United States: Top 10 Practice Tips: Debt Tender Offers

The following 10 practice points are intended to help you in assisting an issuer with a  proposed debt tender offer for cash. Often, issuers of debt securities seek to manage their liabilities through liability management transactions, including debt tender offers  for cash. A cash tender offer consists of a public offer by the issuer to purchase all or a portion of the outstanding principal amount of the relevant debt securities from the  holders at a price, and subject to conditions, set forth in the issuer's offer to purchase.

1. Consider whether the issuer has enough cash and whether there are more effective liability management alternatives.

Prior to undertaking a debt tender offer for cash, an issuer will need to determine whether it has sufficient cash on hand

to effect the repurchases. If an issuer does not have enough cash on hand or views the use of cash to effect a tender offer as an inefficient alternative under the circumstances, the issuer may consider a liability management transaction that does not require deploying cash, such as an exchange offer. In an exchange offer, the issuer offers to exchange new debt securities for certain of its outstanding debt securities. This approach would allow the issuer to achieve a similar result as a debt tender offer by purchasing its outstanding debt securities for non-cash consideration in the form of new securities, thereby obviating the need to deploy cash.

2. Determine whether the class of debt securities is widely held.

In connection with choosing the appropriate liability management approach, the issuer should consider whether the debt securities are widely held as well as the status (retail versus institutional) and location of the holders. If the debt securities are widely held, privately negotiated or open market purchases may not be efficient for an issuer. In such  a situation, a tender offer may be the best way to restructure the issuer's indebtedness. A tender offer allows an issuer  to approach or make an offer to all of the holders of a series of its debt securities. Because tender offers do not have to close until specified (and disclosed) conditions are satisfied (including, in some cases, receipt of consents from debt holders to modify the terms of the debt securities that remain outstanding, completion of any necessary financing for the tender offer and receipt of other necessary consents from third parties), it may be possible to conduct a tender offer and achieve the issuer's objectives.

3. Consider whether the tender offer rules would apply.

A key consideration in formulating a liability management strategy is the extent to which the Securities and Exchange Commission's (SEC) tender offer rules apply to the contemplated transaction, given that these rules affect the manner in which the transaction must be conducted. The tender offer rules can apply when a company is offering securities and/or cash for its outstanding securities, and the level of regulation of the offer (in terms of timing and mandated procedural protections) varies depending on the type of security that is the subject of the offer and whether certain conditions necessary for an abbreviated process  are satisfied.

An issuer repurchasing its debt securities, either in privately negotiated transactions or in open market purchases runs the risk that it may inadvertently trigger the SEC's tender offer rules. The term "tender offer" is not specifically defined in statute or in the SEC's regulations. The lack of a specific definition has permitted the SEC and the courts to apply  the tender offer rules to a broad range of transactions.  Any analysis of whether an offer constitutes a tender  offer begins with the often-cited eight-factor test in the Wellman v Dickinson case:

  • An active and widespread solicitation of public shareholders for the shares of an issuer.
  • A solicitation made for a substantial percentage  of the issuer's securities.
  • The offer to purchase is made at a premium over  the prevailing market price.
  • The terms of the offer are firm rather than negotiable.
  • The offer is contingent on the tender of a fixed number  of shares, often subject to a fixed maximum number to  be purchased.
  • The offer is open only for a limited period of time.
  • The offeree is subjected to pressure to sell his  or her security.
  • Public announcements of a purchasing program  concerning the target issuer precede or accompany  a rapid accumulation of large amounts of the target  issuer's securities.

These eight factors need not all be present for a transaction to be deemed a tender offer, and the weight given to each element varies based on the facts and circumstances.

Courts have also applied a totality-of-the-circumstances test in determining whether a transaction involves a tender offer that should be subject to the statutory requirements and the SEC's rules. In this context, the courts have examined whether, in the absence of disclosure and procedures required under the tender offer rules, there will be a substantial risk that the offeree lacks the information  needed to make an investment decision with respect to the offer. The SEC staff has historically focused on whether a tender offer involves an investment decision on the part of the offeree, particularly where the protections afforded by the tender offer requirements would appear to be necessary based on the nature of the transaction.

For debt repurchases, it is generally possible to structure repurchases in order to avoid the application of these rules. To the extent that an issuer would prefer to avoid the application of the tender offer rules, any repurchase should:

  • Be undertaken for a limited amount of securities
  • Made to a limited number of holders who are sophisticated
  • Not specify a time period or expiration time for the offer
  • Be made at prices that are privately and individually negotiated (i.e., the same terms should not be imposed  on all offerees) -and
  • Not be conditioned on the issuer having attained a specific principal amount

4. Determine whether the target class of debt securities is nonconvertible.

The issuer's structuring options also will depend, in part, on the characteristics of the outstanding security. A repurchase or tender for straight debt securities typically will be less complex than a repurchase or tender relating to convertible debt securities. This is because convertible debt securities are treated like equity securities for purposes of the tender offer rules. Specifically, in connection with tenders for convertible debt securities, issuers must comply with the requirements of Rule 13e-4. The obligation to comply with these provisions makes tender offers for convertible or exchangeable debt securities more complicated and time consuming, and subject the offer to SEC review, which  could result in time delays.

In addition, the requirements of Rule 13e-4 result in less flexibility for tenders for convertible or exchangeable debt securities compared to tenders for straight debt securities. A good illustration of this reduced flexibility is that it is not possible for issuers to sweeten the tender offer for convertible or exchangeable debt securities with an early tender premium as would be possible for straight debt securities.

There also may be some accounting issues in connection with repurchasing or tendering for convertible or exchangeable debt securities. While some effects (such as the elimination of the retired debt from the issuer's balance sheet) may be more intuitive, others may not be. Issuers may wish to consult their accountants early in the process. Issuers that intend to restructure their outstanding convertible debt also should consider the effects of such tender on any of their related call spread transactions or share lending agreements.

Finally, under certain circumstances, repurchases of convertible debt securities could be deemed a forced conversion and, therefore a distribution of the underlying equity security for purposes of Regulation M. Therefore, it is important to identify early on whether the subject debt securities are convertible debt securities and to structure the tender offer accordingly.

5. Determine whether the conditions for the abbreviated tender process apply.

In January 2015, the Staff of the SEC issued a no-action letter indicating that it would not recommend enforcement action in connection with a tender offer or exchange offer for nonconvertible debt securities that is held open for as few as five business days, to the extent that the offer is conducted in accordance with the following significant conditions (among others):

  • The offer must be structured as an any and all offer, but, may include a minimum tender condition.
  • The offer must be made by the issuer of the debt securities or a parent or a wholly owned subsidiary of the issuer  (i.e., third parties tendering for debt securities of an issuer will not be permitted to avail themselves of the shortened tender period).
  • The offer must be open to all record and beneficial holders of the targeted debt securities.
  • The offer must be made solely for cash or other qualified debt securities, which term is defined as securities that  are materially identical to the securities that are the subject of the tender offer.
  • The consideration offered in the tender offer must be fixed or based on a benchmark spread (e.g., U.S. Treasury rates, LIBOR or swap rates).
  • The offer cannot be combined with an exit consent to amend or eliminate covenants or with any other consent solicitation to amend the provisions of the indenture or  the debt securities.
  • Holders must be entitled to withdrawal rights until the earlier of the expiration date and, if the offer is extended, the tenth business day following the launch. Holders also must be allowed to withdraw tenders after the 60th business day following the launch if the offer has not been consummated by such time.
  • The offer must permit tenders prior to the expiration time through guaranteed delivery procedures.

The no-action relief is not available for partial tenders or  for tenders or exchanges with exit consents. In addition,  the relief is not available:

  • If there exists a default or event of default under the relevant indenture, or under any other indenture or material credit agreement to which the issuer is a party
  • At a time when the issuer is the subject of bankruptcy or insolvency proceedings, or otherwise has commenced activity geared toward accomplishing an out-of-court restructuring or pre-packaged bankruptcy
  • In anticipation of, or in response to, or concurrently with, a change of control or other extraordinary transaction involving the issuer, such as a merger, business combination, or sale of all or substantially all of the issuer's assets
  • In anticipation of, or in response to, a competing tender offer; concurrently with a tender offer for any other series of the issuer's securities made by the issuer or certain affiliates of the issuer if the effect of such offer would result in a change to the capital structure of the issuer  (e.g., addition of obligors or collateral, increased priority  of liens or shortened weighted average life to maturity  of such other series) -or
  • In connection with a material acquisition or disposition that would require the furnishing of pro forma financial information with respect to the transaction pursuant to Article 11 of Regulation S-X (whether or not the issuer  is an SEC-reporting company)

Finally, counsel should be aware that any investment grade tender offer that does not qualify for the abbreviated tender offer no-action relief will be subject to the 10 and 20-day period requirements under the tender offer rules.

6. Familiarize yourself with the various pricing methodologies that are used for tender offers.

There are several pricing mechanisms that an issuer can use to determine the consideration that it will pay holders to tender their securities. For instance, in order to limit exposure to interest rate fluctuations, issuers may choose fixed spread pricing. Fixed spread pricing permits an issuer/ offeror to choose a specific yield spread between the debt being tendered for and a benchmark U.S. Treasury security, which matures at or near the earliest redemption date for such debt security. The purchase price is calculated as the present value of the security subject to the tender offer, discounted at an interest rate equal to the applicable spread. While the actual price to be paid in the tender offer is not fixed at the commencement of the offer, the formula for determining the price is fixed. The greater the spread, the higher the discount rate, resulting in a lower present value and purchase price.

In addition, in a tender offer for nonconvertible debt,  an issuer has the flexibility to choose to accept tenders  of securities on a first-come, first-served basis, or offer  limited or no withdrawal rights, or conduct a Dutch  auction or modified Dutch auction for pricing purposes.  In a Dutch auction, a holder submits a bid at a specified  price which the issuer can accept or reject.

7. Consult with the  issuer about retaining  a dealer-manager.

Generally, the more complex and significant a restructuring, the more helpful it may be to engage an investment bank as financial adviser. The investment bank will help formulate a plan, locate and identify security holders, structure the transaction, solicit participation, assist with presenting the structure to the various stakeholders, assist with rating agency discussions and manage the marketing efforts in order to achieve a successful restructuring. Issuers should consider a number of factors, such as the number of debt holders, their sophistication, and whether the issuer has information about, and any contact with, the debt holders.

The investment bank's role varies in liability management transactions. In a cash tender offer for nonconvertible debt, an issuer may engage an investment bank in an advisory role. In a tender offer for convertible debt securities, which is subject to additional tender offer rules, an issuer may choose to engage an investment bank in an advisory role in order to contact and negotiate the terms with debt holders or to act as an active dealer-manager. In a tender offer coupled with a consent solicitation or a public tender offer for all outstanding debt securities, an issuer usually engages a dealer-manager to manage the entire process. In these transactions, issuers also often use a professional services firm to act as information agent during the process. There are no specific rules regarding compensation preventing issuers from using—and paying—an investment bank to solicit tenders.

8. Understand the principal negotiating issues arising  in connection with the  dealer-manager agreement.

The issuer will engage the dealer-manager pursuant to the terms of a dealer-manager agreement. The dealer-manager agreement may be the only agreement between the issuer and the investment bank, or it may supersede an engagement letter relating to the mandate. Usually, the dealer-manager's

counsel will prepare the draft agreement, which will detail the dealer-manager's obligations in respect of the transaction and set out the agreement relating to the fees payable to the dealer-manager. The issuer will make representations and warranties to the dealer-manager related to the offer to purchase and other offer materials used in connection with the tender, as well as make representations regarding receipt of all necessary authorizations (if any), corporate approvals, and make other representations comparable to those found in an underwriting agreement. Generally, the dealer-manager agreement will be executed just prior to commencement of the offer. Usually the agreement will require that certain documents, including officers' certificates and legal opinions, be delivered to the dealer-manager at various junctures during the tender offer period.

9. Familiarize yourself with other securities disclosure requirements applicable to debt tender offers.

Section 14(e) of the Securities Exchange Act is an antifraud provision that establishes the baseline for tender offer regulation. It prohibits an offeror from making any untrue statement of a material fact, or omitting to state a material fact necessary in order to make the statements made, in light of the circumstances in which they were made, not misleading. Section 14(e) also prohibits any fraudulent, deceptive or manipulative acts in connection with a tender offer, and applies to cash tender offers, as well as to exchange offers subject to the tender offer requirements.

Under Regulation 14E, an issuer is not required to file any tender offer documents with the SEC, and Regulation 14E does not prescribe any form requirements with respect to offering materials. Any offer to purchase, or other tender offer documentation, is subject, however, to the general antifraud provisions of the Exchange Act, notably section 10(b), Rule 10b-5 and section 14(e), and, therefore, may not contain any material misstatement or omission. Some courts have found that section 14(e) does not impose a scienter requirement (like Rule 10b-5), because, among other things, section 14(e) prohibits 'any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer' in addition to a Rule 10b-5 scienter-based approach that forms part of the first clause in section 14(e). For example, the Ninth Circuit recently held that section 14(e) requires only a showing of negligence, without a showing of scienter, to bring a case in connection with alleged misstatements or omissions in connection with a tender offer.

10. Determine whether there are any tax consequences for holders.

Tax issues can be an important consideration in any liability management transaction. Even with sound tax advice certain tax consequences are inescapable and must be carefully considered. For instance, corporations with outstanding debt may be subject to tax on cancellation-of-indebtedness (COD) income when all or a portion of such debt has been economically cancelled. COD income can arise in a number of circumstances, including forgiveness of debt by the debt holder, the repurchase of debt by the issuer at a discount, the exchange of one debt instrument of the issuer for another, the modification of debt and the exchange of debt for equity of the issuer. Additionally, repurchases or exchanges by persons related to the issuer can create COD income. Section 108(a) of the Internal Revenue Code provides a number of exceptions to the inclusion of COD income, including exceptions related to insolvency and bankruptcy.

Originally published by LexisNexis

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This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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