illustration of this reduced flexibility is that it is not possible for issuers to "sweeten" the tender offer for convertible or exchangeable debt securities with an "early tender premium" as is the case for straight debt securities.
Accounting and other considerations
Convertible or exchangeable debt securities raise special accounting issues and issuers should carefully consider the accounting aspects of repurchasing their convertible debt before doing so. While some effects (such as the elimination of the retired debt from the issuer's balance sheet) may be more intuitive, others may not be. Issuers may wish to consult their accountants early on, even more so because accounting for convertible debt securities has changed recently.17 Issuers that intend to restructure their outstanding convertible debt also should consider the effects of such tender on any of their "call spread" transactions or share lending agreements.
Special rules for European tenders
It may be the case that the holders of an issuer's debt securities are located in foreign jurisdictions. For instance, if an issuer sold its securities pursuant to Rule 144A in the United States and pursuant to Regulation S outside the United States. Many frequent debt issuers issue and sell their debt securities pursuant to Euro medium-term note programs or market and sell U.S. registered securities into the European Union ("UE") or other foreign jurisdictions. For these tenders, an issuer must not only focus on the various considerations spelled out above, but also must be cautious that its tender does not violate any rules in the home country of its securityholders.
In the EU, there are two directives about which an issuer should be concerned. First, The Market Abuse Directive ("MAD"). As its name suggests, MAD is intended to prevent abuses relating to insider trading. Similar to Regulation FD, MAD requires that an issuer announce without delay information directly concerning it. MAD applies to financial instruments admitted to trading on a regulated market or for which a request for admission to trading has been made. The statute is intended to address insider dealing, market manipulation and the dissemination of false or misleading information. Under MAD, an issuer should perform an analysis similar to that under Regulation FD – is the insider in possession of material nonpublic information. In the case of a debt tender, the terms of the transaction likely was announced, so an issuer need only consider whether it possesses other information that may be considered material.
In the EU, an issuer need also be mindful of anti takeover restrictions contained in Directive 2004/25/EC. This directive pertains to takeover bids for the securities of issuers governed by the laws of a member state, where all or some of the securities are admitted to trading on a regulated market. A takeover bid means a public offer (other than by the offeree issuer itself) made to the holders of securities to acquire all or some of the securities with the objective of acquiring control. Though not directly applicable, the directive provides guidance that an issuer should follow in conducting a tender for its own securities. In particular, all holders must be treated equally and must have sufficient time and information to enable them to reach an informed decision.
Although Regulation M does not apply to investment grade non-convertible debt securities, it does apply to equity securities, non-investment grade debt and convertible debt. An issuer that engages in a tender offer must ensure that it complies with Regulation M. Rule 102 under Regulation M makes it unlawful for an issuer or its affiliates "to bid for, purchase, or attempt to induce any person to bid for or purchase, a covered security during the applicable restricted period." This prohibition is intended to prevent an issuer from manipulating the price of its securities when the issuer is about to commence or is engaged in a distribution.
An issuer that repurchases its debt securities at a discount to its adjusted issue price generally will recognize ordinary COD income in the amount of the discount. This results whether the issuer repurchases the debt securities directly or repurchases the debt securities through a related party, such as an intermediary. We discuss certain exceptions to the recognition of COD income, including under the Recovery Act above under "Introduction—Tax considerations".
A debtholder whose debt security is repurchased by the issuer will recognize gain or loss equal to the difference between the amount of cash received in the repurchase and the holder's adjusted tax basis in the debt security. If the holder acquired the debt security with market discount, a portion of any gain may be characterized as ordinary income.
1 Harris v. Union Electric Co., 787 F. 2s 355 (8th Cir. 1986), cert. denied, 479 U.S. 823 (1986).
2 Wellman v. Dickinson, 475 F. Supp. 783, 823– 24 (S.D.N.Y. 1979).
3 For example, an open-market purchase of 25% of an issuer's stock was held not to constitute a tender offer because: (1) the purchaser contacted only six of the 22,800 securityholders; (2) all six of those securityholders were highly sophisticated; (3) the purchasers did not pressure the securityholders in any way that the tender offer rules were designed to prevent; (4) the purchasers did not publicize the offer; (5) the purchasers did not pay a significant premium; (6) the purchasers did not require a minimum number of shares or percentage of stock; and (7) the purchasers did not set a time limit for the offer. Hanson Trust PLC v. SMC Corp., 774 F. 2d 47, 57– 59 (2d. Cir. 1985).
4 The date on which the tender offer is first published or sent or given to the holders of the relevant securities is the first business day.
5 See, SEC Release No. 34-42055 (Oct. 22, 1999), available at http://www.sec.gov/rules/final/33-7760.htm .
6 If the securities are registered on one or more national securities exchange, the announcement must be made by the first opening of any one of such exchanges on the business day following expiration.
7 See, SEC No-Action Letter, Alliance Semiconductor Corporation (Sep. 22, 2006).
8 See, SEC No-Action Letter, Salomon Brothers Inc. (Mar. 12, 1986); SEC No-Action Letter, Goldman Sachs & Co. (Mar. 26, 1986); SEC No- Action Letter, Merrill Lynch, Pierce, Fenner & Smith Inc. (July 2, 1986).
9 SEC No-Action Letter, Salomon Brothers, Inc. (Oct. 1, 1990).
10 SEC No-Action Letter, Merrill Lynch, Pierce, Fenner & Smith Inc. (July 19, 1993).
11 The SEC also has granted no-action relief in the context of preferred and hybrid securities that behave more like debt securities than equity securities. See, SEC No-Action Letter, BBVA Privanza International Limited and Banco Bilbao Vizcaya Argentaria, S.A., (Dec. 23, 2005).
12 However, the FDIC does not permit the proceeds of FDIC-guaranteed debt to repay or redeem non-FDIC guaranteed debt.
13 The SEC, aware of the length of the offer period, will typically provide any comments within the first ten days.
14 Issuers should be sensitive to whether there are written communications, such as in a press release or a Form 10-K, Form 10-Q or Form 8-K, that are often made in advance of the "commencement" of the tender offer, and that must be filed pursuant to Rule 13e-4(c) – for example, by "checking the box" on the cover of Form 8-K.
15 The tender offer rules have not been revised or amended to take into account greater reliance on the Internet.
16 This requirement is in addition to the prohibition in Rule 14e-5 that, with certain exceptions, prohibits "covered persons" from, directly or indirectly, purchasing or arranging to purchase any subject securities or any related securities (that is, securities immediately convertible or exchangeable for the subject securities) except as part of the tender offer. "Covered persons" include the offeror, its affiliates and the dealermanager and its affiliates.
17 Please see our Client Alert , "New FASB Accounting Rules on Convertible Debt" for a discussion of accounting changes related to convertible debt at http://www.mofo.com/news/updates/files/Client_Alert_FASB_Accounting.pdf
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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