Default - Corporate Bonds and Credit Agreement

A. Default Provisions

Freeport-McMoran Indenture, Section 6.01

Northwest Note Agreement, Section 11

Problem Set # 18
1. What is the distinction between a Default and an Event of Default?

Default vs. Events of Default:

• Some default may require notice and/or passage of time to become an event of default

Types of Event of Default

• Freeport 6.01

  • (a) Payment of interest:

    1. becomes event of default after 30 days, no notice

  • (b) Payment of principal:

    1. becomes event of default immediately, without notice/ passage of time

  • (c) comply with covenant under s. 5.01 (on merger)

    1. becomes event of default immediately

  • (d) fail to comply covenant on some of the sections under Article 4

    1. becomes event of default 30 days after notice

  • (e) fails to comply with agreements in Securities/ Indenture

    1. becomes event of default 60 days after notice

  • (f) cross-default exceed $10M

  • (g)(h) insolvency events

  • (i) non-payment of judgement in amount of $10M

  • (j) guarantees

• C.f. Northwest (private placement)

  • Cure periods tend to be shorter/ none; may have no notice requirement

  • (f) stricter cross-default provision

  • (j) covenant disguised as event of default relating to ERISA

Cross Default Provisions

• Freeport 6.01(f) Cross default

  • (f) “Indebtedness of the Company/ any RS is not paid within any applicable grace period after final maturity or the acceleration by the holders thereof because of a default and the total amount of such indebtedness unpaid or accelerated exceeds $10.0M or its foreign currency equivalent at the time”

  • Different creditors competing with each other

  • Debt 10M not paid after applicable grace period/ maturity/ acceleration

  • Event of Default was created through event of default under indebtedness of the co. to Bond A bondholder B would have the power to generate event of default company would give concessions to B that hurt other bondholders like A

• Northwest: Art 11 Events of Default

  • (f) Cross-default - Stricter/ overly aggressively drafted

    1. (i) Company or RS in default of payment of at least $5M

    2. (ii) default of compliance with any term of indebtedness of at least $5M beyond grace period

    3. (iii) as a consequence of incurrence of any event or condition, co becomes obligated to repay before regular maturity (i.e. acceleration) of at least $5M or one or more Persons have the right to require the company/ RS to purchase or repay such indebtedness (cross-default upon acceleration)

       • Prof: overbroad, calls $10 million of debentures for redemption would also be a default

2. Which of the following constitute Defaults and/or Event of Defaults?

1. Company incurs Indebtedness in violation of the debt limitation covenant.

2. Company fails to make an interest payment when due.

3. Company violates the restrictive payment covenant in an indenture related to another issue of securities. What if the holders of such other issue accelerate the payment of their securities and the Company pays these securities in full upon acceleration?

4. Company calls $10 million of debentures for redemption

   • Would be event of default under Northwest drafted too broadly trigger cross-default

5. Company fails to make a Change of Control Offer within 30 days following a Change of Control.

B. Cure

Metropolitan Life v. RJR Nabisco, 906 F.2d 884 (1990) (P. #1)

• Cure period and litigation Met Life

• Cure period: passage of time between notice of default and generation of default

• What can happen within the period?

  1. Get a waiver on the default from the requisite majority of holders permanent/ extension

  2. Default can be cured but how?

• 2 Types of defaults

  • Generated by positive covenant: easier to cure

    • Failure to do something that you are obligated to do cure by doing it

    • E.g. failed to pay interest on time cure by paying interest

    • E.g. providing info, compliance certificate

  • Generated by negative covenant: more difficult to cure

    • Doing something that you are prohibited to do more difficult to cure

    • Cannot cure if the co. cannot undo

    • E.g. “Company shall not and shall not permit any RS” to make restricted payment and incurs debt when it is not permitted to do cure by find some way to undo it

      • E.g. Incurred debt repay the debt to cure

      • E.g. Made Restrictive payment cure by undoing it (though difficult to get money back sometimes)

      • E.g. Lien default make restrictive payment to eliminate it under Freeport 4.04(1) would generate another default

        • Removing the lien would cure the first default, but may not cure the making of restrictive payment

        • Prof: maybe this provision is to make curing of default more difficult

• Disputed defaults

  • Bondholder notify company of a default (which triggers the cure period) but company view that it is not in default (but unsure if court would hold the same) co can litigate; seek waiver; or cure it

  • Difficult to litigate within the cure period company has to gamble

    • If its going to win the case, need not worry about default

    • If underline default was valid + cure period passed and accelerated result of acceleration would generate another default (Freeport 6.01(b)

      • Once there is a valid acceleration cannot cure it afterwards

      • Prior to valid acceleration can still cure it up to acceleration. Because, in order to have a valid acceleration, 6.02: need default that occurred and discontinued

  • Court: cannot drag the cure period to give time for co to litigate co. has to gamble

  • But if bondholder wants to drag out litigation court may give co. extra time

Problem Set 19
1. Is the contract ambiguous? What is the relevance of the omission of a clause included in other indentures?

2. If the contract is not ambiguous, why toll the cure period for discovery?

3. How would you draft the cure period clause to achieve the effect rejected by the court (i.e. RJR Nabisco’s interpretation)? If the court had adopted RJR Nabisco's interpretation, how would you draft the cure period clause to achieve the Met. Life's interpretation?

C. Rights upon Default

Freeport-McMoran Indenture, Section 6.02-6.12

Northwest Note Agreement, Section 12.01-12.02

Sharon Steel v. Chase Manhattan Bank (Part II) (P. #1)

Wilmington Savings Fund FSB v. Cash America International Inc. (P. #1)

Remedies for Event of Default that has occurred and discontinuing

• Acceleration

• Freeport 6.03 Other remedies

  • “If an Event of Default occurs and is continuing, the Trustee may pursue any available remedy to collect the payment of principal of or interest on the Securities or to enforce the performance of any provision of the Securities or this Indenture”

• Other remedies:

  1. Expectation damages but are never sought

     1. unclear whether trustee is authorised under indentures

        • Collecting damages

        • Enforce performance of securities

     2. holders are not parties to indenture

  2. Injunction

  3. Sharon Steel; Cash America

     1. Company knowingly breached the indenture court found that bondholders

        • not just entitled to accelerate and receive principal amount + also

        • to require company to redeem the bond and pay the redemption

     2. Prof: unclear why

  4. Receiving par

     1. Good remedy if the bond has value below par after breach

     2. If interest rate has declined will tend to put market value of bond with a fixed coupon higher acceleration would be ineffective/ unattractive remedy

     3. But if market interest rate has increased so that value of bond is below par acceleration is unattractive remedy no incentive to look closely to see whether co. have complied with the indenture

• Companies do not generally want event of default, even if bondholders do not accelerate

  • Can trigger cross-default

  • Company need to restate financial statement, as long-term obligations are now subjected to acceleration

How Are Rights Enforced? Freeport

• If company argue it didn’t breach indenture, there will not be event of default unless bondholders starts complaining and sue

• Once Event of Default bondholders would have the right to accelerate at any point of time gives bondholders a put option (valuable to bondholders, don’t have to accelerate right away)

• Majority 50%+ of bondholders can waive Past Default (6.04)

  • Majority holders can give direction to Trustee and rescind acceleration

  • But cannot waive:

    1. Default in payment of principal or interest on a security

    2. Failure to redeem/ purchase security when required…

• 25% of bondholders can

  • send notice of default to triggers the cure period (6.01)

  • accelerate (6.02) once accelerated,

    1. the Trustee may pursue any available remedy (6.03)

    2. holder of majority of bond may give instruction to the trustee (6.05)

    3. of 25% of bond may pursue no-action clause: (6.06)

• Any holder can sue for payment of principal and interest after due dates

Problem Set # 20

1. What remedies exist against an incurrence of debt in violation of a debt limitation covenant? What is the relative attractiveness of these remedies if (i) interest rates have risen substantially since the bonds were issued, (ii) interest rates have fallen substantially since the bonds were issued?

2. When and how are these remedies exercised? Would your answer differ if the Company fails to make an interest payment when due?

3. Was the court right in requiring UV to pay the redemption premium? Is that holding consistent with the approach taken in other cases in interpreting indentures? What if the subject securities were not at all subject to optional redemption? What if the subject securities were subject to optional redemption only as of a later date?

D. No-Action Clauses

Freeport-McMoran Indenture, Section 6.06, 6.07

Upic v. Kinder-Care, 793 F. Supp. 448 (P. #1)

McMahan v. Wherehouse, 859 F. Supp. 743 (1994) (P. #1)

Central Bank of Denver, N.A....