Top 10 Practice Tips: Liability Management Transactions – Finance and Banking

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Top 10 Practice Tips: Liability Management Transactions

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This Top 10 Practice Tips provides key practice tips for
advising a client considering a liability management transaction.
Given recurring periods of market volatility, issuers in a wide
range of industry sectors from time to time evaluate potential
liability management transactions, including debt repurchases,
tender or exchange offers, and consent solicitations. Liability
management transactions allow an issuer to refinance or restructure
its outstanding obligations and may, under certain circumstances,
allow an issuer to achieve certain accounting, regulatory, or tax

Issuers may derive significant benefits from a liability
management transaction including, but not limited to, evidencing a
positive outlook for the issuer in an uncertain market environment,
extending debt maturities, recording an accounting gain,
deleveraging, obtaining potential regulatory capital benefits,
increasing financing flexibility and potentially avoiding a more
fundamental restructuring or bankruptcy. Choosing the most
appropriate liability management transaction is critical and
requires that the issuer and counsel consider a number of factors,
as discussed below.

  • Consider whether the transaction is an opportunistic or
    a distressed transaction
    . Choosing the right liability
    management alternative to restructure or retire outstanding debt
    securities or to manage risk and reduce funding costs depends on a
    number of factors. Understanding an issuer’s business
    objectives and financial health is critical when evaluating the
    feasibility of a given liability management transaction. Often,
    market participants assume that only issuers facing financial
    distress or that are highly leveraged will engage in a liability
    management transaction. Of course, this is not the case, but the
    type of transaction and the terms will depend on the issuer’s
    business objectives, whether the issuer has sufficient cash on
    hand, and on market conditions. The transaction may be motivated by
    an accounting, regulatory, or tax objective or may simply allow the
    issuer to refinance its outstanding indebtedness at attractive
    rates, extend its debt maturities, address its exposure to
    LIBOR-based indebtedness, or repurchase outstanding securities
    trading at a discount. Prior to considering any option, counsel
    must understand whether the transaction is opportunistic or
    whether the issuer faces financial challenges that need to be
    addressed as part of the transaction.
  • Evaluate whether the issuer’s contractual
    agreements prohibit repurchases, tenders, or exchanges of its
    outstanding securities
    . An issuer’s existing
    commitments may prevent the repurchase, tender, or exchange of an
    outstanding security or trigger repayment obligations or
    requirements to use proceeds from a new issuance for other
    purposes. Therefore, the issuer’s existing financing
    arrangements and other material agreements must be carefully
    reviewed. For example, an existing credit facility may prohibit
    prepayment or redemption of the issuer’s outstanding debt
    securities or the debt security itself may have call protection
    features (preventing or limiting a redemption) that should be
    analyzed. Moreover, debt securities may be redeemable by the issuer
    only after a certain period has elapsed or a certain market return
    has been achieved.

    Additionally, an indenture may contain financial covenants that
    restrict the issuer’s ability to use available cash to pay down
    or retire other classes of outstanding debt securities. The
    indenture governing the securities to be redeemed will specify the
    redemption price and mechanics and typically requires notice of not
    less than 30 days nor more than 60 days be provided to holders.
    Often, the redemption price equals the face amount plus the present
    value of future interest payments. In certain situations, to permit
    a desired liability management transaction, an issuer may need to
    first or concurrently conduct a consent solicitation to amend or
    waive restrictive financial covenants or event of default
    provisions under an existing indenture that otherwise would limit
    its ability to engage in the liability management transaction.
    Because consent solicitations can increase flexibility under
    existing restrictive covenants they may serve as a useful tool when
    responding to challenges stemming from the COVID-19 pandemic.

    In connection with providing notice of redemption, a company
    typically issues a press release to announce its decision to redeem
    outstanding debt securities. This public disclosure should occur
    before contacting the company’s debtholders if the broader
    impact of the transaction on the company’s financial condition
    would be viewed as material.

  • Assess whether the tender offer rules apply.
    An issuer repurchasing its securities, whether 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 by the Securities and Exchange
    Commission (SEC) to ensure that the issuer and other offering
    participants do not engage in manipulative practices. Because the
    term “tender offer” is not specifically defined by the
    SEC, courts have historically applied the tender offer rules to a
    broad range of transactions. The analysis of whether a particular
    offer constitutes a tender offer triggering requirements under the
    Securities Exchange Act of 1934, as amended, begins with the test
    set forth in Wellman v. Dickinson, 475 F. Supp. 783, 1979 U.S.
    Dist. LEXIS 11174, which provides that the following eight
    characteristics are typically indicative of a tender offer:

    • An active and widespread solicitation of public shareholders
      for the shares of an issuer.
    • A solicitation is made for a substantial percentage of the
      issuer’s securities.
    • The offer to purchase is made at a premium over the prevailing
      market price.
    • The terms of the offer are firm rather than negotiable.
    • The offer is contingent on the tender of a fixed number of
      shares, often subject to a fixed maximum number to be
    • The offer is open only for a limited period of time.
    • The offeree is subjected to pressure to sell his or her
    • Public announcements of a purchasing program precede or
      accompany a rapid accumulation of large amounts of the issuer’s

      These eight characteristics need not all be present for a
      transaction to be deemed a tender offer, and the weight given to
      each element varies with the individual facts and circumstances of
      the offer. As a result, repurchase programs should be structured
      (i) for a limited number of securities; (ii) to a limited number of
      holders; (iii) over an extended period of time; (iv) at
      individually negotiated prices; and (v) with offers and acceptances
      not contingent on one another.

  • Assess whether the issuer has (or wants to use its)
    available cash to effect the transaction
    . An issuer may
    not have sufficient cash to effect a redemption, repurchase, or
    tender offer, or the issuer’s management may view using cash to
    effect such a transaction as an inappropriate use of resources
    given market uncertainty. In that event, an issuer might instead
    consider a noncash transaction, such as an exchange offer or a
    consent solicitation (likely to require payment of a modest
    cash fee). In an exchange offer, the issuer offers to exchange
    a new debt or equity security for its outstanding debt or equity
    securities in a registered offering or in an offering exempt from
    registration pursuant to Section 3(a)(9) (15 U.S.C. § 77c) of
    the Securities Act of 1933, as amended (Securities Act), or other
    exemption from registration, as discussed below. An exchange offer
    can be an especially useful mechanism for an issuer to reduce its
    interest payments or cash interest expense, reduce the principal
    amount of its outstanding debt, manage its maturity dates, and
    reduce or eliminate onerous financial covenants. Coupled with a
    consent solicitation, an exchange offer may be an attractive option
    for an issuer seeking to significantly amend or waive restrictive
    indenture provisions.

    Conversely, issuers with sufficient cash may consider conducting
    privately negotiated repurchases, open market repurchases, or a
    cash tender offer. Repurchasing debt allows the issuer to obtain
    pricing based upon the current market price of securities that are
    likely trading at a discount. The issuer will often engage a
    financial intermediary to negotiate and effect the repurchase or to
    repurchase the debt securities on a principal basis. A debt
    repurchase is an efficient means of refinancing because it requires
    little preparation, limited or no documentation, and modest
    transaction costs, particularly when the issuer is seeking to
    repurchase only a small percentage of debt or if the debt is not
    widely held. An issuer also may consider a cash tender offer for
    all, or a significant portion, of a class of its outstanding

  • Assess the composition of the holders of the
    issuer’s securities
    . The issuer should consider
    whether the securities that are the subject of the liability
    management transaction are widely held, as well as the status
    (predominantly retail or institutional) and location of the holders
    of such securities (foreign or domestic holders). For example,
    privately negotiated repurchases are usually most effective if the
    issuer is seeking to repurchase a small percentage of an
    outstanding series of debt securities held by a limited number of
    holders. A tender offer may be more appropriate if the security is
    widely held, and the issuer would like to retire all or a
    significant portion of the outstanding securities. Tender offers
    are the most common type of transaction and may be for “any
    and all” of the outstanding securities of one or more series
    or for a maximum principal or purchase amount. Because issuers in
    certain industries continue to face challenges as a result of the
    COVID-19 pandemic, tender offers have become even more relevant as
    they may be used to refinance outstanding debt at lower
    interest rates (and at a discount to the current applicable
    redemption price). The issuer may consider requiring, as a
    condition to the tender or exchange offer, that a substantial
    percentage of the outstanding securities be tendered as part of the
    transaction. Finally, an issuer relying on the exemption of Section
    4(a)(2) of the Securities Act (15 U.S.C. § 77d), or Regulation
    D thereunder, to conduct a private exchange offer will need to
    confirm the status of the participating holders to ensure that the
    offering requirements are satisfied.
  • Consult specialists to assess tax
    . An issuer engaging in a liability management
    transaction must be aware of applicable tax consequences relating
    to cancellation-of-indebtedness (COD) income. Issuers with
    outstanding debt may be subject to tax on COD income when all or a
    portion of such debt has been effectively cancelled. COD income can
    arise in several circumstances, including forgiveness of debt by
    the debt holder, repurchase of debt by the issuer at a discount,
    exchange of one debt instrument of the issuer for another,
    modification of debt, and exchange of debt for the issuer’s
    equity. Additionally, repurchases or exchanges by persons related
    to the issuer may inadvertently result in COD income. The Internal
    Revenue Code provides a number of exceptions to the inclusion of
    COD income, including exceptions related to insolvency and
    bankruptcy. Issuers and counsel are also advised to consider the
    tax and spending measures intended to benefit businesses and
    individuals under the recently passed Coronavirus Aid, Relief, and
    Economic Security Act.
  • Consider applicable stock exchange requirements and
    other securities law issues
    . An issuer must review
    applicable securities exchange provisions if the security to be
    offered as part of a liability management transaction is the
    issuer’s common stock or a security convertible or exercisable
    for the issuer’s common stock. The New York Stock Exchange and
    The Nasdaq Stock Market each require listed companies to obtain
    shareholder approval under certain circumstances for an issuance
    that will exceed more than 20% of the pre-transaction shares of
    common stock outstanding. The exchanges also require an issuer to
    obtain shareholder approval in advance of an issuance that would
    result in a change of control of the issuer.

    may trigger disclosure obligations under SEC Regulation FD
    (disclosure of any material nonpublic information (MNPI) to certain
    market professionals or holders of its securities may require the
    issuer to inform the rest of the market). Issuers should also be
    aware that “testing the waters” for a transaction
    may also trigger this obligation. Therefore, issuers should
    disclose MNPI (e.g., unreleased earnings, potential changes to
    credit ratings) prior to engaging in such repurchases. Issuers
    should also be aware that repurchases may trigger Regulation M
    concerns. Regulation M makes it unlawful for an issuer to “bid
    for, purchase, or attempt to induce any person to bid for or
    purchase, a covered security during the applicable restricted
    period.” Repurchases of convertible debt may be deemed a
    “forced conversion” and thus a distribution of the
    underlying equity security under Regulation M.

  • Determine if offering qualifies for abbreviated tender
    offer relief
    . Historically, a tender or exchange offer of
    non-investment grade debt had to be held open for at least 20
    business days (with 10-business day extensions for certain
    modifications). Investment grade debt was not subject to the
    20-business day offer period and 10-business day extension
    requirements. However, in January 2015 the SEC Staff issued The
    Abbreviated Tender or Exchange Offers for Non-Convertible Debt
    Securities no-action letter 2015 SEC No-Act. LEXIS 22 that provided
    limited relief to certain tender and exchange offers (regardless of
    credit rating) to the extent specified conditions were met. In
    2016, the SEC Staff issued Tender Offer and Schedules compliance and
    disclosure interpretations 162.01–162.05 clarifying the
    2015 no-action letter. This relief permits debt tender offers
    (including tender offers conducted in the context of certain
    exchange offers) to be held open for as few as five business days
    with potential extensions as short as five business days following
    changes to the offered consideration or three business days
    following modifications to other material terms.

    Noteworthy conditions to the relief include, among others, that (i)
    the offer to purchase must be made for any and all nonconvertible
    debt of a particular class or series (however, abbreviated offers
    can have minimum tender conditions); (ii) the offer must be open to
    all record and beneficial holders of that class or series of debt;
    (iii) the offer must be conducted and designed to provide all
    record and beneficial holders of that particular class or series of
    security a reasonable opportunity to participate; (iv) the offer
    must not be made in anticipation or response to other tender offers
    for the issuer’s securities; and (v) the offer must be made
    solely for cash or other qualified debt securities (certain
    nonconvertible debt securities with a longer maturity date) and the
    consideration must be fixed-price or real-time fixed-price spread
    (only a fixed-price spread set two days prior to the expiration of
    the exchange offer is permitted for non-investment grade
    debt). The offer must be announced through a widely disseminated
    press release before 10:00 a.m. on the first business day of the
    five-business-day period, which, if the issuer or offeror is an
    SEC-reporting company, must be furnished to the SEC on a current
    report on Form 8-K (or Form 6-K for a foreign private issuer)
    before noon on the first business day of the offer. The abbreviated
    tender offer relief is not available if the offer is made in
    connection with a consent solicitation, if there is a default under
    the issuer’s material debt agreements, if the offer is made
    concurrently with a tender offer for any other series of the
    issuer’s securities made by the issuer, or in connection with a
    material acquisition or disposition.

  • Determine if the exchange offer will be registered or
    . An exchange offer involves the offer of new
    securities and, as a result, must comply with, or be exempt from,
    the registration requirements of the Securities Act. An issuer may
    rely on the private placement exemption provided by Section 4(a)(2)
    of the Securities Act or Regulation D thereunder. In addition,
    offers and sales outside the United States may qualify for the safe
    harbor exemption of Regulation S.

    Another option frequently used by issuers is an exchange offer
    exempt from registration pursuant to Section 3(a)(9) of the
    Securities Act. Section 3(a) (9) exempts from the registration
    requirements “any securities exchanged by the issuer with its
    existing security holders exclusively where no commission or other
    remuneration is paid or given directly or indirectly for soliciting
    such exchange.” Section 3(a)(9) has the following five
    requirements: (i) the security being issued and the security for
    which it will be exchanged must be issued by the same issuer: (ii)
    the holders must not be asked to part with anything of value
    besides the outstanding security; (iii) the exchange must be
    offered exclusively to the issuer’s existing security holders;
    (iv) the issuer must not pay any commission or remuneration for the
    solicitation of the exchange; and (v) the exchange must be in good
    faith and not as a plan to avoid the registration requirements of
    the Securities Act. Securities issued as part of a Section 3(a)(9)
    exchange remain subject to the same transfer restrictions as the
    original securities.

    If an issuer is unable to conduct a private exchange offer, or to
    rely on Section 3(a)(9), it may instead conduct a registered
    exchange offer. A registered exchange offer must be registered on a
    Form S-4 registration statement (or Form F-4 for foreign private
    issuers) and include descriptions of the securities being offered,
    the terms of the exchange offer, description of the issuer,
    risk factors, financial information and, if applicable, pro forma
    financial statements. The exchange offer may not be commenced until
    the registration statement is declared effective by the SEC. The
    SEC review process, cost to prepare the registration statement, and
    uncertainty concerning timing often make a registered exchange
    offer a less desirable option for issuers. Additionally, the issuer
    and other offering participants in a registered exchange offer are
    subject to potential liability under Sections 11 (15 U.S.C. §
    77k) and 12 (15 U.S.C. § 77l) of the Securities Act for
    material misrepresentations or omissions in the registration
    statement and prospectus.

  • Consider recent Trust Indenture Act cases. In
    recent years, debtholders have sought to invoke the protections of
    the Trust Indenture Act of 1939, as amended (Trust Indenture
    Act), in connection with certain liability management transactions.
    Under most indentures, as well as Section 316(b) of the Trust
    Indenture Act (15 U.S.C. § 77ppp), consenting noteholders
    cannot reduce principal or interest, amend the maturity date,
    change the form of payment, or make other economic changes to the
    terms of the debt securities held by non-consenting noteholders.
    Several recent court cases have reinforced the significance of the
    Trust Indenture Act’s protections and the need to avoid any
    coercive consent solicitation that would deprive non-consenting
    noteholders of repayment on their securities.

Originally published by Lexis Practical

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Mayer Brown article provides information and comments on legal
issues and developments of interest. The foregoing is not a
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