United States: Proposed Brokaw Act Would Affect Change-Of-Control Triggers In Indentures

Change-of-control provisions in high-yield indentures typically define beneficial ownership by reference to Rule 13d-3, promulgated under Section 13(d) of the Securities Exchange Act of 1934 (the "Exchange Act"). Proposed legislation in Congress would broaden the rule's definition of "beneficial ownership" beyond voting or investment power to include a pecuniary interest arising out of certain derivatives transactions. In light of this development, it may be prudent to consider amending indentures to exclude from the definition of beneficial ownership voting stock deemed beneficially owned solely by reason of possession of a pecuniary interest in such voting stock. More generally, it seems that a broader reconsideration of beneficial ownership definitions in indentures may be appropriate.

The Section 13(d) reporting system originated in 1968 with the enactment of the Williams Act in response to a wave of attempts at hostile takeovers of public companies. These takeover attempts were often structured as sudden and coercive tender offers. The Williams Act was designed to give shareholders of a target company adequate time and information to evaluate a third-party tender offer, and to allow both the bidder and management a reasonable time to present their respective cases to shareholders. Any person who acquires beneficial ownership of more than 5% of the outstanding shares of certain classes of equity securities registered under the Exchange Act must file disclosure within 10 days of the acquisition. The disclosure must report, among other things, the identity of the beneficial owner and the nature of that person's beneficial ownership, the source and amount of funds or other consideration used in purchasing the securities, and any plans or proposals to make major changes in the issuer's business or corporate structure.

The definition of beneficial ownership in Rule 13d-3 has always focused on voting and disposition power. However, the proposed Brokaw Act, which is sponsored by Sens. Tammy Baldwin (D-Wis.), Jeff Merkley (D-Ore.), Elizabeth Warren (D-Mass.) and Bernie Sanders (D-Vt.), would expand Rule 13d-3's definition of beneficial ownership to include an investor's possession of a "pecuniary or indirect pecuniary interest." "Pecuniary interest" would be defined as the opportunity to profit from, or share in any profit from, a transaction in the relevant security, including by ownership of a derivative instrument.

This change is a response to criticism that Rule 13d-3's current definition of beneficial ownership ignores synthetic derivative instruments (usually cash-settled equity total return swaps, or "TRSs") that confer economic exposure to securities without voting or disposition power. This criticism came to a head in CSX Corp. vs. Children's Investment Fund Management LLP (2d Cir. July 18, 2011). That case involved two hedge funds that built up economic exposure to CSX through TRSs in anticipation of a proxy contest for control of the company. As is typical, the counterparties to the TRSs held a corresponding hedging position in the actual stock itself. CSX sued the hedge funds for violating 13(d), claiming that through their bank hedges, the hedge funds had a reportable interest in CSX. As support for its claim, CSX argued that the hedge funds could likely influence the banks' voting of these hedged shares. Although neither the district court nor the Second Circuit on appeal reached a conclusion on this claim, CSX's argument reflected broader sentiment that excluding synthetic derivatives from the definition of beneficial ownership undermines investor confidence and market transparency. Specifically, critics contend that hedge funds can skirt disclosure of significant economic exposure to a company's stock, even when a hedge fund accumulates that exposure in anticipation of acquiring actual ownership and/or control over corporate affairs.

However, CSX is not the only case to consider that beneficial ownership can exist "uncoupled" from voting or dispositive power. Wilmington Savings Fund Society, FSB v. Foresight Energy L.P. (Del. Ch. December 4, 2015) involved senior notes issued by subsidiaries of Foresight Energy, L.P. ("Foresight"). Under the indenture, a change of control was defined to include any transaction that resulted in any person acquiring beneficial ownership of at least 35% of the voting stock of Foresight's general partner, Foresight Energy GP, LLC (the "General Partner"). In 2015, Murray Energy Corporation ("Murray") purchased 34% of the General Partner, hoping to avoid triggering the 35% change of control under the indenture. Murray also purchased an option (the "Option") to acquire an additional 46% of the General Partner, subject to a 61-day advance notice provision. The notice period was specifically set at 61 days to avoid a provision of Rule 13d-3 that the right to acquire a security within 60 days constitutes beneficial ownership. As a further means of deferring beneficial ownership under existing case law, the Option contained a third-party refinancing condition that was beyond Murray's control. Foresight also granted Murray various blocking rights, including the right to veto any attempt by Foresight to transfer its voting interests in the General Partner to a third party, and authorized a subsidiary of Murray to oversee all of its day-to-day business and operations. The CEO of Foresight and the General Partner were also replaced with a Murray executive.

The trustee sued on behalf of the noteholders, contending that a change of control had occurred. The Delaware Chancery Court (the "court") agreed, partly basing its conclusion on the anti-evasion provisions of Rule 13d-3. That provision states in its relevant part that:

Any person who, directly or indirectly, creates or uses a ... contract, arrangement, or device with the purpose or effect of divesting such person of beneficial ownership of a security or preventing the vesting of such beneficial ownership as part of a plan or scheme to evade the reporting requirements of section 13(d) ... of the Act shall be deemed for purposes of such sections to be the beneficial owner of such security.

Based on the anti-evasion provision, the Court held that Murray had acquired de facto control of Foresight.

The Brokaw Act's proposed changes to Rule 13d-3 are more far-reaching in scope than CSX and Wilmington Savings Fund, but all of them consider beneficial ownership as potentially "uncoupled" from voting or dispositive power. Collectively, they highlight a fundamental mismatch in using Rule 13d-3 as the definition of beneficial ownership in high-yield indentures. Section 13(d) and Rule 13d-3 thereunder are securities law provisions which require the filing of disclosure with the SEC, while change-of-control provisions in indentures trigger an immediate offer to repurchase all outstanding notes. If the Brokaw Act becomes law, it will become necessary to exclude from change-of-control definitions in indentures all positions of beneficial ownership resulting solely from holding a pecuniary interest by reason of owning a derivative, in order to avoid inadvertent and innocuous triggering of an offer to purchase notes. (The proposed Brokaw Act has been referred to the Senate Committee on Banking, Housing and Urban Affairs, but no hearings on the bill have yet taken place.) In addition, the uncertainty regarding the circumstances under which the anti-evasion provisions of Rule 13b-3 might be applied to confer unintended beneficial ownership, as demonstrated in Wilmington Savings Fund, should also prompt careful consideration of excluding the anti-evasion provisions of Rule 13d-3 from the definition of beneficial ownership in high-yield indentures.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions