United States: When A Redemption Period Is Not Really A "Redemption" Period: A Red Flag Courtesy Of Chesapeake Energy

In May 2013, the Southern District of New York decided Chesapeake Energy Corp. v. Bank of New York Mellon Trust Co., N.A.¹ The decision, which found that an early redemption period in an indenture referred to the deadline to give notice and not the deadline to actually redeem the bonds, is notable because it raises possible red flags about the industry-standard language used for many trust indenture bond redemption clauses.

Chesapeake Energy Corp. ("Chesapeake") decided to redeem notes earlier than their stated maturity date. Chesapeake sent notice of its plan to the trustee, The Bank of New York Mellon Trust Company, N.A. ("BNY Mellon"), on the last day that their indenture provided for an Early Redemption Period, which allowed for early redemption of the bonds. Over BNY Mellon's argument that Chesapeake missed its notice deadline a month earlier, District Judge Paul A. Englemayer (the "Court") held that the Early Redemption Period solely defined the period within which Chesapeake had to give notice of its early bond call, and not necessarily to affect the redemption.

This client advisory will summarize the decision, address its significance, and offer practical suggestions for avoiding the pitfalls presented by the case.

Background

In February 2012, Chesapeake, a publicly-traded oil and natural gas producer, completed a public offering of $1.3 billion in notes, at a rate of 6.775 percent, due in 2019. The notes were issued according to two indentures: first, a base indenture, naming BNY Mellon, a banking association, as indenture trustee; and second, a supplemental indenture, whose terms applied solely to the 2019 notes and contained the language concerning the Early Redemption Period.

The notice provision referred to in this section—though the actual contractual language is not quoted in the Court's decision—stated that Chesapeake, after giving notice of redemption, must wait between thirty and sixty days before redeeming the notes. The supplemental indenture further provided that if Chesapeake were to miss the Special Early Redemption Period, it would have to redeem the notes at a make-whole price that would be far more costly than redemption at par plus interest, as Section 1.7(b) allowed. 

In March 2013, over BNY Mellon's objections, Chesapeake attempted to invoke its Section 1.7(b) redemption rights upon realizing it would be able to refinance the debt at an advantageous price given today's low-interest-rate environment. On March 15, after negotiations between the two failed, Chesapeake issued a Notice of Special Redemption. BNY Mellon's principal objection was that the Special Early Redemption Period identified the period during which the actual redemption of bonds pursuant to Section 1.7(b) may occur. Based on the notice provision's thirty to sixty day delay, BNY Mellon argued that Chesapeake's deadline to give notice was February 13, 2013—thirty days before March 15. Chesapeake's position likewise turned on an interpretation of the second sentence in Section 1.7(b). Chesapeake argued that the redemption period defined in the section was simply a notice period; the March 15, 2013 deadline was not the final date of actual redemption, but rather the final date that notice of redemption could be given. Therefore, Chesapeake argued, May 13, 2013, or sixty days after March 15, was the last day that actual redemption could occur.

The Decision

The Court ruled in Chesapeake's favor, holding that Chesapeake gave proper notice to recall its notes early because the Court determined that the redemption clause referred to the last day that notice could be given, and not the last day that the notes could actually be redeemed.

The Court analyzed the specific clause in question, then considered it in light of the rest of the text within the supplemental and base indentures. As to the clause itself, according to the Court, it "unequivocally supports Chesapeake's position that it had until March 15, 2013 to give notice, with the actual redemption . . . occurring between 30 and 60 days afterwards." The Court reasoned, "[t]hat is because the [first] sentence of Section 1.7(b) defines the 'Special Early Redemption Period' as 'any time from and including November 15, 2012 to and including March 15, 2013.'" Given that Section 1.7(b) allows notice "during" that timeframe, the Court felt that the clause, when read in isolation, decisively meant that the Special Early Redemption Period was a notice period.

Compared to the rest of the base indenture and the supplemental indenture, however, this view was "tarnished." This distinction turned on the interpretation of the verb "redeem," and its use in other sections within the base indenture and the supplemental indenture and not being "couched in terms of notice to redeem." For example, elsewhere in the base indenture and supplemental indenture, the word is used to permit Chesapeake, "at its option, [to] redeem the Notes [at par]." And, as BNY Mellon "persuasively" showed, the dictionary definition of "to redeem" and its customary industry usage refers to an act—it "refers to the act of paying a noteholder in exchange for his or her note"; not merely "giving notice of a redemption or to the overall redemption process." As the Court acknowledged, "the Base Indenture and the earlier supplemental indentures . . . all use that term in its customary sense," as described by BNY Mellon.

To this key point about industry-standard language, the Court took an interesting next step. It recognized that, in order for Chesapeake's construction of the clause to be sustained, it would require reading "to redeem" two different ways throughout the indentures: on the one hand, in the Early Redemption Period provision, it would have to be defined as "may commence the redemption process" (i.e., give notice), while, on the other hand, throughout the rest of the supplemental and base indentures, it would keep its industry-standard definition (i.e., actual redemption).

The Court felt that the awkwardly-drafted wording of Section 1.7(b) required this double-meaning. It pointed to the temporal inconsistency that using the industry-standard definition in Section 1.7(b) would create. BNY Mellon argued for the industry usage and read the clause as allowing actual redemption to take place during the Special Early Redemption Period (i.e., from November 15, 2012 to March 15, 2013). The Court explained that BNY Mellon accounted for the notice provision in the clause by claiming that it "limit[s] Chesapeake's right, at the front end (the first 30 days) of this period to make such redemptions." 

BNY Mellon attempted to reconcile the second sentence of Section 1.7(b)—the "during" wording—by arguing that the sentence "requires Chesapeake to give notice of such a redemption during that same Special Early Redemption Period." This reasoning would prevent Chesapeake from exercising its actual redemption until the first thirty days of the period have passed, and makes the last day to give notice February 13, 2013 (thirty days before the Special Early Redemption Period ended). The Court responded that BNY Mellon's construction created an "irreconcilable conflict." The Court noted that, if the Special Redemption Period spanned from November 2012 to March 2013, then BNY Mellon's reading, which cut off the first and last thirty days, went directly against the express wording in the clause. Under this reading, in effect, "the second sentence of Section 1.7(b) would not serve any other purpose than to partially repudiate the first sentence." The Court further addressed the timing issues in BNY Mellon's argument:

The Court found this construction unreasonable.

The Court noted, however, that the issues surrounding the clause were readily preventable. Chesapeake should have used the phrase "may give notice of redemption" or "may commence the redemption process" instead of "may redeem." Or, the Court continued, Chesapeake could have used clarifying language that "the last date for a redemption was May 14, 2013, or stated generally that the redemptions after March 15, 2013 are permitted if noticed by or on that date." 

Significance

The decision is significant because the Southern District of New York, which hears a substantial amount of bond and note related litigation, now has precedent that is counter-intuitive to the industry-wide understanding of terms used in many bond redemption clauses. By acknowledging the industry standard and, at the same time, allowing Chesapeake to proceed with its reading of the redemption clause, the Court's decision poses potential issues for defining the parameters of redemption dates.

Industry-standard definitions in redemption notifications did not come about by chance. Industry-wide usage helps ensure predictability as to obligations and provides trustees with ample time to carry out early bond calls. The American Bankers Association ("ABA") and the Securities and Exchange Commission developed guidelines and standards specifically to overcome redemption notification issues, and the ABA's Corporate Trust Committee disseminated its "Recommended Guidelines for Processing Bond Calls" in 1989. ² Likewise, the National Association of Bond Lawyers ("NABL") published a form trust indenture that includes a sample redemption clause.sup>3 Both documents are worth comparing to the clause in Chesapeake Energy because it is standard practice to draft indentures with an eye towards the guidelines and the form indenture. 

Although the guides do not exactly match, as the Court stated, the "awkwardly drafted provision" in Chesapeake Energy, there are similarities. The ABA's recommended guidelines suggest that notices should include the redemption date, which is the date that the called securities are due to be paid. It further provides that a thirty-day notice period should exist between the notice date and the redemption date. Likewise, the NABL's form trust indenture provides in Section 3.09 Notice of Redemption that the issuer "shall give . . . notice of the redemption of the Bonds to the Trustee not later than [45] days prior to the redemption date or such shorter time as may be acceptable to the trustee." Section 1.7(b)'s second sentence creates virtually the same notice requirement—a thirty-day provision—and places it within a special redemption period. These similarities should raise flags for all parties to an indenture with comparable wording because the result in Chesapeake Energy makes it more difficult to distinguish between the notice and redemption periods and pinpoint the exact deadlines for each one.

Practical Suggestions

After the Chesapeake Energy ruling, it is essential that trustees and noteholders review early redemption period provisions in current supplemental indentures and prospectus supplements. As evidenced in Chesapeake Energy, documents may contain special provisions outside of the normal industry-recognized practice, allowing issuers to redeem bonds or notes early as long as they provide notice of redemption within the period specified.  Proper disclosure is necessary because investors may think the end date of the early redemption period serves as the last possible redemption date and that bonds or notes must be fully redeemed by this date. However, as Chesapeake Energy demonstrated, these provisions may extend the actual redemption date beyond the early redemption periods stated in the debt documents. Under these early redemption notice periods, issuers can give notice of redemption until the last day of the notice period and must complete the redemption before the redemption date, determined by the required days of notice.  For example, if an issuer is required to give thirty days' notice prior to redemption, a special early redemption notice period allows the issuer to redeem the notes as late as thirty days following the last day of the notice period.  Investors must know if any of their current holdings contain these provisions to ensure they account for scenarios involving early redemptions beyond the periods specified in the debt documents.

Issuers, underwriters, and trustees must also carefully craft early redemption provisions to prevent ambiguous language and conflicting interpretations.  As the Court discussed in Chesapeake Energy, parties can prevent issues and litigation by explicitly stating intentions and allowed actions in the debt documents.  Indentures with redemption periods that only require notice of redemption during the period should expressly state these requirements.  It is also essential that there is consistency in the use of terms and meaning of terms throughout all documents governing a transaction.  If a term has a different meaning in different documents or sections of the same document, the document should indicate this contrary meaning or use alternative language to prevent ambiguity or conflicts.  Prior to finalizing documents, parties should agree as to the intent of contested provisions and document any intentions or agreements.

Conclusion

Following the Chesapeake Energy ruling, trustees, underwriters, and issuers must ensure they always disclose, define, and differentiate their intended redemption terms in order to eliminate the possibility of misunderstandings. All parties to a bond or note issuance should disclose unique provisions in the debt documents and clearly state the intent behind these provisions. Parties should clearly define these unique provisions and any terms with alternate meanings in the accompanying documents and in discussions prior to the offering. Lastly, unique provisions should be differentiated when they are contrary to common practice, all parties should understand the implications of these differences, and the difference should be clearly explained in the indenture.

Footnotes

^{1.Chesapeake Energy Corp. v. Bank of New York Mellon Trust Co., N.A., No. 13 Civ. 1582, 2013 WL 1890278 (S.D.N.Y. May 8, 2013).}

^{2.Robert I. Landau & Romano I. Peluso, Corporate Trust Administration and Management}

^{220–21 (6th ed. 2008).}

^{3.Form Trust Indenture, National Association of Bond Lawyers, http://www.nabl.org/uploads/cms/documents/nablformalreportsmodeldocs-nablformtrustindenture.pdf .}

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.