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The new year has brought an unexpected controversy in an
otherwise very issuer-friendly high yield bond market, one
involving limiting the available remedies following default that
were expanded in last year's decision by the Southern District
of New York in Wilmington Savings Fund Society, FSB v. Cash
America International Inc. The court in Cash
America held that when a default is caused by voluntary
actions of the issuer and the issuer has the ability to make the
applicable redemption payment, a bondholder may pursue a remedy of
specific performance of the redemption provisions of the indenture
for the payment of the applicable redemption premium.
Prior to Cash America, most market participants
believed that such a remedy would only be available where an issuer
intentionally defaulted for the purpose of avoiding paying the
redemption premium (under the reasoning set forth in Sharon
Steel Corp. v. Chase Manhattan Bank NA, 691 F.2d 1039 (2d
Cir.1982)). After Cash America, an issuer financially
capable of refinancing bonds and paying the redemption premium that
defaults under an indenture other than by reason of an involuntary
default (e.g., a bankruptcy or insolvency default, judgment
default, cross default, or loss of collateral or guarantees) can be
compelled to redeem the bonds and pay the applicable redemption
premium.
In response to this extension of the redemption premium remedy,
issuers have recently attempted (successfully, in certain
instances) to include language in indentures that eliminates the
redemption premium remedy — but not only in circumstances
when there is no bad faith. This new language would eliminate the
redemption premium remedy even where an issuer intentionally
breaches for the express purpose of avoiding paying the redemption
premium. It is this "land grab" by issuers that ignited
last week's kerfuffle.
The reaction to the new language by high-yield investor
constituencies is difficult to describe as measured: "If
investors do not rapidly start rejecting these deals, it is the
beginning of the end of bond covenants," announced Adam Cohen,
founder of Covenant Review, which has successfully staked out for
itself the role of vigilant gatekeeper of high yield bond covenants
(much to the chagrin and at times fury of issuers and underwriters
and their counsel). As if on cue, prominent counsel
representing issuers and underwriters
pooh-poohed the concerns raised by Covenant Review,
claiming that the new language could not be expected to have a
practical impact on issuer behavior. Their reasoning, though,
is rather disarranged: "companies rarely intentionally
default" — true enough but now that the new language
provides a compelling economic incentive to do so, it is not hard
to imagine an aggressive sponsor doing so; and "[D]oing so
triggers a number of negative consequences for the issuer,
including cross defaults in other debt, cross defaults in hedges,
leases and other financial obligations, supplier retraction of
credit, going-concern qualifications in financial statements and
loss of shelf registration eligibility" — again, this
ignores the intentional nature of the breach. If the issuer
simply arranges committed take out financing for the bonds in
advance of the planned breach, it could obtain cross default
waivers (which would quite likely be obtainable on reasonable
terms), and there would be no supplier contraction of credit or
going-concern qualification because the issuer's credit would
be unimpaired. Finally, for the majority of sponsor portfolio
companies in this era of 144A-for-life distribution that are not
SEC reporting companies, the spectre of loss of shelf registration
availability is obviously a non-event. Lastly, the cudgel of
injunctive relief was raised, but without any explanation as to why
the availability of money damages would not be sufficient to defeat
such a claim for such relief.
If the goal is to return to the post-Sharon Steel, pre-Cash
America status quo, it seems the fix is rather simple: A
scaled-down version of the controversy-provoking new language that
retains protection against bad faith breaches. For example:
"Notwithstanding any other
provision of the indenture or the notes, Holders of the notes shall
not be entitled to specific performance of the optional redemption
provisions described under 'Optional Redemption' above, and
no premium will be due or available as a remedy (and no damages or
remedy shall be payable that are based on the loss of or
deprivation of the amount of any such premium), in each case in
connection with or following (x) any Default or Event of Default
other than a Default or Event of Default resulting from an
intentional breach of the terms of the Indenture with the purpose
of avoiding the payment of such premium or (y) any acceleration of
all, or any portion of, the notes (other than an acceleration in
respect of an Event of Default (1) resulting from an intentional
breach of the terms of the Indenture with the purpose of avoiding
the payment of such a premium or (2) for failing to pay the
redemption price when due following any election to redeem notes
pursuant to the optional redemption provisions described under
'Optional Redemption' above, to the extent any premium is
due as part of the redemption price".
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