United States: Love Me Tender [Bonds] – An Overview

The famous song, Love Me Tender, by Elvis Presley, includes lyrics such as "We'll never part" and about being together " 'Til the end of time." In contrast to Elvis' wish, the issuer of tax-exempt bonds that makes a tender offer is hoping the exact opposite happens to the relationship between the bondholder and tax-exempt bond. In other words, the issuer hopes that economics drive a wedge between the two.

A tender offer is an offer by an issuer of bonds made to its bondholders to repurchase its outstanding bonds at a specified price on a specific date. There are several common reasons why an issuer may want to make a tender offer to its bondholders. First, the outstanding bonds may be paying interest at a rate that is higher than the current market rate, but the outstanding bonds are not yet callable (and taxable advance refundings no longer produce savings). Second, the issuer's outstanding bonds may be trading on the open market for less than face value. Thus, the issuer can offer to repurchase its bonds by paying above fair market value, but below the face amount, possibly saving itself some money (depending upon the time-value-of-money factors). Third, an issuer may have cash on hand and would like to pay down some of its liabilities, but its bonds may not be currently callable (and taxable advance refundings no longer produce savings). An issuer may offer cash or new bonds in exchange for the outstanding bonds being tendered. In the alternative, the issuer may offer to adjust the terms of the outstanding bonds.

If all applicable requirements are satisfied, an issuer can use the proceeds of tax-exempt bonds to finance its purchase of the tendered bonds, because the tender purchase constitutes a current refunding if the tender purchase occurs within 90 days after the issuance of the tax-exempt bonds.

Where an issuer offers new bonds in exchange for its outstanding bonds, or offers to adjust the terms of its outstanding bonds, the primary tax consideration for the issuer is whether a "reissuance" of the exchanged or modified bonds has occurred for federal tax purposes. If a reissuance occurs, from a federal tax standpoint, the newly issued bonds or modified bonds are deemed to have currently refunded the outstanding bonds. Thus, the newly issued/modified bonds must meet all of the federal tax requirements governing tax-exempt bonds, and the deemed refunding of the old tax-exempt bonds may, among other things, trigger rebate obligations and deemed terminations of integrated swaps. Accordingly, most of the time issuers prefer to avoid a reissuance of its outstanding tax-exempt bonds.

In general, a reissuance occurs if a change is made to the tax-exempt bond terms that results in a "significant modification" as described in Treas. Reg. Section 1.1001-3(e). Examples of the types of modifications made to tax-exempt bonds that rise to the level of "significant modifications" are: a change in yield over certain thresholds, a deferral of debt service payments over certain time periods, a change in the obligor or security of the bonds resulting in a change in payment expectations, and a change in the nature of the tax-exempt bond (e.g., from recourse to nonrecourse).

Reissuance is no exception to the general rule that tax rules always have exceptions. One such exception to the reissuance rules of Treas. Reg. Section 1.1001-3 is the "qualified tender bond." A qualified tender bond is generally a tax-exempt bond that, pursuant to its original terms, permits certain interest rate mode changes. Such changes are often spoken of being "baked into" the bond document. In connection with the interest rate mode change, the tax-exempt bond terms will contain a right of the bondholder to, or a requirement that the bondholder must, tender the bond to the issuer at par. Once tendered, the issuer must either retire the tax-exempt bond or use reasonable best efforts to resell the tax-exempt bond within 90 days.¹ In other words, qualified tender bonds are designed to break the bond (pun intended) between the issuer and bondholder before final maturity without triggering a reissuance.

Footnote

1. The detailed provisions governing qualified tender bonds are set forth in IRS Notice 88-130, IRS Notice 2008-41 and Proposed Reissuance Regulations, and the issuer may choose to comply with the most favorable guidelines, at least until the proposed reissuance regulations are finalized. Almost five years ago, my colleague wrote a blog post summarizing the primary provisions in the Proposed Reissuance Regulations. Such post appears timeless, as nothing has changed since then.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.