Restructurings may lead to legal challenges. The legal challenges usually come from holders of securities that do not participate in the restructuring and believe that the value if these securities or protections afforded by their securities are adversely affected. In addition, because the "all holders" rule does not apply to tender offers for straight debt securities, holders who are not offered the right to participate (for example, because the offering is limited to QIBs) may also claim that their securities are impaired. The effects of litigation can be burdensome. In some instances, the litigation will enjoin the issuer from completing the tender or exchange offer. However, if litigation is resolved after the completion of the transaction, it is unclear how the violation would be remedied because in the case of an exchange, holders already hold the new securities.
A recent Delaware court case crystallizes some of the challenges associated with debt restructurings. In the Realogy case,40 Realogy Corporation ("Realogy") announced an exchange offer for its outstanding notes (Senior Notes due 2014, Senior Toggle Notes due 2014 and Senior Subordinated Notes due 2015) for up to $500 million of additional term loans issued pursuant to an accordion feature under Realogy's senior credit facility. This accordion feature allowed Realogy to incur additional indebtedness under the credit facility. The new term loans would be secured, whereas existing notes were unsecured. The terms of the offer set a priority as to which holders were entitled to accept the offer – holders of Senior Subordinated Notes ($125 million), then holders of Senior Notes ($500 million) and then holders of Toggle Notes ($500 million, less any amounts tendered by the other classes). As a result of this priority, holders of Toggle Notes would likely be unable to participate in the exchange offer and would, effectively, be subordinated to tendering holders from the other classes who would receive secured debt.
The trustee and a noteholder controlled by Carl Icahn, High River L.P., sued Realogy on the basis that, among other things, the exchange offer violated the terms of the indenture, specifically the "negative pledge" covenant. The senior credit facility allowed "Permitted Refinancing Indebtedness" to refinance the notes, provided the refinancing indebtedness had no greater security than the debt being refinanced. Because the new loans were secured, and the notes being exchanged were not, the court found in favor of the trustee, reasoning that the new loans were not "Permitted Refinancing Indebtedness" and, as a result, the liens securing the new loans were not "Permitted Liens" under the indenture. The court granted the plaintiffs summary judgment and the exchange offer did not proceed.
This case turned on contract negotiation and the specific terms of the contracts, and it highlights the need to ensure that a thorough and complete review of the underlying documents, other debt instruments and an issuer's capital structure is completed before commencing any refinancing.
For balance sheet restructuring, like so many other things in life, timing can be everything. Issuers are cautioned not to wait too patiently for their fortunes to improve. The most effective balance sheet restructuring occurs when an issuer's balance sheet is neither too healthy nor too stressed. It's a bit like Goldilocks' porridge – best eaten when not too hot and not too cold.
Review of Exchange requirements
The securities exchanges – the New York Stock Exchange ("NYSE"), the Nasdaq Stock Market ("Nasdaq") and the NYSE Alternext ("Alternext" and collectively, the "Exchanges")41 require shareholder approval for the issuance of equity securities by their listed issuers in various situations.42 Each Exchange also applies these shareholder approval provisions to offerings of securities that are convertible into or, in the case of the NYSE and Nasdaq, exchangeable for, common stock, such as convertible debt. An issuer must carefully review the Exchange provisions if the security to be exchanged in a restructuring is either actual equity or convertible or exchangeable debt, or if the transaction cannot be categorized as a "public offering."
Under Nasdaq Rule 4350(i) and Alternext Rules 712 and 713, shareholder approval is required for transactions involving the issuance of:
- 5% or more of the current outstanding common stock in an acquisition, if a director, officer, or substantial securityholder of the issuer has a 5% interest (10% if a group) in the company or assets to be acquired,
- 20% or more of the current outstanding common stock in an acquisition, or
- 20% or more of the current outstanding common stock in any transaction other than a public offering.
Under NYSE Rule 312.03, shareholder approval is a prerequisite to issuing additional shares equal to:
- more than 1% of the current outstanding common stock to an insider (an officer or director, or an entity affiliated with an officer or director) or a substantial holder; however, if the purchaser is only a substantial holder (and not an officer or director) and the cash purchase price is at least as great as each of the book and market value of the issuer's common stock, then shareholder approval will not be required unless the number of shares of common stock to be issued (or into which the security may be convertible or exercisable), exceeds either 5% of the outstanding common stock before the issuance, or
- 20% or more of the current outstanding common stock other than an issuance involving a public offering or a "bona fide private financing" (as defined in NYSE Rule 312.04(g)).
The percentages in all cases apply both to outstanding common equity or common voting power.43
Each Exchange also requires shareholder approval when an issuance will result in a "change of control" of the issuer.44 None of the Exchanges however, have adopted a definition of "change of control." A general rule of thumb (there are variations between the Exchanges) is that purchases of between 20% and 30% of the outstanding voting stock may be deemed a change of control, unless preexisting control positions are not displaced by the transaction. It is prudent to consider both the change of control rule and the 20% rule in any transaction that involves an issuance close to 20%. In many cases, it will be appropriate to consult the relevant Exchange early in the transaction process.
Shareholder approval is not required for financing transactions (involving share issuances) that are structured as "public offerings" under the rules or policies of any of the three Exchanges. It is important to note that an offering is not deemed to be a "public offering" for these purposes merely because it is effected under a registration statement. The Nasdaq and Alternext staffs will consider all relevant factors when determining whether an offering will qualify for the public offering exemption, including, but not limited, to: (i) the type of offering;45 (ii) the manner in which the offering is marketed; (iii) the extent of the offering's distribution, including the number of investors who participate in the offering; (iv) the offering price; and (v) the extent to which the issuer controls the offering and its distribution. The NYSE does not offer formal guidance to determine when a particular offering would qualify as a public offering in the context of a restructuring. It should also be noted that restructurings effected under Rule 144A of the Securities Act are, by definition, not "public offerings" despite the fact that such offerings typically having many of the indicia of a public offering.
Each of the NYSE, Nasdaq and Alternext have indicated46 that mere filing of tender offer documents with the SEC does not necessarily make the tender offer a "public offering," and that they should be contacted when a particular transaction arises for a definitive determination. Alternext suggested that two factors to be considered are (i) the market price of the security when issued compared to the price at which it is being exchanged; and (ii) the original price the debt was being issued and what the reset is. Because of the uncertainty regarding whether a registered exchange offer will be categorized as a "public offering," exchange offers may be structured with a "cap" (that is, the exchange is capped at 19.9% and the remaining percentage above 20% is subject to shareholder approval).47
Review FINRA requirements
If a financial intermediary (such as a dealer-manager) is involved in the restructuring, the requirements of The Financial Industry Regulatory Authority ("FINRA") may also apply. FINRA Rule 5110,48 known as the Corporate Financing Rule, requires certain filings with FINRA to determine whether the compensation to the financial intermediary is fair. However, the financial intermediary does not have to file (although it will be required to comply with the substantive provisions of FINRA Rule 5110) if the transaction is an exchange offer where the securities to be issued are listed on Nasdaq, the NYSE or the Alternext; or the issuer qualifies to register an offering on Forms S-3, F-3, or F-10 under the Securities Act.49 FINRA Rule 5110 will not apply at all if the transaction is a tender offer made pursuant to Regulation 14D, which regulates tender offers for equity securities. Absent any such exception, a registered exchange offer has to be filed with FINRA for review.
Involvement of affiliates
Under certain circumstances, affiliates of an issuer may seek to purchase the issuer's debt securities. This may occur on the corporate level, such as when a parent purchases securities of its subsidiaries or when subsidiaries purchase securities of its parent or other subsidiaries. It may also occur if officers, directors or significant shareholders seek to purchase the securities. In these instances, the "affiliates" would generally be considered insiders of the issuer and subject to the same disclosure obligations as the issuer. The issuer should coordinate closely with the affiliate in structuring any repurchase program, including to ensure that other corporate requirements are not implicated, such as an affiliate running afoul of the "corporate opportunity" doctrine. In many circumstances, involvement of an affiliate may preclude reliance on the Section 3(a)(9) exemption for an exchange offer.
The Role of Financial Intermediary
When should an issuer engage an investment bank or other financial intermediary to assist with liability management transactions? The short answer is that it depends – it depends on the issuer's situation and the transaction contemplated. Generally, the more complex and significant a restructuring, the more helpful it may be to engage an investment bank as financial adviser. The bank will help formulate a restructuring plan, locate and identify securityholders, structure the transaction, solicit participation, assist with presenting the structure to the various stakeholders, assist with rating agency discussions and manage the marketing efforts to achieve a successful restructuring. Issuers should consider a number of factors, such as the number of debtholders, their organization and sophistication and whether the issuer has information about, and any contact with, its debtholders. In a distressed situation, the challenges that many issuers face often lead them to contact an investment bank. Typically, such banks have "liability management," "restructuring" or "workout" teams specialized in debt restructurings. Issuers that wish to take advantage of declining secondary market prices for debt securities also may benefit from engaging an investment bank to locate, contact and negotiate with debtholders to sell (or exchange) their debt securities. The type of transaction will dictate the investment bank's role, which ranges from merely an advisory role or responsibilities as an agent, principal or as dealer-manager, as well as any limitations on its activities.
If the issuer has few debtholders that are already known to it, it may not need assistance from an investment bank. However, an investment bank may be involved in these transactions, for example, to contact and bring unknown debtholders to the table, acting either as an agent (acting as a broker for the issuer) on behalf of the issuer, or as principal (buying the debt securities from the debtholder and selling them back to the issuer). Both the issuer and its advisers must be mindful of any activities that put a repurchase at risk of being deemed a "tender offer."
The investment bank's role varies in tender offers. In a cash tender offer for straight debt, an issuer may engage an investment bank in an advisory role. In a tender offer for convertible debt securities, which is subject to additional tender offer rules, an issuer may choose to engage an investment bank in an advisory role to contact and negotiate the terms with debtholders or to act as a more active dealer-manager. In a tender offer coupled with a consent solicitation or a public tender offer for all outstanding debt securities, issuers usually engage a dealer-manger to manage the process. In these transactions, issuers also often use an investor relations firm to act as information agent during the process. There are no specific rules regarding compensation preventing issuers from using - and paying – an investment bank to solicit tenders.
Private exchange offers
An issuer may choose to engage an investment bank in an advisory role for a private exchange offer, however, because the exchange involves a limited number of debtholders, a more active dealer-manager is not always needed. Issuers may engage the bank that acted as the initial purchaser for the old debt securities, this way, in an exchange offer under Rule 144A, the bank may have existing "QIB" letters on file to pre-qualify holders. The investment bank's activities cannot include any "general solicitation." There are no specific rules regarding compensation preventing issuers from using, or paying, an investment bank to solicit private exchanges.
Section 3(a)(9) exchange offers
Issuers are permitted to engage third parties, such as financial advisers and investor relations firms, to assist with Section 3(a)(9) exchanges, but their role must be limited. Under Section 3(a)(9), an issuer cannot pay anyone, including a financial adviser or dealer-manager, to solicit exchanges. Pursuant to SEC no-action guidance, a financial adviser may undertake certain activities so long as it is not paid a success fee. Issuers facing a complex restructuring may decide that they need a dealer-manager to solicit exchanges and manage the process to ensure a successful restructuring.
The SEC has provided guidance as to how an investment bank may be compensated in a Section 3(a)(9) exchange.
In general, an investment bank can:
- engage in pre-launch discussions or negotiations with legal and financial representatives of bondholder committees;
- provide a fairness opinion;50 and
- only provide debtholders with information that was included in communications sent directly by the issuer.
In general, an investment bank cannot:
- solicit (directly or indirectly) exchanges or consents; and
- make recommendations regarding the exchange offer to debtholders or their advisors.
If an investment bank is involved in a Section 3(a)(9) exchange offer, it should be paid a fixed advisory fee, as opposed to a success fee for its services. Although, paid promotion is strictly off-limits, the issuer can still reimburse an advisor for expenses related to the exchange.
The issuer may rely on an investor relations firm or other sales force, such as engaging an information agent, to inform securityholders of the exchange offer.51 Filling this role with an investment bank is efficient as the firm that sold the securities in the first place may be in the best position to contact its former customers. The permitted activities are limited to contacting securityholders to confirm that the issuer's mailings were received, that the securityholder understands the mechanical requirements necessary to participate in the exchange, and to determine whether or not the securityholder intends to participate in the exchange offer.52 Under this arrangement, however, payment would have to be made on a flat, per-contact basis, and communications with securityholders may not include any recommendation regarding the decision to accept or reject the exchange offer.53 An issuer should instruct its agents to defer on all questions relating to the merits of the offer if the issuer wishes to use the Section 3(a)(9) exemption.
Registered exchange offers
In a registered exchange offer, there is more flexibility regarding the investment bank's role. Often, an issuer engages an investment bank to act both as adviser and dealer-manager (which includes soliciting holders if the exchange offer is coupled with a consent). The dealer-manager for a registered exchange offer (or public tender offer) may actively solicit acceptances and be compensated for these activities, including with a success fee. Because of the heightened liability standard involved with a registered exchange offer, the dealer-manager will want to conduct due diligence comparable to the diligence conducted for an ordinary registered offering. In addition, the dealer-manager may require delivery of legal opinions, a 10b-5 negative assurance letter with respect to disclosure, and a comfort letter or agreed upon procedures letter.54 The dealer-manager must keep in mind all rules relating to pre-filing or pre-launch communications with debtholders to avoid gun-jumping issues and Regulation FD issues.
40 The Bank of New York Mellon and High River Limited Partnership v. Realogy Corporation, Court of Chancery of the State of Delaware, C.A. No. 4200-VCL, Memorandum Opinion, December 18, 2008.
41 On October 1, 2008, NYSE Euronext completed its acquisition of the American Stock Exchange and changed the exchange's name to NYSE Alternext US.
42 See, e.g., Nasdaq Marketplace Rule 4350(i) (the "Nasdaq Rules"), and related publicly available interpretive guidance;: NYSE Issuer Manual Sections 312.00 – 312.07 (the "NYSE Rules"); and NYSE Alternext LLC Manual Sections 710-713 (the "Alternext Rules").
43 Nasdaq Rule 4350(i)(3) and NYSE Rule 312.04(d) each provide that only shares actually issued and outstanding (excluding treasury shares or shares held by a subsidiary) are to be used in making any calculation provided for in this paragraph (i). Unissued shares reserved for issuance upon conversion of securities or upon exercise of options or warrants will not be regarded as outstanding. Alternext does not have a similar rule.
44 See, Nasdaq Rule 4350(i)(1)(B), Alternext Rule 713(b) and NYSE Rule 312.03(d).
45 For example, this may include: (1) whether the offering is conducted by an underwriter on a firm commitment basis; (2) whether the offering is conducted by an underwriter or placement agent on a best efforts basis; or (3) whether the offering is self-directed by the issuer. See, Nasdaq Interpretive Material 4350-3; Commentary to Alternext Section 713.
46 Telephone conversations between this firm and each of the Exchanges in February 2009.
47 In certain circumstances, if the issuance of the original securities was structured to comply with the 19.9% cap, the Exchanges may, unless the issuer can demonstrate a change of circumstances, aggregate any securities issued in the exchange with the remaining outstanding nontendered securities for purposes of calculating the percentage. In addition, the exchange may calculate the percentage based on the issuer's outstanding share capital as of the original issue date as opposed to the exchange date.
48 Formerly NASD Rule 2810.
49 For FINRA purposes only, an issuer's qualification to register an offering on Form S-3, F-3 or F-10 is based on the eligibility requirements prior to October 21, 1992, which were conditioned on a 36-month reporting history and $150 million aggregate market value of the voting stock held by non-affiliates (or $100 million and an annual trading volume of 3 million shares).
50 An issuer is permitted to hire an investment bank to render a fairness opinion on the terms of the exchange; however, if the investment bank also is acting as a dealer-manager and conducting solicitation activities, the SEC has held that obtaining a fairness opinion would violate Section 3(a)(9). See, SEC Division of Corporation Finance, Compliance and Disclosure Interpretations: Securities Act Sections (#125.07) (November 26, 2008), available at http://www.sec.gov/divisions/corpfin/guidance/sasinterp.htm .
51 Other permitted activities involve confirming debtholder contact details, confirming their receipt of all requisite materials and reminding debtholders of approaching deadlines.
52 SEC No-Action Letter, Dominion Mortgage & Realty Trust, (April 3, 1975).
53 This second requirement applies to any of the issuer's agents who contact the securityholders, and not only to dedicated sales departments.
54 These deliverables are usually also requested by the dealer-manager in a tender offer. The scope of these deliverables can significantly increase the cost of the tender offer or exchange offer and are often negotiated between the parties.
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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