In gentle of continued unfavourable macroeconomic developments—together with however not restricted to meaningfully increased international inflation, tightening financial coverage by central banks, risky power costs, slowing consumption, continued provide chain points and geopolitical conflicts[1]—international monetary markets have been adversely impacted in 2022. Buying and selling costs for a lot of debt securities and financial institution loans have fallen considerably as market expectations have adjusted. This volatility in secondary markets could current a horny alternative for firms and, within the non-public fairness house, their sponsors to repurchase excellent debt and de-lever at a major low cost.
This shopper alert highlights sure key points firms ought to usually think about with respect to potential debt buybacks and associated modification/legal responsibility administration workout routines.
Contractual Restrictions
As all the time, it’s crucial that firms seek the advice of their authorized counsel and assessment their debt agreements to find out whether or not any contemplated legal responsibility administration transaction is permitted. Credit score agreements will typically restrict the power of an organization to purchase again or in any other case prepay junior debt, which may embody junior lien, unsecured and/or subordinated debt relying on the actual phrases of the settlement, and will require professional rata prepayments of obligations beneath such agreements in reference to the prepayment of different debt. Likewise, high-yield bond indentures usually prohibit an issuer’s capacity to prepay subordinated debt. Funding covenants in each credit score agreements and indentures may additionally be implicated (relying on the actual definition and who the issuers and purchasers of the debt are). As well as, any new debt or liens incurred should adjust to any present limitations except amendments or waivers are obtained.
Debt Securities
Open Market Purchases and Privately Negotiated Transactions
Firms trying to repurchase their bonds within the open market should abide by relevant U.S. securities legal guidelines, together with anti-fraud provisions. Firms (and their associates) shouldn’t repurchase their bonds when in possession of fabric private info. Amongst different issues, firms ought to seek the advice of their insider buying and selling insurance policies and related buying and selling blackout durations when contemplating a bond repurchase.
Firms also needs to think about whether or not the repurchase itself or the supply of funds used to execute it give rise to any disclosure obligations. There may additionally be Regulation FD-type selective disclosure concerns for firms participating in privately negotiated repurchases.
Moreover, firms should be sure that any repurchases don’t represent a “tender supply” that’s topic to particular guidelines beneath the U.S. federal securities legal guidelines. If any repurchases have been discovered to represent a “tender supply” and have been performed with out complying with relevant tender supply guidelines, an organization could threat financial damages, injunctive reduction and SEC enforcement. When evaluating whether or not sure repurchases could represent a young supply, elements to think about embody: the quantity of bonds being repurchased, the quantity and class of holders solicited, the way by which the holders are solicited and the phrases of the repurchase. For open market repurchases, limiting the principal quantity of bonds repurchased in any quarter is prudent, whereas a higher variety of bonds could also be repurchased privately in transactions negotiated individually with a extra restricted variety of subtle holders. Market individuals use varied guidelines of thumb to find out whether or not repurchases could also be thought of a young supply, resembling repurchases under a set share of the combination principal quantity of bonds excellent or from holders that don’t exceed a set quantity, however each state of affairs requires cautious evaluation based mostly on the actual information and circumstances.
Debt Tender and Trade Presents
Debt tender and change provides permit issuers to purchase again or change all or a portion of a collection of debt securities from holders at giant, topic to compliance with U.S. securities legal guidelines. Debt tender and change provides could also be coupled with a consent solicitation to incentivize participation within the supply and acquire covenant reduction.
Debt Tender Presents. Money tender provides for non-convertible debt securities don’t require the submitting of a registration assertion or SEC assessment, however are topic to sure SEC guidelines. Typically, the supply should be open for at the least 20 enterprise days, and holders should be paid “promptly” following the expiration of the supply. Sure modifications to the phrases of the supply (e.g., a rise or lower within the share of securities being sought or the value being provided) will usually require that the supply stay open for at the least ten extra enterprise days (doubtlessly necessitating an extension) and corresponding public announcement. An SEC no-action letter permits abbreviated five-business day tender provides for non-convertible debt securities as long as sure circumstances are met.[2]
Firms have quite a lot of flexibility in structuring the phrases of a debt tender supply, together with providing an “early tender” premium for holders that tender their bonds early within the supply, providing to buy a number of collection of notes in a single tender supply utilizing a “waterfall” construction, “Dutch Public sale”-style pricing and variations within the quantities of notes sought and the value being paid. A few of this structuring flexibility just isn’t obtainable within the abbreviated five-business day tender provides talked about above. Tender provides require restricted documentation, and firms can sometimes launch and execute them fairly shortly.
Debt Trade Presents. Trade provides could contain a debt-for-equity change or debt-for-debt change. In contrast to money tender provides, change provides contain a brand new situation of securities and, thus, would require both SEC registration of the brand new securities or an exemption from registration. Public firms wishing to change debt for freely tradable shares of frequent inventory or new registered debt securities might want to undergo the SEC registration course of, which can be prolonged and unpredictable.[3] Consequently, change provides are sometimes restricted to institutional buyers and non-U.S. individuals that qualify for an exemption from SEC registration; nevertheless, this limitation might not be sensible if a good portion of the related debt securities is held by retail buyers. If the change supply features a consent solicitation to amend the phrases of the previous debt securities (as mentioned under), it might additionally make limiting the change supply to sure lessons of the prevailing buyers extra sophisticated. Firms are generally in a position to reap the benefits of Sections 3(a)(9) and three(a)(10) of the Securities Act of 1933, which allow exchanges with out registration in restricted circumstances.
Along with these SEC registration and exemption concerns, change provides are topic to the identical SEC tender supply guidelines as money debt tender provides, together with a minimal 20-business day supply interval (with the power to execute a five-business day change supply topic to sure circumstances), and have comparable flexibility by way of pricing and construction. Firms trying to launch an change supply ought to permit for extra time, nevertheless, even when the supply doesn’t require SEC registration and assessment. It’s because the supply would require a disclosure doc (much like an providing memorandum for a Rule 144A bond providing) and, if a financial institution is engaged to behave as a vendor supervisor to assist with the change, further due diligence, authorized opinions and unfavourable assurance letters, and auditor consolation letters.
Consent Solicitations
A consent solicitation is the customary methodology for acquiring the approval of holders of debt securities for waivers and amendments to the phrases of their securities. Most covenants may be amended with the consent of the holders of bonds representing a majority of the excellent principal quantity, however modifications to financial or different elementary phrases (e.g., principal quantity, rate of interest, curiosity cost dates and maturity, amongst others) sometimes require the consent of every affected holder beneath the related documentation.[4] Indentures typically disregard bonds held by the issuer and its associates when figuring out whether or not the requisite principal quantity of bonds to impact an modification have been obtained.
Consent solicitations are usually performed both together with a young or change supply or on a “stand-alone” foundation.
When mixed with a young or change supply, holders who take part within the supply additionally present their consent to the proposed covenant modifications, generally eradicating considerably all restrictive covenants. That is known as an “exit consent” as a result of it’s offered by holders “on their manner out” of their bond positions. The modifications within the phrases of the bonds that stay excellent will solely develop into operative as soon as the related tender or change supply has closed. The minimal period of that provide is ruled by the SEC tender supply guidelines, and abbreviated five-business day provides can’t be made along with an exit consent.
Against this, stand-alone consent solicitations could also be accomplished shortly and with few necessities. Nevertheless, with out an related tender or change supply, firms may have to supply holders a consent price to acquire their consent to the proposed modification of the phrases of their securities.
Convertible Bonds
Convertible bonds are handled as fairness securities beneath SEC tender supply guidelines. Tender provides for convertible bonds due to this fact require submitting of a Schedule TO that’s topic to SEC assessment and remark whereas the supply is pending. Tender provides for convertible bonds should additionally adjust to the “all holders/finest worth” rule relevant to fairness tender provides, and issuers due to this fact can not supply an early tender premium or exclude retail holders (as in sure change provides). Sometimes, convertible bonds are held by a comparatively small variety of institutional buyers, and issuers could possibly construction money repurchases or exchanges as privately negotiated transactions to keep away from SEC registration and assessment (though care should be given to keep away from having the transaction represent as a “tender supply,” which might set off the fairness tender supply guidelines described above). Firms ought to think about the affect of short-covering purchases by holders of convertible bonds in reference to a repurchase of their bonds, and any bond hedge and associated warrant transactions could need to be partially unwound to account for any discount within the quantity of excellent convertible bonds. All of this additionally raises disclosure concerns, together with these regarding Regulation FD, that can have to be analyzed.
Time period Loans
Mortgage buybacks arose within the syndicated mortgage market because of the monetary disaster of 2008/2009. Previous to the disaster, most credit score agreements didn’t ponder borrower buybacks and, actually, many credit score agreements particularly offered that the borrower and its associates weren’t eligible assignees of the loans. After that monetary disaster, many credit score agreements mostly within the syndicated time period mortgage B market particularly started to ponder the power of the borrower and/or its associates to buy loans (sometimes restricted to the time period loans) both via non-pro rata open market purchases or via a “Dutch Public sale” course of that in lots of instances is required to be open to all lenders of the category of loans being bought on a professional rata foundation.
Open Market Purchases
Open market purchases permit the borrower to repurchase the loans on a one-off non-pro rata foundation on a easy, quick and cost-efficient foundation. Credit score agreements normally would require that the principal quantity of the loans bought by the borrower (together with accrued and unpaid curiosity thereon) or any of its restricted subsidiaries might be mechanically cancelled and extinguished as of the date of the acquisition (however such level must be confirmed for every explicit credit score settlement). Credit score agreements sometimes will even situation the power of the borrower to buy its loans on (i) there being no default or occasion of default or, in sure instances, no cost or chapter occasion of default and (ii) a liquidity take a look at, which generally requires that no proceeds of the borrower’s revolving credit score facility are used to fund the acquisition of time period loans. The restriction of use of revolving credit score facility proceeds could also be significantly notable as debtors may additionally be trying to attracts of their revolving credit score facility as potential sources of liquidity, and given the fungible nature of money, would require cautious evaluation. As well as, a assessment of the relevant credit score settlement might be required to find out whether or not the borrower (or its affiliate) is required to make a illustration that it isn’t in possession of fabric private info with respect to itself and its enterprise that has not been disclosed to the lenders usually or state that it can not make such illustration. Additionally, credit score agreements could present that within the case of a purchase order of loans by the borrower (or its associates) that the lenders have agreed to sure non-reliance/“huge boy” provisions in connection therewith or in any other case require such lender to execute a “huge boy” letter.
Dutch Auctions
As mentioned above, many credit score agreements at present include provisions permitting the borrower to voluntarily prepay the time period loans at a reduction to par pursuant to enumerated Dutch public sale procedures set forth in such agreements. A borrower could resolve to interact in a Dutch public sale course of if it wishes to buy a considerable portion of its loans that’s in extra of the traditional buying and selling quantity of such loans. In its easiest kind, these Dutch public sale procedures permit the proposed purchaser of the loans to submit a suggestion to buy a specified quantity of the time period loans at a given worth expressed as a reduction to par. Lenders will then be given a time period to just accept such supply and the borrower would buy the loans tendered in such supply (topic to professional rata reductions if the principal quantity of loans tendered is bigger than the principal quantity of loans provided to be repurchased). There are numerous credit score agreements that permit the proposed purchaser to supply to buy the time period loans based mostly on a worth vary moderately than a single particular buy worth and so the borrower would repurchase loans on the lowest worth provided by accepting lenders that might allow the borrower to repurchase the specified quantity of loans. If the borrower is the purchaser of the loans in such supply, the provisions set forth above in “Open Market Purchases” concerning cancellation of the loans and the associated circumstances will apply.
Purchases by Associates of the Borrower
Beneath sure circumstances, together with the place the borrower and its house owners need to protect the borrower’s liquidity, associates of the borrower could want to buy the loans by way of open market purchases. Usually, credit score agreements will prohibit the power of associates to buy time period loans and train rights as lenders. These restrictions normally embody: a cap on the principal quantity of loans that could be bought (sometimes round 25–30%), limitations on entry to info and “lender solely” conferences, sure limitations on voting rights and waivers of sure rights in chapter proceedings and, in sure circumstances, an affirmative enterprise to not problem the lenders’ authorized privilege. A variety of credit score agreements exclude “debt fund associates” from the restrictions described within the previous sentence however will ordinarily restrict such debt fund associates’ vote on “required lenders” issues to an mixture of 49.9% of such vote in order that such debt fund associates wouldn’t represent the required lenders by themselves. Associates which have bought these loans might be permitted (however not required) to contribute such loans to the borrower and, if that’s the case contributed, such loans would ordinarily be cancelled and extinguished. As described above for debtors, a assessment of the credit score settlement might be required to find out the scope of any representations that such purchasers might be required to make with respect to materials private info in reference to such buy.
Repurchase of loans by the borrower, any of its subsidiaries or any of its different associates will seemingly affect sure different provisions of a credit score settlement that can have to be reviewed. Such provisions embody: the affect on the definition of EBITDA and leverage ratios, the calculation of extra money stream and the power to incur incremental debt.
Amendments
Usually, the holders of a majority in principal quantity of the loans and commitments (the “required lenders”) and the executive agent might be required to approve any modification or waiver of the covenants; besides that in covenant-lite services the place the monetary covenant is for the good thing about the revolving lenders solely, the consent of the holders of a majority of the revolving loans/commitments could be required as a substitute of all loans. Likewise, in most credit score agreements, amendments to the obligatory prepayment provisions would additionally require approval of the required lenders and the agent. Deferrals of curiosity or principal and/or paying such quantities in variety would usually require an affirmative vote from all lenders or all affected lenders.
Tax Issues
If a borrower acquires its debt (e.g., both via a repurchase or debt-for-debt change) for an quantity lower than its adjusted situation worth, the borrower could acknowledge cancellation of indebtedness (“COD”) revenue, which may give rise to a money tax legal responsibility. The quantity of COD revenue usually is the distinction between the principal quantity of cancelled debt and the repurchase worth. COD revenue may be triggered by the forgiveness of debt by its holder, modification of the debt, and the repurchase of the debt by the corporate at a reduction. COD revenue may additionally come up if a associated get together (resembling a personal fairness sponsor that owns the borrower) engages within the repurchase transaction. COD revenue sometimes just isn’t acknowledged to the extent of the issuer’s insolvency or within the case of chapter of the issuer.
Firms ought to think about the tax points concerned with debt buybacks and legal responsibility administration concerns with their tax advisers.
Particular due to affiliate Aylmer Wang (New York-Finance) who co-authored this publication.
Footnotes
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