November 10, 2022
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In light of continued negative macroeconomic trends—including but not limited to meaningfully higher global inflation, tightening monetary policy by central banks, volatile energy prices, slowing consumption, continued supply chain issues and geopolitical conflicts[1]—global financial markets have been adversely impacted in 2022. Trading prices for many debt securities and bank loans have fallen significantly as market expectations have adjusted. This volatility in secondary markets may present an attractive opportunity for companies and, in the private equity space, their sponsors to repurchase outstanding debt and de-lever at a significant discount.
This client alert highlights certain key issues companies should generally consider with respect to potential debt buybacks and related amendment/liability management exercises.
As always, it is imperative that companies consult their legal counsel and review their debt agreements to determine whether any contemplated liability management transaction is permitted. Credit agreements will often limit the ability of a company to buy back or otherwise prepay junior debt, which could include junior lien, unsecured and/or subordinated debt depending on the particular terms of the agreement, and may require pro rata prepayments of obligations under such agreements in connection with the prepayment of other debt. Likewise, high-yield bond indentures generally restrict an issuer’s ability to prepay subordinated debt. Investment covenants in both credit agreements and indentures may also be implicated (depending on the particular definition and who the issuers and purchasers of the debt are). In addition, any new debt or liens incurred must comply with any existing limitations unless amendments or waivers are obtained.
Companies looking to repurchase their bonds in the open market must abide by applicable U.S. securities laws, including anti-fraud provisions. Companies (and their affiliates) should not repurchase their bonds when in possession of material non-public information. Among other things, companies should consult their insider trading policies and associated trading blackout periods when considering a bond repurchase.
Companies should also consider whether the repurchase itself or the source of funds used to execute it give rise to any disclosure obligations. There may also be Regulation FD-type selective disclosure considerations for companies engaging in privately negotiated repurchases.
Furthermore, companies must ensure that any repurchases do not constitute a “tender offer” that is subject to specific rules under the U.S. federal securities laws. If any repurchases were found to constitute a “tender offer” and were conducted without complying with applicable tender offer rules, a company may risk monetary damages, injunctive relief and SEC enforcement. When evaluating whether certain repurchases may constitute a tender offer, factors to consider include: the amount of bonds being repurchased, the number and sophistication of holders solicited, the manner by which the holders are solicited and the terms of the repurchase. For open market repurchases, limiting the principal amount of bonds repurchased in any quarter is prudent, whereas a greater number of bonds may be repurchased privately in transactions negotiated separately with a more limited number of sophisticated holders. Market participants use various rules of thumb to determine whether repurchases may be considered a tender offer, such as repurchases below a set percentage of the aggregate principal amount of bonds outstanding or from holders that do not exceed a set number, but every situation requires careful analysis based on the particular facts and circumstances.
Debt tender and exchange offers allow issuers to buy back or exchange all or a portion of a series of debt securities from holders at large, subject to compliance with U.S. securities laws. Debt tender and exchange offers may be coupled with a consent solicitation to incentivize participation in the offer and obtain covenant relief.
Debt Tender Offers. Cash tender offers for non-convertible debt securities do not require the filing of a registration statement or SEC review, but are subject to certain SEC rules. Generally, the offer must be open for at least 20 business days, and holders must be paid “promptly” following the expiration of the offer. Certain changes to the terms of the offer (e.g., an increase or decrease in the percentage of securities being sought or the price being offered) will generally require that the offer remain open for at least ten more business days (potentially necessitating an extension) and corresponding public announcement. An SEC no-action letter permits abbreviated five-business day tender offers for non-convertible debt securities so long as certain conditions are met.[2]
Companies have a great deal of flexibility in structuring the terms of a debt tender offer, including offering an “early tender” premium for holders that tender their bonds early in the offer, offering to purchase multiple series of notes in a single tender offer using a “waterfall” structure, “Dutch Auction”-style pricing and variations in the amounts of notes sought and the price being paid. Some of this structuring flexibility is not available in the abbreviated five-business day tender offers mentioned above. Tender offers require limited documentation, and companies can typically launch and execute them quite quickly.
Debt Exchange Offers. Exchange offers may involve a debt-for-equity exchange or debt-for-debt exchange. Unlike cash tender offers, exchange offers involve a new issue of securities and, thus, will require either SEC registration of the new securities or an exemption from registration. Public companies wishing to exchange debt for freely tradable shares of common stock or new registered debt securities will need to go through the SEC registration process, which may be lengthy and unpredictable.[3] As a result, exchange offers are typically limited to institutional investors and non-U.S. persons that qualify for an exemption from SEC registration; however, this limitation may not be practical if a significant portion of the relevant debt securities is held by retail investors. If the exchange offer includes a consent solicitation to amend the terms of the old debt securities (as discussed below), it may also make limiting the exchange offer to certain classes of the existing investors more complicated. Companies are sometimes able to take advantage of Sections 3(a)(9) and 3(a)(10) of the Securities Act of 1933, which permit exchanges without registration in limited circumstances.
In addition to these SEC registration and exemption considerations, exchange offers are subject to the same SEC tender offer rules as cash debt tender offers, including a minimum 20-business day offer period (with the ability to execute a five-business day exchange offer subject to certain conditions), and have similar flexibility in terms of pricing and structure. Companies looking to launch an exchange offer should allow for additional time, however, even if the offer does not require SEC registration and review. This is because the offer will require a disclosure document (similar to an offering memorandum for a Rule 144A bond offering) and, if a bank is engaged to act as a dealer manager to help with the exchange, additional due diligence, legal opinions and negative assurance letters, and auditor comfort letters.
A consent solicitation is the customary method for obtaining the approval of holders of debt securities for waivers and amendments to the terms of their securities. Most covenants can be amended with the consent of the holders of bonds representing a majority of the outstanding principal amount, but changes to economic or other fundamental terms (e.g., principal amount, interest rate, interest payment dates and maturity, among others) typically require the consent of each affected holder under the relevant documentation.[4] Indentures often disregard bonds held by the issuer and its affiliates when determining whether the requisite principal amount of bonds to effect an amendment have been received.
Consent solicitations are generally conducted either in combination with a tender or exchange offer or on a “stand-alone” basis.
When combined with a tender or exchange offer, holders who participate in the offer also provide their consent to the proposed covenant changes, sometimes removing substantially all restrictive covenants. This is referred to as an “exit consent” because it is provided by holders “on their way out” of their bond positions. The changes in the terms of the bonds that remain outstanding will only become operative once the associated tender or exchange offer has closed. The minimum duration of that offer is governed by the SEC tender offer rules, and abbreviated five-business day offers cannot be made in conjunction with an exit consent.
By contrast, stand-alone consent solicitations may be completed quickly and with few requirements. However, without an associated tender or exchange offer, companies may need to offer holders a consent fee to obtain their consent to the proposed modification of the terms of their securities.
Convertible bonds are treated as equity securities under SEC tender offer rules. Tender offers for convertible bonds therefore require filing of a Schedule TO that is subject to SEC review and comment while the offer is pending. Tender offers for convertible bonds must also comply with the “all holders/best price” rule applicable to equity tender offers, and issuers therefore cannot offer an early tender premium or exclude retail holders (as in certain exchange offers). Typically, convertible bonds are held by a relatively small number of institutional investors, and issuers may be able to structure cash repurchases or exchanges as privately negotiated transactions to avoid SEC registration and review (although care must be given to avoid having the transaction constitute as a “tender offer,” which would trigger the equity tender offer rules described above). Companies should consider the impact of short-covering purchases by holders of convertible bonds in connection with a repurchase of their bonds, and any bond hedge and related warrant transactions may have to be partially unwound to account for any reduction in the amount of outstanding convertible bonds. All of this also raises disclosure considerations, including those relating to Regulation FD, that will need to be analyzed.
Loan buybacks arose in the syndicated loan market as a result of the financial crisis of 2008/2009. Prior to the crisis, most credit agreements did not contemplate borrower buybacks and, in fact, many credit agreements specifically provided that the borrower and its affiliates were not eligible assignees of the loans. After that financial crisis, many credit agreements most commonly in the syndicated term loan B market specifically began to contemplate the ability of the borrower and/or its affiliates to purchase loans (typically limited to the term loans) either through non-pro rata open market purchases or through a “Dutch Auction” process that in many cases is required to be open to all lenders of the class of loans being purchased on a pro rata basis.
Open market purchases allow the borrower to repurchase the loans on a one-off non-pro rata basis on a simple, fast and cost-efficient basis. Credit agreements usually will require that the principal amount of the loans purchased by the borrower (including accrued and unpaid interest thereon) or any of its restricted subsidiaries will be automatically cancelled and extinguished as of the date of the purchase (but such point should be confirmed for each particular credit agreement). Credit agreements typically will also condition the ability of the borrower to purchase its loans on (i) there being no default or event of default or, in certain cases, no payment or bankruptcy event of default and (ii) a liquidity test, which in most cases requires that no proceeds of the borrower’s revolving credit facility are used to fund the purchase of term loans. The restriction of use of revolving credit facility proceeds may be particularly notable as borrowers may also be looking to draws of their revolving credit facility as potential sources of liquidity, and given the fungible nature of cash, would require careful analysis. In addition, a review of the applicable credit agreement will be required to determine whether the borrower (or its affiliate) is required to make a representation that it is not in possession of material non-public information with respect to itself and its business that has not been disclosed to the lenders generally or state that it cannot make such representation. Also, credit agreements may provide that in the case of a purchase of loans by the borrower (or its affiliates) that the lenders have agreed to certain non-reliance/“big boy” provisions in connection therewith or otherwise require such lender to execute a “big boy” letter.
As discussed above, many credit agreements currently contain provisions allowing the borrower to voluntarily prepay the term loans at a discount to par pursuant to enumerated Dutch auction procedures set forth in such agreements. A borrower may decide to engage in a Dutch auction process if it desires to purchase a substantial portion of its loans that is in excess of the normal trading volume of such loans. In its simplest form, these Dutch auction procedures allow the proposed buyer of the loans to submit an offer to purchase a specified amount of the term loans at a given price expressed as a discount to par. Lenders will then be given a period of time to accept such offer and the borrower would purchase the loans tendered in such offer (subject to pro rata reductions if the principal amount of loans tendered is greater than the principal amount of loans offered to be repurchased). There are many credit agreements that allow the proposed buyer to offer to purchase the term loans based on a price range rather than a single specific purchase price and so the borrower would repurchase loans at the lowest price offered by accepting lenders that would permit the borrower to repurchase the desired amount of loans. If the borrower is the purchaser of the loans in such offer, the provisions set forth above in “Open Market Purchases” regarding cancellation of the loans and the related conditions will apply.
Under certain circumstances, including where the borrower and its owners want to preserve the borrower’s liquidity, affiliates of the borrower may desire to purchase the loans via open market purchases. In general, credit agreements will restrict the ability of affiliates to purchase term loans and exercise rights as lenders. These restrictions usually include: a cap on the principal amount of loans that may be purchased (typically around 25–30%), limitations on access to information and “lender only” meetings, certain limitations on voting rights and waivers of certain rights in bankruptcy proceedings and, in certain circumstances, an affirmative undertaking not to challenge the lenders’ legal privilege. A number of credit agreements exclude “debt fund affiliates” from the limitations described in the preceding sentence but will ordinarily limit such debt fund affiliates’ vote on “required lenders” matters to an aggregate of 49.9% of such vote so that such debt fund affiliates would not constitute the required lenders by themselves. Affiliates that have purchased these loans will be permitted (but not required) to contribute such loans to the borrower and, if so contributed, such loans would ordinarily be cancelled and extinguished. As described above for borrowers, a review of the credit agreement will be required to determine the scope of any representations that such purchasers will be required to make with respect to material non-public information in connection with such purchase.
Repurchase of loans by the borrower, any of its subsidiaries or any of its other affiliates will likely impact certain other provisions of a credit agreement that will need to be reviewed. Such provisions include: the impact on the definition of EBITDA and leverage ratios, the calculation of excess cash flow and the ability to incur incremental debt.
In general, the holders of a majority in principal amount of the loans and commitments (the “required lenders”) and the administrative agent will be required to approve any amendment or waiver of the covenants; except that in covenant-lite facilities where the financial covenant is for the benefit of the revolving lenders only, the consent of the holders of a majority of the revolving loans/commitments would be required instead of all loans. Likewise, in most credit agreements, amendments to the mandatory prepayment provisions would also require approval of the required lenders and the agent. Deferrals of interest or principal and/or paying such amounts in kind would generally require an affirmative vote from all lenders or all affected lenders.
If a borrower acquires its debt (e.g., either through a repurchase or debt-for-debt exchange) for an amount less than its adjusted issue price, the borrower may recognize cancellation of indebtedness (“COD”) income, which can give rise to a cash tax liability. The amount of COD income generally is the difference between the principal amount of cancelled debt and the repurchase price. COD income can be triggered by the forgiveness of debt by its holder, modification of the debt, and the repurchase of the debt by the company at a discount. COD income may also arise if a related party (such as a private equity sponsor that owns the borrower) engages in the repurchase transaction. COD income typically is not recognized to the extent of the issuer’s insolvency or in the case of bankruptcy of the issuer.
Companies should consider the tax issues involved with debt buybacks and liability management considerations with their tax advisers.
Special thanks to associate Aylmer Wang (New York-Finance) who co-authored this publication.
[1] See “Implications for Credit Agreements After the Russian Invasion of Ukraine”
[2] Such conditions include: that the offer is for “any and all” of the securities of the relevant series, the consideration consists solely of cash, “qualified debt securities” (i.e., securities that are identical in all material respects to the existing debt securities sought in the offer, other than maturity, weighted average life to maturity, redemption provisions and interest rate and related payment and record dates), or a combination of both, the consideration must be fixed or based on a spread over a benchmark (such as U.S. Treasury yields), there is no concurrent consent solicitation asking to amend the terms of the subject securities, and that the tender offer is not financed with “senior debt” (as further defined).
[3] Well known seasoned issuers (WKSIs) will not be able to utilize an existing shelf registration statement or take advantage of the automatically effective registration rules because those cannot be used for exchange offers.
[4] Furthermore, if amendments are significant so as to substantially affect the rights of the debt security holders, the changes may constitute the issuance of a new security, raising tax and other concerns.
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