#16516 - Covenants Intro Merger Asset Sales - Corporate Bonds and Credit Agreement

A. Introduction and Overview

Kahan & Tuckman, Private vs. Public Lending
Amihud, Garbade & Kahan, A New Governance Structure for Corporate Bonds (excerpt)
Petrohawk Indenture, Section 4.2, 4.16
Northwest Note Agreement, Section 7.1, 7.2, 7.3
Newpage Credit Agreement, Section 5.1, 5.6

Overview

• Covenants are stronger in bank loan agreements than in private/public bond indentures

  • Bank loan: has fewer parties, less trading

  • Public bond: huge number of holders, large amount of trading

• Effect of such differences

  • Ability to monitor

    • Bond: disperse holders subject to collective action problem, high turnover in holders reduces ability and incentive to monitor

  • Costs of obtaining amendments

    • Bank loan: lower, relatively easier and regularly gets amendments

    • Bond: higher, complicated due to large amount of holder who know little, may be reluctant

  • Reputational incentive of creditors

    • Bank loan: bank don’t want to have reputation to extract money from their creditors no one would want to borrow from the bank, need to be nice to their customers

    • Publicly traded bond: no reputation incentives, even if they buy a lot of bonds, company is not in control of who buy their bond, co. has no reason to be nice

  • Covenant structure

    • Affirmative (requires certain acts) vs. negative (prohibit certain acts)

    • Tight vs. loose

      • Bonds: tend to have looser covenants less amendment needed

      • Loan: tighter covenants

    • High vs. low info rights

    • Incurrence vs. maintenance

      • Public issued bonds tend to be incurrence covenant

        • Less likely to be breached, usually within control of the co.

      • Banks: tends to have maintenance covenants require things to be true

What information rights do bondholders have?

Default Notice

• Petrohawk 4.16 Compliance Certificate.

  • “(a)…within 90 days after the end of each fiscal year of the Company ending after the Issue Date a statement stating whether or not the signers know of any Default or Event of Default that occurred during such period

  • (c) So long as any of the Securities are outstanding, the Company will deliver to the Trustee, forthwith upon any Officer becoming aware of any Default or Event of Default, an Officers' Certificate specifying such Default or Event of Default and what action the Company is taking or proposes to take with respect thereto.”

  • Company would tell you there is a breach of covenant (underlying default) if failed to tell you = breach of 4.16 same to be in breach of one covenant and two covenants

    • Principal remedy: acceleration but you can only accelerate once

  • Unlikely that the company would send you fraudulent compliance certificates

    • Not telling under (c) is a breach of contract by the company, but from the co.’s perspective breaching once and twice is the same

    • Signing a compliance certificate that is false = breach of company + personal fraudulent of the signer

  • But if ambiguity in the default may find a lawyer to interpret it that the court would find there is no default can sign now without being fraudulent

  • Also, default may be fixed within 90 days would only send certificate at the end of that 90 days

  • Relatively good clause for the bondholders, comparing to Freeport

• Freeport

  • 4.09 “The Company shall deliver to the Trustee within 120days after the end of each fiscal year of the Company an Officers' Certificate stating that in the course of the performance by the signers of their duties as Officers of the Company they would normally have knowledge of any Default and whether or not the signers know of any Default that occurred during such period.”

  • No immediate notification upon default

  • Only Officers’ Certificate within 120 days after end of each fiscal year certificate only relates to the fiscal year if default after 120 days, would only find out the next year

  • A lot of manipulation possible non-obvious default may not be known to bondholders; obvious defaults need not be notified by co. (e.g. late interest payment)

• Newpage 5.1(d)(f)

  • (d) Compliance Certificate

  • (f) Notice of Default. “Promptly upon any Senior Officer of co. obtaining knowledge (i) of any condition or event that constitutes a Default or an Event of Default or that notice has been given to Co. with respect to… a certificate of its Authorised Officer specifying the nature and period of the nature and period of existence of such condition, event of change, or specifying the notice given and action taken by any such Person and the nature of such claimed Event of Default… and what co. has taken, is taken and purposes to take with respect thereto”

• Bondholders less likely to find out, co. lower incentive to give notice

  • C.f. for Bank loan, easier for borrowers to find out, bank would usually give notice, won’t want to risk getting caught nor lose confidence

Information rights beyond default notice:

• Newpage: Creditor can get everything + anything else if they ask

  • 5.01(a) Monthly Reports of income, equity, cashflow, subs

    • (b) quarterly financial statements

    • (c) annual financial statements

    • (d) statements of reconciliation after change in accounting principals

    • … ERISA report, Financial, Insurance report, Notice of change in board of director, Material change… etc.

  • 5.06 Each Credit Party would keep company’s account, right to inspect property, need to show them everything and can talk to any officers

• C.f. Newport (Bond Agreement)

  • 4.02 SEC Reports but do not require a covenant get such report

  • No inspection rights to bondholders

    • Unlike bank which can be trusted, anyone can be bondholder would have confidentiality issues

• C.f. Petrohawk

  • 4.2 SEC Reports, Co. will furnish to Holders:

    • “(1) all quarterly and annual financial info that would be required to be contained in a filing with the SEC on Forms l0-Q and 10-K if the Company were required to file…

    • (2) … If the Company has designated any of its Subsidiaries as Unrestricted Subsidiaries, then the quarterly and annual financial information required by the preceding paragraph shall include a reasonably detailed presentation, either on the face of the financial statements or in the footnotes thereto, and in Management's Discussion and Analysis of Financial Condition and Results of Operations, of the financial condition and results of operations of the Company and its Restricted Subsidiaries separate from the financial condition and results of operations of the Unrestricted Subsidiaries of the Company”

    • Unrestricted subsidiaries are generally limited portions that are not subject to any of the companies may not be counted for accounting purposes

• Less access to info for publicly traded bonds bondholders have limited ability to enforce covenants

Problem Set # 8B
Compare the Petrohawk Indenture, the Northwest Note Agreement, and the Newpage Credit
Agreement.

1. When must the company inform holders or a representative of the holders of a default? How frequently and what information must the company assemble to determine whether there has been a default?

• Kahan: Newpage: default notices must be given promptly upon knowledge; compliance
  certificates are quarterly; Petrohawk: notices forthwith, certificates annually.

2. Are the holders or a representative of the holders entitled to receive any information from the company beyond the company’s filings under the securities laws? What type of information? Who is entitled to it?

• Kahan: Newpage: Yes, lots. Petrohawk: Yes, company must make and supply filings even if not required by securities laws and filings must provide some additional information on unrestricted subs.

B. Merger and Asset Sales

BMS Indenture, Section 7.01-7.02, Exhibit A
Freeport-McMoran Indenture, Section 5.01
Petrohawk Indenture, Section 5.1, 5.2, Exhibit A
Lennar Indenture, Section 5.01-5.02, Exhibit A
Northwest Note Agreement, Section 10.5
Newpage Credit Agreement, Section 6.9 lead-in and (a)
Sharon Steel v. Chase Manhattan Bank, 691 F.2d 1039 (1982) (P. #1)
Alleco v. IBJ Schroeder, 745 F.Supp. 1467 (1989) (Part I) (P. #1)

Mergers and Asset Sales

• Structure of covenant

  • Applies to mergers, consolidations, and sales of all or substantially all assets

    • E.g. Lennar: 5.1 Company will not consolidate with or merge into any corporation… unless certain conditions have been satisfied

  • Permits transaction if

1. Purchaser/surviving entity is US corporation,

2. Assumes obligations, and

3. No default

4. [Officer’s certificate and opinion of counsel] sometimes

5. [Sometimes additional requirements]

   • E.g. no decline in net worth; coverage ration (can incur $1 in debt)

   • Makes sense for merger, consolidation, but why asset sales?

     • Possible to permit asset sale without any restrictions

     • Seller remains an entity, legally obligated to pay debt

       • Additional protection for creditors

       • Seller and buyer remained obligated

     • So why require purchaser to assume?

       • Debt stays with assets rationale

       • If seller is not released, assumption is better for holders

       • If seller is released permits seller to liquidate

       • [But Prof: doesn’t agree with any of these rationales]

• Default condition

  • Why prohibit merger if there is a default

    • If the company merges while on default another default

  • What is effect of condition?

    • Injunction?

    • Cure ability?

      • Default can be cured before event of default not big issue

      • Event of default that is easily curable not big issue

      • Doubling default may add an incurable default more difficult to cure

      • Default by merging cannot cure as you cannot unmerge

    • Damages?

      • Higher damages, principle remedy is acceleration

    • Compliance Certificates?

      • Officer may not want to give such certificate

      • Trustee can get opinion of counsel

    • Use of...