liability management handbook 2015 update

Ze’-ev D. Eiger

Nilene R. Evans

David Goett

Thomas A. Humphreys

David M. Lynn

Brandon C. Parris

Anna T. Pinedo

Shane M. Shelley

James R. Tanenbaum

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Liability Management Handbook 2015 update 1

We first published the Liability Management Handbook in the midst of the financial crisis. As wethen noted, during the early 2000s, corporate issuers issued debt in substantial amounts, withsome companies becoming overleveraged in the process. Financial institutions also had reliedsignificantly on regular issuances of hybrid securities such as trust preferred securities,mandatory convertibles, and REIT preferred securities. Financial institutions were not alone inrelying on complex financing tools. Issuers in the US and globally offered a stunning diversityof new financial instruments, which were structured to achieve customised legal, tax, accountingand other goals.

What to do with these capital structures and how to do it falls under the rubric of liabilitymanagement. In today’s world it requires an understanding not only of the law, but also ofcomplex capital structures. To operate in this area, the team of professionals needs to know notonly the relevant securities, tax, banking, bankruptcy and other laws, but also must have a keenappreciation for why structures were created, why structures worked, and why the structures maynot serve today’s needs. While unprecedented in its severity, the financial crisis brought with itvaluable lessons for practitioners in the area – whether through innovative debt-for-equityexchanges, the remarketing of outstanding securities, new approaches to tender offers, or newguidance from regulators. This learning will serve to inform us on how to approach any futurewave of restructurings or liability management exercises.

We have compiled this handbook to help attorneys, investment bankers and corporate counselnavigate their way through the complex legal maze that has come to surround liabilitymanagement transactions in the post-recession/crisis world. It is designed to pull together in oneplace not only the law relating to liability management, but also the modern practice of liabilitymanagement. While the financial crisis may be viewed as part of a prior period in our financialhistory, each period brings with it new challenges, and hopefully, new opportunities. As of thiswriting, liability management issues for entities operating in the energy sector are the subject ofincreased focus. Next month, or next year, this focus likely will be elsewhere. The key point tobe made is that understanding liability management approaches and techniques will not becomeirrelevant anytime soon.

© Morrison & Foerster and Euromoney Institutional Investor 2015. All rights reserved.

Introduction

2 Liability Management Handbook 2015 update

Ze’-ev D. Eiger is a partner in the Capital Markets Group in the New York office of Morrison& Foerster. Mr. Eiger’s practice focuses on securities and other corporate transactions for bothforeign and domestic companies. He represents issuers, investment banks/financialintermediaries, and investors in financing transactions, including public offerings and privateplacements of equity and debt securities. Mr. Eiger also works with financial institution clientsin the equity derivative markets, focusing on designing and structuring new products andassisting with offerings of equity-linked debt securities. He also represents foreign private issuersin connection with securities offerings in the United States and the Euro markets, and financialinstitutions in connection with domestic and international offerings of debt securities andmedium-term note programs.

Nilene R. Evans is Of Counsel in the Capital Markets Group in the New York office ofMorrison & Foerster. Ms. Evans counsels domestic and foreign, public and privately heldcompanies, advising them on issues ranging from securities offerings, mergers, acquisitions anddispositions to ongoing disclosure and compliance obligations and general strategic planning.She has extensive experience acting as counsel for underwriters and issuers in initial andsubsequent public and private equity and debt offerings, including PIPEs, complex privateequity investments, in fast-paced “shelf ” public and Rule 144A offerings by major corporations.

David Goett is an associate in the Federal Tax Group in the New York office of Morrison &Foerster. He works with several banks on the tax aspects of domestic and international capitalmarkets offerings and also has experience with restructurings, mergers and acquisitions, REITs,and joint ventures.

Thomas A. Humphreys is co-chair of the Federal Tax Practice Group as well as co-chair of theTax Department at Morrison & Foerster. Mr. Humphreys has extensive experience with the taxaspects of capital markets transactions, financial instruments, real estate investment trusts,mortgage and asset-backed securities, mutual funds, mergers and acquisitions, bankruptcy andreorganization, and international transactions. Mr. Humphreys works with investment banksand issuers on developing new financial products. He has advised investment banks and bankson most of the major capital markets developments in the last decade including trust preferreds,tier 1 capital instruments, mandatorily remarketed debt instruments, mandatorily exchangeabledebt instruments, and contingent convertible bonds. He currently works with several banks andinvestment banks on developing new capital markets products involving equity, debt andpreferred stock.

About the authors


David M. Lynn is a partner in the Washington D.C. office of Morrison & Foerster, and is co-chairof the firm’s Corporate Finance practice. He is the former Chief Counsel of the Division ofCorporation Finance at the U.S. Securities and Exchange Commission (SEC). Mr. Lynn’s practiceis focused on advising a wide range of clients on SEC matters, securities transactions and corporategovernance. In addition to being a leading authority on SEC issues, Mr. Lynn is particularly wellknown in the area of executive compensation disclosure, having co-authored, The ExecutiveCompensation Disclosure Treatise and Reporting Guide. While serving as Chief Counsel of theSEC’s Division of Corporation Finance, Mr. Lynn led the rulemaking team that drafted sweepingrevisions to the SEC’s executive compensation and related party disclosure rules.

Brandon C. Parris is a partner in the San Francisco office of Morrison & Foerster, and is co-chairof the firm’s Global Corporate Department. He maintains a corporate and securities practice, withspecial emphasis on securities offerings, mergers and acquisitions, and corporate counseling. Heprimarily represents public companies in a variety of industries, including biotechnology, clean-tech, consumer goods and services, financial services, gaming, healthcare, and high-technology. Mr.Parris also regularly advises investment banks in capital markets and strategic transactions. He alsoadvises members of executive management, boards of directors, and special committees on strategicand corporate governance issues, and counsels numerous public companies on all aspects of theSecurities Act of 1933 and the Securities Exchange Act of 1934.

Anna T. Pinedo is a partner in the Capital Markets Group in the New York office of Morrison& Foerster. She has concentrated her practice on securities and derivatives. She representsissuers, investment banks/financial intermediaries, and investors in financing transactions,including public offerings and private placements of equity and debt securities, as well asstructured notes and other structured products. Ms. Pinedo works closely with financialinstitutions to create and structure innovative financing techniques, including new securitiesdistribution methodologies and financial products. In the derivatives area, Ms. Pinedo counselsa number of major financial institutions acting as dealers and participants in the commoditiesand derivatives markets. Ms. Pinedo advises on structuring issues, as well as on regulatory issues,monetization, and hedging techniques. Her work focuses on foreign exchange, equity and creditderivatives products, and structured derivatives transactions.

Shane M. Shelley is a partner in the Federal Tax Group in the San Diego office of Morrison &Foerster. He has a comprehensive tax practice with a focus on federal income tax matters. Mr.Shelley has substantial experience advising on the tax aspects of business transactions, includingmergers and acquisitions, fund formations, venture capital investments, and internationalstructuring. In addition, his expertise includes familiarity with a range of complex capital marketstransactions and experience advising real estate investment trusts and regulated investmentcompanies. He has significant experience in the taxation of settlements and judgments. Mr. Shelleyalso regularly advises corporations, partnerships, limited liability companies, and other businessentities regarding their day-to-day domestic and international operations.

James R. Tanenbaum serves as chair of the firm’s Global Capital Markets practice. Mr.Tanenbaum has concentrated his practice on corporate finance and the structuring of complexdomestic and international capital markets transactions. He represents issuers, including some of thenation’s largest financial institutions, underwriters, agents, and other financial intermediaries, inpublic and private offerings of securities as well as issuers, investment banks, and purchasers inhybrid, mortgage-related, and derivative securities transactions. He has developed some of the mostwidely used hybrid techniques for the placement and distribution of securities. Mr. Tanenbaumworks closely with leading investment banks to formulate new methodologies for securities offeringsand to structure innovative financial products. He has also represented many technology-basedcompanies, including biotech and medical device companies.


We are Morrison & Foerster – a global firm of exceptional credentials. Our clients include someof the largest financial institutions, investment banks, Fortune 100, technology, and life sciencecompanies. We’ve been included on The American Lawyer’s A-List for eleven straight years, andFortune named us one of the “100 Best Companies to Work For.” Our lawyers are committedto achieving innovative and business-minded results for our clients, while preserving thedifferences that make us stronger. This is MoFo. Visit us at www.mofo.com

Morrison & Foerster attorneys represent issuers, dealer-managers, solicitation agents and otherparties in connection with a variety of liability management transactions. Our attorneys haveparticular experience advising on, and structuring, debt tender offers, including tenders forinvestment grade and non-investment grade debt securities, and tenders involving hybridsecurities, such as trust preferred securities. A liability management transaction may be anopportunistic or preventive transaction, or part of a more complete recapitalisation orrestructuring. Our capital markets, corporate, bankruptcy & restructuring, and tax attorneyswork closely together to structure multi-step transactions. Attorneys in our Tax Departmenthave substantial expertise in the management of liabilities and the structuring of debt issuances,repurchases and exchanges. We have significant experience with the full panoply of transactionsavailable to issuers restructuring their liabilities, including the use of securities like contingentconvertible debt instruments, high-yield and zero coupon obligations, and other structuredproducts. Our tax attorneys have the ability to address and manage the variety of tax and non-tax concerns an issuer might face, including the minimisation of cancellation of indebtednessincome, the preservation of net operating losses, the conservation of cash and recapitalisations,or other reorganisations on a tax-free basis. We are comfortable advising both healthy companiesrevisiting their balance sheet or pursuing a leveraged acquisition and distressed companiesapproaching bankruptcy and non-bankruptcy workouts. Our ultimate goal is to provideconcrete and practical solutions to the problems faced by issuers.

About the firm


CHAPTER 1

Liability management: overview 7APPENDIX AOther considerations 24APPENDIX BThe role of the financial intermediary 26

CHAPTER 2

Liability management: summary of options 31CHAPTER 3

Liability management continuum 35CHAPTER 4Cash debt tenders: an overview and summary of no-action advice 37

APPENDIX ARule 14e-1 – Unlawful tender offer practices 47APPENDIX BRule 14e-2 – Position of subject company with respect to a tender offer 48APPENDIX CRule 14e-3 – Transactions in securities on the basis of material, nonpublic information in the context of tender offers 48

CHAPTER 5

Section 3(a)(9) exchange offers 53CHAPTER 6

Tender and Dutch auction guidance 65CHAPTER 7

Tax issues 81CHAPTER 8Distressed debt exchange: global cross-sector criteria 87

Rating implications of exchange offers 95

Contents


Issuers should consider re-balancing their balancesheets under one or more of the followingcircumstances:

• New business and market realities. Many issuers are stillrecovering from the financial crisis and coming to termswith the new realities brought about by more stringentregulatory requirements and enhanced oversight andsupervision. In certain instances, issuers have had torevisit their businesses and discontinue certain businesslines or types of transactions, or consider dispositions ofcertain assets. These types of changes, together withcontinuing market volatility, declining stock prices,rating downgrades, write downs and modified earningsprojections, often lead an issuer to evaluate arecalibration of its debt/equity mix.

• Deleveraging efficiently. Some debt securities, hybridsecurities and converts are trading at discounts. Anissuer may be able to affect an efficientrepurchase/tender given market conditions-optimise itsbalance sheet, reduce its interest expense and the like.

• US tax considerations. Changes to the US federal taxlaws in recent years facilitate the repurchase of debtsecurities.

• Investor perceptions. Investors may be more willing toconsider exchange and restructuring opportunities.Investors may seek liquidity or appreciate theopportunity to move up in the capital structure.

This overview highlights a number of balance sheetrestructuring approaches that issuers should consider andwhich are discussed in more detail in subsequent sectionsof this book.

Repurchases for cash include:

• Redemptions – a purchase of outstanding debt securitiesfor cash in accordance with the terms of the security;

• Repurchases – opportunistic repurchases of debtsecurities for cash, including privately negotiated andopen market repurchases; and

• Tender offers – an offer made to all bondholders torepurchase outstanding debt securities for cash.

Exchange offers not involving cash include:

• Private exchange offers – unregistered debt for debtexchanges pursuant to section 4(a)(2) usually made toqualified institutional buyers (QIBs) as defined underRule 144A under the Securities Act of 1933, asamended (the Securities Act), and non-US personsunder Regulation S;

• Section 3(a)(9) exempt exchange offers – exempt debt fordebt exchanges; and

• Registered exchange offers – public debt for debtexchanges registered with the Securities and ExchangeCommission (SEC) and subject to the tender offerrules.

• Exchanges involving non-debt securities – exchanges ofsecurities that are subject to the tender offer rules.

We also discuss related matters, such as consentsolicitations, both on a standalone basis and as exitconsents, in connection with an exchange offer.

General tax considerations

IssuersCentral to the tax considerations for an issuer restructuringits debt is the potential recognition of cancellation-of-indebtedness (COD) income. Under the Internal RevenueCode (the Code), taxpayers with outstanding debt areoften subject to tax on COD income when all or a portionof such debt has been economically cancelled unless specialexceptions apply (for example, in the event of bankruptcyor insolvency of the taxpayer). In addition, corporationsthat issue obligations with original issue discount (OID) aspart of their restructuring also must consider potentiallimitations on the deductibility of such discount. Forcorporations that issue certain high-yield obligations withsignificant OID (AHYDOs), a portion of such discount istreated as a nondeductible dividend under section163(e)(5) of the Code, while the remaining discount maynot be deducted until actually paid.

CHAPTER 1

Liability management: overview


Debt holdersIn part, the tax consequences to debt holders depend onwhether the restructuring constitutes a recapitalisationwithin the meaning of section 368(a)(1)(E) of the Code.Generally, debt exchanges involving debt securities withterms longer than five years qualify as recapitalisations. Onthe other hand, a repurchase of debt securities will result ingain or loss to the debt holder equal to the differencebetween the amount of cash received and the holder’sadjusted tax basis in the debt security. If the holderacquired the debt security with market discount, a portionof any gain may be characterised as ordinary income.

How to choose an approachLegal, accounting, ratings, regulatory capital and taxconsiderations should all be factored into determining thebest approach to re-balancing:

• Cash? If the issuer has cash on hand, open marketrepurchases or a tender will be possible.

• No cash? If the issuer does not have cash on hand, or arepurchase would not be considered a prudent use ofresources, an issuer should consider an exchange offer.

• Holders? The issuer will have to consider whether thesecurities are widely held and the status (retail versusinstitutional) and location of the holders.

• Buying back a whole class of debt securities? Open marketrepurchases will provide only selective or limited relief.A tender offer may be necessary in order to buy all of aclass of outstanding bonds.

• Straight debt? Convertible debt? Hybrid? The issuer’soptions also will depend on the structure of theoutstanding security. A repurchase/tender for straightdebt securities typically will be more streamlined than arepurchase/tender of convertible debt securities.

• Tender? Again, the structure and rating of theoutstanding security will drive whether the issuer canconduct a fixed spread or fixed price offer.

• Covenants? Is the issuer concerned about ongoingfinancial or operating covenants as well as de-leveraging?

• Part of a broader effort? The issuer should considerwhether a buy back is only a precursor to a restructuringor recapitalization, as well as whether an exchangeoffer/tender is only one element of a bigger process. Theissuer should keep the bigger picture in mind.

• Mix and match? Well, not really. It may be possible tostructure a variety of transactions. However, an issuershould be careful to structure any liability managementtransaction carefully. Open market repurchases incontemplation of a tender offer may be problematic.

Benefits from a repurchase or exchange ofdebt securitiesThere can be a number of benefits to the issuer from arepurchase or exchange of debt securities, including:

• Perception – a buy back may signal that an issuer has apositive outlook;

• Deleveraging;

• Recording of accounting gains if securities arerepurchased at a discount to par; the issuer will have toconsider the structure of its buyback, exchange ortender;

• Reducing interest expense;

• Potential earnings per share improvement;

• Potential regulatory capital and ratings benefit; and

• Alternative to more fundamental restructuring orpotential bankruptcy.

Repurchases and exchanges (debt for debt, hybrid ordebt/equity) can be particularly important for financialinstitutions for the following reasons:

• Many financial institutions are facing deadlines to complywith the regulatory capital requirements arising as a resultof the implementation of the Basel III framework, and toaddress the “phase out” of the favourable regulatorycapital treatment received in respect of certainoutstanding hybrid securities. The interest rateenvironment and regulatory requirements may make thisan opportune time to restructure a balance sheet.

• Rating agencies, analysts and commentators are focusedon tangible common equity and similar measures. Thismay motivate financial institutions to restructure.Exchange offers may be used in order to create higherquality regulatory capital.

• A financial institution will benefit (from a capitalperspective) by buying back debt securities that aretrading at a discount and cancelling such securities.


• A restructuring may be a component of insurancecompany and bank reorganisations and/or good bank-bad bank or other split off transactions.

• May be used as a potential exit from governmentsupport.

Structuring challengesIn structuring a debt repurchase, particularly a tenderoffer, issuers face a number of challenges.

• Holdouts – The issuer and its financial and otheradvisers should consider how to address potentialholdouts—one approach may be to include a highminimum tender or exchange condition (such as 90%or higher).

• Timetable – Starting out with a timetable that complieswith both contractual deadlines and applicable tenderoffer rules is key to a successful process.

• Bondholder committees – A bondholder committee maybe helpful in the context of a broad restructuring orrecapitalisation. However, the interests of bondholdersmay not be aligned. For example, the interests of hedgefund holders of convertible debt may not be compatiblewith the interests of institutional investors that holdstraight debt or hybrid securities. Disagreements amongcommittee members can delay or prevent a successfultender or exchange offer.

General disclosure concernsIn addition to the disclosures to debt holders required inthe repurchase transaction itself (as discussed below),issuers have ongoing disclosure obligations to all itssecurity holders under the Securities Exchange Act 1934,as amended (the Exchange Act). In relation to therepurchase or tender offer, these obligations includerequirements under Form 8-K to disclose entry into ortermination of a material definitive agreement, creation ofa direct financial obligation or an obligation under an off-balance sheet arrangement and unregistered sales of equitysecurities. An issuer may also need to file a Form 8-K for acash tender if the tender may be considered an accelerationof a financial obligation.

Further, the issuer may also determine that before it canenter into a repurchase or redemption plan, it mustdisclose other material non-public information. To avoidviolating the antifraud provisions of the federal securitieslaws, particularly Rule 10b-5 under the Exchange Act, bypurchasing a security and/or issuing a security at a timewhen the issuer has not disclosed material non-public

information, whether or not related to the repurchase, theissuer should plan to disclose all material non-publicinformation in advance.

Examples of material information include unreleasedearnings or an unannounced merger, both of which mayneed to be disclosed before purchasing securities from adebt holder. This can be accomplished through the filingof an annual report on Form 10-K or a Quarterly Reporton Form 10-Q but may also be accomplished by filing aCurrent Report on Form 8-K. In addition, if an issuerengages in privately negotiated or open market repurchasesin advance of conducting a tender offer, it may beconsidered manipulative – the issuer will have priorknowledge of its intention to commence a tender that itdid not disclose to holders from whom it is purchasing (seefurther below).

Repurchases for cash

RedemptionsAn issuer may redeem its outstanding debt securities inaccordance with their terms, assuming that the debtsecurities do not prohibit a redemption. A credit line mayprohibit prepayment and the debt securities may haveabsolute call protection and may not be redeemable. Anissuer also may find that other debt securities have limitedcall protection, and may be redeemable followingexpiration of a certain period of time after issuance, oftenfive or 10 years. Specific kinds of debt securities also maybe more or less likely to contain redemption provisions –for instance, zero coupon bonds generally are not by theirterms redeemable.

Prior to deciding to redeem outstanding debt securities,an issuer must ensure that the redemption is permitted,not just under the terms of the debt security in question,but also under the terms governing the issuer’s other debtinstruments. Many credit agreements limit an issuer’sability to redeem other outstanding debt. The usual areasof concern include definitions of, and restrictions on,permitted indebtedness, permitted re-financings,permitted liens and restricted payments, as well ascovenants regarding incurrence of indebtedness. An issuershould carefully review its existing debt instruments toensure that redemption is permitted and that it would nottrigger repayment obligations. There also may be other,non-financial agreements, such as lease agreements or evenacquisition agreements, which may affect an issuer’s abilityto redeem its securities. In addition, redemption mayrequire prior approval by the issuer’s board of directors.

The terms of the debt securities, which were negotiatedat the time of issuance, usually specify the redemptionprice. The redemption price typically will reflect the


holders’ yield to maturity on the outstanding debtsecurities and debt holders will be made whole. The pricewill typically equal the face amount of the debt security,plus the present value of future interest payments. Theeffect of this is that the debt securities will be redeemed ata premium. For issuers with limited cash on hand,redemption may not be a viable option. In addition, as anissuer generally is required to provide at least 30 days’ priornotice of redemption, if it announces a redemption onfixed rate debt securities, it runs the risk that the cost of theproceeds it intends to use for the redemption, which at thetime the notice was issued were available at a lower cost,may have increased, and may even increase above theredemption cost.

The process for redeeming an outstanding debt securityis spelled out in the instrument governing the debtsecurity, usually the indenture. Typically, an issuer mustgive holders not more than 60 and not less than 30 days’prior notice of redemption. This notice also may requirethat the issuer include other information, such as theredemption price, the redemption date, and identify thesecurities (if not all) which are being selected forredemption. If not all of the securities are being redeemed,the securities will be redeemed either on a pro rata basis orby lot; the process for a redemption usually is determinedby the trustee or by the trustee working with thedepository.

In connection with delivery of the redemption notice, anissuer often will announce via press release that it hasdecided to redeem the debt securities in accordance withtheir terms. An issuer should publicly disclose aredemption, to the extent that its broader impact on anissuer’s financial condition would be viewed as material,prior to contacting debt holders. During the financialcrisis, there were a few notable instances in which thefailure by issuers to disclose their intention to redeemcertain securities gave rise to allegations of selectivedisclosure (violating the issuer’s Regulation FD [FairDisclosure] obligations) and bondholder claims.1

In connection with any redemption of outstanding debtsecurities, an issuer must also ensure that it has compliedwith securities law antifraud provisions. In particular, if theissuer has not, in the original offering documents,adequately disclosed, for instance, that a specific series ofdebt securities may be redeemed, the issuer may be liableunder Rule 10b-5 of the Exchange Act, for materialmisstatements or omissions in the prospectus as they relateto the redemption.2

Privately negotiated and open market debt repurchasesAn issuer that has cash on hand, or can obtain it quickly,may determine that a privately negotiated or open marketrepurchase (or repurchases) of its debt securities is anefficient use of capital. In the context of a debt repurchase,an issuer will also need to review the terms of all of itsoutstanding debt instruments and other securities todetermine that repurchases are permissible. The terms ofthe indenture will not dictate the purchase price payable byan issuer in connection with repurchases. As a result, anissuer may (and should) negotiate the purchase price withsecurity holders in order to achieve the best possiblepricing.

Benefits of a debt repurchaseRepurchases may be conducted with little advancepreparation, they require limited or no documentation andgenerally can be conducted for little cost to the issuer(outside of the purchase price). Privately negotiated andopen market purchases are usually most effective if theissuer is seeking only to repurchase a small percentage of anoutstanding series of debt securities, or if the class of debtsecurities is held by a limited number of holders.Repurchases may be conducted in a number of differentways – the issuer may negotiate the purchase price or otherterms directly with security holders; the issuer maypurchase the debt securities on the secondary market; theissuer may engage a financial intermediary to identifyholders, negotiate with holders and repurchase the debtsecurities for resale to the issuer; or the issuer may agreewith a financial intermediary to repurchase debt securitiesthat the financial intermediary purchases on a principalbasis. If the issuer’s debt securities are trading at a discount,a repurchase will be efficient. An issuer that repurchases itsdebt securities at a discount and cancels the debt securitieswill be able to improve its overall capital position. For afinancial institution, the issuer may be able to increase itsTier 1 regulatory capital levels by doing so.

An issuer often may engage a financial intermediary toeffect open market repurchases. This entity usually will bethe same entity that acted as an underwriter or initialpurchaser for the initial issuance of the debt securitiesbecause the investment bank’s sales force will have betterknowledge regarding the secondary market for the issuer’sdebt securities, including the most appropriate pricing.The financial intermediary will be able to contact holdersand easily negotiate the terms of the transaction.

Regulation FDIn connection with a privately negotiated or open marketrepurchase, an issuer needs to ensure that it complies with


all applicable laws, including those enacted under theSecurities Act and the Exchange Act. Among other things,these rules and regulations affect the information that anissuer must provide to its security holders in connectionwith debt repurchases.

Private negotiations with creditors, including debtholders, can trigger disclosure or other obligations underRegulation FD. In particular, concerns may arise when anissuer conducts discussions with one or more bondholderor lender groups to test the waters with respect to aparticular repurchase plan. Regulation FD provides,subject to certain exceptions, that whenever an issuer, orany person acting on its behalf, such as a financial adviser,discloses any material non-public information regardingthat issuer or its securities to market professionals orholders of the issuer’s securities who may trade on the basisof such information, the issuer shall make public disclosureof that information either simultaneously, in the case of anintentional disclosure, or promptly, in the case of a non-intentional disclosure. In the context of privatelynegotiated repurchases, the fact that an issuer isconducting these repurchases may be considered materialnon-public information in and of itself. A repurchase thatis part of a restructuring, because of its broader impact onan issuer’s financial condition and in many circumstances,its ability to operate, would likely be viewed as material.Disclosure of the repurchases to a debt holder may triggera disclosure obligation on the issuer’s part. However, theissuer may avoid the obligation to disclose suchinformation if the person that receives the information iseither under a duty of trust or confidentiality or suchperson expressly agrees to keep the informationconfidential. An issuer should consider whether to use aconfidentiality agreement.

An issuer also should consider when it will discloseinformation regarding a repurchase to the public. If theissuer engages in private repurchases over time, it may notbe appropriate to disclose each repurchase until the processends. Similarly, negotiations over the terms of arestructuring (including a tender or exchange offer) maytake time or may ultimately be fruitless. In those cases,debt holders may object to being kept out of the marketfor such an extended time, and may negotiate a specifictime or event by which disclosure must be made public bythe issuer or a determination made that the information isno longer material or current for any reason, includingbecause of the occurrence of superseding events.

An issuer should consider the benefits of disclosingeither in general terms or specific terms its restructuringgoals, and giving up some negotiating flexibility fordisclosure protection. The issuer may consider announcingthe debt restructuring program (if there is a program, as

opposed to opportunistic repurchases) with a press releaseand file the release as an exhibit to a Current Report onForm 8-K. The issuer may also disclose its intentions in aperiodic report, such as in its Annual Report on Form 10-K or a Quarterly Report on Form 10-Q. However, thismay raise concerns about a tender, which we discuss below.The disclosure need not be very detailed and may simplystate that the issuer will repurchase its debt securities in theopen market or in privately negotiated transactions ifmarket conditions warrant. More specific disclosure maybe problematic.

An issuer also should take care to avoid entering intodiscussions with debt holders that may rise to the level ofan “offer” under the US securities laws. If this occurs, theoffer must either: qualify as a bona fide private offer; beregistered with the SEC, or be exempt from theregistration requirements of the Securities Act by virtue ofsection 3(a)(9).

Regulation M and other considerationsAlthough Regulation M does not apply to investmentgrade non-convertible debt securities, it does apply toequity securities, non-investment grade debt securities andconvertible debt securities. An issuer that is engaged in adistribution while effecting a repurchase program mustensure that it complies with Regulation M. Rule 102under Regulation M makes it unlawful for an issuer or itsaffiliates “to bid for, purchase, or attempt to induce anyperson to bid for or purchase, a covered security during theapplicable restricted period”. This prohibition is intendedto prevent an issuer from manipulating the price of itssecurities when the issuer is about to commence or isengaged in a distribution. A distribution may be deemedto take place in connection with a proxy mailing. Inaddition, issues under Regulation M arise when an issueruses the proceeds from a new offering to repurchaseoutstanding debt securities. The new offering may be adistribution under Regulation M and any purchases underthe buyback may be prohibited. An issue also arises if thedebt repurchases are for debt securities that are convertibleinto the issuer’s equity securities. Under certaincircumstances, repurchases of convertible debt securitiescould be deemed a forced conversion and, therefore adistribution of the underlying equity security for thepurposes of Regulation M.

Avoiding the tender offer rulesAn issuer repurchasing its debt securities, either inprivately negotiated transactions or in open marketpurchases runs the risk that it may inadvertently trigger thetender offer rules. The tender offer rules were adopted toensure that issuers, and others, tendering for equity


securities would be prohibited from engaging inmanipulative practices in respect of those tenders. Withequity securities, in particular, the market price is subjectto manipulation as it fluctuates with market pressures.However, debt securities are not subject to the sameconsiderations as equity securities and therefore, a debttender poses less risk than one for equity securities. For adebt tender, it is possible to structure the purchases toavoid the application of these rules.

Section 14(e) of the Exchange Act does not define atender offer. Without a clear definition from the SEC,courts have provided a set of eight factors to helpdifferentiate between a tender offer and other publicsolicitations. The eight-part test (and the caseimplementing that test) involved equity securities. It islikely, though, that any discussion on debt securities andtender offers would begin with the eight characteristicslisted below. An issuer considering an open market orprivately negotiated repurchase of its debt securities shouldcarefully review the impact of the eight factors andstructure the transaction to avoid the tender offer rules.Courts have found the following eight characteristicsindicative of a tender offer:

(1) active and widespread solicitation of publicshareholders for the shares of an issuer;

(2) solicitation is made for a substantial percentage ofthe issuer’s stock;

(3) offer to purchase is made at a premium over theprevailing market price;

(4) terms of the offer are firm rather than negotiable;(5) offer is contingent on the tender of a fixed number

of shares, often subject to a fixed maximum number to bepurchased;

(6) offer is open only for a limited period of time;(7) offeree is subjected to pressure to sell his stock; and(8) public announcements of a purchasing program

concerning the target issuer precede or accompany a rapidaccumulation of large amounts of the target issuer’ssecurities.3

These elements need not all be present for a transactionto constitute a tender offer, and the weight given to eachelement varies with the individual facts andcircumstances.4 To ensure that a debt repurchase does nottrigger application of these rules, it should be made for alimited amount of securities and to a limited number ofholders, preferably sophisticated investors, should be madeover an extended period of time (with no pressure forholders to sell), and prices should be privately, andindividually, negotiated with each holder, with offers thatare independent of one another.

Regulation 14EIn 1968, Congress amended the Exchange Act to addprovisions relating to tender offers. The statutoryamendments together with the SEC’s rules adopted in1968 are typically referred to collectively as the WilliamsAct. The rules were significantly amended in 1999.Regulation 14E and Rules 14e-1, 14e-2 and 14e-3 underthe Exchange Act apply to all tender offers – both equityand debt. However, these rules do not apply to tenders orexchanges of securities that are exempt securities undersection 3(a) of the Securities Act. In addition, the SEC hasprovided no-action guidance that limits the applicability ofsome of these rules to tenders of investment grade debtsecurities and more recently to tenders of non-investmentgrade debt securities that meet specified conditions. If thetender involves equity securities (which for purposes of thetender offer rules includes debt securities with equitycomponents, such as convertible or exchangeable notes),additional rules apply.

Rule 14e-1 sets forth certain requirements for tenderoffers generally.

• Offer Period – Rule 14e-1 provides that a tender offermust generally be held open for at least 20 business daysfrom the date the tender offer commences.5 The offermust also stay open for at least 10 business days fromthe date of a notice of an increase or decrease in: (1) thepercentage of securities to be acquired pursuant to thetender (if the change exceeds two percent of the originalamount); (2) the consideration offered, without any deminimis exception; or (3) any dealer-manager’ssolicitation fee, is first published or sent to the holdersof the relevant securities. By analogy to therequirements of Rule 14d-4, a tender offer subject onlyto Regulation 14E must remain open for a minimum offive business days for any other material change to theoffer or waiver of a material condition.6

• Extension of Offering Period – Rule 14e-1 also providesthat any extension of the offer period must be made bya press release or other public announcement by9.00am Eastern time, on the next business day after thescheduled expiration date of the offer, and the pressrelease or other announcement must disclose theapproximate number of securities tendered to date.7

• Prompt Payment – The offeror must either pay theconsideration offered or return the securities tenderedpromptly after termination or withdrawal, respectively,of the offer.


Under Regulation 14E, an issuer is not required to filetender offer documents with the SEC and the rules do notprescribe any form requirements. Any offer to purchase,and other tender offer documentation, is subject to thegeneral antifraud provisions of the Exchange Act, notablyRule 10b-5 and section 14(e), and therefore, may notcontain any material misstatement or omission.

Rule 14e-1 does not specifically require withdrawalrights. However, it is standard practice to provide holderswith withdrawal rights for tender offers for straight debtsecurities. These withdrawal rights typically expire after aninitial period, often after the first ten business days. Anissuer also should consider whether it should reinstatelimited withdrawal rights following the occurrence of anymaterial change in the terms of the tender offer or thewaiver of a material condition.

Rule 14e-2 requires that the issuer subject to a tenderoffer, disclose its position with respect to the bidder’stender to its security holders- whether it recommends it,expresses no opinion or is unable to take a position.Interestingly, Rule 14e-2 does not contain an explicitexemption for issuer tenders, though the subject issuer andthe bidder would be the same entity. It is common for anissuer to include in its tender offer materials a statementthat the issuer makes no recommendation as to the tender.

Rule 14e-3 contains an antifraud prohibition onactivities of a person conducting a tender offer, similar toRule 10b-5. If such person is in possession of material non-public information that he knows or has reason to know isnon-public and knows or has reason to know was acquiredfrom the offering person, the issuer or any of its directors,officers or employees, it is unlawful for that person topurchase or sell or cause to be purchased or sold any of thesecurities being tendered for. In the case of an issuer tender,an issuer must be careful not to conduct a tender at a timewhen it possesses material non-public information. Thisinformation may include unreleased earnings, a potentialchange in an issuer’s credit ratings or an unannouncedmerger. To avoid any issues, the issuer should disclose thisinformation prior to commencing a tender offer.

Debt tenders for cashIn some cases, privately negotiated or open marketrepurchases of debt securities may not provide an issuerwith the desired results, particularly if the issuer wishes toretire all or a significant portion of a series or class ofoutstanding debt securities. Privately negotiated or openmarket purchases may not be efficient for an issuer if thedebt securities are widely held or the issuer plans asimultaneous consent solicitation. In those situations, atender offer may be the most appropriate way torestructure the indebtedness. A tender offer allows an

issuer to approach or make an offer to all of the holders ofa series of its debt securities. Because tender offers do nothave to close until specified (and disclosed) conditions aresatisfied (including receipt of consents from the debtholders to modify the terms of the debt securities thatremain outstanding, completion of any necessaryfinancing for the tender offer and receipt of othernecessary consents from third parties), it may be possibleto conduct a tender offer and achieve the issuer’sobjectives.

Cash tenders for straight debt securitiesCash tender offers for straight debt securities may becompleted more quickly and at a lower cost than othertenders because of the absence of specific disclosure orstructuring requirements. In a cash tender for straight debtsecurities, an issuer typically will mail tender offermaterials to holders describing the terms of the offer andproviding them with material information. An issuer oftenwill announce the commencement of a tender offer in apress release, and may even supplement thatannouncement by publishing notice of the tender in anationally circulated newspaper.

While a cash tender for straight debt securities can be arelatively straightforward transaction, if a cash tender iscombined with a consent solicitation, the process maybecome more complicated. Further, because cash tenderoffers for straight debt securities are not subject to the bestprice rules applicable to equity tender offers, it is commonpractice to encourage participation in the tender byproviding for an early tender premium. Holders thattender early in the offering period, typically within the first10 business days, may receive the total consideration.Holders that tender after the early tender periodterminates will receive lesser consideration for theirsecurities. The early tender feature benefits the issuerbecause it may gain greater visibility regarding the successof the tender offer. An issuer needs to be mindful that thefalling away of the premium may, under in certaincircumstances, constitute a change in consideration thatmay require that the tender stay open for an additional 10days as discussed above.

Pricing considerationsTypically, in its tender offer documents, an issuer willspecify the amount of securities it is seeking to purchase, aswell as the price at which it will purchase these securities(or the method for calculating the purchase price).However, in some cases, an issuer may specify the amountof securities to be tendered, but may set the price using amodified Dutch auction pricing structure. In thisstructure, the issuer sets a cascading range of prices at


which a holder may tender its securities. The purchaseprice will be the highest price at which the issuer is able tobuy all of the securities for which it has solicited a tender(or a smaller amount, if not all the securities are tendered).This price is often referred to the clearing price. The SEChas permitted tender offers to proceed without the issuerdisclosing this range in the tender offer documents, so longas the aggregate amount of securities to be purchased isdisclosed (and the range of securities to be purchased if theoffer were fully subscribed).8 Usually the permitted pricerange is very narrow – often no more than 15% of theminimum price.

Cash tenders for investment grade debt securitiesThe requirements of Regulation 14E may be limiting foran issuer conducting a tender offer. Specifically, if an issuermust keep the offer open for 20 business days or extendthe offer period if there are any changes in theconsideration or percentage sought, it can adversely affectthe tender because the issuer is subject to market riskduring this time. Most debt tender offers occur wheninterest rates are low – the issuer is trying to lower its costof funds by retiring high interest rate debt securities withthe proceeds from new securities issued at a lower rate, ora lower- interest rate credit facility. If interest rates declineduring the offer period, an issuer will not retire as muchdebt and if rates increase, the retired debt will come at ahigher price. Longer offer periods translate into increaseduncertainty.

Since 1986, based in large measure on the belief thatissuer debt tender offers for cash for any and all non-convertible, investment grade debt securities may presentconsiderations that differ from any and all or partial issuertenders for a class or series of equity securities or non-investment grade debt, the SEC staff consistently grantedrelief to issuers of investment grade debt in the context oftenders for their debt securities. Based on those no-actionletters, which have, to an extent, been superseded by theissuance in January 2015 of a more recent no-action letter(discussed below), an issuer need not keep the tender openfor 20 business days, provided the following conditions aremet:9

• Offers to purchase were made for any and all of theinvestment grade debt, non-convertible debt of aparticular series or class;

• The offer is open to all record and beneficial holders ofthat series or class;

• The offer is conducted so as to afford all record andbeneficial holders of that series or class the reasonable

opportunity to participate, including dissemination ofthe offer on an expedited basis in situations where thetender offer is open for period of less than 10 calendardays; and

• The tender offer is not being made in anticipation of orin response to other tender offers for the issuer’ssecurities.

Following the series of no-action letters issued since1986, investment grade debt issuers were no longer subjectto the 10- and 20-business day requirements.10 In 1990,the SEC staff expanded this no-action relief for investmentgrade debt. Salomon Brothers proposed to conduct anoffer wherein the issuer would offer to purchase its debtsecurities from tendering holders at a price determined oneach day during the offer period by reference to a fixedspread over the then-current yield on a specifiedbenchmark US Treasury security determined as of the date,or a date preceding the date, of tender. This is referred toas a fixed-spread tender offer. In connection with a fixedspread tender, the SEC staff required that the offer providethat information regarding the benchmark Treasurysecurity will be reported each day in a daily newspaper ofnational circulation and that all tendering holders of thatclass will be paid promptly for their tendered securitiesafter the securities are accepted, within the standardsettlement period (now, three days).11

The SEC followed by expanding again the breadth of theno-action relief for tenders of investment grade debtsecurities. This relief applies to tenders for investment gradedebt securities for which the nominal purchase price wouldbe calculated by reference to a stated fixed spread over themost current yield on a benchmark US Treasury securitydetermined at the time the holder tenders, rather than byreference to a benchmark security as of the date, or datepreceding the date, of tender. This is referred to as a real-timefixed-spread tender offer. The SEC imposed the followingadditional requirements for a real-time fixed spread tender:

• The offer must clearly indicate the benchmark interestrate to be used and must specify the fixed spread to beadded to that yield;

• The offer must state the nominal purchase price thatwould have been payable under the offer based on theapplicable reference yield immediately precedingcommencement of the tender offer;

• The offer must indicate the reference source to be usedduring the offer to establish the current benchmarkyield;


• The offer must describe the methodology used tocalculate the purchase price; and

• The offer must indicate that the current benchmarkyield and the resulting nominal purchase price of thedebt securities will be available by calling a toll-freephone number established by the dealer-manager.12

With the assistance of counsel, an issuer should be able tostructure its tender offer for investment grade debt securitiesto fit within existing no-action letter guidance. Structuringwithin the guidance will relieve the issuer of the burden ofcomplying with the 10- and 20-business day requirements.13

Treatment of investment grade versus non-investment grade debtUntil relatively recently, tender offers for investment gradedebt were subject to the more lenient process outlinedabove, while similar relief remained unavailable for tenderoffers for non-investment grade debt. In January 2015, theSEC staff issued a no-action letter (which supersedes theprior letters discussed above in most respects) thateffectively eliminates the distinction between investmentgrade and other debt securities, and permits debt tenderoffers (including tender offers conducted in the context ofcertain exchange offers) to be held open for as few as fivebusiness days if certain specified conditions are satisfied.The significant conditions include:

• The offer must be made available to all holders of thedebt securities and for all of the outstanding securities.

• The offer must be made by the issuer of the debtsecurities or a parent or subsidiary of the issuer.

• The offer must be made solely for cash or other so-called qualified debt securities, which is defined assecurities that are materially identical to the securitiesthat are the subject of the tender offer.

• The consideration offered in the tender offer must befixed or based on a benchmark spread.

• The offer cannot be combined with an exit consent toamend or eliminate covenants or otherwise to amendthe provisions of the indenture or the debt securities.

The no-action letter is significant in that it may offersome issuers more flexibility to tender for theiroutstanding debt securities; however, not all issuers will beable to comply with the specified conditions summarisedabove and the additional disclosure related conditions. We

discuss the letter in greater detail in Chapter 4.

Cash tender offers for convertible debt securitiesCertain provisions of the Williams Act are applicable onlyto tenders of equity securities, including tenders ofconvertible or exchangeable debt. If an issuer has a class ofequity securities registered under the Exchange Act or isotherwise reporting under the Exchange Act, tenders for adebt security with equity features must comply with theseprovisions, including Rule 13e-4, which regulates tenderoffers by issuers. The obligation to comply with theseprovisions makes tender offers for convertible orexchangeable debt securities more complicated and time-consuming, and subject the offer to SEC review, whichcould result in additional time delays.

Requirements of tenders subject to Rule 13e-4The principal additional requirements for a tender subjectto Rule 13e-4 are:

• Filing with the SEC – Rule 13e-4 requires that an issuerfile a Schedule TO for a self tender for convertible orexchangeable debt securities on the day that such tenderoffer commences. Schedule TO has a number ofspecific disclosure requirements; disclosures must bemade either in the Schedule TO itself or in thedocumentation sent to security holders. Schedule TOsare subject to review by the SEC,14 and material changesin the information provided in the Schedule TO mustbe included in an amendment filed with the SEC. Rule13e-4 also requires that all written communicationsregarding the tender offer be filed with the SEC.15 Byreason of the Schedule TO filing obligation, the tenderoffer then becomes subject to the requirements ofRegulation 14D, which governs the form and contentof the Schedule TO.

• Offers to all holders – Under Rule 14e-4, generallytender offers must be made to all holders of the relevantsecurities.

• Best price – The consideration paid to any security holderfor securities tendered in the tender offer must be thehighest consideration paid to any other security holderfor securities tendered in the tender offer. Note that thisdoes not prevent an issuer from offering holders differenttypes of consideration as long as the holders are given anequal right to elect among each type of consideration,and the highest consideration of each type paid to anysecurity holder is paid to any other security holderreceiving that type of consideration.


• Dissemination – Rule 13e-4 provides alternativemethods for disseminating information regarding anissuer tender offer. The most common method ofdissemination is to publish a tombstone advertisementin The Wall Street Journal or other daily newspaper withnational circulation.16

• Withdrawal rights – Rule 13e-4 requires that the tenderoffer permit tendered securities to be withdrawn at anytime during the period that the tender offer remainsopen. In addition, Rule 13e-4 specifically permitswithdrawal after 40 business days from thecommencement of the tender offer if the securities havenot yet been accepted for payment.

• Purchases outside the tender offer – Rule 13e-4(f )(6)provides that until the expiration of at least 10 businessdays after the date of termination of the issuer tenderoffer, neither the issuer nor any affiliate shall make anypurchases, otherwise than pursuant to the tender offer,of: (1) any security that is the subject of the issuertender offer, or any security of the same class and series,or any right to purchase any such securities; and (2) inthe case of an issuer tender offer that is an exchangeoffer, any security being offered pursuant to suchexchange offer, or any security of the same class andseries, or any right to purchase any such security.17

The requirements of Rule 13e-4 result in less flexibilityfor tenders for convertible or exchangeable debt securitiescompared to tenders for straight debt securities. A goodillustration of this reduced flexibility is that it is notpossible for issuers to sweeten the tender offer forconvertible or exchangeable debt securities with an earlytender premium as is the case for straight debt securities.

Accounting and other considerationsConvertible or exchangeable debt securities raise specialaccounting issues and issuers should carefully consider theaccounting aspects of repurchasing their convertible debtbefore doing so. While some effects (such as theelimination of the retired debt from the issuer’s balancesheet) may be more intuitive, others may not be. Issuersmay wish to consult their accountants early on, even moreso because accounting for convertible debt securities haschanged recently.18 Issuers that intend to restructure theiroutstanding convertible debt also should consider theeffects of such tender on any of their call spreadtransactions or share lending agreements.

Special rules for European tendersIt may be the case that the holders of an issuer’s debtsecurities are located in foreign jurisdictions. For instance,an issuer may have sold its securities pursuant to Rule144A in the United States and pursuant to Regulation Soutside the United States. Many frequent debt issuers issueand sell their debt securities pursuant to Euro medium-term note programs or market and sell US registeredsecurities into the European Union (EU) or other foreignjurisdictions. For these tenders, an issuer must not onlyfocus on the various considerations spelled out above, butalso must be cautious that its tender does not violate anyrules in the home country of its security holders.

Regulation MAlthough, as discussed above, Regulation M does notapply to investment grade non-convertible debt securities,it does apply to equity securities, non-investment gradedebt and convertible debt. An issuer that engages in atender offer must ensure that it complies with RegulationM. Rule 102 under Regulation M makes it unlawful for anissuer or its affiliates “to bid for, purchase, or attempt toinduce any person to bid for or purchase, a coveredsecurity during the applicable restricted period”. Thisprohibition is intended to prevent an issuer frommanipulating the price of its securities when the issuer isabout to commence or is engaged in a distribution.

Tax considerationsAn issuer that repurchases its debt securities at a discountto its adjusted issue price will generally recognise ordinaryCOD income in the amount of the discount. This resultswhether the issuer repurchases the debt securities directlyor repurchases the debt securities through a related party,such as an intermediary.

A debt holder whose debt security is repurchased by theissuer will recognise gain or loss equal to the differencebetween the amount of cash received in the repurchase andthe holder’s adjusted tax basis in the debt security. If theholder acquired the debt security with market discount, aportion of any gain may be characterised as ordinaryincome.

Non-cash tender offersIf an issuer does not have or want to use its available cashresources, an alternative to a cash tender is an exchangeoffer. In an exchange offer, the issuer offers to exchange anew debt or equity security for its outstanding debt orequity securities. For distressed issuers, an exchange offermay be the best non-bankruptcy restructuring option.Exchange offers enable an issuer to reduce interestpayments or cash interest expense (by exchanging debt


securities with a high rate for a lower one), reduce theprincipal amount of outstanding debt (in the case of a debtequity swap), manage its maturity dates (by exchangingdebt securities that are coming due for debt securities withan extended maturity) and reduce or eliminate onerouscovenants (if coupled with an exit consent). Anotherbenefit to conducting an exchange offer is that the issuermay sweeten the deal by providing a cash payment to theholder as an inducement to exchange.

Securities Act considerationsAn exchange offer must comply with the tender offer rules.However, because an exchange offer involves the offer ofnew securities, it also must comply with, or be exemptfrom, the registration requirements of the Securities Act.For this reason, documentation for an exchange offer willbe more detailed than that for a cash tender offer and mustdescribe the terms of the new securities. In addition,because the exchange involves the offer of new securities,participants are liable under the antifraud protections ofsection 11 of the Securities Act. If an issuer engages afinancial intermediary to assist with the solicitation oftenders, the intermediary may be subject to statutoryunderwriter liability and will conduct its own diligencereview of the issuer, including delivery of legal opinionsand comfort letters.

An exchange offer may either be exempt fromregistration or registered with the SEC. An issuer may relyon the private placement exemptions provided undersection 4(a)(2) of the Securities Act or the exemptionprovided by section 3(a)(9) of the Securities Act. Inaddition, an exemption pursuant to Regulation S for offersand sales to non-US persons may be available on astandalone basis or combined with other applicablesecurities exemptions.

Regulation MAn issuer must be mindful of Regulation M’s prohibitionson bidding for, or purchasing, its securities when it isengaged in an offer. If the debt being exchanged isconvertible into the issuer’s equity securities, under certaincircumstances, repurchases of convertible debt securitiescould be deemed a forced conversion and, therefore, adistribution of the underlying equity security forRegulation M purposes.

Private exchange offersAn exchange offer may be conducted as a privateplacement. Because the issuer must structure the exchangewithin the confines of section 4(a)(2), it may not engage ina general solicitation of its security holders. In addition,any offerees must be sophisticated investors. Typically, if an

issuer is relying on section 4(a)(2) for its exchange, it willlimit its offer only to qualified institutional investors, orQIBs,19 as a precaution. To ensure that the offer restrictionsare satisfied, an issuer often will pre-certify its holders toensure that they meet the requirements (either QIB oraccredited investor20 status). If the issuer has engaged afinancial intermediary, the intermediary will identify debtholders and contact them in advance. Often, the financialintermediary will have certifications on file for the debtholder and verify its status, or it may obtain the requisitecertification on the issuer’s behalf. This typically can beaccomplished by requiring that the holder sign a letterconfirming its status. As with any other restructuring, anissuer must ensure that the transaction is permitted underthe governing debt instrument, as well as under its otherfinancial arrangements.

If an issuer conducts a private exchange, the newlyissued securities will not be freely tradable, as they wereissued pursuant to an exemption from registration. In thepast, an issuer covenanted with the holders to register thesecurities issued in the exchange, either through a resaleregistration statement or via a registered exchange. In lightof the 2007 amendments to Rule 144 that shortened theholding period for restricted securities, holders may nolonger require an issuer to register their securities issued inthe exchange. Under the Rule 144 amendments,unaffiliated holders may sell their securities withoutrestriction after a six-month holding period, provided theissuer is a reporting company and has current information.Whether registration rights are requested may depend onthe type of security issued (for instance, holdersexchanging equity for debt may want liquidity sooner thanholders exchanging debt for debt). Rule 144(d)(3)(ii)provides that a holder of a security may tack the holdingperiod of the underlying security to its holding period foran exchanged security in certain circumstances. Rule144(d)(3)(ii) states: “If the securities sold were acquiredfrom the issuer solely in exchange for other securities of thesame issuer, the newly acquired securities shall be deemedto have been acquired at the same time as the securitiessurrendered for conversion or exchange, even if thesecurities surrendered were not convertible orexchangeable by their terms” (emphasis added).

Section 3(a)(9) exchange offersAnother option is an exchange offer exempt pursuant tosection 3(a)(9). Section 3(a)(9) of the Securities Act appliesto any securities exchanged by the issuer with its existingsecurity holders exclusively where no commission or otherremuneration is paid or given directly or indirectly forsoliciting such exchange.

Section 3(a)(9) has five requirements:


• Same issuer – the issuer of the old securities surrenderedis the same as the issuer trying to effectuate an exchangeof the new securities;

• No additional consideration from the holder – the securityholder must not be asked to part with anything of valuebesides the outstanding security;

• Offer only to existing holders – the exchange must beoffered exclusively to the issuer’s existing securityholders;

• No remuneration for solicitation – the issuer must notpay any commission or remuneration for thesolicitation of the exchange; and

• Good faith – the exchange must be in good faith and notas a plan to avoid the registration requirements of theSecurities Act.

Same issuerSection 3(a)(9) exempts any securities exchanged by theissuer with its security holders. The SEC has interpretedthe word “its” to mean that the new securities being issuedand the securities that are being surrendered mustoriginate from a single issuer. While this concept may seemrelatively straight forward, there are a number of scenariosthat can complicate an identity of issuer analysis. The SEChas granted no-action relief in response to facts andcircumstances that do not fit neatly within the single issuerrequirement. For example, the SEC has granted no-actionrelief for an exchange of guaranteed debt securities of asubsidiary for the securities of the parent issuer guarantor.21

The SEC concluded that the exchange as a wholeinvolved a single issuer. In its analysis, the SEC first heldthat as a matter of economic reality, the holders of thesubsidiary’s securities were in fact holders of the parentissuer’s securities. Next, the SEC placed heavy emphasis onthe relationship between the parent issuer and thesubsidiary. The subsidiary was established by the parentissuer to issue securities and finance the activities of theparent issuer. The subsidiary had minimal assets andliabilities that were tied to the issuance of securities. “Ineconomic reality, it is the [parent issuer’s] financial positionand business prospects and the value of the [parent issuer’s]securities to be issued ... that will be of interest to investorsin making their investment decisions”.22

In another no-action letter, an issuer transferred itscommon stock to a trust.23 The issuer wanted to execute anexchange whereby the trust would facilitate an exchange ofold securities for new ones. The issue was whether theissuance by the trust, which is ostensibly a different issuer,

would preclude the issuer from relying on section 3(a)(9).The SEC found this exchange exempt under section3(a)(9), finding that the trust was a “special purpose entityestablished for the sole purpose of allowing... investors toobtain the economic right in [a security]. The [trust] doesnot engage in any activities unrelated to this purpose andhas no independent financial or economic activity.”

These two no-action letters, which we discuss only forillustrative purposes, demonstrate that the SEC will look atthe underlying economic reality when confronted with anidentity of issuer question. There are a number of otherno-action letters and other SEC guidance that provideadditional interpretation in satisfying the conditions ofsection 3(a)(9).24

No additional consideration from the holderThe term “exclusively” in Section 3(a)(9) refers to theconsideration that security holders are required toexchange. This excludes from the safe harbor of section3(a)(9) all exchange offers where the holder must give upanything other than old securities. Conversely, an issuerrelying on section 3(a)(9) is free to include cash in what itgives to the security holders.

Rule 149 under the Securities Act provides an exceptionto the no-cash payment rule “to effect an equitableadjustment, in respect of dividends or interest paid orpayable on the securities involved in the exchange, asbetween such security holder and other security holders ofthe same class accepting the offer of exchange.” Anexample of an equitable adjustment is when, due to thetiming of interest payments and intra-security holder sales(that is, sales not involving the issuer), one security holdermay get the benefit of an interest payment due to anothersecurity holder. Should this be the case, the issuer may, inan exchange offer, require an unjustly enriched securityholder to reimburse the issuer for an extra interestpayment. section 3(a)(9) does permit an issuer to requirethe security holders waive the right to receive an interestpayment or other consideration accruing from a security.25

Offer only to existing holdersAny exchange offer conducted in reliance on section3(a)(9) may be made only to existing holders. Though itappears simple, this requirement can sometimes bebreached if an issuer is conducting a simultaneous offeringof new securities for cash. In this case, the issuer must takecare to keep the two offerings separate.


No remuneration for solicitationSection 3(a)(9) expressly prohibits an issuer from paying a“commission or other remuneration ... directly orindirectly for soliciting such exchange”. In conducting a“commission... remuneration” analysis, it is important toconsider:

• the relationship between the issuer and the personfurnishing the services;

• the nature of the services performed; and

• the method of compensation for those services.

An issuer’s officers, directors and employees may solicitparticipation provided that they were not hired for suchpurpose, have responsibilities other than solicitingparticipation and are not paid a bonus or specialcompensation for such solicitation.26 Issuers also arepermitted to engage third parties, such as financial advisersand investor relations firms, to assist in a section 3(a)(9)exchange subject to certain restrictions. The servicesprovided by the third party must be “ministerial”27 or“mechanical.”28 Any services not deemed mechanical mustbe “by [their] nature ancillary to the effective mechanicaloperation of the process of formulating a restructuringproposal in a work-out situation.”29 An issuer needs to beparticularly mindful of firms, such as investor relationsfirms, that communicate with security holders. Hiring afirm to communicate with security holders could beconstrued as payment for solicitation. The SEC allowsinvestor relations firms to participate in exchanges in alimited capacity. We discuss the role of a financialintermediary in Appendix B. Third parties assisting in anexchange are not permitted to make any recommendationsto security holders regarding the exchange offer,30 thoughan investment bank may provide a fairness opinion inconnection with an exchange provided it is not acting as adealer manager and conducting solicitation activities.31

Other considerationsSecurities issued in a section 3(a)(9) exchange may besubject to limitations on transfer because section 3(a)(9) isa transactional exemption only. In a section 3(a)(9)transaction, the newly issued securities are subject to thesame restrictions on transferability, if any, of the originalsecurities.32 An issuer also needs to be cautious of having itsexchange offer integrated with other securities offeringsconducted in close proximity to the exchange. In making adetermination regarding integration, an issuer must applythe SEC’s five factor integration test.33

Registered exchange offersIf an issuer is unable to conduct a private exchange, or torely on section 3(a)(9), it may instead conduct a registeredexchange offer. As with a tender offer, additional ExchangeAct rules will apply to exchanges of debt with equitycharacteristics, such as convertible debt.

The registration statementA registered exchange offer must be registered on a FormS-4 registration statement (Form F-4 for foreign privateissuers).34 It may be time consuming to prepare aregistration statement, particularly if the issuer does nothave the ability to incorporate by reference informationfrom its Exchange Act filings. Also, unlike a Form S-3, aForm S-4 registration statement does not become effectiveautomatically upon filing,35 and except to the limitedextent described below, the exchange offer may not becommenced until the registration statement is declaredeffective. The SEC review process and uncertaintyconcerning timing may make a registered exchange offer aless desirable option for an issuer.

The registration statement must include descriptions ofthe securities being offered, the terms of the exchangeoffer, a description of the issuer and its business and riskfactors. In addition, depending on the extent of therestructuring, the issuer may be required to provide proforma financial information statements reflecting theeffects of the exchange.

Early commencement activitiesRule 162 under the Securities Act provides some flexibilityby allowing an issuer to elect early commencement of itsexchange offer. Rule 162 permits solicitations of tenders incertain exchange offers before the registration statement isdeclared effective.36 An issuer may begin the offering periodprior to effectiveness (shortening the time aftereffectiveness that it must remain open), provided that nosecurities are actually exchanged/purchased until theregistration statement is effective and the tender offer hasexpired in accordance with the tender offer rules. Rule 162is available for exchange offers that comply with Rule 13e-4 and Regulation 14D.

In December 2008, Rule 162 was amended so that itmight be available for exchange offers for straight debtsecurities provided that: (1) the offeror provides the samewithdrawal rights as it would if the offering were for equitysecurities; (2) if a material change occurs in theinformation published, sent or given to the debt holders,the offeror disseminates information about the materialchange to the debt holders in compliance with Rule 13e-4;and (3) the offer is held open with withdrawal rights forthe minimum periods specified in Rule 13e-4 and


Regulation 14D. For exchange offers of straight debtsecurities, an issuer must decide whether the benefits ofearly commencement outweigh the ability to provide no orlimited withdrawal rights, or to provide for an early tenderoption.

Tax considerationsAn issuer that exchanges new debt for old debt, or thatmodifies old debt, may recognise ordinary COD income ifit results in a taxable exchange. In the event of a taxableexchange, the issuer will recognise ordinary COD incometo the extent the adjusted issue price of the old debtexceeds the issue price of the new debt. A modification ofexisting debt or a debt-for-debt exchange will be treated asa taxable exchange if the modification to the old debt issignificant. Generally, modifications are significant if,among other things: (1) the yield changes by the greater of25 basis points and 5% of the existing yield; (2) scheduledpayments are materially deferred; (3) modified creditenhancements change payment expectations; or (4) thenature of the security changes (for example, from debt toequity or from recourse to nonrecourse). By contrast,certain consent solicitations that seek to change“customary accounting or financial covenants” would not,in themselves, constitute significant modifications.

Assuming the exchange or modification constituted arecapitalisation, such exchange or modification generallyshould not result in gain or loss to the debt holder.However, depending on the terms of the new debt relativeto the old debt, certain tax consequences could follow. Forexample, if the principal amount of the new debt exceededthat of the old debt the holder could recognise gain equalto the fair market value of such excess. Exchanges andmodifications also can create OID or, conversely, anamortisable premium, due to differences in the issue priceof the new debt and the stated redemption price atmaturity.

In each case, particular attention must be paid to termsof art like issue price, the meaning of which may varydepending on a number of factors. For example, if existingdebt is publicly traded, the issue price of new debt issued(or constructively issued, in the case of a modification) inexchange for such debt is deemed the current market price.Depending on prevailing economic conditions, debtexchanges or modifications will result in COD income ifthe market prices of existing debt securities are discountedfrom their adjusted issue prices.

Consent solicitationsOften, an issuer may wish to solicit consents from its debtholders, whether on a standalone basis or coupled with atender offer or exchange offer. The purpose of soliciting

such a consent is to modify the terms of the debt securitybeing tendered or exchanged. The first step is to undertakea review of the applicable indenture provisions todetermine the consent requirements for amendments orwaivers. In addition, amendments involving a significantchange in the nature of the investment to the remainingholders may result in the remaining securities beingdeemed a new security that would have to be registeredunder the Securities Act or be subject to an exemptionfrom registration.37 There are a few limitations with respectto consents, in that under most indentures and undersection 316(b) of the Trust Indenture Act of 1939,consents cannot reduce principal or interest, amend thematurity date, change the form of payment or make othereconomic changes to the terms of the debt securities heldby non-tendering debt holders. Several recent court caseshave reinforced the significance of the Trust IndentureAct’s protections and the need to avoid any “coercive”consent solicitation that would result in depriving non-consenting holders from any source of payment on theirsecurities.

Standalone consentsIn certain situations, in order for example to permit apotential transaction, such as an acquisition,reorganisation or refinancing, an issuer may want toconduct a standalone consent solicitation as a means ofamending restrictive covenants or events of defaultprovisions under an existing indenture that otherwisewould limit its ability to engage in the transaction. In thecurrent environment, some issuers must modify indenturecovenants that restrict or prohibit a restructuring of otherdebt in order to preserve going concern value and avoidbankruptcy. Because consenting holders will remainsubject to the terms of the indenture as amended orwaived, holders may be reluctant to agree to significantchanges. Standalone consent solicitations typically remainopen for a minimum of 10 business days, although asupplemental indenture giving effect to the amendmentsor waivers sought may be executed and delivered as soon asthe requisite consents from security-holders are obtained.

Exit consentsIf an issuer would like to significantly change restrictiveindenture provisions, a tender offer or exchange offercoupled with a consent solicitation can be an attractiveoption. Exit consents are different from standalone orordinary consent solicitations because they are given bytendering or exchanging debt holders (who are about togive up the old securities) as opposed to continuingholders of the old debt securities. The tendering debtholders will be required to consent to the requested


amendments as part of the tender of securities pursuant tothe tender offer or exchange offer.

If the requisite percentage of holders (specified in theindenture) tender their securities, the issuer will be able toamend the terms of the indenture and bind all the holders.Exit consents can prove to be a useful incentive toparticipate in a tender or exchange offer and to addressholdout problems. These amendments or waivers generallywill not affect the tendering holders that receive cash ornew securities upon the consummation of the offer.38

However, the result of obtaining the requisite consents isthat non-tendering holders will be bound by the changes.Accordingly, when an issuer announces that the requisitenumber of holders (for example a majority) has decided toparticipate in the tender offer or exchange offer, for allpractical purposes the remaining debt holders must decidewhether to tender/exchange, or be left with a debtobligation with significantly reduced protections.

Generally, a consent solicitation is not subject to anylegal framework other than that applicable to tender offersand exchange offers. US courts have viewed exit consentsas permissible contract amendments governed by basiccontract law principles.39 The total consideration offered ina tender or exchange may include a consent paymentavailable only to holders that tender on or prior to theconsent deadline, typically 10 business days after thecommencement of the offer and consent solicitation (atender offer or exchange offer must be kept open for 20business days). Typically, the payment deadline also is theexpiration time for withdrawal rights, unless such rightsare required by statute to remain available longer.

In some instances, the modifications effected by theconsent solicitation or exit consent may rise to the level ofa modification for tax purposes.

Other exchanges

Debt equity swapsA debt equity swap is another means of recalibrating anissuer’s balance sheet. In a debt equity swap, the issuerexchanges already outstanding debt for newly issued equitysecurities. It is, in essence, an exchange offer. A debt equityswap may be executed with a bank lender, or it may beexecuted with holders of an issuer’s debt securities. In fact,in recent years, it has become more common for a bank orother lender to engage in a debt equity swap rather thanforce a defaulting issuer into bankruptcy. Lenders oftenhope that they will receive a higher return on theirinvestment by taking an equity position. The issuer, bychanging its debt to equity ratio, benefits financially fromthe exchange, and may improve its ratings.

Securities law considerationsThere are a number of considerations that an issuer mustbear in mind in carrying out a debt equity swap. The issuermust be mindful that any exchange of securities mustcomply with the tender offer and exchange rules describedabove. If a lender extinguishes a bank line in exchange forequity, the issuance of the equity securities must complywith all applicable securities laws – namely it must eitherbe registered or exempt from registration. In addition, anissuer needs to be mindful of the disclosure obligationsthat may be triggered by such an event, as it may constitutea material event.

Corporate governance and other considerationsThe number of shares to be issued depends on the value ofoutstanding debt to be exchanged. An issuer seeking toengage in a debt equity swap must ensure that it hassufficient authorised capital available prior to commencingthe exchange. If the issuer lacks sufficient authorisedcapital, it may be necessary to amend the issuer’s certificateof incorporation to increase the share capital. This canoften be a time consuming process since it entails seekingshareholder approval. An issuer also needs to determine thepercentage of equity securities that may be issued; anissuance of over 20% of pre-transaction total sharesoutstanding may trigger national securities exchangelimits,40 and may require shareholder approval. Because theissuance of equity securities as part of a debt equity swapwill be dilutive to existing holders, this may prove difficult.

Because the lender or debt holder will be effectivelysubordinating its position by giving up its creditor status,it may require a sweetener – this may come in the form ofissuing preferred stock or convertible preferred stock, orissuing participating preferred. An issuer needs to considercarefully the terms of the security it will offer, includingthe class, voting rights and dividend.

Tax considerationsAn issuer that engages in a debt equity swap will recogniseordinary COD income to the extent the adjusted issueprice of the debt exceeds the market value of the equity itissues. Similar to debt for debt exchanges, a debt for equityswap also should not result in gain or loss to the holder ifthe exchange constitutes a recapitalisation. It should benoted market discount accrued on the exchanged debt willcarryover to the equity.

Equity for equity exchangesWhen an issuer tenders for its own equity securities, anumber of considerations arise. First, an issuer must ensurethat it is permitted to engage in the exchange under statelaw. section 160(a)(1) of the Delaware General


Corporation Law prohibits a corporation from purchasingits own stock if the entity’s capital is impaired or if suchpurchase would impair capital.

In the context of an equity for equity exchange, an issuermust be mindful of its disclosure obligations underRegulation FD and the securities law antifraud provisions,particularly Rule 10b-5. Under Rule 10b-5 an issuer isprohibited from purchasing its securities when it is inpossession of material non-public information. The sameconsiderations that apply to a purchase of debt securitiesare applicable in this context. An issuer must determinewhether the transaction itself constitutes material non-public information. An issuer also must determinewhether it is in possession of other information, such asunreleased earnings or an unannounced acquisition, thatmust be disclosed prior to commencing an exchange.

In addition, an issuer must comply with all tender offerrules when conducting an equity exchange. Sections 13(d),13(e), 14(d), 14(e) and 14(f ) all are applicable to an equityexchange. An issuer also is required, as it is with anexchange of convertible debt, to file a Schedule TO withthe SEC.

An issuer must be cautious that its equity exchange doesnot inadvertently trigger the going private rules under Rule13e-3 of the Exchange Act. These rules apply if anypurchase of an issuer’s equity securities is intended to causethe equity security of an issuer registered under section12(g) or section 15(d) of the Exchange Act to be held byfewer than 300 persons. Rule 13e-3(g)(2) contains anexemption from the going private rules if the securityholders are offered or receive only an equity security that:(1) has substantially the same rights as that being tendered,including voting, dividends, redemption and liquidationrights (except that this requirement is deemed satisfied ifnon-affiliated holders are offered common stock); (2) isregistered pursuant to section 12 of the Exchange Act (orreports are required to be filed by the issuer pursuant tosection 15(d)); and (3) is listed on a national securitiesexchange or authorised to be quoted on Nasdaq (if thetendered security also was so listed or quoted).

If an equity exchange involves a distribution underRegulation M, the issuer is prohibited from making bidsfor, or purchasing, the offered security. These prohibitionswill not apply to investment grade rated, nonconvertiblepreferred stock, however. These restrictions typicallycommence when the exchange offer materials are mailedand continue through the conclusion of the offer.

Incentives and disincentivesThere are a number of structural considerations that maycreate incentives to tender or to tender early. An issuershould consider some or all the following depending on

the structure and legal requirements of the tender orexchange:

• Minimum threshold. To discourage holdouts require, asa condition to the tender or exchange, require that asubstantial percentage (typically 90% or higher) of theoutstanding securities be tendered.

• Sweeteners. Encourage acceptance of the tender orexchange offer by providing a cash payment or betterterms for the new securities. Consider offeringtendering/exchanging holders an inducement in theform of a warrant kicker or common stock (if there ispotential for future upside), or exchanging highcoupon, unsecured debt for low coupon, secured debt.In addition, consider providing recourse to collateral.

• Exit consents. Solicit exit consents simultaneous with thetender or exchange offer to penalise holdouts (bystripping protective covenants and events of defaultfrom the old securities).

• Early tender premium or consent payment. Motivateholders to tender early by establishing an early tenderpremium or early consent payment. The best price ruledoes not apply to tender and exchange offers for straightdebt securities.

• The bankruptcy threat. In a restructuring, convey thatbankruptcy is unavoidable if the tender or exchangeoffer fails and that debt holders will be in a betterposition if bankruptcy is avoided. This involves adelicate balancing act.

Liability considerationsRestructuring transactions, whether redemptions, privatelynegotiated or open market purchases, or tender orexchange offers, involve the purchase and sale of [a]security. Therefore, these transactions are subject to thegeneral antifraud provisions of section 10(b) of theExchange Act and Rule 10b-5. section 10(b) of theExchange Act is an implied cause of action covering alltransactions in securities and all persons who use anymanipulative or deceptive devices in connection with thepurchase or sale of any securities. Rule 10b-5 coverssubstantially the same ground as section 10(b) andprohibits, among other matters, the making of any untruestatement of a material fact or the omission of a materialfact necessary to make the statements made notmisleading. Under Rule 10b-5, the issuer, its directors,officers and employees, and its agents, including financialintermediaries retained by the issuer, may be held liable.


Tender and efxchange offers are also subject to section14(e) of the Exchange Act and the rules promulgatedthereunder. In addition to specific proceduralrequirements, section 14(e) contains substantially identicalprohibitions regarding material misstatements andomissions as section 10(b) and Rule 10b-5.

If the exchange offer is registered under the SecuritiesAct, participants, in addition to liabilities under theExchange Act, will be subject to liability under theSecurities Act, including section 11 liability (with respectto registration statements) and section 12 (with respect tothe prospectuses and oral communications).41 Financialintermediaries in particular may be subject to liability asstatutory underwriters in connection with solicitations ofparticipation in the exchange offer.42 It is thereforecustomary for a dealer-manager, in order to avail itself of adue diligence defence to Securities Act liability, to engagein appropriate due diligence regarding the issuer and itsoperations, financial status and prospects as well as toreceive legal opinions and comfort letters from the issuer’saccountants. The diligence process also adds time and costto the exchange offer.

Legal challengesRestructurings may lead to legal challenges. The legalchallenges usually come from holders of securities that donot participate in the restructuring and believe the value ofthese securities or the protections afforded by theirsecurities are adversely affected. In addition, because the allholders rule does not apply to tender offers for straightdebt securities, holders who are not offered the right toparticipate (for example, because the offering is limited toQIBs) may also claim that their securities are impaired.The effects of litigation can be burdensome. In someinstances, the litigation will enjoin the issuer fromcompleting the tender or exchange offer. However, iflitigation is resolved after the completion of thetransaction, it is unclear how the violation would beremedied because in the case of an exchange, holdersalready hold the new securities.

Realogy CaseA 2008 Delaware court case crystallises some of thechallenges associated with debt restructurings. In theRealogy case,43 Realogy Corporation announced anexchange offer for its outstanding notes (Senior Notes due2014, Senior Toggle Notes due 2014 and SeniorSubordinated Notes due 2015) for up to $500 million ofadditional term loans issued pursuant to an accordionfeature under Realogy’s senior credit facility. Thisaccordion feature allowed Realogy to incur additionalindebtedness under the credit facility. The new term loans

would be secured, whereas existing notes were unsecured.The terms of the offer set a priority as to which holderswere entitled to accept the offer – holders of SeniorSubordinated Notes ($125 million), then holders of SeniorNotes ($500 million) and then holders of Toggle Notes($500 million, less any amounts tendered by the otherclasses). As a result of this priority, holders of Toggle Noteswould likely be unable to participate in the exchange offerand would, effectively, be subordinated to tenderingholders from the other classes who would receive secureddebt.

The trustee and a noteholder controlled by Carl Icahn,High River, sued Realogy on the basis that, among otherthings, the exchange offer violated the terms of theindenture, specifically the negative pledge covenant. Thesenior credit facility allowed Permitted RefinancingIndebtedness to refinance the notes, provided therefinancing indebtedness had no greater security than thedebt being refinanced. Because the new loans were secured,and the notes being exchanged were not, the court foundin favor of the trustee, reasoning that the new loans werenot Permitted Refinancing Indebtedness and, as a result,the liens securing the new loans were not Permitted Liensunder the indenture. The court granted the plaintiffssummary judgment and the exchange offer did notproceed.

This case turned on contract negotiation and the specificterms of the contracts, and it highlights the need to ensurethat a thorough and complete review of the underlyingdocuments, other debt instruments and an issuer’s capitalstructure is completed before commencing anyrefinancing.

ConclusionFor balance sheet restructuring, like so many other thingsin life, timing can be everything. Issuers are cautioned notto wait too patiently for their fortunes to improve. Themost effective balance sheet restructuring occurs when anissuer’s balance sheet is neither too healthy nor too stressed.It’s a bit like Goldilocks’ porridge – best eaten when nottoo hot and not too cold.


Exchange requirementsThe securities exchanges, the New York Stock Exchange(NYSE), the Nasdaq Stock Market (Nasdaq) and theNYSE MKT (NYSE MKT and collectively, theexchanges), require shareholder approval for the issuanceof equity securities by their listed issuers in varioussituations.44 Each exchange also applies these shareholderapproval provisions to offerings of securities that areconvertible into or, in the case of the NYSE and Nasdaq,exchangeable for, common stock, such as convertible debt.An issuer must carefully review the Exchange provisions ifthe security to be exchanged in a restructuring is eitheractual equity or convertible or exchangeable debt, or if thetransaction cannot be categorised as a public offering.

Under Nasdaq Rule 5635 and NYSE MKT Rules 712and 713, shareholder approval is required for transactionsinvolving the issuance of:

• 5% or more of the current outstanding common stockin an acquisition, if a director, officer, or substantialsecurity holder of the issuer has a 5% interest (10% if agroup) in the company or assets to be acquired;

• 20% or more of the current outstanding common stockin an acquisition; or

• 20% or more of the current outstanding common stockin any transaction other than a public offering.

Under NYSE Rule 312.03, shareholder approval is aprerequisite to issuing additional shares equal to:

• more than 1% of the current outstanding common stockto an insider (an officer or director, or an entity affiliatedwith an officer or director) or a substantial holder;however, if the purchaser is only a substantial holder(and not an officer or director) and the cash purchaseprice is at least as great as each of the book and marketvalue of the issuer’s common stock, then shareholderapproval will not be required unless the number ofshares of common stock to be issued (or into which thesecurity may be convertible or exercisable), exceedseither 5% of the outstanding common stock before theissuance; or

• 20% or more of the current outstanding common stockother than an issuance involving a public offering or a

“bona fide private financing” (as defined in NYSE Rule312.04(g)).

The percentages in all cases apply both to outstandingcommon equity or common voting power.45

Each exchange also requires shareholder approval whenan issuance will result in a change of control of the issuer.46

None of the exchanges however, has adopted a definitionof “change of control.” A general rule of thumb (there arevariations between the exchanges) is that purchases ofbetween 20% and 30% of the outstanding voting stockmay be deemed a change of control, unless preexistingcontrol positions are not displaced by the transaction. It isprudent to consider both the change of control rule andthe 20% rule in any transaction that involves an issuanceclose to 20%. In many cases, it will be appropriate toconsult the relevant exchange early in the transactionprocess.

Shareholder approval is not required for financingtransactions (involving share issuances) that are structuredas public offerings under the rules or policies of any of thethree exchanges. It is important to note that an offering isnot deemed to be a public offering for these purposesmerely because it is effected under a registration statement.The Nasdaq and NYSE MKT staffs will consider allrelevant factors when determining whether an offering willqualify for the public offering exemption, including, butnot limited, to: (i) the type of offering;47 (ii) the manner inwhich the offering is marketed; (iii) the extent of theoffering’s distribution, including the number of investorswho participate in the offering; (iv) the offering price; and(v) the extent to which the issuer controls the offering andits distribution. The NYSE does not offer formal guidanceto determine when a particular offering would qualify as apublic offering in the context of a restructuring. It shouldalso be noted that restructurings effected under Rule 144Aof the Securities Act are, by definition, not public offeringsdespite the fact that such offerings typically having manyof the indicia of a public offering.

Each of the NYSE, Nasdaq and NYSE MKT hasindicated48 that mere filing of tender offer documents withthe SEC does not necessarily make the tender offer apublic offering, and that they should be contacted when aparticular transaction arises for a definitive determination.NYSE MKT suggested that two factors to be consideredare: (i) the market price of the security when issuedcompared to the price at which it is being exchanged; and

APPENDIX A

Other considerations


(ii) the original price the debt was being issued and whatthe reset is. Because of the uncertainty regarding whether aregistered exchange offer will be categorised as a publicoffering, exchange offers may be structured with a cap (inother words, the exchange is capped at 19.9% and theremaining percentage above 20% is subject to shareholderapproval).49

Finra requirementsIf a financial intermediary (such as a dealer-manager) isinvolved in the restructuring, the requirements of TheFinancial Industry Regulatory Authority (Finra) may alsoapply. Finra Rule 5110 known as the Corporate FinancingRule, requires certain filings with Finra to determinewhether the compensation to the financial intermediary isfair. However, the financial intermediary does not have tofile (although it will be required to comply with thesubstantive provisions of Finra Rule 5110) if thetransaction is an exchange offer where the securities to beissued are listed on Nasdaq, the NYSE or the NYSE MKT;or the issuer qualifies to register an offering on Forms S-3,F-3, or F-10 under the Securities Act.50 Finra Rule 5110will not apply at all if the transaction is a tender offer madepursuant to Regulation 14D, which regulates tender offersfor equity securities. Absent any such exception, aregistered exchange offer has to be filed with Finra forreview.

Involvement of affiliatesUnder certain circumstances, affiliates of an issuer mayseek to purchase the issuer’s debt securities. This may occuron the corporate level, such as when a parent purchasessecurities of its subsidiaries or when subsidiaries purchasesecurities of its parent or other subsidiaries. It may alsooccur if officers, directors or significant shareholders seekto purchase the securities. In these instances, the affiliateswould generally be considered insiders of the issuer andsubject to the same disclosure obligations as the issuer. Theissuer should coordinate closely with the affiliate instructuring any repurchase program, including to ensurethat other corporate requirements are not implicated, suchas an affiliate running afoul of the corporate opportunitydoctrine. In many circumstances, involvement of anaffiliate may preclude reliance on the section 3(a)(9)exemption for an exchange offer.


When should an issuer engage an investment bank orother financial intermediary to assist with liabilitymanagement transactions? The short answer is that itdepends. It depends on the issuer’s situation and thetransaction contemplated. Generally, the more complexand significant a restructuring, the more helpful it may beto engage an investment bank as financial adviser. Thebank will help formulate a restructuring plan, locate andidentify security holders, structure the transaction, solicitparticipation, assist with presenting the structure to thevarious stakeholders, assist with rating agency discussionsand manage the marketing efforts to achieve a successfulrestructuring. Issuers should consider a number of factors,such as the number of debt holders, their organisation andsophistication and whether the issuer has informationabout, and any contact with, its debt holders. In adistressed situation, the challenges that many issuers faceoften lead them to contact an investment bank. Typically,such banks have liability management, restructuring orworkout teams specialised in debt restructurings. Issuersthat wish to take advantage of declining secondary marketprices for debt securities also may benefit from engaging aninvestment bank to locate, contact and negotiate with debtholders to sell (or exchange) their debt securities. The typeof transaction will dictate the investment bank’s role,which ranges from merely an advisory role orresponsibilities as an agent, principal or as dealer-manager,as well as any limitations on its activities.

Debt repurchasesIf the issuer has few debt holders that are already known toit, it may not need assistance from an investment bank.However, an investment bank may be involved in thesetransactions, for example, to contact and bring unknowndebt holders to the table, acting either as an agent (actingas a broker for the issuer) on behalf of the issuer, or asprincipal (buying the debt securities from the debt holderand selling them back to the issuer). Both the issuer and itsadvisers must be mindful of any activities that put arepurchase at risk of being deemed a tender offer.

Tender offersThe investment bank’s role varies in tender offers. In a cashtender offer for straight debt, an issuer may engage aninvestment bank in an advisory role. In a tender offer forconvertible debt securities, which is subject to additionaltender offer rules, an issuer may choose to engage an

investment bank in an advisory role to contact andnegotiate the terms with debt holders or to act as a moreactive dealer-manager. In a tender offer coupled with aconsent solicitation or a public tender offer for alloutstanding debt securities, issuers usually engage a dealer-manager to manage the process. In these transactions,issuers also often use an investor relations firm to act asinformation agent during the process. There are no specificrules regarding compensation preventing issuers fromusing – and paying – an investment bank to solicit tenders.

Exchange offers

Private exchange offersAn issuer may choose to engage an investment bank in anadvisory role for a private exchange offer, however, becausethe exchange involves a limited number of debt holders, amore active dealer-manager is not always needed. Issuersmay engage the bank that acted as the initial purchaser forthe old debt securities, this way, in an exchange offer underRule 144A, the bank may have existing QIB letters on fileto pre-qualify holders. There are no specific rules regardingcompensation preventing issuers from using, or paying, aninvestment bank to solicit private exchanges.

Section 3(a)(9) exchange offersIssuers are permitted to engage third parties, such asfinancial advisers and investor relations firms, to assist withsection 3(a)(9) exchanges, but their role must be limited.Under section 3(a)(9), an issuer cannot pay anyone,including a financial adviser or dealer-manager, to solicitexchanges. Pursuant to SEC no-action guidance, afinancial adviser may undertake certain activities so long asit is not paid a success fee. Issuers facing a complexrestructuring may decide that they need a dealer-managerto solicit exchanges and manage the process to ensure asuccessful restructuring.

The SEC has provided guidance as to how aninvestment bank may be compensated in a section 3(a)(9)exchange. In general, an investment bank can:

• engage in pre-launch discussions or negotiations withlegal and financial representatives of bondholdercommittees;

• provide a fairness opinion;51 and

APPENDIX B

The role of the financial intermediary


• only provide debt holders with information that wasincluded in communications sent directly by the issuer.In general, an investment bank cannot:

• solicit (directly or indirectly) exchanges or consents; and

• make recommendations regarding the exchange offer todebt holders or their advisors.

If an investment bank is involved in a section 3(a)(9)exchange offer, it should be paid a fixed advisory fee, asopposed to a success fee for its services. Although, paidpromotion is strictly off-limits, the issuer can stillreimburse an advisor for expenses related to the exchange.

The issuer may rely on an investor relations firm or othersales force, such as engaging an information agent, toinform security holders of the exchange offer.52 Filling thisrole with an investment bank is efficient as the firm thatsold the securities in the first place may be in the bestposition to contact the holders. The permitted activitiesare limited to contacting security holders to confirm thatthe issuer’s mailings were received, that the security holderunderstands the mechanical requirements necessary toparticipate in the exchange, and to determine whether thesecurity holder intends to participate in the exchangeoffer.53 Under this arrangement, however, payment wouldhave to be made on a flat, per-contact basis, andcommunications with security holders may not includeany recommendation regarding the decision to accept orreject the exchange offer.54 An issuer should instruct itsagents to defer on all questions relating to the merits of theoffer if the issuer wishes to use the section 3(a)(9)exemption.

Registered exchange offersIn a registered exchange offer, there is more flexibilityregarding the investment bank’s role. Often, an issuerengages an investment bank to act both as adviser and asdealer-manager (which includes soliciting holders if theexchange offer is coupled with a consent solicitation). Thedealer-manager for a registered exchange offer (or a publictender offer) may actively solicit acceptances and becompensated for these activities, including with a successfee. Because of the heightened liability standard involvedwith a registered exchange offer, the dealer-manager willwant to conduct due diligence comparable to the diligenceconducted for an ordinary registered offering of securities.In addition, the dealer-manager may require delivery oflegal opinions, a 10b-5 negative assurance letter withrespect to disclosure, and a comfort letter or agreed uponprocedures letter.55 The dealer-manager must keep in mindall rules relating to pre-filing or pre-launch

communications with debt holders in order to avoid gun-jumping issues and Regulation FD issues.


1 See, for example, Order in the Matter of Fifth Third Bancorp,

http://www.sec.gov/litigation/admin/2011/34-65808.pdf.

2 Harris v. Union Electric Co., 787 F. 2s 355 (8th Cir. 1986), cert. denied,

479 US 823 (1986).

3 Wellman v. Dickinson, 475 F. Supp. 783, 823-24 (S.D.N.Y. 1979).

4 For example, an open-market purchase of 25% of an issuer’s stock was

held not to constitute a tender offer because: (1) the purchaser contacted

only six of the 22,800 security holders; (2) all six of those security

holders were highly sophisticated; (3) the purchasers did not pressure the

security holders in any way that the tender offer rules were designed to

prevent; (4) the purchasers did not publicise the offer; (5) the purchasers

did not pay a significant premium; (6) the purchasers did not require a

minimum number of shares or percentage of stock; and (7) the

purchasers did not set a time limit for the offer. Hanson Trust PLC v.

SMC Corp., 774 F. 2d 47, 57-59 (2d. Cir. 1985).

5 The date on which the tender offer is first published or sent or given to

the holders of the relevant securities is the first business day.

6 See the text accompanying note 135 of SEC Release No. 34-42055

(October 22 1999), available at http://www.sec.gov/rules/final/33-

7760.htm.

7 If the securities are registered on one or more national securities

exchanges, the announcement must be made by the first opening of any

one of such exchanges on the business day following expiration.

8 See SEC No-Action Letter, Alliance Semiconductor Corporation

(September 22 2006).

9 See SEC No-Action Letter, Abbreviated Tender or Exchange Offer for

Non-Convertible Debt Securities (January 23 2015).

10 See SEC No-Action Letter, Salomon Brothers Inc. (March 12 1986);

SEC No-Action Letter, Goldman Sachs & Co. (March 26 1986); SEC

No-Action Letter, Merrill Lynch, Pierce, Fenner & Smith Inc. (July 2

1986).

11 SEC No-Action Letter, Salomon Brothers, Inc. (October 1 1990).

12 SEC No-Action Letter, Merrill Lynch, Pierce, Fenner & Smith Inc. (July

19 1993).

13 The SEC also has granted no-action relief in the context of preferred and

hybrid securities that behave more like debt securities than equity

securities. See SEC No-Action Letter, BBVA Privanza International

Limited and Banco Bilbao Vizcaya Argentaria, S.A. (December 23

2005).

14 The SEC, aware of the length of the offer period, will typically provide

any comments within the first 10 days.

15 Issuers must be sensitive to whether there are written communications,

such as in a press release or a Form 10-K, Form 10-Q or Form 8-K, that

are often made in advance of the commencement of the tender offer, and

that must be filed pursuant to Rule 13e-4(c) – for example, by checking

the box on the cover of Form 8-K.

16 The tender offer rules have not been revised or amended to take into

account greater reliance on the Internet.

17 This requirement is in addition to the prohibition in Rule 14e-5 that,

with certain exceptions, prohibits covered persons from, directly or

indirectly, purchasing or arranging to purchase any subject securities or

any related securities (that is, securities immediately convertible or

exchangeable for the subject securities) except as part of the tender offer.

Covered persons include the offeror, its affiliates and the dealer-manager

and its affiliates.

18 Please see: “New Fasb Accounting Rules on Convertible Debt” for a

discussion of accounting changes related to convertible debt at

http://www.mofo.com/news/updates/files/Client_Alert_FASB_Accountin

g.pdf.

19 Qualified institutional investor is defined in Rule 144A under the

Securities Act.

20 “Accredited investor” is defined in Rule 501 of Regulation D under the

Securities Act.

21 See SEC No-Action Letter Echo Bay Resources Inc. (May 18 1998).

22 However, the SEC did not find a single identity of issuer between a

subsidiary and its parent where the subsidiary had outstanding a class of

debentures guaranteed by its parent and the subsidiary proposed to offer

a new debenture in exchange for the guaranteed debenture that would

not be guaranteed by its parent. See SEC Division of Corporation

Finance, Compliance and Disclosure Interpretations: Securities Act

Sections (#125.05) (November 26 2008), available at

http://www.sec.gov/divisions/corpfin/guidance/sasinterp.htm.

23 See SEC No-Action Letter, Grupo TMM, S.A. de C.V. (June 27 2002).

ENDNOTES


24 See SEC Division of Corporation Finance, Compliance and Disclosure

Interpretations: Securities Act Sections, available at

http://www.sec.gov/divisions/corpfin/guidance/sasinterp.htm; and SEC

Division of Corporation Finance, Compliance and Disclosure

Interpretations: Securities Act Rules, available at

http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-

interps.htm.


Interpretations: Securities Act Sections (#125.04) (November 26 2008),

available at http://www.sec.gov/divisions/corpfin/guidance/sasinterp.htm.

26 See SEC No-Action Letter, URS Corporation (May 8 1975).




28 See SEC No-Action Letter, Exxon Mobil Corp. (June 28 2002).

29 SEC No-Action Letter, Seaman Furniture Co., Inc. (October 10 1989);

see also SEC Division of Corporation Finance, Compliance and

Disclosure Interpretations: Securities Act Sections (#125.06) (November

26 2008), available at


30 SEC No-Action Letter, Dean Witter & Co., Inc. (November 21 1974).

See also SEC No-Action Letter, Stokley-Van Camp, Inc. (March 31

1983).




32 See e.g. SEC Division of Corporation Finance, Compliance and




33 The five factor test requires that an issuer consider: whether the offerings

are part of a single plan of financing; whether the offerings involved

issuances of the same class of securities; whether the offerings were made

at or about the same time; whether the same type of consideration is

received; and whether the offerings were made for the same general

purposes. See SEC Release No. 33-4552 (November 6 1962).

34 Forms S-3 and F-3 are available only for offerings for cash; they are not

available for an exchange offer.

35 This is a particular issue for well known seasoned issuers or WKSIs, who

may be used to automatic effectiveness of their registration statements.

36 Many market participants and commentators note that there remains a

need to examine the registration requirements for exchange offers,

particularly as they affect WKSIs. In particular, market participants have

suggested that registration statements on Form S-4 filed by WKSIs

become effective immediately upon filing. See Letter from Securities

Industry and Financial Markets Association to the Securities and

Exchange Commission, dated January 27 2009.

37 An attempt to revise key payment terms such as maturity, interest rate or

type of interest paid may be considered an offer and sale of a “new

security” under SEC interpretations, which would be treated as an

exchange offer for securities law purposes. See Bryant B. Edwards and

Jon J. Bancone, “Modifying Debt Securities: The Search for the Elusive

‘New Security’ Doctrine,” 47 BUS LAW, 571 (1992).

38 The effectiveness of the amendments and waivers is typically subject to

the condition that the tendered securities have been accepted for

payment or exchange pursuant to the offer.

39 See example, Katz v. Oak Industries, 508 A. 2d 873 (Del. Ch. 1986).

40 Discussed further in Appendix A.

41 Cash tender offers are not registered under the Securities Act. Therefore,

none of the participants, including financial intermediaries, will have

Securities Act liabilities.

42 Section 2(a)(11) of the Securities Act defines underwriter broadly as:

“Any person who has purchased from an issuer with a view to, or offers

or sells for an issuer in connection with, the distribution of any security,

or participates or has a direct or indirect participation in any such

undertaking, or participates or has a participation in the direct or

indirect underwriting of any such undertaking; but such term shall not

include a person whose interest is limited to a commission from an

underwriter or dealer not in excess of the usual and customary

distributors’ or sellers’ commission.”

43 The Bank of New York Mellon and High River Limited Partnership v.

Realogy Corporation, 979 A.2d 1113, 2008 Del. Ch. LEXIS 186 (Del.

Ch. 2008).

44 See example, Nasdaq Marketplace Rule 5635 (the Nasdaq rules) and

related publicly available interpretive guidance; NYSE Issuer Manual

Sections 312.00 – 312.07 (the NYSE rules); and NYSE MKT LLC

Company Guide Sections 710-713 (the NYSE MKT Rules).

45 Nasdaq Rule 5635(e)(1) and NYSE Rule 312.04(d) each provide that

only shares actually issued and outstanding (excluding treasury shares or

shares held by a subsidiary) are to be used in making any calculation


provided for in this paragraph: (i). Unissued shares reserved for issuance

upon conversion of securities or upon exercise of options or warrants will

not be regarded as outstanding. NYSE MKT does not have a similar

rule.

46 See Nasdaq Rule 5635(b), NYSE MKT Rule 713(b) and NYSE Rule

312.03(d).

47 For example, this may include: (1) whether the offering is conducted by

an underwriter on a firm commitment basis; (2) whether the offering is

conducted by an underwriter or placement agent on a best efforts basis;

or (3) whether the offering is self-directed by the issuer. See Nasdaq

Interpretive Material 5635-3; Commentary to NYSE MKT Section 713.

48 Telephone conversations between this firm and each of the exchanges.

49 In certain circumstances, if the issuance of the original securities was

structured to comply with the 19.9% cap, the Exchanges may, unless the

issuer can demonstrate a change of circumstances, aggregate any

securities issued in the exchange with the remaining outstanding non-

tendered securities for purposes of calculating the percentage. In

addition, the exchange may calculate the percentage based on the issuer’s

outstanding share capital as of the original issue date as opposed to the

exchange date.

50 For Finra purposes only, an issuer’s qualification to register an offering

on Form S-3, F-3 or F-10 is based on the eligibility requirements prior

to October 21 1992, which were conditioned on a 36-month reporting

history and $150 million aggregate market value of the voting stock held

by non-affiliates (or $100 million and an annual trading volume of 3

million shares).

51 An issuer is permitted to hire an investment bank to render a fairness

opinion on the terms of the exchange; however, if the investment bank

also is acting as a dealer-manager and conducting solicitation activities,

the SEC has held that obtaining a fairness opinion would violate Section

3(a)(9). See SEC Division of Corporation Finance, Compliance and




52 Other permitted activities involve confirming debt holder contact details,

confirming their receipt of all requisite materials and reminding debt

holders of approaching deadlines.

53 SEC No-Action Letter, Dominion Mortgage & Realty Trust (April 3

1975).

54 This second requirement applies to any of the issuer’s agents who contact

the security holders, and not only to dedicated sales departments.

55 These deliverables are usually also requested by the dealer-manager in a

tender offer. The scope of these deliverables can significantly increase the

cost of the tender offer or exchange offer and are often negotiated

between the parties.


CHAPTER 2

Liability management: summary of options

Redemptions

Repurchases

Debt tenders

• Speed (no registrationrequired, no documentationneeded)

• Flexible (may redeem all orpart of an outstanding class)

• Speed (no registrationrequired and nodocumentation needed)

• Privately negotiated. Pricingtakes advantage of marketfluctuations

• Less visibility to the market• For financial institutions, may

help improve Tier 1 regulatorycapital position

• May be part of an ongoingrepurchase program

• May engage investment bankto assist

• Speed (no registrationrequired and not subject toSEC review, unless convertibledebt)

• Flexible (able to retire an entireseries or class of debtsecurities)

• Able to approach all holders(subject to compliance withthe tender offer rules)

• May engage investment bankto solicit

• Can pair with a consentsolicitation

• Requires cash on hand• Expensive (redemption price

usually preserves yield tomaturity)

• Notice must be outstandingbetween 30 and 60 days(rates may fluctuate)

• Requires cash on hand• May only retire a small

percentage of securities froma limited number of holders

• May trigger disclosureobligations

• May trigger tender offer rules

• Requires cash on hand• If subject to the tender offer

rules, debt tenders must beheld open for a specified timeperiod, which may varydepending upon the ratingascribed to the debt securitiesand the ability to comply withcertain conditions specified inSEC guidance

• Holdout issue• Convertible debt tenders are

subject to the tender rules forequity securities

• Must pay all investors of thesame class the same price (ifsubject to the tender offerrules regarding any equityderivative)

ADVANTAGES DISADVANTAGES


Private exchange offer

3(a)(9) exchange offer

• Speed (no registrationrequired and not subject toSEC review, unless convertibledebt)

• Does not require cash on hand(only minimal costs)


• May engage investment bankto solicit

• Able to pre-certify investorstatus

• No section 11 liability inrespect of offeringmemorandum


• Often can be accomplishedlargely tax-free for debtholders

• Speed (no registrationrequired and not subject toSEC review)




• No section 11 liability withregard to offeringmemorandum



• Generally limited to QIBs andnon-US investors

• No general solicitationpermitted

• Holdout issue• New securities may be

restricted (but holder may beable to tack its holding period)

• Holders may requestregistration of the newsecurities

• New securities may berestricted (but holder may beable to tack its holding period)

• Limited ability to engage andcompensate investment bank

• Holdout issue• May be integrated with offers

made in close proximity• Must pay all investors of the

same class the same price (ifsubject to the tender offerrules)



Registered exchange offer

Debt for equity exchanges


• Does not require cash on hand • New securities are freely

transferable• May engage an investment

bank to solicit (no restrictionson compensation)




• Used by issuers as analternative to bankruptcybecause of upside potentialfor investors

• Improves debt/equity ratio,potentially improving creditratings




• Time consuming (subject toSEC review and filingrequirements)

• Must remain open for 20business days (if subject tothe tender offer rules)

• Section 11 liability • More expensive than an

unregistered exchange offer orrepurchase

• Holdout issue• Must pay all investors of the


• If registered, can be timeconsuming (subject to SECreview and filing requirements)

• Must remain open for aspecified time period (ifsubject to the tender offerrules)

• Equity issuance may triggersecurities exchange issuancelimitations

• If insufficient share capital,issuer may be required toobtain shareholder approval

• Terms of equity securities maybe onerous

• Must pay all investors of thesame class the same price (ifsubject to the tender offerrules)



Equity for equity exchanges

Consent solicitation


• Terms of new securities maybe less onerous

• Generally a tax freetransaction


• May be undertaken alone orwith a tender or exchangeoffer

• Able to modify onerous orrestrictive covenants

• Not subject to SEC review ortender offer rules

• No section 11 liability• Does not require cash on hand

(only minimal costs)• Generally tax-free unless

considered a significantmodification of the debt

• Must be permitted under statelaw

• If registered, can be timeconsuming (subject to SECreview and filing requirements)

• Must remain open for aspecified time period (ifsubject to the tender offerrules)

• No balance sheet impact• Must pay all investors of the


• May require a supermajority toenact modifications

• TIA does not permitmodification of interest,principal, maturity and otherprovisions without 100%approval; TIA provisions mayserve to limit certainamendments that depriveholders of a right to a sourceof payment

• Modifications may result in theremaining securities beingconsidered new for SecuritiesAct purposes

• Holdout issue



CHAPTER 3

Liability management continuum

Least documentation Most documentation

Redemptions

Repurchases

Debt tendersDebt for equityswaps

Private exchangeoffers

3(a)(9) exchangeoffers

Registeredexchange offers

Equity for equityexchanges

Least time consuming Most time consuming


An issuer considering debt repurchases faces aseries of important decisions regarding thescope of the repurchases, terms, and otherrelated matters. For example, an issuer may

purchase debt securities consensually in open markettransactions or, conversely, in a non-consensual redemptionaccording to the terms of the applicable indenture or notepurchase agreement. Alternatively, the issuer may exchangeoutstanding securities for a new series of securities.1

Depending on the path taken, issuers will have to bemindful of various requirements and obligations. Some,such as the anti-fraud provisions of the securities laws,apply regardless of the route taken. Others, such as theconditions relating to reliance on the section 3(a)(9)exemption from registration under the Securities Act of1933, as amended (the Securities Act), affect only certainexchanges.

Redemptions

Complying with the terms of the governing indentureDepending on the terms of the governing indenture, anissuer may be able to redeem its debt securities at a pre-determined price without the holder’s consent. Theredemption price is likely to be based on the holder’s yieldto maturity. Some indentures, typically those governingzero-coupon obligations or debt with a relatively shortmaturity, have absolute call protection and do not permitredemption. Other indentures include restrictions on thetime period during which issuers can redeem the securities.

An issuer may have the most difficulty with indentureprovisions that restrict the source of funds the issuer canuse to redeem the securities. These types of provisionstypically prohibit an issuer from financing the redemptionof its securities with the proceeds of offerings of lower-costdebt securities. In addition, an issuer should consider theprovisions of its credit agreements or bank facilities, whichmay contain prohibitions on redemptions of debtsecurities.

Fortunately, courts permit an issuer to demonstrate that,despite a concurrent lower-cost offering of securities, thedirect source of the funds used to repurchase the old debtoriginated elsewhere.2 One court allowed an issuer to make

a tender offer for its own debt securities using the proceedsof the tainted, lower-cost securities, while simultaneouslyredeeming those not tendered with clean cash raisedthrough other means.3 Nevertheless, these cases hinge onthe contractual terms of the relevant indenture. An issuerredeeming its securities should not mistake favourablejudicial precedent for a guarantee that its own indenturepermits a particular strategy. At the very least, an issuermust be very careful to segregate the clean funds used toredeem securities from the proceeds of any other lower-cost securities offerings. Even if an issuer takes suchprecautions, however, it is possible the market will perceivethe issuer as having breached the terms of the indenture.The boundaries of activity contractually permissible donot always overlap with the boundaries of activityconducive to good reputation.

Providing adequate disclosureAn issuer that redeems its securities must comply with theanti-fraud provisions of the securities laws. Though theterms of the relevant indenture may permit variousactivities, no private contract can waive the anti-fraudprotections afforded by the Securities Act and theSecurities Exchange Act of 1934, as amended (theExchange Act). For example, one court found that, despitethe issuer’s compliance with the terms of the indenture, itsfailure to disclose all relevant facts regarding theredemption violated Rule 10b-5(b).4 An issuer mustcomply with the terms set forth in the indenture as well aswith the anti-fraud prohibitions of the securities laws.

Repurchasing debt securities in the open marketUnlike a redemption, where an issuer repurchases itssecurities without the consent of the holders, an open-market purchase is a voluntary transaction between theissuer and a willing debt holder. The primary challenge foran issuer undertaking an open market purchase is to lessenthe possibility that the transaction will be regarded by theSEC as a tender offer. Tender offer or not, however, anissuer repurchasing securities in the open market must bemindful of the SEC’s disclosure requirements.

CHAPTER 4

Cash debt tenders: an overview andsummary of no-action advice


Avoiding the definition of tender offerSection 14(d) of the Exchange Act requires certain filingsand disclosures when any person or group makes a tenderoffer, resulting in the ownership of greater than 5% of agiven class of securities. Section 14(e) of the Exchange Actis an anti-fraud provision that forbids misstatements,omissions and fraudulent or misleading acts in connectionwith any tender offer. These two sections, and the rulespromulgated under these sections, apply only when atransaction constitutes a tender offer.

Congress, in adopting the William Act and section14(d), did not define tender offer in order to give thecourts and the SEC flexibility.5 In its rules under section14(d) and 14(e), the SEC also has not defined tender offerto give itself flexibility in applying the rules. Courts havefilled this gap, providing a set of factors useful indifferentiating between tender offers and other publicsolicitations. The test used by a majority of courts listseight characteristics that are typical of a tender offer:

1. Active and widespread solicitation of publicshareholders for the shares of an issuer.

2. Solicitation made for a substantial percentage of theissuer’s stock.

3. Offer to purchase made at a premium over theprevailing market price.

4. Terms of the offer are firm rather than negotiable.5. Offer is dependent on the tender of a fixed number of

shares, often subject to a fixed maximum number to bepurchased.

6. Offer is open for only a limited period of time.7. Offeree is subjected to pressure to sell his or her stock.8. Public announcements of a purchasing program

concerning the target company precede or accompanyrapid accumulation of large amounts of the targetcompany’s securities.6

Not all of these elements need to be present for atransaction to constitute a tender offer, and the weightgiven to each element varies with the circumstances. Forexample, an open-market purchase of 25% of acorporation’s stock was not considered to constitute atender offer for various reasons. The purchaser contactedonly six of the 22,800 security holders, all six of thosesecurity holders were highly sophisticated and thepurchaser did not pressure the security holders in any waythat the tender offer rules were designed to prevent.Additionally, the purchaser did not publicise the offer, thepurchasers did not pay a significant premium – nor didthey require a minimum number of shares or percentage ofstock, and the purchasers did not set a time limit for theoffer.7 In determining whether a tender offer has occurred,

this Court noted that courts should be guided by thestatutory purpose to protect the “ill-informed solicitee”.8

The eight-part test and above case implementing it bothinvolved equity securities. Congress and the SEC haveacknowledged that tender offers for non-convertible debtsecurities are usually less problematic from both a tenderoffer and public policy perspective.9 However, anydiscussion of an acquisition of debt securities should beginwith consideration of the eight characteristics listed above.An issuer considering an open-market repurchase of itsdebt securities should therefore be mindful of the eightfactors if it wishes to avoid the strictures of the tender offerrules.

Disclosure requirements for open-market transactionsAn issuer that repurchases securities in the open marketmust comply with the anti-fraud provisions of thesecurities laws. For repurchase programs, the primaryconcern is adequate disclosure. Before repurchasingsecurities, an issuer must consider whether it is inpossession of material, non-public information that thesecurities laws require it to disclose. Both Rule 10b-5 andRegulation FD place disclosure obligations on parties whopossess material non-public information about thesecurities they purchase. Examples of material informationinclude unreleased earnings or an unannounced merger –both of which would need to be disclosed beforepurchasing securities from a bondholder.

It is possible that the repurchase program itselfconstitutes material, non-public information. Forexample, an issuer that drastically reduces the total amountof its outstanding debt through a repurchase programshould consider disclosing the program as material. Thiswould also be true if the repurchase program is likely tosignificantly reduce the issuer’s cash reserves. Generallyspeaking, an issuer’s plans to repurchase some of its debtwill not constitute a material event, so long as a significantprincipal amount of debt remains outstanding after therepurchase. This is also the case if the public float of agiven series remains constant (that is, if the issuerrepurchases bonds only from insiders). An issuer shouldconsult with counsel if it is concerned about themateriality of a planned transaction.

An issuer has at least two options should it decide itmust disclose its plan to repurchase debt securities. Theissuer may announce the debt repurchase program with apress release and file the release as an exhibit to a CurrentReport on Form 8-K. A more subtle approach would befor the issuer to disclose its intentions in a periodic report,such as in the liquidity discussion in the MD&A section ofan Annual Report on Form 10-K, or a Quarterly Report


on Form 10-Q. Debt repurchase programs likely willproceed more smoothly when the program has beenplanned for and the marketplace has been informed of it inthe issuer’s MD&A section. This is not always possible,however, and a Form 8-K filing is an acceptable alternative.

Structuring a debt tender offer in light of no-action letter guidanceIt may not be possible for an issuer to ensure that the SECwill not regard an open-market repurchase program as atender offer. In that case, the issuer/buyer and any dealermanager will need to comply with the requirements ofRules 14e-1, 14e-2, and 14e-3 of the Exchange Act – eachof which is applicable to all tender offers (Rule 13e-4applies only to tender offers for equity securities).10 Themost problematic requirement associated with these ruleshas traditionally been that the offer remain open for 20business days, and that following any change inconsideration or in the amount of securities sought, theoffer must remain open for 10 business days. The reasonthese requirements have been troubling is that most debttender offers occur when interest rates are low – the issueris trying to retire its higher-interest debt using proceedsfrom current, lower-interest bonds. If the interest ratesdecline during the offer period, the issuer will not retire asmuch debt as hoped for. If rates increase, the debt to beretired by the issuer will come at a higher price. Longeroffer periods translate into increased uncertainty for debttender offers, which in turn leads to fewer debt tenderoffers.11

In the past, the SEC staff (the staff ) has consistentlygranted relief from the requirement that non-convertible12

debt tender offers be held open for 20 business days,provided certain conditions are met. The SEC staff has alsoprovided additional relief from other provisions ofparagraphs (a) and (b) of Rule 14e-1, as issuers and theirdealer managers have proposed new methodologies fortender offers. In many of the no-action letters (particularlythe earlier ones establishing the general relief ) the staff hasstated an often unelaborated belief. This is that issuer debttender offers for cash, for any and all non-convertible debtsecurities of a particular class or series, may presentconsiderations different from any and all issuer tenderoffers, for a class or series of equity securities or non-investment grade debt.13

With the assistance of counsel, an issuer should be ableto structure a tender to fit within existing no-actionguidance and avoid the need to file for its own no-actionrelief. Structuring within the existing guidance will sparethe issuer from the 10 and 20-business day requirements.As we discuss below, based upon recently issued no-actionletter guidance, in any and all tenders that meet certain

requirements, the time period may be shortened to fivebusiness days.

The following discussion addresses the differentmethodologies for debt tender offers in light of existingSEC no-action letter guidance.14

Non-convertible Debt Tender for Cash: backgroundand basic conditionsIn its no-action relief, the staff has consistently requiredthe following four basic conditions. These were establishedin a series of nearly identical 1986 no-action letters frominvestment banks, following amendments to sections14(d) and 14(e) of the Exchange Act requiring that alltender offers remain open for 20 business days:

• Offers to purchase are made for any and allnonconvertible debt of a particular class or series.

• The offers are open to all record and beneficial holdersof that class or series of debt.

• The offers are conducted in a manner designed toprovide all record and beneficial holders of that class orseries of debt with a reasonable opportunity toparticipate in the tender offer. This includesdissemination of the offer on an expedited basis insituations where the tender offer is open for a period ofless than 10 calendar days.

• The offers are not made in anticipation of or in responseto other tender offers for the issuer’s securities.15

In many of the no-action letters, the proposed debttender offers are open for 10 calendar days (or sevencalendar days if the expedited procedure indicated above isused), and any extension following a change in number ofsecurities sought or consideration offered can be less than10 business days. However, not all of these no-actionletters requested relief from the 20-business dayrequirement.

The no-action letters that established these basicconditions did not indicate whether the debt wasinvestment grade. However, in a 1990 no-action letterresponse, the staff advised Salomon Brothers that its 1986response letters were limited to investment grade debtsecurities only.16

Investment grade debt: fixed spread pricingAs discussed earlier, the principal concern whenconducting a debt tender offer is that prevailing marketinterest rates will change, so that holders will not tender orany tender will become more expensive. In addition to


shortening the time period for the tender offer in order tolimit exposure to interest rate fluctuations, anotherprotective measure is to price the tender using fixed spreadpricing.

Fixed spread pricing permits an issuer/offeror to choosea specific yield spread between the debt being tendered forand a benchmark US Treasury security (benchmarktreasury security), which matures at or near the earliestredemption date for such debt security. The purchase priceis calculated as the present value of the security subject tothe tender offer, discounted at an interest rate equal to theapplicable spread.17 While the actual price to be paid in thetender offer is not fixed, the formula for determining theprice is. The greater the spread, the higher the discountrate, resulting in a lower present value and purchase price.

The no-action letter guidance has focused on the timingof the fixed spread calculation and has required additionalconditions for these kinds of tenders. All of these no-actionletters involve investment grade securities.18

1. Date of, or date immediately preceding date of, tender –Salomon Brothers (October 1 1990)

Salomon Brothers suggested the issuer would offer topurchase its debt securities from tendering holders at aprice determined on each day during the tender period.This would be by reference to a fixed spread over the then-current yield on a specified benchmark US Treasurysecurity, determined as of the date, or date preceding thedate, of tender.

The staff, in granting no-action relief, required thefollowing additional conditions:

• Information regarding such benchmark treasury securitywill be reported each day in a daily newspaper ofnational circulation.

• All tendering holders of that class or series of debt arepaid promptly for their tendered securities after suchsecurities are accepted for payment (in this no-actionletter, daily settlement was contemplated).

2. Real-time fixed spread offer – Merrill Lynch, Pierce, Fenner& Smith Incorporated (July 19 1993)

Merrill Lynch refined the fixed spread pricing initiallycreated by Salomon Brothers. Merrill Lynch proposed touse a fixed spread pricing methodology in connection withissuer tender offers. However, the nominal purchase pricein the offer would be calculated by reference to a statedfixed spread over the most current yield on a benchmarktreasury security, determined at the time that the holder of

the debt security tenders the security. This is rather than byreference to the yield on a benchmark treasury security asof the date, or date preceding the date, of tender. MerrillLynch called this a real-time fixed spread offer.

The staff said it would not recommend enforcementaction in respect of a real-time fixed spread offer, subject tothe following additional conditions:

• The offer identifies the specific benchmark treasurysecurity and specifies the fixed spread to be added to theyield on the benchmark treasury security.

• States the nominal purchase price that would have beenpayable under the offer be based on the applicablereference yield immediately preceding commencementof the offer.

• Indicates the daily newspaper of national circulation thatwill provide the closing yield of the benchmark treasurysecurity on each day of the offer.

• Indicates the reference source to be used during theoffer, establishing current yield information on thebenchmark treasury security.

• Describes the methodology to be used to calculate thepurchase price paid for the tendered securities.

• Indicates that the current yield on the benchmarktreasury security and the resulting nominal purchaseprice of the debt securities will be accessible on a real-time basis – either by calling the dealer-manager collector through an 800 telephone number established foreach offer.19

• Provides that all tendering holders of that class or seriesof debt will be paid promptly for their tenderedsecurities after such securities are accepted for payment,within the standard settlement time frame for broker-dealer trades (then five and now three business days fromthe date of tender).

• In addition to these conditions, the dealer-managermust make and maintain records showing at least thefollowing information in connection with any real-timefixed spread offer:

• The date and time of the tender.

• The current yield on the benchmark treasury security atthe time of the tender.


• The purchase price of the tendered securities based onthat yield.

• No later than the next business day, send a confirmationto the tendering debt holder providing the specifics ofthe tender offer transaction, including, upon request,the time of the tender.

3. Continuously priced fixed spread tender offer / singlesimultaneous settlement – Goldman Sachs (December 31993)

Goldman Sachs created its own version of MerrillLynch’s real-time fixed spread offer and named it acontinuously priced fixed spread tender offer. It wasdescribed as being similar to the real-time fixed spreadoffer described above, but with a provision forsimultaneous settlement. Although the target securitieswould be irrevocably accepted for payment on acontinuous basis throughout the tender offer period, theissuer would pay for validly tendered securities on a singlesimultaneous settlement date promptly after thetermination of the tender offer, if the holder were to makesuch election.

The benefit to the holder of making the election is thatthe target securities would continue to accrue interest tothe settlement date. The staff indicated it would notrecommend enforcement action in respect of acontinuously priced fixed spread tender offer, subject tothe same conditions required in the Merrill Lynch 1993letter. However, the staff also required the followingslightly different conditions with respect to the dealermanager’s obligations:

• Records must be maintained showing at least thefollowing information:

• The date and time of the tender.

• The current yield on the benchmark treasury security atthe time of the tender.

• The purchase price of the tendered securities based onthat yield.

• The date the simultaneous settlement procedure is madeavailable, whether or not the holder tendering securitieselected to receive payment on a single settlement daterather than within the standard time frame.

• No later than the next business day, send a confirmationto the tendering debt holder providing the specifics of

the tender offer transaction, including the date and(upon request), the time of the tender, price to be paidfor the tendered securities, and the settlement date.

4. Indirect obligor – Embassy Suites (April 15 1992)

Embassy Suites requested confirmation that the staffwould not recommend any enforcement action be takenunder Rule 14e-1(b) in regard to a cash tender offer forcertain non-convertible investment grade debt securities.Embassy Suites was not the direct obligor on the debtsecurities. The existing structure for the debt securitiesinvolved a direct pay letter of credit from a bank,20 andfollowing a series of spin-off and merger transactionsEmbassy Suites became one of the obligors party to areimbursement agreement – although Holiday Inn was stillthe nominal obligor.

The proposed transaction involved an offer to purchaseany and all of the series of notes, which Embassy Suiteswould then submit to the trustee for cancellation. Thetender offer would be a fixed spread issuer tender offer fornon-convertible investment grade debt. The request letterstated that “from an economic standpoint, Embassy and[its parent] have assumed the primary repayment liabilityon the Notes through assumption of the ReimbursementAgreement and the indemnification obligations.”

Embassy Suites described the requirements of theSalomon Brothers no-action letter, dated October 1 1990,and indicated that it would comply with thoserequirements. The staff indicated it would not recommendenforcement action pursuant to Rule 14e-1(b), andemphasised the following factors in addition to the onesalready described in earlier no-action letters:

• The offer will be held open for at least 20 business daysfrom the date the offer is first published or sent or givento note holders.

• Since the pre-offer agreements between the issuer andthe bidder eliminate any risk that the bidder could usethe notes acquired in the offer to influence the issuer,there are no control implications to the offer.

• The bidder has the same economic interests in thepricing and completion of the offer and retirement ofthe notes as an issuer of debt securities would have in anissuer debt tender offer.


5. Market Conditions and fluctuations – Citizens RepublicBancorp (August 21 2009) and Lloyds Banking Group (May28 2010)

Issuers also have recently adjusted pricing mechanismsto more fully reflect market conditions and fluctuations.They have also asked the staff for no-action letter relief forsuch pricing mechanisms under Rule 14e-1(b). In CitizensRepublic Bancorp Inc, the staff provided no-action letterrelief for an exchange offer of non-convertiblesubordinated notes and trust preferred securities forcommon shares. This was where the pricing mechanismincluded an averaging period, which was the five tradingdays ending on the second day before the expiration dateof the offer.21

As part of the exchange, the issuer would issue commonshares having a value (based on their Average VWAP) equalto a fixed dollar amount specified in the related prospectusat the time of the offer’s launch. Average VWAP wasdefined as the arithmetic average of the daily volume-weighted average price (VWAP), over an averaging periodof five trading days ending on the day of expiration. Inaddition, the related prospectus included a link to awebpage that would show:

• Indicative Average VWAP and resulting indicativeexchange ratios calculated as if that day were the last ofthe exchange offer. This was done by 4.30pm (New Yorktime) on each trading day before the first day of theaveraging period.

• Indicative Average VWAP and resulting indicativeexchange ratios using actual cumulative trading dateduring the VWAP averaging period, updated every threehours starting at 10.30 am (New York time) on eachtrading day.

• The last closing price for the common shares each timethe webpage was updated.

The issuer argued the pricing mechanism should bepermitted under Rule 14e-1(b) by citing free and readyaccess to updated indicative exchange ratios, which wouldenable informed decisions about whether or not to tender.The issuer also pointed out that the pricing mechanismwould result in a fixed, constant dollar value exchange,provide greater certainty about the ultimate return toinvestors, and allow investors to better predict the valuethey would receive in the exchange offer compared to afixed exchange ratio.

In Lloyds Banking Group plc, the staff provided no-action letter relief under Rule 14e-1(b) for an exchange

offer of non-convertible notes for ordinary shares, wherethe pricing formula included as a data input the USdollar/UK pound exchange rate.22 More specifically, theexchange ratio was specified as a stated dollar amountdivided by the Dollar VWAP, which was defined as theproduct of the average daily VWAP in British poundssterling (UK pound), for the securities tendered. Thesewere reported by Bloomberg for each LSE trading day inthe 10-LSE trading period, prior to the expiration date. Itwas also defined as the product of the US dollar/UKpound spot exchange rate as reported by Bloomberg at orabout 4.00pm (London time) on the expiration date.

Additionally, the pricing formula operated, and the finalpricing was disclosed, on the expiration date of the offer.The maximum amount of securities that would beaccepted in the offer, and the possible application ofproration to securities tendered, depended on the results ofthe pricing formula’s operation on the expiration date ofthe offer.23 The issuer said the pricing formula wasimportant to holders because the tendered securities wereUS dollar-denominated, and the offer enabled holders toreceive an amount of consideration with a value thatreflected the most recent exchange rate for the US dollar.

Corporate Restructurings, multiple series ofdebt securitiesThe staff has also provided no-action letter guidance fordebt tender offers in the context of corporate mergers,acquisitions and divestitures – particularly when the issueris tendering for more than one series of debt, or there areother factors involved. These include consent solicitationsand exchange offers (rather than solely cash tender offers).Because of the potential complexity of these transactions,the staff imposes additional conditions.

1. Multiple Transactions – Playtex FP (November 22 1988)

In connection with certain acquisitions, divestitures andmergers pertaining to the Playtex group of companies, fourPlaytex entities sought an exemption from Rule 10b-6.This was with respect to concurrent cash tender offers forthree series of existing debt securities, an exemption underRule 10b-6 with respect to a public offer of a new series ofnotes, which would include change of control provisionsand confirmation that the staff would not recommendenforcement action under Rule 14e-1(b).24

The staff said it would not recommend enforcementaction under Rule 14e-1(b) if Playtex complied with thefollowing tender offer features that Playtex described:


• Notice of the offering and tender offer will be given toall holders of the pertinent class of existing debtsecurities. The tender offer will be made to all holders ofsuch class.

• The tender offers will remain open for at least 20business days.

• Existing debt securities tendered pursuant to a tenderoffer may be withdrawn at any time until the expirationof such offer.

• If, for any reason, the price to be offered to holders in atender offer is increased after such offer is made, theincreased price will be paid to all holders tenderingpursuant to the tender offer.

2. Consent Solicitation – The Times Mirror Company(November 15 1994)

The Times Mirror Company had entered into a mergeragreement to dispose of its cable television business to CoxCable. As part of the merger, The Times Mirror Companywas to turn New Times Mirror into a spin-off. Inconnection with this spin-off, The Times Mirror Companyproposed to conduct a cash tender offer for a series ofnotes, a separate exchange offer for a different series ofnotes and a related exit consent solicitation.

The cash tender offer would be priced as a stated fixedspread over the yield on a specified benchmark treasurysecurity, as of 2.00pm New York time on the business dayimmediately preceding the expiration date of the offer. Asa condition to accepting the tender offer, tenderingnoteholders would be required to give their consent tocertain indenture amendments. In the exchange offer,notes of an old series would be exchanged for new notesissued by the New Times Mirror. Exchanging noteholderswould be required to give the same consent to certainindenture amendments as in the cash tender offer. Notesnot repurchased or exchanged would remain outstandingobligations of The Times Mirror Company.

The exit consent solicitation was intended to avoid thesituation where both Cox Cable and New Times Mirrorwould become co-obligors with respect to the notes thatremained outstanding after completion of the cash tenderoffer and exchange offer. The Times Mirror Companyindicated that previous no-action letters had notspecifically allowed for tender offer structures, where adebtholder’s right to tender is conditioned on such holdergiving an exit consent.

The staff indicated it would not recommendenforcement action under Rule 14e-1(b) if Times Mirror

conducted a cash tender offer for the notes at a pricedetermined as described above. This was subject to theconditions applicable for a fixed price spread offering (asdescribed above), plus an additional requirement thatwithdrawal of the tendered notes shall be deemed awithdrawal of the exit consent solicitation.

Debt-like securitiesThe staff has also provided no action guidance forsecurities not denominated as debt, but with debt-likecharacteristics – such as certain kinds of preference shares.

1. Preference Shares – BBVA Privanza et al (December 232005)

BBVA and Banco Bilbao proposed to make a cash tenderoffer for all of the outstanding non-cumulative guaranteedpreference shares, series D of BBVA Privanza International(Gibraltar), including preference shares represented byAmerican Depositary Shares. It was a condition to thetender that all such shares be validly tendered and notwithdrawn. The intention was to price the tender offerbased on a stated fixed spread over the yield on a specifiedbenchmark treasury security. This was to be from 2.00pmNew York time, on the second business day immediatelypreceding the expiration date of the offer (the 18thbusiness day of the offer period).

BBVA and Banco Bilbao said the tender offer would bemade consistent with the principles established in priorno-action letters, as relating to formula pricing in issuertender offers for equity securities. Additionally, the offerwould be substantially similar to the tender offers coveredby no-action letters relating to the use of fixed spreadpricing methodologies for non-convertible, investmentgrade debt tender offers.

The staff stated that it would not recommendenforcement action under Rule 14e-1(b) against BBVA orBanco Bilbao if the tender offer used the pricingmechanism described, and if the tender offer was otherwiseconducted in the manner represented.

In granting the requested relief, the staff noted, inaddition to the typical conditions for fixed spreadtransactions, that:

• The subject securities are represented as being valued byinvestors on the basis of their yield. This is taking intoaccount the issuer’s credit spread, compared to abenchmark yield. The yield of the subject securitiesfluctuates in response to changes in prevailing interestrates.


• The final offer price will be set at least two trading daysprior to the scheduled expiration of the offer.

• The offering party will issue a press release to publicallyannounce the final offer price prior to the close ofbusiness on the pricing date.

2. Trust preferred securities

The staff has also provided informal oral advice to say thattrust preferred securities are sufficiently debt-like. This meansthat tender offers for trust preferred securities would besubject to the requirements applicable to debt tender offers orexchange offers, and not the more restrictive requirementsapplicable to equity tender offers under Rule 13e-4. Thestaff ’s position is predicated on the applicable instrumentsbeing qualified under the Trust Indenture Act.25

Non-investment grade debtUntil the issuance of a no-action letter in January 2015,the SEC had not issued written no-action relief for tenderoffers for non-investment grade debt securities.

Prior to the recent no-action letter guidance, the SECstaff ’s informal advice had been premised on the notion thatfixed spread tender offers for non-investment grade debtsecurities had different characteristics than those forinvestment grade securities and less flexible pricing terms.The pricing must be fixed on a pricing date, which should beno later than the second business day preceding the offer’sexpiration.26 This results in all holders receiving the samepurchase price. While not providing real time pricing, as withinvestment grade tenders, this pricing mechanism doesmitigate the interest rate risks faced by both theissuer/purchaser and the holder. In addition to this pricingmechanism the staff requires the following conditions, whichthe issuer/purchaser must agree in writing to undertake:

The securities:

• Trade on a basis of a spread over the US treasury market.

• Are liquid based on trading volume and the number ofmarket makers.

• Are widely followed (evidence for which includes arating by at least one nationally recognised statisticalrating organisation).

• The offer to purchase, and each press release regardingthe tender, will provide a toll-free number to allowholders to ask questions about the offer.

• The offer must be open for at least 20 business days.

• A press release announcing the purchase price will beissued no later than the business day immediatelyfollowing the pricing date.

The SEC has also required additional conditions if aconsent solicitation is part of the non-investment gradedebt tender offer, including the following:

• Withdrawals of tenders and consents are allowed untilthe consents from holders of the required amount ofsecurities are obtained.

• If consent to deletion of indenture covenants is sought,the issuer or purchaser must prove that the changes tothe covenants should not have a material effect on thetrading value of the securities not tendered in theoffering.

• If a consent fee is paid and the consent period ends priorto expiration of the tender itself, the tender offer willremain open for five business days following the end ofthe consent solicitation period.

• If the consent solicitation period expires on the 10thbusiness day of the tender, but the tender price is notfixed until later (day 18), the offering materials statewhen the consent payment will be made.

• A press release announcing that the requisite number ofconsents has been received must be issued no later thanthe opening of business on the day immediatelyfollowing the date the threshold is reached.

• If an exit consent is required in order to tender, the offermust specify that the withdrawal of the tenderedsecurities will be deemed a withdrawal of the consent.

• If the consent fee is payable only until a specified date (theconsent expiration date) or the date that a majority ofconsents is obtained, the majority must be obtained by theconsent date. If not, withdrawal rights for tenderedsecurities and consents must be extended until at least6.00pm on the business day following the issuer’s publicannouncement (in a press release) that the issuer hasreceived consents from holders representing a majority inprincipal amount of the outstanding securities tendered for.

• That the revised covenant terms (typically set forth in asupplemental indenture), will not become effective untilthe tender offer is consummated.


• If the consent solicitation is amended resulting inmaterial adverse change to the rights of security holders,the solicitation period will be extended for 10 businessdays to allow holders to revoke their consents.

Recent SEC no-action letter guidance applicable to non-convertible debt securitiesAs noted above, historically, the SEC staff drew a cleardistinction between tender and exchange offers forinvestment grade debt securities and those for non-investment grade debt securities. In structuring tender andexchange offers, market participants relied on existing no-action letter guidance and on informal guidance soughtfrom the SEC staff. In January 2015, the SEC staff issueda new no-action letter that addresses certain tender andexchange offers to the extent that these meet specifiedconditions and, for the first time, provides reliefcomparable to that available for investment grade securitiesto offers for non-investment grade securities. It isimportant to keep in mind that this guidance, which mayprovide additional flexibility, especially for addressingoutstanding non-investment grade securities, is notavailable in each and every case. Many tender andexchange offers will continue to be made in reliance on thepre-existing guidance and approaches.

Summary of new guidanceOn January 23 2015, the SEC responded to a requestsubmitted by a consortium representing a group of issuers,investment banks, investors and their counsel, and issued ano-action letter indicating that it would not recommendSEC enforcement action in connection with a tender offeror exchange offer for non-convertible debt securities that isheld open for as few as five business days, to the extent thatthe offer is conducted in accordance with certain specifiedconditions outlined in the letter.27

This no-action letter (which supersedes the prior letters)eliminates the distinction between investment-grade andother debt securities. It also permits debt tender offers(including tender offers conducted in the context ofcertain exchange offers) to be held open for as few as fivebusiness days if the specified conditions are satisfied. Thesignificant conditions include:

• The offer must be made available to all holders of thedebt securities and for all of the outstanding securities(in other words, the offer must be structured as an anyand all offer).

• The offer must be made by the issuer of the debtsecurities or a parent or a wholly owned subsidiary of theissuer. Consequently, third parties tendering for debt

securities of an issuer will not be permitted to availthemselves of the shortened tender period.

• The offer must be open to all record and beneficialholders of the targeted debt securities. It is still possibleto restrict an exchange offer to QIBs or non-US personsprovided that other holders of the targeted debtsecurities have the option to receive cash in an amountequal to the approximate value of the exchange offerconsideration.

• The offer must be made solely for cash or other qualifieddebt securities, which is defined as securities that arematerially identical to the securities that are the subjectof the tender offer.

• The consideration offered in the tender offer must befixed or based on a benchmark spread, which mayinclude US Treasury rates, LIBOR, or swap rates.

• The offer cannot be combined with an exit consent toamend or eliminate covenants or with any other consentsolicitation to amend the provisions of the indenture orthe debt securities.

• Holders must be entitled to withdrawal rights until theearlier of the expiration date and, if the offer is extended,the tenth business day following the launch. Holdersalso must be allowed to withdraw tenders after the 60thbusiness day following the launch if the offer has notbeen consummated by such time.

As outlined above, the consideration must consist solelyof cash or non-convertible debt securities that are (i)identical in all material respects to the targeted debtsecurities (including as to obligors, collateral, lien priority,covenants and other terms) except for payment-relateddates, redemption provisions and interest rate; (ii) haveinterest terms payable only in cash; and (iii) a weightedaverage life to maturity that is longer than that of thetargeted debt securities.

The offer must be announced no later than 10:00 am,Eastern time, on the first business day of the five businessday period, through a widely disseminated press release,which in the case of an offer by an SEC reporting companymust also be furnished almost immediately under aCurrent Report on Form 8-K. The press release mustinclude all of the basic terms of the offer and contain ahyperlink to the offer to purchase and letter of transmittalas well as any other relevant documents or instructions.Changes in the offered consideration or other materialterms of the offer may result in the requirement to extend


the offer period, such that at least five business days remainfrom and including the announcement of any change inthe offered consideration, and at least three business daysremain from and including the announcement of anyother material change in the offer. In a manner similar tothe announcement of these expedited offers, issuers mustnotify investors of these material changes by a widelydisseminated press release, and SEC reporting issuers mustdescribe changes to the offered consideration almostimmediately in a Form 8-K. The results of the offer alsomust be announced through a press release.

As noted above, the no-action letter is not available forpartial tenders. The letter also is not available for tendersor exchanges with exit consents. In addition, the relief isnot available:

• at a time when the issuer is the subject of bankruptcy orinsolvency proceedings, or otherwise has commencedactivity geared toward accomplishing an out-of-courtrestructuring or pre-packaged bankruptcy;

• in anticipation of or in response to, or concurrentlywith, a change of control or other extraordinarytransaction involving the issuer;

• in anticipation of or in response to a competing tenderoffer;

• concurrently with a tender offer for any other series ofthe issuer’s securities made by the issuer or certainaffiliates of the issuer if the effect of such offer wouldresult in a change to the capital structure of the issuer(e.g., addition of obligors or collateral, increased priorityof liens or shortened weighted average life to maturity ofsuch other series); or

• in connection with a material acquisition or disposition.

There are a number of instances where issuers will berelegated to continuing to rely on the prior no-action letterguidance and structure their offers to remain open for 20business days.

As a means reasonably designed to prevent fraudulent,deceptive or manipulative acts or practices within themeaning of section 14(e) of the Act, no person who makesa tender offer shall:

a. Hold such tender offer open for less than 20 businessdays from the date such tender offer is first published orsent to security holders; provided, however, that if thetender offer involves a roll-up transaction as defined inItem 901(c) of Regulation S-K and the securities beingoffered are registered (or authorised to be registered) onForm S-4 or Form F-4, the offer shall not be open forless than 60 calendar days from the date the tender offeris first published or sent to security holders;

b. Increase or decrease the percentage of the class ofsecurities being sought or the consideration offered orthe dealer’s soliciting fee to be given in a tender offerunless such tender offer remains open for at least 10business days from the date that notice of such increaseor decrease is first published or sent or given to securityholders;

Provided, however, that, for purposes of this paragraph,the acceptance for payment of an additional amount ofsecurities not to exceed two percent of the class ofsecurities that is subject the tender offer shall not bedeemed to be an increase. For purposes of thisparagraph, the percentage of a class of securities shall becalculated in accordance with section 14(d)(3) of theAct.

c. Fail to pay the consideration offered or return thesecurities deposited by or on behalf of security holderspromptly after the termination or withdrawal of a tenderoffer. This paragraph does not prohibit a bidder electingto offer a subsequent offering period under Rule 14d-11from paying for securities during the subsequentoffering period in accordance with that section.

d.Extend the length of a tender offer without issuing anotice of such extension by press release or other publicannouncement, which notice shall include disclosure ofthe approximate number of securities deposited to dateand shall be issued no later than the earlier of:i. 9.00am Eastern time, on the next business day after

the scheduled expiration date of the offer orii. If the class of securities which is the subject of the

tender offer is registered on one or more nationalsecurities exchanges, the first opening of any one ofsuch exchanges on the next business day after thescheduled expiration date of the offer.

e. The periods of time required by paragraphs (a) and (b)of this section shall be tolled for any period duringwhich the bidder has failed to file in electronic format,absent a hardship exemption (Rules 232.201 and232.202 of this chapter), the Schedule TO Tender OfferStatement (Rule 240.14d-100), any tender offermaterial required to be filed by Item 12 of that Schedulepursuant to paragraph (a) of Item 1016 of RegulationM-A, and any amendments thereto.

If such documents were filed in paper pursuant to ahardship exemption (see Rule 232.201 and Rule232.202(d)), the minimum offering periods shall betolled for any period during which a requiredconfirming electronic copy of such Schedule and tenderoffer material is delinquent.


APPENDIX A

Rule 14e-1 – Unlawful tender offerpractices

a. Position of subject company. As a means reasonablydesigned to prevent fraudulent, deceptive or manipulativeacts or practices within the meaning of section 14(e) of theAct, the subject company, no later than 10 business daysfrom the date the tender offer is first published or sent orgiven, shall publish, send or give to security holders astatement disclosing that the subject company:

1. Recommends acceptance or rejection of the bidder’stender offer;

2. Expresses no opinion and is remaining neutraltoward the bidder’s tender offer; or

3. Is unable to take a position with respect to thebidder’s tender offer.

Such statement shall also include the reason(s) for theposition (including the inability to take a position)disclosed therein.

b.Material change. If any material change occurs in thedisclosure required by paragraph (a) of this section, thesubject company shall promptly publish, send or give a

statement disclosing such material change to securityholders.

c. Any issuer, a class of the securities of which is the subjectof a tender offer filed with the Commission on Schedule14D-1F and conducted in reliance upon and inconformity with Rule 14d-1(b) under the Act, and anydirector or officer of such issuer where so required by thelaws, regulations and policies of Canada and/or any ofits provinces or territories, in lieu of the statementscalled for by paragraph (a) of this section and Rule 14d-9 under the Act, shall file with the Commission onSchedule 14D-9F the entire disclosure document(s)required to be furnished to holders of securities of thesubject issuer by the laws, regulations and policies ofCanada and/or any of its provinces or territoriesgoverning the conduct of the tender offer, and shalldisseminate such document(s) in the United States inaccordance with such laws, regulations and policies.

d.Exemption for cross-border tender offers. The subjectcompany shall be exempt from this section with respectto a tender offer conducted under Rule 14d-1(c).

a. If any person has taken a substantial step or steps tocommence, or has commenced, a tender offer (theoffering person), it shall constitute a fraudulent,deceptive or manipulative act or practice within themeaning of section 14(e) of the Act for any other personwho is in possession of material information relating tosuch tender offer which information he knows or has

reason to know is nonpublic and which he knows or hasreason to know has been acquired directly or indirectlyfrom:1. The offering person;

2. The issuer of the securities sought or to be sought bysuch tender offer; or


APPENDIX B

Rule 14e-2 – Position of subject company with respect to a tender offer

APPENDIX C

Rule 14e-3 – Transactions in securitieson the basis of material, nonpublic infor-mation in the context of tender offers

3. Any officer, director, partner, employee or any otherperson acting on behalf of the offering person orsuch issuer, to purchase or sell or cause to bepurchased or sold any of such securities or anysecurities convertible into or exchangeable for anysuch securities or any option or right to obtain or todispose of any of the foregoing securities, unlesswithin a reasonable time prior to any purchase or salesuch information and its source are publicallydisclosed by press release or otherwise.

b. A person other than a natural person shall not violateparagraph (a) of this section if such person shows that:

1. The individual(s) making the investment decisionon behalf of such person to purchase or sell anysecurity described in paragraph (a) or to cause anysuch security to be purchased or sold by or on behalfof others did not know the material, nonpublicinformation; and

2. Such person had implemented one or a combinationof policies and procedures, reasonable under thecircumstances, taking into consideration the natureof the person’s business, to ensure that individual(s)making investment decision(s) would not violateparagraph (a), which policies and procedures mayinclude, but are not limited to:i. Those which restrict any purchase, sale and

causing any purchase and sale of any suchsecurity; or

ii. Those which prevent such individual(s) fromknowing such information.

c. Notwithstanding anything in paragraph (a) to contrary,the following transactions shall not be violations ofparagraph (a) of this section:1. Purchase(s) of any security described in paragraph (a)

by a broker or by another agent on behalf of anoffering person; or

2. Sale(s) by any person of any security described inparagraph (a) to the offering person.

d.1. As a means reasonably designed to prevent

fraudulent, deceptive or manipulative acts orpractices within the meaning of section 14(e) of theAct, it shall be unlawful for any person described inparagraph (d)(2) of this section to communicatematerial, nonpublic information relating to a tenderoffer to any other person under circumstances inwhich it is reasonably foreseeable that such

communication is likely to result in a violation ofthis rule except that this paragraph shall not apply toa communication made in good faith,i. To the officers, directors, partners or employees of

the offering person, to its advisors or to otherpersons, involved in the planning, financing,preparation or execution of such tender offer;

ii. To the issuer whose securities are sought or to besought by such tender offer. Also to its officers,directors, partners, employees or advisors or toother persons, involved in the planning,financing, preparation or execution of theactivities of the issuer with respect to such tenderoffer; or

iii. To any person pursuant to a requirement of anystatute or rule or regulation announcedthereunder.

2. The persons referred to in paragraph (d)(1) of thissection are:i. The offering person or its officers, directors,

partners, employees or advisors;

ii. The issuer of the securities sought or to be soughtby such tender offer or its officers, directors,partners, employees or advisors;

iii. Anyone acting on behalf of the persons inparagraph (d)(2)(i) or the issuer or persons inparagraph (d)(2)(ii); and

iv. Any person in possession of material informationrelating to a tender offer which information heknows or has reason to know is non-public andwhich he knows or has reason to know has beenacquired directly or indirectly from any of theabove.



1 See section 3(a)(9) exchange offers.

2 Morgan Stanley & Co Inc v. Archer Daniels Midland Co, 570 F.

Supp.1529, 1536 (S.D.N.Y. 1983); Franklin Life Insurance Co v.

Commonwealth Edison Co, 451 F. Supp. 602, 614 (S.D. Ill. 1978).

3 Mutual Savings Life Insurance Co v. James River Corp of Virginia, 716 So.

2d 1172, 1178 (Ala. 1998). See also, Part II.

4 Harris v. Union Electric Co, 787 F. 2d 355, 370 (8th Cir. 1986). Harris

provides a lesson in the need for careful drafting of the original offering

document, although the tone in Harris is so harsh that there is an

inference there was more to the Court’s decision than merely failure to

disclose material information (an earlier Missouri Court of Appeals

decision in the matter had held that the redemption process complied

with the indenture). See Harris v. Union Electric Co, 622 S.W.2d 239

(Mo.Ct.App. 1981).

5 Hanson Trust PLC v. SMC Corp, 774 F. 2d 47, 56 (2d. Cir. 1985). The

Hanson Court noted Congressional concern that a “rigid definition

would be evaded.”

6 Wellman v. Dickinson, 475 F. Supp. 783, 823–24 (S.D.N.Y. 1979); see

also Hanson Trust, supra note 5.

7 Hanson Trust, supra note 5 at 57–59.

8 Id. at 57.

9 While both equity and debt tender offers are subject to sections 14(d)

and 14(e) and the rules thereunder, equity tender offers are also subject

to the requirements of Rule 13e-4. See also Part III and infra note 13.

10 See Appendix A for the texts of Rules 14e-1, 14e-2 and 14e-3.

11 The staff acknowledged these concerns in response to a series of no-

action letter requests in 1986. See infra note 15.

12 Tender offers for debt securities that are convertible into equity

securities, such as common stock, are treated as equity tender offers,

which raise different concerns and are not discussed in this

memorandum.

13 See example, SEC No-Action Letter, Merrill Lynch, Pierce, Fenner &

Smith Inc (July 2 1986) (“For example, because of the modest premiums

typically offered in an Issuer Debt Tender Offer, it is not clear that

participation in the tender offer by individual non-institutional

debtholders would be materially increased by requiring that tender offer

be held open for twenty business days.”)

14 The following discussion highlights the most significant no-action letters

concerning structuring debt tender offers, and is not exhaustive of all the

no-action guidance.

15 SEC No-Action Letters, Salomon Brothers Inc (March 12 1986);

Goldman Sachs & Co. (March 26 1986); First Boston Corporation

(April 17 1986); Kidder, Peabody, & Co Inc (May 5 1986); and Merrill

Lynch, Pierce, Fenner & Smith Inc (July 2 1986).

16 See SEC No-Action Letter, Salomon Brothers Inc (October 1 1990).

17 See id. The total purchase price for a debt security would be the sum of

(1) the present value as of the payment date of (a) the interest payments

on the debt from the payment date until maturity or the earliest call date

and (b) any principal payments to and redemption premium at the

earliest call date or maturity, plus (2) any accrued and unpaid interest to

the purchase date.

18 It is interesting to note that in the first of the fixed price spread requests,

SEC No-Action Letter, Salomon Brothers Inc (October 1 1990),

Salomon did not refer to “investment grade” but the staff ’s response was

specifically limited to “investment grade” debt securities.

19 Now this methodology should also include access to a website with such

information.

20 In a direct pay letter of credit transaction, the letter of credit bank makes

the payments on the securities and then seeks reimbursement from the

ultimate obligor. This credit-enhancing structure results in the debt

security taking on the credit rating of the bank and not of the ultimate

obligor.

21 SEC No-Action Letter, Citizens Republic Bancorp, Inc (August 21

2009).

22 SEC No-Action Letter, Lloyds Banking Group plc (May 28 2010).

ENDNOTES


23 The staff has previously permitted a formula pricing method in which

the pricing formula operated, and the final pricing was disclosed, on the

expiration date of the relevant offer. See, e.g. SEC No-Action Letter,

Lazard Frères & Co (August 11 1995), SEC No-Action Letter, AB Volvo

(May 16 1997), SEC No-Action Letter, Epicor Software Corporation

(May 13 2004), SEC No-Action Letter, TXU Corp (September 13

2004), SEC No-Action Letter McDonald’s Corporation (September 27

2006), SEC No-Action Letter, Weyerhaeuser Company (February 23

2007), SEC No-Action Letter, Halliburton Company (March 23 2007),

SEC No-Action Letter, Kraft Foods Inc (July 1 2008), SEC No-Action

Letter, Citizens Republic Bancorp, Inc, supra note 21, SEC No-Action

Letter, Thermo Fisher Scientific (November 13 2009), and SEC No-

Action Letter, Towers Watson Co (May 17 2010).

24 Prior to the repeal of Rule 10b-6 and the adoption of Regulation M, it

was necessary to obtain an exemption under Rule 10b-6 if an issuer

engaged in a “distribution” of new debt securities at or about the same

time as it made a tender offer for outstanding debt securities of the same

class and series. See Johnson and McLaughlin, Corporate Finance and

the Securities Laws, section 13.02 (2009). The restrictions of Rules 101

and 102 announced under Regulation M apply only to securities that are

identical in all of their terms to the securities being distributed. The staff

granted no-action relief in Playtex with respect to Rule 10b-6.

25 The staff has previously indicated that “[the Trust Indenture] Act

generally would apply… to preferred securities issued by a trust that

represent an interest in debt issued by a single obligor”. See SEC


Interpretations: Trust Indenture Act of 1939 (Question 101.04) (March


http://www.sec.gov/divisions/corpfin/guidance/tiainterp.htm.

26 The staff has allowed some alternatives to this second business day

pricing models, but its goal appears to be to ensure that holders of non-

investment grade debt have information early in the process regarding

the final expected price, rather than a price to be calculated based on

yield. This reflects the staff ’s concern that the market for non-

investment grade (or high yield) debt securities is less liquid and may be

more susceptible to manipulation.

27 See SEC No-Action Letter, Abbreviated Tender or Exchange Offer for

Non-Convertible Debt Securities (January 23 2015).


Liability management is attractive for many issuersas there are a wide array of transactions andrestructuring options available for issuers. Theseinclude: redemptions; repurchases; debt tenders;

private exchange offers; section 3(a)(9) exchange offers;registered exchange offers; debt for equity swaps; equity forequity exchanges; and consent solicitations.1

BackgroundIn an exchange offer, the issuer offers to exchange new debtor equity securities for its outstanding debt or equitysecurities. An exchange offer often is used as an alternativeto a cash tender offer if an issuer does not have or want touse its available cash resources to repurchase outstandingdebt or equity securities. For distressed companies, anexchange offer may be the best non-bankruptcyrestructuring option. An exchange offer enables an issuerto, among other things:

• reduce interest payments or cash interest expense (byexchanging debt securities with a high rate for debtsecurities with a lower rate);

• reduce the principal amount of outstanding debt (in thecase of a debt-equity swap);

• manage the maturity dates of outstanding debt (byexchanging debt securities that are coming due for debtsecurities with an extended maturity);

• modify the terms of securities (for example, interestpayment dates, conversion ratios and redemptionprovisions); or

• reduce or eliminate onerous covenants (if coupled withan exit consent).

An issuer may need to comply with the tender offerrules in connection with an exchange offer, depending onthe facts and circumstances. Because an exchange offeralso involves the offer of new securities, it must complywith, or satisfy an exemption from, the registrationrequirements of the Securities Act.2 An issuer may rely on

the private placement exemption provided under section4(a)(2) of the Securities Act or the exemption providedby section 3(a)(9) of the Securities Act. In addition, anexemption pursuant to Regulation S for offers and salesto non-US persons may be available on a stand-alonebasis or combined with other applicable exemptions fromregistration. An issuer also must be mindful ofRegulation M’s prohibitions on bidding for, orpurchasing, its securities when it is engaged in anexchange offer.3

Section 3(a)(9) exchange offers present a number ofadvantages compared to other types of exchange offers andrestructuring options, including the following:

• can be completed quickly, as there is no registrationrequired and, therefore, no SEC staff review (however, ifthe exchange offer is subject to the tender offer rules,then it is likely that the Schedule TO would bereviewed);4

• are flexible (an issuer can retire an entire series or class ofdebt securities);

• do not require cash on hand (there are only minimalcosts);

• there is no section 11 liability with regard to an offer toexchange, as there is no registration statement required;

• can be paired with a consent solicitation; and

• often can be accomplished largely tax-free for debtholders.

However, section 3(a)(9) exchange offers also have anumber of disadvantages compared to other exchangeoffers and restructuring options, including the following:

• the new securities issued in the exchange offer may berestricted securities, depending on the status of thesecurities surrendered for exchange;

CHAPTER 5

Section 3(a)(9) exchange offers


• there is a limited ability to engage and compensate aninvestment bank or other third parties in connectionwith the exchange offer;

• there may be holdout issues;

• the exchange offer may be integrated with other offersmade by the issuer in close proximity;

• if the exchange offer is subject to the tender offer rules,the offer must be made to all existing security holders;and

• if the exchange offer is subject to the tender offer rules,all investors of the same class must be paid the sameprice.

Requirements under section 3(a)(9)Section 3(a)(9) of the Securities Act applies to “anysecurities exchanged by the issuer with its existing securityholders exclusively where no commission or otherremuneration is paid or given directly or indirectly forsoliciting such exchange”.5 The exemption fromregistration provided by section 3(a)(9) is a transactionalexemption only.6 This means that the new securities issuedare subject to the same restrictions on transferability, if any,of the old securities, and any subsequent transfer of thenewly issued securities will require registration or anotherexemption from registration. For example, if the oldsecurities were issued without registration in a section4(a)(2) private placement and then were exchanged by aholder for new securities, the holder could only sell ortransfer the new securities without registration pursuant toRule 144, pursuant to section 4(a)(1), or, with respect tosecurities held by affiliates, in a section 4(a)(1-1/2) privateplacement.7

The four main requirements of section 3(a)(9) are asfollows:

• Same issuer. The issuer of the old securities beingsurrendered is the same as the issuer trying to exchangeinto the new securities.

• No additional consideration from the security holder. Thesecurity holder must not be asked to part with anythingof value besides the outstanding securities.

• Offer only to existing security holders. The exchange mustbe offered exclusively to the issuer’s existing securityholders.

• No remuneration for the solicitation. The issuer must notpay any commission or remuneration for the solicitationof the exchange.

In addition, as a general matter and similar to otherexempt offerings, any exchange offer under section 3(a)(9)must be made in good faith and not as part of a plan toavoid the registration requirements of the Securities Act.

Same issuerSection 3(a)(9) exempts any securities exchanged by theissuer with its security holders. This means that the newsecurities being issued and the securities that are beingsurrendered must originate from a single issuer. Althoughthis concept seems relatively straight forward, there are anumber of scenarios that can complicate the identity ofissuer analysis. In fact, over the years the SEC staff hasgranted no-action relief in response to facts andcircumstances that do not fit neatly within the “singleissuer” requirement. For example, in Echo Bay Resources,the SEC granted no-action relief under section 3(a)(9) foran exchange of guaranteed debt securities of a financesubsidiary for the securities of the parent-issuer guarantor.8

The incoming letter in Echo Bay Resources emphasised theeconomic reality of the transaction. This included therelationship between the parent issuer and the subsidiary;the SEC noted that the subsidiary was established by theparent-issuer to issue securities and finance the activities ofthe parent-issuer and the subsidiary had minimal assetsand liabilities that were tied to the issuance of securities.9

It should be noted that the SEC staff takes the view thatthere is no identity of issuer between a subsidiary and itsparent where the subsidiary had outstanding a class ofdebentures guaranteed by its parent and the subsidiaryproposed to offer a new debenture that would not beguaranteed by its parent in exchange for the guaranteeddebenture.10 However, the SEC staff has provided no-action relief in the case where there is an exchange of a newparent security for an outstanding parent security that hasone or more upstream guarantees from the parent’s wholly-owned subsidiaries.11

In Suntrust Banks, the SEC staff provided no-actionrelief in connection with the same issuer requirementunder section 3(a)(9), in a situation where the trustpreferred trust securities of an existing trust and thesubstantially similar trust preferred securities of a newlyformed trust were deemed to constitute securities of theirparent, given that the trusts had limited purposes and theobligations of the trusts were guaranteed under back-uparrangements between the parent and the trusts.12

In Grupo TMM, an issuer transferred its common stockto a trust in order to facilitate the exchange of old securities


for new ones.13 The issue in the no-action request waswhether the issuance by the trust, which was ostensibly adifferent issuer, would preclude the issuer from relying onthe section 3(a)(9) exemption. The SEC staff, withoutagreeing with counsel’s analysis (and noting “policyconsiderations”), provided no-action relief from SecuritiesAct registration requirements. The incoming letter notedthat the trust was a special purpose entity established forthe sole purpose of allowing investors to obtain theeconomic right in a security and the trust did not engagein any activities unrelated to this purpose and has noindependent financial or economic activity. Moresignificantly, the SEC staff ’s approach, along with theapproach taken in Echo Bay Resources, Suntrust Banks andsimilar no-action letters, indicates that the SEC will oftenfocus on the underlying economic reality of the exchangefor the purposes of the identity of issuer analysis.14

Consistent with these precedents, issuers have relied onsection 3(a)(9) to exchange common or preferred stock fortrust preferred securities. For example, on June 3 2009,KeyCorp announced an offer to exchange, in reliance onsection 3(a)(9), its common shares for any and all trustpreferred securities of KeyCorp Capital I, KeyCorpCapital II, KeyCorp Capital III and KeyCorp Capital IV,15

and on June 30 2005, Foster Wheeler announced an offerto exchange, in reliance on section 3(a)(9), its commonshares for all outstanding shares of its 9% trust preferredsecurities.16

Another frequent concern with the identity of an issuerarises when, through a merger, acquisition or othertransaction, an issuer has unconditionally assumed theobligations of the securities of another issuer. The SECstaff is of the view that the section 3(a)(9) exemption isavailable for the exchange of the securities of one issuer forthe debt securities of another issuer when the obligationson those debt securities have been fully andunconditionally assumed by the issuer of the newsecurity.17 However, the SEC staff has indicated that a USparent may not rely on section 3(a)(9) to exempt theconversion of shares of a Canadian subsidiary into USparent shares, even though holders of the Canadiansubsidiary shares indirectly share the same dividend,liquidation and voting rights held by commonstockholders of the US parent.18

In summary, the SEC staff has recognised that a lack ofcomplete identity of the issuer in certain contexts wouldnot preclude reliance on the Section 3(a)(9) exemption tothe extent that the securities involved offer a similarinvestment—that is the investor looked to thecreditworthiness and overall financial condition of theparent, as guarantor or otherwise, or where two entitiescomprise a single indivisible business. For example, the

SEC staff has issued no-action letter guidance in proposedexchanges where: an issuer is relying on a depositary(technically, the “issuer”) that performs a ministerial rolein facilitating an exchange of “unit” American DepositaryShares;19 in the case of parent guarantees which areexchangeable for new parent securities where although twoor more issuers are involved, the investor can be assumedto have regarded the exchange of the outstanding parentsecurities for a new parent security as the substance of theexchange; in reorganizations, where an issuer reorganizesto create a holding company and the new parentguarantees the outstanding securities of the issuer, whichare thereafter exchangeable for a parent security; and in thecase of “paired securities” of a parent and a subsidiarywhich were deemed to represent the same economic risk inthe parent company as did the parent company for whichthey were to be exchanged.20

No additional consideration from the security holderUnder section 3(a)(9), the consideration that securityholders exchange must consist only of the old securities.However, there are two limited exceptions to thisrequirement. First, under Rule 150 under the SecuritiesAct, an issuer can make payments to its security holders “inconnection with an exchange of securities for outstandingsecurities, when such payments are part of the terms of theoffer of the exchange”. The SEC staff has provided no-action relief where these payments included cash or a cashequivalent21 and even when paid by an affiliate of theissuer.22 Second, under Rule 149 under the Securities Act,a security holder can make any cash payments that may benecessary “to effect an equitable adjustment, in respect ofdividends or interest paid or payable on the securitiesinvolved in the exchange, as between such security holderand other security holders of the same class accepting theoffer of exchange”. For example, an equitable adjustmentmay be necessary when, due to the timing of interestpayments and sales between security holders, one securityholder receives the benefit of an interest payment due toanother security holder. In this case, the issuer can requirethe unjustly enriched security holder to reimburse theissuer for the extra interest payment. In addition, an issuercan also require the security holders to waive the right toreceive an interest payment or other considerationaccruing from a security.23

Offer only to existing security holdersAny exchange offer conducted in reliance on section3(a)(9) may be made only to existing security holders.Although this requirement also appears straightforward, itmay not be satisfied if an issuer is conducting an offeringof new securities for cash at the same time as the exchange


offer. In this case, the issuer must take care to keep the twoofferings separate and avoid their integration, which wouldrequire the registration of the combined offerings or theapplication of another exemption from registration. Thedetermination regarding integration is fact specific, andthe issuer must apply the SEC’s five-factor test.

Further, if any part of the issue in the same transactionas the exchange is sold for cash, or intended to be sold forcash, or provided to creditors (as opposed to securityholders), even if those portions of the transaction areexempt pursuant to another exemption or are registered,then section 3(a)(9) would not be available.24

There is no requirement, however, that a section 3(a)(9)offering be made to all members of a given class of securityholders (assuming that tender offer rules do not apply tothe transaction). As a result, an issuer may choose to relyon section 3(a)(9) to exchange with securities with one ora limited group of investors.

No remuneration for solicitationSection 3(a)(9) expressly prohibits an issuer from paying aperson or entity a commission or other remunerationeither directly or indirectly for soliciting the exchange.When determining what activity and/or commission orother remuneration is permissible under section 3(a)(9), anissuer or a third party involved in the exchange shouldconsider the following factors:

• the relationship between the issuer and the person orentity furnishing the services;

• the nature of the services performed; and

• the method of compensation for the services.

Issuer’s activitiesAs a general rule, an issuer may solicit holders of targetsecurities without jeopardising the use of the section3(a)(9) exemption. An issuer soliciting holders of targetsecurities should adhere to the following guidelines:

• the personnel chosen to contact the security holders,which may include the issuer’s directors, officers, andkey employees (the “corporate solicitors”), should havesignificant responsibilities with the issuer other than thesolicitation of the exchange and should not be hired forthe purpose of soliciting the exchange;

• no special bonus, commission, fee, or any other type ofremuneration should be paid to the corporate solicitorsfor their solicitation activities, which means they shouldbe paid no more than their regular salary; and

• the corporate solicitors should attend to their regularduties, with their solicitation efforts only beingadditional assignments.25

Third party activitiesAn issuer also may engage third parties, such as financialadvisers, investment banks, and investor relations firms, toassist in the exchange offer, subject to certain limitations.Whether an issuer should engage a third party for assistingwith an exchange offer and the services that the third partywill provide depends on the issuer’s particular situationand the type of transaction contemplated. Generally, themore complex and significant a restructuring (for example,a restructuring for a distressed company), the more helpfulit may be for an issuer to engage a financial intermediary,such as an investment bank. The type of transaction willdictate an investment bank’s role (including anylimitations on its activities), which ranges from merely anadvisory role to responsibilities as an agent or principal.

However, an issuer merely interested in taking advantageof declining secondary market prices for debt securitiesalso may benefit from engaging an investment bank tolocate, contact, and negotiate with security holders toretire (or exchange) their securities on favorable terms. Ineither case, an investment bank, which typically has aliability management, restructuring or workout teamspecialising in debt restructurings, will help create arestructuring plan, structure the transaction, solicitparticipation, and manage the marketing efforts to achievea successful restructuring. Some important factors toconsider in determining whether to engage a third partyinclude the number of security holders and theirorganisation and sophistication and whether the issuer hasinformation about, or any contact with, its securityholders.

Impermissible activities. Services may be provided bypersons or entities other than the issuer in a section 3(a)(9)exchange, subject to the following limitations:

• cannot make any recommendation regarding theexchange to any security holder, or to any adviser orother representative of any such security holder;26

• when communicating with security holders, can provideonly that information which is included in the variouscommunications sent by the issuer to the securityholders; and

• should limit its activities to performing functionaryservices or administrative assistance in the distributionof exchange materials and providing information aboutthe mechanics of the exchange.


If any security holder or any adviser or otherrepresentative to any security holder asks for a third party’sopinion on an investment-related attribute of theexchange, the third party should direct the holder of thetarget securities to contact the appropriate officer oremployee of the issuer. The third party may respond toquestions from security holders regarding substantiveelements of the exchange that are addressed in theexchange materials by directing the security holder to thepertinent portion of the exchange materials; however, thethird party must not convey management’s views orrecommendations on the exchange, even if those views orrecommendations or both are contained in the exchangematerials.

Permissible activities. Permissible activities can begrouped into two broad categories: (1) advice to the issuerwith respect to the terms and mechanics of the exchange;and (2) services that are administrative, ministerial, ormechanical in nature in furtherance of the exchange.27 Anyservices not deemed administrative, ministerial, ormechanical must be ancillary to the effective mechanicaloperation of the process of formulating a restructuringproposal.28

For example, in Seaman Furniture, the SEC granted no-action letter relief in connection with a proposed exchangeoffer for which the issuer hired investment bankers fromMerrill Lynch to act as its financial advisers.29 The issuercharacterised the services and activities provided by itsfinancial advisers as follows:

Since their engagement by the Company in July1989, the investment bankers from Merrill LynchCapital Markets who have acted as the Company’sfinancial advisors have performed the followingservices for the Company: (1) performed financialanalyses; (2) assisted the Company in formulating arestructuring proposal; (3) advised the Company withrespect to the terms of the new securities to be issuedin connection with the restructuring and the newcapital structure of the Company; (4) participated inmeetings between representatives of the Company, onthe one hand, and the banks, on the other hand; (5)participated in meetings between representatives ofthe Company, on the one hand, and the legal andfinancial advisors to the Committee, on the otherhand; and (6) conversed by telephone withrepresentatives of the banks and the legal and financialadvisors to the Committee. Merrill Lynch CapitalMarkets will not: (1) be named as a dealer manager ofthe Exchange Offer; (2) deliver a fairness opinion withrespect to the Exchange Offer; or (3) communicatedirectly with any holder of Existing Sub Debt withrespect to substantive matters relating to the

restructuring or the Exchange Offer. The Companyunderstands that during the aforementionedtelephone conversations and meetings its financialadvisors have: (1) outlined the current status ofnegotiations between the Company and the othercreditors of the Company; (2) discussed theCompany’s financial statements and projections; (3)presented the Company’s current proposals withrespect to the terms of the Exchange Offer and therestructuring to the banks and the legal and financialadvisors to the Committee; and (4) received anddiscussed the counterproposals of the banks and thelegal and financial advisors to the Committee andrelayed such counterproposals to the Company. Weunderstand that the Company’s financial advisors havenot: (1) expressed to the banks or the legal or financialadvisors to the Committee their views as to (a) thefairness of the proposed restructuring or the ExchangeOffer or (b) the value of the securities to be issued inconnection with the Exchange Offer or (2) made anyrecommendation to the banks or the legal andfinancial advisors to the Committee with respect tothe restructuring or the Exchange Offer.30

The argument made by the issuer that such services andactivities were permitted under section 3(a)(9) was thatthere was no direct contact between the issuer’s financialadvisers and any debt holder with respect to substantivematters relating to the exchange offer.31 In addition, theissuer stated that the activities of the issuer’s financialadvisers constituted activities “effecting” rather than“promoting” an exchange because (1) the exchange offerhad not been made, (2) the issuer’s financial advisers hadnot and would not make any recommendation to the debtholders or their advisers with respect to the proposedexchange offer, and (3) it is customary for an issuerinvolved in a complex financial transaction to engage aninvestment banker to act as an intermediary among theparties to a negotiation, especially when the other partiesare professional legal and financial advisers.32 A financialadvisor may advise the issuer with respect to virtually allaspects of developing and executing the exchange. TheSEC has taken a no-action position with respect to each ofthe following advisory services:33

• performance of financial analysis for the issuer;

• formulation or assistance in the formulation of arestructuring proposal for the issuer’s approval;

• advice on the issuer’s capital structure following therestructuring;


• advice on the timing and organisation of therestructuring proposal;

• advice on the proposed terms and mechanicalprocedures for the exchange;

• advice on the proposed terms of the new securities;

• assistance in the preparation of the various exchangematerials to be sent by the issuer to the security holders;

• advice to employees of the issuer on the procedures to beused in conversations with security holders concerningthe exchange;

• engaging in pre-launch discussions or negotiations withlegal and financial representatives of debt holdercommittees;

• providing a fairness opinion regarding the exchange;34

and

• consulting with institutional investors as to what theywould consider to be an acceptable exchange offer.

A third party can engage in administrative, ministerial,or mechanical services designed to convey the informationin the exchange materials to security holders.35 Theseactivities can be divided into two groups: (1) those inwhich the third party merely services as a functionary indisseminating information; and (2) those in which thethird party communicates directly with security holders ortheir advisers or other representatives. However, the lattergroup of services should be conducted with great care.

The SEC staff has acknowledged in no-action lettersthat third parties may provide each of the followingfunctionary services in disseminating information tosecurity holders:36

• obtain a list of the issuer’s security holders from theissuer, and confirm the accuracy of the addresses of thesecurity holders;

• mail or otherwise assist in the distribution of exchangematerials;

• maintain records on the exchange;

• be named as a financial intermediary in the exchangematerials;

• contact nominees holding target securities and ascertainthe number of the exchange materials needed by eachbrokerage house for transmittal to beneficial holders;

• deliver sufficient quantities of the exchange materials tobrokerage houses, trust officers, other banks, and othernominees for distribution to beneficial holders of thetarget securities; and

• mail duplicate copies of exchange materials to securityholders who appear to have lost or mislaid thoseoriginally sent to them.

The issuer may rely on a third party, such as an investorrelations firm or other sales force or an information agent,to inform security holders of the exchange offer.37 A thirdparty can contact security holders directly for the followingadministrative, mechanical, or ministerial purposes,subject in all instances to the requirement that nosolicitation take place as a result of any such contacts:

• to determine whether the security holders received theexchange materials;

• to determine whether the security holders understandthe procedures for participating in the exchange (forexample, expiration dates and to whom to forwarddocuments);

• to answer questions or resolve any confusion about theprocedures for participating in the exchange;

• to contact back-office personnel of nominees who holdsecurities for the benefit of others to make sure that theypromptly forward exchange materials to the nominees;

• to urge back-office personnel to check with thebeneficial holders of the target securities about whethersuch holders have received the exchange materials,understand procedurally how to participate in theexchange, and are generally aware of the relevant datesand deadlines;

• to determine whether the security holders intend toparticipate in the exchange and to communicate theirresponses to the issuer;

• to remind the security holders of all appropriatedeadlines; and


• to respond to the questions of security holders that donot concern the mechanical aspects of the exchange bydirecting the security holders to the relevant portions ofthe exchange materials.

Fees paid to third partiesSection 3(a)(9) does not specify the types of fees that thirdparties can receive in an exchange. However, the SEC staffhas indicated through various no-action letters that afinancial adviser may receive a fixed fee for its services, notcontingent upon the success of the exchange, plusreasonable expenses related to the exchange. A fixed feearrangement eliminates one factor which might otherwisesupport the inference that the financial adviser had anincentive to engage in a solicitation of security holders.Therefore, whenever paid third parties are contactingsecurity holders within permissible guidelines, it isadvisable that their fees be a fixed amount not tied to thesuccess of the exchange. Nevertheless, determiningwhether a paid solicitation has occurred is a fact-specificanalysis that will turn on the facts present in a particulartransaction. Note that this determination is not necessarilybased upon the method of payment of fees to the thirdparty. In addition, if the issuer relies on an investorrelations firm, sales force, information agent or others toinform security holders of the exchange, then the issuercan only pay a fee on a flat, per-contact basis to thatfinancial intermediary.38

Redemption standby agreementA redemption standby agreement between an issuer and aninvestment bank can be combined with an exchange ofsecurities under section 3(a)(9). An issuer engages aninvestment bank as a standby purchaser when it plans toforce the conversion of convertible debentures (or othersimilar instruments) by calling the debentures forredemption. But it is also when the issuer would like toprotect itself from having to make substantial cash outlaysin the event that the issuer’s stock price declines in theperiod between the redemption notice and the redemptiondate and the holders elect for redemption.

A standby agreement between an issuer and aninvestment bank is similar to an underwriting agreementfor a primary distribution of securities. The investmentbank agrees, for a fee, to purchase at a price slightly abovethe redemption price all of the debt securities that areoffered to it before the redemption date, and then toconvert those debt securities into common stock. Theissuer can rely on section 3(a)(9) to exempt the exchangeof its common stock for the debt securities acquired by theinvestment bank.39

Open market purchasesAn investment bank also can itself effect open marketpurchases of an issuer’s securities as a principal and thenlater exchange those securities with the issuer for newsecurities in reliance on section 3(a)(9). However, all of theconditions under section 3(a)(9) must be satisfied, whichmeans that the investment bank cannot receive anycommission or remuneration in connection with the openmarket purchases.

Other considerations

Involvement of affiliatesIn some circumstances, affiliates of an issuer may seek toexchange the issuer’s debt or equity securities. This mayoccur on the corporate level, such as when a parentexchanges securities of its subsidiaries or when subsidiariesexchange securities of their parent or other subsidiaries, orif officers, directors or significant shareholders seek toexchange the issuer’s securities. In these instances, theaffiliates would generally be considered insiders of theissuer and subject to the same disclosure obligations as theissuer. In many circumstances, the involvement of anaffiliate may preclude reliance on the section 3(a)(9)exemption for an exchange offer.

Qualification under the Trust Indenture ActExchange offers of debt securities that are exempt fromregistration under sections 3(a)(9) are not exempt fromqualification under the Trust Indenture Act. 40 Unless anindenture for a debt security is qualified under section 305of the Trust Indenture Act, which covers registeredofferings, or is exempt from qualification under section304 (which does not include an exemption for section3(a)(9) exchange offers), the sale of a debt securitypursuant to a section 3(a)(9) exchange would generallyviolate section 306 of the Trust Indenture Act unless anapplication for qualification of the related indenture hasbeen filed with the SEC.41 Qualification under the TrustIndenture Act is accomplished by filing a Form T-3 withthe SEC, which is subject to review by the SEC staff. Thesolicitation of the exchange offer may not commence untilthe Form T-3 is filed, and no sales may be made until theForm T-3 is declared effective by the SEC staff.

Securities exchange requirementsThe securities exchanges, including the New York StockExchange (NYSE), the Nasdaq Stock Market and theNYSE MKT, require shareholder approval for the issuanceof equity securities by listed issuers in various situations.42

Each exchange also applies these shareholder approvalprovisions to offerings of securities that are convertible


into, or in the case of the NYSE and Nasdaq, exchangeablefor, common stock, such as convertible debt. For example,the requirement for shareholder approval for issuances ofcommon stock in an amount more than 20% of thecurrent outstanding common stock, at a price below thegreater of book or market value, has resulted in manysection 3(a)(9) exchange offers structured with a price floorfor the common stock, a volume weighted average price(VWAP) or a maximum amount of common stock issuedjust below the appropriate threshold. An issuer also mustcarefully review the securities exchange rules if the securityto be exchanged is either actual equity or convertible orexchangeable debt, or if the exchange offer cannot becategorised as a “public offering.” In addition, thesecurities exchanges require shareholder approval when anissuance will result in a “change of control” of the issuer.43

Tax considerationsAn issuer that exchanges new debt for old debt in anexchange offer may recognise ordinary cancellation ofindebtedness (COD) if it results in a taxable exchange. Inthe event of a taxable exchange, the issuer will recogniseCOD income to the extent the adjusted issue price of theold debt exceeds the issue price of the new debt. Amodification of existing debt, as part of an exchange offer,also will be treated as a taxable exchange if themodification to the old debt is significant. Generally,modifications are significant if, among other things: (1)the yield changes by the greater of 25 basis points or 5% ofthe existing yield; (2) scheduled payments are materiallydeferred; (3) modified credit enhancements changepayment expectations; or (4) the nature of the securitychanges (for example, from debt to equity or from recourseto nonrecourse).

Assuming the exchange or modification constituted arecapitalisation, the exchange or modification generallyshould not result in gain or loss to the debt holder.However, depending on the terms of the new debt relativeto the old debt, certain tax consequences could follow. Forexample, if the principal amount of the new debt exceededthat of the old debt, the holder could recognise gain equalto the fair market value of the excess. Exchanges andmodifications also can create OID or, conversely, anamortisable premium, due to differences in the issue priceof the new debt and the stated redemption price atmaturity.44

Liability considerationsRestructuring transactions, including exchange offers,involve the purchase and sale of securities. Therefore, thesetransactions are subject to the general antifraud provisionsof section 10(b) of the Exchange Act and Rule 10b-5

under the Exchange Act. Section 10(b) provides animplied cause of action covering all transactions insecurities and all persons who use any manipulative ordeceptive devices in connection with the purchase or saleof any securities. Rule 10b-5 covers substantially the sameground as section 10(b) and prohibits, among otherthings, the making of any untrue statement of a materialfact or the omission of a material fact necessary to makethe statements made not misleading. Under Rule 10b-5,the issuer, its directors, officers and employees, and itsagents, including third parties retained by the issuer, maybe held liable. Exchange offers may also be subject tosection 14(e) of the Exchange Act, which, in addition tospecific procedural requirements, contains prohibitionsregarding material misstatements and omissions similar tothose in section 10(b) and Rule 10b-5.

1 For more information regarding liability management, see “Liability

Management: Is Now the Time to Rebalance Your Balance Sheet?”

(March 5 2009) [hereinafter, Liability Management Client Alert],

available at

http://www.mofo.com/news/updates/files/090305DebtRepurchases.pdf.

2 For this reason, the documentation for an exchange offer (including the

offer to exchange) must be more detailed than that for a cash tender

offer; for example, the offering materials must describe the terms of the

new securities.

3 If the securities being exchanged are debt securities convertible into

equity securities, under certain circumstances, repurchases of the

convertible debt securities could be deemed a forced conversion and,

therefore, a distribution of the underlying equity securities for

Regulation M purposes.

4 When debt securities are offered, an indenture may need to be qualified

under the Trust Indenture Act and the Form T-3 filed for the purpose of

qualifying the indenture may be subject to SEC staff review.

5 Section 3(a)(9).

6 The exemption does not apply with respect to a security exchanged

under Chapter 11 of the US Bankruptcy Code. Other exemptions, such

as Section 1145 of the US Bankruptcy Code, may apply with respect to

securities exchanged pursuant to a plan of reorganisation. If an issuer

relies on section 3(a)(9) for a solicitation of security holders prior to a

bankruptcy filing, and then, following the bankruptcy filing, completes

the exchange pursuant to section 1145 of the US Bankruptcy Code, then

the issuer would need to file a Form T-3 before commencing the pre-

bankruptcy filing solicitation. See SEC Division of Corporation Finance,

Compliance and Disclosure Interpretations: Securities Act Sections

(Question 125.11) (June 4 2010), available at



Interpretations: Securities Act Sections (Question 125.08) (November 26

2008), available at


8 See SEC No-Action Letter, Echo Bay Resources Inc. (May 18 1998).

9 The incoming letter stated: “In economic reality, it is the [parent issuer’s]

financial position and business prospects and the value of the [parent

issuer’s] securities to be issued … that will be of interest to investors in

making their investment decisions.”



2008), available at

http://www.sec.gov/divisions/corpfin/guidance/sasinterp.htm. In this

circumstance, the SEC staff views the guarantee and the debenture as

separate securities, therefore the exchange of the old parent guarantee for

the subsidiary’s new debenture would not involve an exchange between

the same issuer, even though the exchange of the primary security is

exempt from registration.

11 See SEC No-Action Letter, Section 3(a)(9) Upstream Guarantees

(January 13 2010). As a result of this guidance, issuers of securities with

upstream guarantees: (1) will not be required to maintain a shelf

registration statement effective for the term of an outstanding convertible

security to cover exercises; and (2) will have an attractive option for

effecting exchange offers in addition to registration (which has timing

implications) and relying on a private placement exemption (which

limits the number of potential offerees).

12 See SEC No-Action Letter, Suntrust Banks, Inc. (July 16 1999).

13 See SEC No-Action Letter, Grupo TMM, S.A. de C.V. (June 27 2002).

14 There are a number of other no-action letters and additional SEC

materials that provide additional guidance regarding the Section 3(a)(9)

requirements. See SEC Division of Corporation Finance, Compliance

and Disclosure Interpretations: Securities Act Sections, available at

http://www.sec.gov/divisions/corpfin/guidance/sasinterp.htm, SEC


Interpretations: Securities Act Rules, available at

http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-

interps.htm, and SEC Division of Corporation Finance, Compliance and

Disclosure Interpretations: Trust Indenture Act of 1939, available at


15 See Press Release, “KeyCorp Commences Separate Exchange Offers for

$503,530,000 of Its Series A Preferred Stock and for $797,647,000 Trust

Preferred Securities of Four Affiliated Trusts” (June 3 2009), available at

http://finance.yahoo.com/news/KeyCorp-Commences-Separate-prnews-

15424331.html?.v=1.

16 See Press Release, “Foster Wheeler Launches New Equity-for-Debt

Exchange” (June 30 2005), available at http://phx.corporate-

ir.net/phoenix.zhtml?c=80422&p=irol-newsArticle&ID=725266&highli

ght=.


ENDNOTES



2008).


Interpretations: Securities Act Sections (Question 125.10) (August 14

2010). The offering structure in this instance was designed to take

advantage of a Canadian tax exemption for the disposition of shares in a

Canadian enterprise through a business combination where the

consideration is paid in securities of another Canadian issuer.

19 See SEC No-Action Letter, Klabin S.A. (July 14 2014).

20 See SEC No-Action Letter, Bamboo.com (December 20 1999), and SEC

No-Action Letter, Ageas SA/NV and Ageas N.V. (March 20 2012).

21 See The News Corporation Limited, SEC No-Action Letter (May 15

1992) and International Controls Corp., SEC No-Action Letter (August

6 1990).

22 See Carolina Wholesale Florists, Inc., SEC No-Action Letter (August 17

1976).



2008), available at


24 The five-factor test requires that an issuer consider: (1) whether the

offerings are part of a single plan of financing; (2) whether the offerings

involve issuances of the same class of securities; (3) whether the offerings

are made at or about the same time; (4) whether the same type of

consideration is received; and (5) whether the offerings are made for the

same general purposes. See SEC Release No. 33-4552 (November 6

1962).

25 See Release No. 33-2029 (August 8 1939).

26 See SEC No-Action Letter, URS Corporation (May 8 1975).

27 See SEC No-Action Letter, Dean Witter & Co., Inc. (November 21

1974). See also SEC No-Action Letter, Stokley-Van Camp, Inc. (March

31 1983).



2008), available at


29 See SEC No-Action Letter, Seaman Furniture Co., Inc. (October 10

1989). An issuer also needs to be particularly mindful of those third

parties, such as investor relations firms, that communicate with security

holders. Hiring a firm to communicate with security holders could be

construed as payment for solicitation. The SEC, however, allows investor

relations firms to participate in exchange offers in a limited capacity.

30 See id.

31 See id.

32 See id.

33 See, for example, SEC No-Action Letter, Seaman Furniture Co., Inc.

(October 10 1989); SEC No-Action Letter, Mortgage Investors of

Washington (September 8 1980); SEC No-Action Letter, Hamilton

Brothers Petroleum Corp. (August 14 1978); SEC No-Action Letter,

Valhi, Inc. (September 15 1976); and SEC No-Action Letter, Dean

Witter & Co., Inc. (January 22 1975).

34 An issuer is permitted to hire an investment bank to render a fairness

opinion on the terms of the exchange. However, if the investment bank

also is acting as a dealer-manager and conducting solicitation activities,

the SEC has held that obtaining a fairness opinion would violate section

3(a)(9). See SEC Division of Corporation Finance, Compliance and

Disclosure Interpretations: Securities Act Sections (Question 125.07)

(November 26 2008), available at



Interpretations: Securities Act Sections (Question 125.06) (April 24

2009), available at


36 See, for example, SEC No-Action Letter, Mortgage Investors of

Washington (September 8 1980); SEC No-Action Letter, Barnett

Winston Investment Trust (October 11 1977); and SEC No-Action

Letter, Dominion Mortgage & Realty Trust (April 3 1975).

37 Relying on an investment bank in this instance may be efficient as the

firm that initially sold the securities may be in the best position to

contact its former customers.

38 See supra note 29.

39 See SEC No-Action Letter, TransTechnology Corp. (February 23 1983);

SEC No-Action Letter, Foster Wheeler Corp. (July 2 1973); SEC No-

Action Letter, Kewanee Oil Co. (February 5 1973); and SEC No-Action

Letter, Squibb Corp. (June 23 1971).



Interpretations: Trust Indenture Act of 1939 (Question 101.05) (March


http://www.sec.gov/divisions/corpfin/guidance/tiainterp.htm. See also

SEC No Action Letter, Mississippi Chemical Corp. (November 25 1988)

and SEC No Action Letter, Mississippi Chemical Corp. (June 23 1989).

41 Section 306 of the Trust Indenture Act does not apply to exchange offers

that are exempt under Section 3(a)(9) where the offering does not exceed

$5 million and Section 304(a)(8) and Rule 4a-1 under the Trust

Indenture Act otherwise are available. See SEC Division of Corporation

Finance, Compliance and Disclosure Interpretations: Trust Indenture Act

of 1939 (Interpretation 207.01) (March 30 2007), available at


42 See example, Nasdaq Marketplace Rule 5635(a)-(f ), and related publicly

available interpretive guidance; NYSE Issuer Manual Sections 312.00 –

312.07; and NYSE MKT Company Guide Sections 710-713.

43 See Nasdaq Rule 5635(b); NYSE Rule 312.03(d); and NYSE MKT LLC

Company Guide Section 713(b).

44 In each case, particular attention must be paid to terms of art, including

issue price, the meaning of which may vary depending on a number of

factors. For example, if existing debt is publicly traded, the issue price of

new debt issued (or constructively issued, in the case of a modification)

in exchange for existing debt is deemed the current market price. Debt

exchanges or modifications will often result in COD income because the

market prices of many existing debt securities are steeply discounted

from their adjusted issue prices.



Akey consideration in developing any liabilitymanagement strategy is the extent to which theSEC’s tender offer rules apply to anycontemplated transactions, given that these

rules can substantially affect the manner in which atransaction is conducted, the timing of the transaction, aswell as the issuer’s ability to conduct other transactions inits securities around the time of the tender offer. The tenderoffer rules can apply when a company is offering securitiesand/or cash for its outstanding securities, and the level ofregulation of the offer (in terms of timing and mandatedprocedural protections) varies depending on the type ofsecurity that is the subject of the offer. In the case ofexchange offers, the tender offer rules may apply inaddition to the requirement that the issuer must eitherregister the transaction or meet the conditions for anexemption from registration under the Securities Act.

Tender Offer Requirements

Defining the tender offerThe comprehensive regulation of tender offers came aboutwith the enactment of the Williams Act in 1968. TheWilliams Act and the SEC’s implementing regulations aredesigned to require the dissemination of materialinformation about a tender offer, while providingsufficient procedural protections so that security holdersget the opportunity to consider the disclosure whenmaking a decision about whether to tender their securitiesin the offer. The tender offer rules apply in the case of athird-party tender offer for the securities of another issuer,as well as to a tender offer by an issuer for its ownsecurities.

The term tender offer is not specifically defined in thestatute or in the SEC’s regulations. The lack of a specificdefinition has permitted the SEC and the courts to applythe tender offer rules to a broad range of transactionstructures. The analysis of whether an offer constitutes atender offer begins with the often-cited “eight factor” testin the case of Wellman v. Dickinson1:

1.An active and widespread solicitation of publicshareholders for the shares of an issuer;

2.A solicitation is made for a substantial percentage of theissuer’s securities;

3.The offer to purchase is made at a premium over theprevailing market price;

4.The terms of the offer are firm rather than negotiable;

5.The offer is contingent on the tender of a fixed numberof shares, often subject to a fixed maximum number tobe purchased;

6.The offer is open only for a limited period of time;

7.The offeree is subjected to pressure to sell his or hersecurity; and

8.Public announcements of a purchasing programconcerning the target issuer precede or accompany arapid accumulation of large amounts of the targetissuer’s securities.

These eight factors need not all be present for atransaction to be deemed a tender offer, and the weightgiven to each element varies with the individual facts andcircumstances. While these factors were cited in thecontext of an offer for equity securities, the principleswould equally apply to tender offers involving debtsecurities or equity securities other than common stock.The eight-factor test may be applied in the context of boththird-party offers, as well as offers by an issuer for its ownsecurities.

Courts have also applied a totality-of-the-circumstancestest in determining whether a transaction involves a tenderoffer that should be subject to the statutory requirementsand the SEC’s rules. In this context, the courts haveexamined whether, in the absence of disclosure andprocedures required under the tender offer rules, there willbe a substantial risk that the offeree will lack the informationneeded to make an investment decision with respect to the

CHAPTER 6

Tender and Dutch auction guidance


offer.2 The SEC staff has historically focused on whether atender offer involves an investment decision on the part ofthe offeree, particularly where the protections afforded bythe tender offer requirements would appear to be necessarybased on the nature of the transaction.

Requirements applicable to all tender offersSection 14(e) of the Securities Exchange Act of 1934 (theExchange Act) is an antifraud provision that establishes thebaseline for tender offer regulation. Section 14(e) prohibitsan offeror from making any untrue statement of a materialfact, or omitting to state any material fact necessary inorder to make the statements made, in light of thecircumstances in which they were made, not misleading.Section 14(e) also prohibits any fraudulent, deceptive ormanipulative acts in connection with a tender offer.Section 14(e) applies to cash tender offers, as well as toexchange offers subject to the tender offer requirements.

Pursuant to the authority specified in section 14(e), theSEC has adopted Regulation 14E.3 Regulation 14Especifies requirements applicable to all tender offers, andfor those tender offers where additional requirementsapply (such as tender offers for equity securities), therequirements of Regulation 14E must still be satisfied.Regulation 14E applies to cash tender offers, as well asexchange offers subject to the tender offer requirements. Inaddition, Regulation 14E applies to both third-partytender offers as well as issuer tender offers.

What is required by Regulation 14E?Regulation 14E sets forth certain requirements for tenderoffers that must be carefully followed throughout thecourse of an offer. These requirements seek to preventpractises that would be deemed fraudulent, deceptive ormanipulative acts in connection with a tender offer.Regulation 14E requires that:

• A tender offer must be held open for at least 20 businessdays;

• The percentage of the class of securities being sought orthe consideration being offered may not be increased ordecreased unless the tender offer remains open for atleast 10 business days from the date that the notice ofsuch increase or decrease is first published or sent orgiven to security holders;

• The offeror promptly pay the consideration, or returntendered securities, upon termination or withdrawal ofthe tender offer;

• Public notice be provided in connection with the

extension of a tender offer, and such notice must includedisclosure of the amount of securities already tendered;

• The issuer subject to a tender offer disclose to its securityholders its position with respect to the offeror’s tenderoffer;

• Certain trading be avoided when a person is inpossession of material nonpublic information relating tothe tender offer;

• Tendering person must have a net long position in thesubject security at the time of tendering and at the endof the proration period in connection with partial tenderoffers (and not engage in short-tendering and hedgedtendering in connection with their tenders); and

• No covered person directly or indirectly purchase orarrange to purchase any subject securities or any relatedsecurities except as part of the tender offer, from the timeof public announcement of the tender offer until thetender offer expires.

Each of these requirements is described in more detailbelow.

Minimum offer periodRule 14e-1(a) provides that a tender offer must remainopen for at least 20 business days from the date the tenderoffer commences.4 Rule 14e-1(b) provides that the offermust also stay open for at least 10 business days from thedate of a notice is first published or sent or given to theholders of the subject securities of an increase or decreasein: (i) the percentage of securities to be acquired pursuantto the tender offer (if the change exceeds 2% of the originalamount); (ii) the consideration offered, without any deminimis exception; or (iii) any dealer-manager’s solicitationfee. The SEC has stated that a tender offer subject only toRegulation 14E must remain open for a minimum of fivebusiness days for any other material change to the offer orwaiver of a material condition.5

Prompt paymentRule 14e-1(c) provides that the offeror must either pay theconsideration offered or return the securities tenderedpromptly after termination or withdrawal, respectively, ofthe tender offer.

The SEC staff has generally taken the view that “promptpayment” under Rule 14e-1(c) requires the payment ofconsideration or the return of tendered securities no laterthan three business days after the conclusion of the tenderoffer.


Extension of offering periodRule 14e-1(d) provides that any extension of the offerperiod must be made by a press release or other publicannouncement by 9.00am, Eastern time, on the nextbusiness day after the scheduled expiration date of theoffer, and the press release or other announcement mustdisclose the approximate number of securities tendered todate. If the securities are registered on one or morenational securities exchange, the announcement must bemade by the first opening of any one of such exchanges onthe next business day following the scheduled expirationdate of the tender offer.

Disclosure of position regarding the offerRule 14e-2 requires that an issuer that has securitiessubject to a tender offer disclose to its security holders itsposition with respect to the offeror’s tender offer, in otherwords, whether the issuer recommends the offer, expressesno opinion with respect to the offer or is unable to take aposition. The disclosure must be provided no later than 10business days after the tender offer is first disseminated tosecurity holders. In the event of any material change in thedisclosure, the subject company must promptlydisseminate a statement to security holders noting thematerial change. Given that Rule 14e-2 is not expresslylimited to third party tender offers, it is common for anissuer conducting an issuer tender offer to include in itstender offer materials a statement that the issuer makes norecommendation as to the tender.

Prohibited tradingRule 14e-3 contains an antifraud prohibition on activitiesof a person conducting a tender offer. If such person is inpossession of material nonpublic information that he orshe knows or has reason to know is nonpublic and knowsor has reason to know was acquired from the offeringperson, the issuer or any of its directors, officers oremployees, it is unlawful for that person to purchase or sellor cause to be purchased or sold any of the securities thatare the subject of the tender offer. The prohibition applieseven if the trading does not occur in breach of a duty ortrust or confidence. In the case of an issuer tender, anissuer must be careful not to conduct a tender at a timewhen it possesses material nonpublic information.Material nonpublic information for this purpose mayinclude unreleased earnings, a potential change in anissuer’s credit ratings or an unannounced merger. Theissuer should, to avoid any issues, disclose any suchmaterial nonpublic information prior to commencing atender offer.

Prohibited transactions in connection with partial tender offersPartial tender offers typically involve the risk to securityholders that not all of the securities that the security holdertenders will be accepted in the tender offer (commonlyreferred to as proration risk). Rule 14e-4 prohibits securityholders from engaging in the practice of short tendering,which occurs when the security holder tenders more sharesthan they own in order to avoid or mitigate the prorationrisk, or hedged tendering, which occurs when a securityholder tenders securities but then sells a portion of theirshares before the proration deadline to a person that couldthen tender those shares. Under Rule 14e-4, a tenderingperson must have a net long position in the subject securityat the time of tendering and at the end of the prorationperiod.

Prohibited purchases outside of a tender offerRule 14e-5 provides that, subject to certain exceptions, nocovered person may directly or indirectly purchase orarrange to purchase any subject securities or any relatedsecurities except as part of the tender offer. Theprohibition in Rule 14e-5 applies from the time of publicannouncement of the tender offer until the tender offerexpires, but does not apply to any purchases orarrangements to purchase made during the time of anysubsequent offering period as provided for in Rule 14d-11,as long as the consideration paid or to be paid for thepurchases or arrangements to purchase is the same in formand amount as the consideration offered in the tenderoffer.

For the purposes of Rule 14e-5, covered person isdefined broadly to include: (i) the offeror and its affiliates;(ii) the offeror’s dealer-manager and its affiliates; (iii) anyadvisor to any of the persons specified in (i) and (ii) above,whose compensation is dependent on the completion ofthe offer; and (iv) any person acting, directly or indirectly,in concert with any of these persons in connection withany purchase or arrangement to purchase any subjectsecurities or any related securities. Subject securities aredefined for the purposes of Rule 14e-5 to include thesecurities or class of securities that are sought to beacquired in the transaction or that are otherwise thesubject of the transaction.

The period during which purchases outside of the tenderoffer are prohibited runs from the potentially earlier dateof public announcement as compared to commencementof the tender offer. Public announcement is defined for thepurposes of Rule 14e-5 as “any oral or writtencommunication by the offeror or any person authorised toact on the offeror’s behalf that is reasonably designed to, orhas the effect of, informing the public or security holders


in general about the tender offer”. Given the potentiallybroad reach of this definition, offerors must be very carefulabout what is stated in advance of any potential cashtender offer or exchange offer, particular when it iscontemplated that purchases of subject securities or anyrelated securities may occur in advance of commencementof the offer.

Exceptions to the Rule 14e-5 prohibition on purchasesoutside of the tender offer include:

• The exercise, conversion or exchange of related securitiesinto subject securities, as long as the related securitieswere held prior to public announcement of the tenderoffer;

• Purchases or arrangements to purchase by or for a planthat are made by an agent independent of the issuer;

• Purchases during odd-lot offers;

• Purchases by or through a dealer-manager or its affiliatesthat are made in the ordinary course of business andmade either on an agency basis not for a covered person;or as principal for its own account if the dealer-manageror its affiliate is not a market maker, and the purchase ismade to offset a contemporaneous sale after havingreceived an unsolicited order to buy from a customerwho is not a covered person;

• Purchases or arrangements to purchase a basket ofsecurities containing a subject security or a relatedsecurity under specified conditions;

• Purchases or arrangements to purchase to cover a shortsale or the exercise of an option by a non-covered person,if: (i) the short sale or option transaction was made inthe ordinary course of business and not to facilitate theoffer; (ii) the short sale was entered into before publicannouncement of the tender offer; and (iii) the coveredperson wrote the option before public announcement ofthe tender offer;

• Purchases or arrangements to purchase pursuant to acontract, if an unconditional and binding contract wasentered into before public announcement of the tenderoffer, and the existence of the contract and all materialterms including quantity, price and parties are disclosedin the offering materials;

• Purchases or arrangements to purchase by an affiliate ofa dealer-manager under specified conditions;

• Purchases by connected exempt market makers orconnected exempt principal traders under certainconditions; and

• Purchases made during cross-border tender offers underspecified circumstances.

What is not required by Regulation 14E?Under Regulation 14E, an issuer is not required to file anytender offer documents with the SEC, and Regulation 14Edoes not prescribe any form requirements with respect tooffering materials. Any offer to purchase, and other tenderoffer documentation, is subject, however, to the generalantifraud provisions of the Exchange Act, notably section10(b), Rule 10b-5 and section 14(e), and, therefore, maynot contain any material misstatement or omission.

Regulation 14E does not specifically require that anofferor provide withdrawal rights to offerees.6 Similarly, theproration, best price, all holders and other provisions setforth in section 14(d) and Rule 13e-4 of the Exchange Actare only applicable to tender offers conducted pursuant toRegulation 14D and Rule 13e-4, and do not apply totender offers subject only to Regulation 14E.

Requirements applicable to issuer tender offers forequity securitiesPursuant to Rule 13e-4 under the Exchange Act, an issuerwith equity securities registered under section 12 or that isrequired to file periodic reports with the SEC pursuant tosection 15(d) is required, in connection with any tenderoffer for its own equity securities, to file a tender offerstatement (on schedule TO) to make certain disclosures toofferees. Rule 13e-4 is intended to prevent fraudulent,deceptive or manipulative acts in connection with issuertender offers.

In general, Rule 13e-4 imposes disclosure, filing, andprocedural requirements on issuers and their affiliates inconnection with issuer tender offers. For the purposes ofthis rule, issuer tender offer is defined as a tender offer for,or a request or invitation for tenders of, any class of equitysecurity made by the issuer of that class of security or by anaffiliate of that issuer. An soon as practicable on thecommencement date of the issuer tender offer, the issuer oraffiliate making the offer must comply with the filing,disclosure and dissemination requirements specified in therule.

Applicability of Rule 13e-4 to equity securitiesEquity securities used in Rule 13e-4 is not defined in therule. Section 3(a)(11) of the Exchange Act provides ageneral definition of the term equity security, whichincludes “any stock or similar security; or any security


future on any such security; or any security convertible,with or without consideration, into such a security, orcarrying any warrant or right to subscribe to or purchasesuch a security; or any such warrant or right; or any othersecurity which the Commission shall deem to be of asimilar nature and consider necessary or appropriate, bysuch rules and regulations as it may prescribe in the publicinterest or for the protection of investors, to treat as anequity security.” Under the statute, the SEC has discretionto evaluate the nature of a security and to consider publicpolicy implications in determining the characterisation ofthe security. Based on this definition, the term equitysecurities for the purposes of the applicability of Rule 13e-4 includes debt securities convertible or exchangeable forequity securities.

In the past, the staff has provided limited no-action letterrelief in respect of offers that should be excluded from theapplication of Rules 13e-3 and 13e-4 based on whether thesubject securities were deemed “equity securities” for thepurposes of those rules. In a no-action letter to AmericanFinancial Corporation,7 the staff concluded it would notrecommend enforcement action if, in reliance on anopinion of counsel, the issuer proceeded with an exchangeoffer relating to non-voting, non-participating,mandatorily redeemable preferred stock withoutcompliance with either Rule 13e-3 or Rule 13e-4. Counselto the issuer had concluded that in economic substance thepreferred stock was equivalent to a debt security. The stafflater affirmed this view in a subsequent no-action letterissued to American Financial Corporation.8 In betweenthese two letters, the staff issued no-action letter guidanceto Republic New York Corporation.9 In Republic New YorkCorporation, the staff concluded that it could not assurethe company that it would not recommend enforcementaction if the issuer were to undertake purchases of shares ofits cumulative preferred stock without compliance withRule 13e-3. The staff will not necessarily take the same viewtoday with respect to preferred stock, particularly insituations where preferred stock which has debt-likecharacteristics has not been treated as debt for the purposesof matters such as compliance with the Trust Indenture Actof 1939 and legality opinions.

On the other hand, the staff has provided informal, oraladvice that trust preferred securities are sufficiently “debt-like” so that tender offers for trust preferred securitieswould be subject to the requirements applicable to debttender offers or exchange offers, and not the morerestrictive requirements applicable to equity tender offersor exchange offers under Rule 13e-4. The staff ’s position ispredicated on the applicable instruments being qualifiedunder the Trust Indenture Act.10 The staff also has focusedon the nature of the legality opinions issued by counsel in

connection with the original registration of the trustpreferred securities.

Further, in a no-action letter for BBVA PrivanzaInternational Limited and Banco Bilbao VizcayaArgentaria,11 BBVA and Banco Bilbao proposed to make acash tender offer for all of the outstanding non-cumulativeguaranteed preference shares, series D of BBVA PrivanzaInternational (Gibraltar), including preference sharesrepresented by American depositary shares. It was acondition to the tender that all such shares be validlytendered and not withdrawn. The intention was to pricethe tender offer based on a stated fixed spread over theyield on a specified benchmark US Treasury security as of2.00pm New York time, on the second business dayimmediately preceding the expiration date of the tenderoffer (the 18th business day of the offer period).

BBVA and Banco Bilbao described that the tender offerwould be made consistent with the principles establishedin prior no-action letters relating to formula pricing inissuer tender offers for equity securities, and that the offerwould be substantially similar to the tender offers coveredby no-action letters relating to the use of fixed spreadpricing methodologies for non-convertible, investmentgrade debt tender offers.

The staff stated that it would not recommendenforcement action under Rule 14e-1(b) against BBVA orBanco Bilbao if the tender offer uses the pricingmechanism described and if the tender offer was otherwiseconducted in the manner represented.

In granting the requested relief, the staff noted, inaddition to the typical conditions for fixed spreadtransactions, that:

• the subject securities are represented as being valued byinvestors on the basis of their yield, taking into accountthe issuer’s credit spread, compared to a benchmarkyield, and the yield of the subject securities fluctuates inresponse to changes in prevailing interest rates;

• the final offer price will be set at least two trading daysprior to the scheduled expiration of the offer; and

• the offerors will issue a press release to publiclyannounce the final offer price prior to the close ofbusiness on the pricing date.

Filing requirementsUnlike under Regulation 14E, Rule 13e-4 requires that anissuer12 engaged in an issuer tender offer must file a tenderoffer statement on schedule TO with the SEC as soon aspracticable on the commencement date of the offer.13 Inaddition, the issuer is required to file:


• Any of its written communications relating to the issuertender offer, from and including the first publicannouncement, as soon as practicable on the date of thecommunication;

• An amendment to the schedule TO reporting promptlyany material changes in the information disclosed in thepreviously filed schedule TO and amendments thereto;14

and

• A final amendment to the schedule TO reportingpromptly the results of the issuer tender offer.

A significant amount of disclosure is required to be filedunder cover of schedule TO.15 Most of the specific lineitem requirements are satisfied by reference to a separateoffer to purchase or offer to exchange document that isfiled as an exhibit to the schedule TO. The informationrequired by schedule TO includes:

• A summary term sheet;

• Information about the issuer;

• The identity and background of filing persons;

• The terms of the transaction;

• Any past contacts, transactions and negotiations;

• The purposes of the transactions and plans or proposals;

• The source and amount of funds or other considerationfor the tender offer;

• Interests in subject securities;

• Persons/assets retained, employed, compensated or used;

• Financial statements, if material;

• Additional information;

• Exhibits; and

• To the extent applicable, information required bySchedule 13E-3.

In addition to the schedule TO filing, an issuerconducting an issuer tender offer must file any pre-commencement written communications under cover ofschedule TO, marking the box on the cover page to note

the status of the materials as pre- commencementcommunications.16 Pursuant to instruction 3 to Rule 13e-4(c), each pre-commencement written communicationmust include a prominent legend in clear, plain languageadvising shareholders to read the tender offer statementwhen it becomes available because it contains importantinformation.

If pre-commencement communications are made inconnection with an exchange offer that is registered underthe Securities Act, then the issuer can file thecommunications solely under Rule 425 under theSecurities Act, and such communications will be deemedfiled for the purposes of Rule 13e-4.

Disclosure requirementsAn issuer making an issuer tender offer under Rule 13e-4must publish, send, or give to shareholders:

• the summary term sheet required by Item 1 of scheduleTO; and

• the information required by the remaining schedule TOitems for issuer tender offers, except for Item 12(exhibits), or a fair and adequate summary of theinformation.

To the extent that there are any material changes to theinformation previously disclosed to shareholders,paragraphs (d)(2) and (e)(3) of Rule 13e-4 require that theissuer disclose those changes promptly to shareholders in amanner reasonably calculated to inform them of thechange.

In the event that an the issuer disseminates the issuertender offer by means of summary publication as discussedbelow, any summary advertisement used by the issuer mustnot include a letter of transmittal that would permitshareholders to tender securities, and the advertisementmust disclose at least the following information:

• the identify of the issuer (or affiliate);

• the material terms and purposes of the transaction, asspecified in Items 1004(a)(1) and 1006(a) of RegulationM-A;

• instructions as to how shareholders can promptly obtaina copy of the disclosure statement required by Rule 13e-4(d)(1), at the issuer’s expense; and

• a statement that the information contained in thedisclosure statement discussed above is incorporated byreference.


Dissemination requirementsWith respect to issuer tender offers in which theconsideration offered consists solely of cash and orsecurities exempt from registration under section 3 of theSecurities Act, an issuer must disseminate the requireddisclosure to security holder by on or more of thesemethods: long form publication of the information, theuse of security holder lists or through summarypublication.

Rule 13e-4(e)(1)(i) provides that dissemination may occurby making adequate long form publication of the tenderoffer in a newspaper or newspapers on the commencementdate of the issuer tender offer. For this purpose, theinstruction to paragraph (e)(1) specifies that adequatepublication may require publication in a newspaper with anational circulation, a newspaper with a metropolitan orregional circulation, or a combination of the two, dependingon the specific facts and circumstances.

Alternatively, Rule 13e-4(e)(1)(iii) permits publicationof a summary advertisement in a newspaper or newspaperson the commencement date including the disclosuresreferenced above, and by mailing or otherwise furnishingpromptly the Rule 13e-4(d)(1) disclosure statement and atransmittal letter to any security holder upon request.

Tender offer materials may also be disseminated by usingsecurity holder lists and security position listings. Underthe procedures specified in 13e-4(e)(1)(ii), the materialsmay be distributed by:

• Mailing or otherwise furnishing promptly the disclosurerequired by Rule 13e-4(d)(1) to each security holderwhose name appears on the issuer’s most recent securityholder list;

• Contacting each participant on the most recent securityposition listing of any clearing agency within thepossession or access of the issuer, and inquiring of eachparticipant as to the approximate number of beneficialowners of the subject securities held by the participant;

• Furnishing to each participant a sufficient number ofcopies of the Rule 13e-4(d)(1) disclosure statement fortransmittal to the beneficial owners; and

• Agreeing to reimburse each participant promptly for itsreasonable expenses incurred in forwarding thestatement to beneficial owners.

• In an exchange offer where the consideration consistssolely or partly of securities that are registered under theSecurities Act, then Rule 13e-4(e)(2) provides that theissuer must:

• File a registration statement containing all of therequired information, including pricing information;and

• Deliver to shareholders a preliminary prospectus or aprospectus that meets the requirement of section 10(a)of the Securities Act, along with a letter of transmittal.17

Material changesRule 13e-4(e)(3) specifies that when a material changeoccurs in the information that the issuer has published,sent or given to security holders, then the issuer mustpromptly disseminate disclosure of the material change “ina manner reasonably calculated to inform security holdersof the change”.

In the case of a registered exchange offer, special timingprovisions govern the dissemination of material changeswhen the issuer has disseminated a preliminary prospectusin accordance with Rule 13e-4(d)(2). Rule 13e-4(e)(3)specifies that the offer must remain open from the date onwhich the issuer disseminates material changes to thetender offer materials to shareholders, as follows:

• Five business days for a prospectus supplementcontaining a material change other than price or sharelevels;

• 10 business days for a prospectus supplement containinga change in price, the amount of securities sought, thedealer’s soliciting fee, or other similarly significantchange;

• 10 business days for a prospectus supplement includedas part of a post-effective amendment to the registrationstatement; and

• 20 business days for a revised prospectus when the initialprospectus was “materially deficient.”

Procedural requirementsRule 13e-4(f ) prescribes the manner in which issuers mayconduct an issuer tender offer, including specificrequirements with respect to the period during which thetender offer must remain open; the availability ofwithdrawal rights, pro rata acceptance, any increases inconsideration, prompt payment for or return of securitiestendered, purchases outside of the tender offer and the allholders and best price protections.

Offering periodRule 13e-4(f )(1)(i) specifies that, unless withdrawn, anissuer tender offer must remain open until expiration of:


• At least 20 business days from commencement of theissuer tender offer; and

• At least 10 business days from the date that notice of anincrease or decrease in one of the following is firstpublished, sent or given to security holders:

• The percentage of the class of securities being sought;18

• The consideration being offered (subject to no deminimis exception); or

• The dealer’s soliciting fee to be given.

Withdrawal rightsRule 13e-4(f )(2) provides that the issuer making an issuertender offer must permit shareholders to withdrawsecurities tendered pursuant to the issuer tender offer:

• At any time during the period when the issuer tenderoffer remains open; and

• If tendered securities have not yet been accepted forpayment, after the expiration of 40 business days fromthe commencement of the tender offer.

Pro rata acceptanceRule 13e-4(f )(3) requires that the tender offer by the issueror affiliate is for fewer than all of the outstanding equitysecurities of a class, and the number of securities tenderedexceeds the number that the issuer is bound or willing totake up and pay for, the issuer or affiliate must accept andpay for the securities as nearly as may be pro rata,disregarding fractions, according to the number ofsecurities tendered by each shareholder during the periodthat the offer remains open.

Rule 13e-4(f )(3) does not prohibit the issuer making anissuer tender offer from:

• Accepting all securities tendered by shareholders whoown no more than a specified number of shares less than100 and who tender all of their securities, before prorating securities tendered by others; or

• Accepting by lot securities tendered by shareholders whotender all of their shares and who elect to have all ornone (or at least a minimum amount and none)accepted, if the issuer or affiliate first accepts thesecurities tendered by persons who have not made suchan election.

Increase in considerationRule 13e-4(f )(4) requires equal treatment of securityholders in the event of an increase in the considerationoffered. If the issuer increases the consideration offeredafter the tender offer has commenced, then issuer must paythat increased consideration to all shareholders whosetendered securities are accepted for payment.

Prompt payment or returnUnder Rule 13e-4(f )(5), an issuer must either pay theconsideration offered, or return the tendered securities,promptly after the termination or withdrawal of the tenderoffer.

Purchases outside the tender offerRule 13e-4(f )(6) prohibits purchases outside of the tenderoffer. Until at least 10 business days after the terminationof the tender offer, the issuer and its affiliates cannotpurchase (other than pursuant to the tender offer) anysubject security, any security of the same class and series, orany right to purchase such securities. With respect toexchange offers, this prohibition applies to the purchasesof any security being offered in the exchange offer, anysecurities of the same class and series, and any right topurchase such a security.

All holders requirementRule 13e-4(f )(8)(i) provides that the tender offer must beopen to all security holders19 of the class of securitiessubject to the tender offer.20

This all-holders provision would not prohibit an issueror affiliate from excluding all security holders in a statewhere the tender offer is prohibited by administrative orjudicial action under a state statute after a good faith effortto comply with the statute.

Best price requirementRule 13e-4(f )(8)(ii) requires that the consideration paid toany security holder for securities tendered in the tenderoffer is the highest consideration paid to any other securityholder for securities tendered in the tender offer.

Rule 13e-4(f )(10) specifies that the best pricerequirement does not prohibit more than one type ofconsideration being offered in a tender offer, providedthat: (i) security holders have an equal right to elect amongeach of the types of consideration offered; and (ii) thehighest consideration of each type paid to any shareholderis paid to any other shareholder receiving that type ofconsideration.

Under Rule 13e-4(f )(11), if the offer and sale ofsecurities constitute consideration offered in the tenderoffer, and the issuer or affiliate has made a good faith effort


to register or qualify the offer and sale in a particular state,but is prohibited by the appropriate authority of that state,the issuer or affiliate may offer shareholders in that state analternative form of consideration. The alternative form ofconsideration need not be offered or paid to shareholdersin any other state.

Antifraud provisionsRule 13e-4(j) specifies antifraud requirements applicableto issuer tender offers, prohibiting issuers and affiliates, inconnection with an issuer tender offer, from:

• Employing any device, scheme or artifice to defraud anyperson;

• Making any false statement of material fact or omissionof material fact necessary to make the statements made,in light of the circumstances under which they weremade, not misleading; or

• Engaging in any act, practice, or course of business thatoperates or would operate as a fraud or deceit on anyperson.

Rule 13e-4(j) also states that, as a means reasonablydesigned to prevent fraudulent, deceptive, or manipulativepractices in connection with an issuer tender offer, it isunlawful for an issuer or affiliate to make an issuer tenderoffer unless it complies with the requirements of Rule 13e-4(b), (c), (d), (e), (f ), and (j). In addition, the otherantifraud and anti-manipulation provisions of theExchange Act would apply to an issuer tender offer,including section 10(b) and Rule 10b-5 thereunder, as wellas section 14(e).

ExemptionsCertain transactions are exempt from the application ofthe rule under Rule 13e-4(h) from the issuer tender offerprovisions. Specifically, Rule 13e-4 does not apply to:

• Calls or redemptions pursuant to the governinginstrument;21

• Offers to purchase evidenced by a scrip certificate, orderform, or similar document that represents a fractionalinterest in a share of stock;

• Offers to purchase shares of dissenting shareholders inaccordance with a statutory procedure;

• Tender offers subject to Exchange Act section 14(d);

• Offers to purchase from owners of up to a specifiednumber of shares less than 100, provided that the offersatisfies the all holder provisions of the rule with respectto shareholders who own a number of shares equal to orless than the specified number of shares (except that theissuer can exclude participants in certain plans foremployees or security holders, and can exclude securityholders who do not own their shares as of a specifieddate); and the equal consideration provisions of rule aresatisfied or consideration paid is determined on the basisof a uniformly applied formula based on the subjectsecurity’s market price;

• Issuer tender offers made solely to effect a rescissionoffer, provided that: (1) the offer is registered under theSecurities Act; and (2) the consideration equals the pricepaid by each security holder, plus legal interest if theissuer elects or is required to pay legal interest;

• Offers by closed-end management investmentcompanies to repurchase equity securities underInvestment Company Act Rule 23c-3;

• Issuer tender offers by a foreign private issuer undercertain conditions relating to: (1) the maximumpercentage of US holders of the subject class ofsecurities; (2) the equal treatment of US holders andother holders; and (3) dissemination of informationaldocuments; and

• Transactions exempted by the SEC, on written requestor on its own motion, either unconditionally or subjectto conditions.

An offer may qualify for the Tier I exemption from thetender offer rules if it can be established that 10% or lessof the securities are held by US resident holders, lookingthrough to the beneficial owners. For the purpose of thisexemption, holders of notes held in bearer form may bepresumed to be outside the United States unless the issuer“knows or has reason to know that these securities are heldby US residents”. Under recently adopted amendments tothe Tier I exemption, an offeror may calculate ownershipby US resident holders as of any date no more than 60 daysbefore, and no more than 30 days after, the publicannouncement of the transaction, rather than as of thedate that is 30 days prior to the publication of the offerdocument as was previously required. In situations wherethe offeror is unable to conduct the necessary analysis ofbeneficial holders within the 90-day period, the SEC nowpermits the use of a date not more than 120 days beforethe public announcement. Under the recently effective


amendments, individual holders of more than 10% of thesubject securities are no longer excluded for the purposesof calculating the level of US ownership.

SEC staff reviewWhen a schedule TO is filed, the SEC staff may review andcomment on the disclosure in the schedule TO, the offerto purchase or offer to exchange, and any other relateddocuments, as well as compliance with Rule 13e-4 andRegulation 14E. The staff Office of Mergers &Acquisitions in the Division of Corporation Financereviews the schedule TO. Typically, the staff tries to issuecomment quickly (within five to seven business days),because the tender offer is only required to be open for 20business days. The staff ’s comments may require that theissuer file amendments to the schedule TO anddisseminate changes in order to address the staff ’sconcerns.

Considerations for liability management transactions

Debt versus equity tender offersThe requirements of Rule 13e-4 result in significantly lessflexibility for tender offers or exchange offers forconvertible or exchangeable debt securities, common stockand preferred stock, when compared to tender offers orexchange offer for straight debt securities. For example, itis not possible for issuers to sweeten a tender offer orexchange offer for convertible or exchangeable debtsecurities, preferred stock or common stock with an earlytender premium as is sometimes the case in tender offers orexchange offers for straight debt securities. Holders thattender early in the offering period, typically within the first10 business days, may receive the total consideration.Under this approach, holders that tender after the earlytender period terminates will receive lesser considerationfor their securities. The early tender feature benefits theissuer because it may have greater visibility regarding thesuccess of the tender offer. An issuer needs to be mindfulthat the falling away of the premium may, under in certaincircumstances, constitute a change in consideration thatmay require that the tender stay open for an additional 10days, as discussed above.

Moreover, in a straight debt tender offer, an issuer hasthe flexibility to choose to accept tenders of securities on afirst come, first served basis, or offer limited or nowithdrawal rights, or conduct a Dutch auction or modifiedDutch auction for pricing purposes.

SEC staff relief for investment grade debt securities The requirements of Regulation 14E may still be limitingfor an issuer conducting a tender offer for straight debtsecurities. Specifically, if an issuer must keep the offer openfor 20 business days or extend the offer period if there areany changes in the consideration or percentage sought, itcan adversely affect the tender because the issuer is subjectto market risk during this time. Most debt tender offersoccur when interest rates are low: the issuer is trying tolower its cost of funds by retiring high interest rate debtsecurities with the proceeds from new securities issued at alower rate, or a lower-interest rate credit facility. If interestrates decline during the offer period, an issuer will notretire as much debt and if rates increase, the retired debtwill come at a higher price. Longer offer periods translateinto increased uncertainty.

Because the SEC staff believes that issuer debt tenderoffers for cash for any and all non-convertible, investmentgrade debt securities may present considerations that differfrom any and all or partial issuer tenders for a class or seriesof equity securities or non-investment grade debt, itconsistently has granted relief to issuers of investmentgrade debt in the context of tenders for their debtsecurities. We discuss this relief in Chapter 4.

Modified Dutch auctionsTypically, in its tender offer documents, an issuer willspecify the amount of securities it is seeking to purchase, aswell as the price at which it will purchase these securities(or the method of calculating the purchase price).However, in some cases, an issuer may specify the amountof securities to be tendered, but may set the price using amodified Dutch auction pricing structure. In thisstructure, the issuer sets a cascading range of prices atwhich a holder may tender its securities. The purchaseprice will be the highest price at which the issuer is able tobuy all of the securities for which it has solicited a tender(or a smaller amount, if not all the securities are tendered).This price is often referred to the clearing price.22

The SEC staff has permitted tender offers to proceedwithout the issuer disclosing the range of prices in thetender offer documents, so long as the aggregate amount ofsecurities to be purchased is disclosed (and the range ofsecurities to be purchased if the offer were fullysubscribed). Usually, the permitted price range is verynarrow: often no more than 15% of the minimum price.In this regard, modified issuer Dutch auction tender offershave been permitted under Rule 13e-4, subject to severaladditional conditions:

• Disclosure in the tender offer materials reflects theminimum and maximum consideration to be paid;


• Pro rata acceptance occurs throughout the offer with allsecurities purchased participating equally in pro-rationing;

• Withdrawal rights are available throughout the offer;

• The issuer makes a prompt announcement of thepurchase price, if determined prior to the expiration ofthe offer; and

• The purchase of all accepted securities is made at thehighest price paid to any security holder under theoffer.23

In prior no-action letter guidance, the staff had noted itsbelief that issuers conducting modified Dutch auctiontender offers could not satisfy the requirements of (then)Schedule 13e-4 by stating a range of shares to be sought inthe tender offer. In this regard, the staff appeared to beconcerned that an issuer would have discretion to select anumber from within that range that might be purchased inthe tender offer.24

More recently, in a recent no-action letter to AllianceSemiconductor Corporation,25 the staff considered amodified Dutch auction tender offer where the issuersuggested that the total number of securities may bedisclosed in terms of the maximum number that can bepurchased, subject to the number of shares tendered and atwhich price those shares are tendered. In the proposedtender offer, the offer to purchase was to state that themaximum number of shares is 10,909,090, and that if theoffer was fully subscribed, the issuer would buy an amountof shares between 10,000,000 and 10,909,090, with exactnumber dependent on the terms of the offer, not a decisionon the part of the issuer. As a result of this structure, theamount that would be purchased in the tender offer isdetermined as a function of the prices at which shares arevalidly tendered and the number of shares tendered.Alliance Semiconductor argued that Rule 13e-3(f )(1)(ii)would not require extending the offer for 10 days after thepurchase price (and hence exact number of shares to bepurchased) was determined, and that the disclosure of therange of shares presented would satisfy the requirement ofItem 1004(a)(1)(i) of Regulation M-A to disclose the “totalnumber and class of securities”.

In providing its response that no enforcement actionwould be recommended if the offer was conducted asdescribed in the letter, the staff particularly noted that:

• The total number and dollar value of securities beingsought in the offer is disclosed in the offer materials asrequired by Item 1004(a)(1)(i) of Regulation M-A;

• The maximum number of shares that may be purchasedin the offer is stated on the cover page of the offer topurchase;

• The offer to purchase discloses the range of shares thatwill be purchased if the offer is fully subscribed; and

• The exact number of shares to be purchased in the offerwill be based on the purchase price established by theshareholders determined in accordance with the terms ofthe offer as disclosed in the offer to purchase.

Other pricing mechanismsIssuers also have adjusted pricing mechanisms to morefully reflect market conditions and fluctuations, and haveasked the staff for no-action letter relief for such pricingmechanisms under Rules 13e-4(d)(1), 13e-4(f )(1)(ii) and14e-1(b). In Thermo Fisher Scientific Inc., the staffprovided no action relief in the context of a cash tenderoffer for convertible notes when the issuer proposed tooffer to pay cash for the tendered securities in an amountdetermined by reference to the average VWAP (defined asthe simple arithmetic average of the daily VWAP over anaveraging period of 21 consecutive trading days ending onthe expiration date of the tender offer).26 In granting therelief, the staff particularly noted that:

• the offer to purchase would disclose the pricingmechanism for determining the final purchase price persubject security that is equal to the sum of the parityvalue (defined as the number of shares of common stockinto which a subject security is currently convertible)plus a fixed amount of cash (together with any accruedand unpaid interest);

• the offer to purchase would include an illustrative tableshowing calculations of the purchase price;

• the offer to purchase would disclose a fixed minimumpurchase price that will be paid by the company for eachsubject security tendered and purchased;

• the pricing mechanism and the minimum price wouldremain fixed throughout the duration of the offer; and,if there was a change in the pricing mechanism or theminimum price, the offer would remain open for at least10 business days;

• the common stock used as the reference security in thepricing mechanism was listed on the New York StockExchange;


• the company’s belief that the value of the subjectsecurities was directly correlated to the trading price ofthe common stock;

• the company would publish the daily indicativecalculated purchase prices per subject security on awebpage maintained for the offer and provided a toll-free number that holders of the subject securities coulduse to obtain pricing related information;

• the company would publish the final purchase price onthe offer webpage and in a press release no later than4.30pm, New York time, on the expiration date of theoffer, and electronically file that information on anamended schedule TO;

• the company would make available forms of VOI andnotice of withdrawal in its printed offering materials andon the offer webpage, will permit tenders andwithdrawals to be made until midnight on theexpiration date, and will disclose the procedures formaking tenders and withdrawals in the offeringmaterials;

• the offer to purchase would include disclosure informingbeneficial holders of the subject securities that they mustmake arrangements with their brokers or similarinstitutions for such brokers or similar institutions to faxa VOI or notice of withdrawal (as applicable) to theDepositary on such beneficial holders’ behalf prior tomidnight, New York time, on the expiration date; and

• the offer to purchase disclosed that the company wasseeking to buy any and all of the subject securities.

Following the Thermo Fischer Scientific Inc. letter, theSEC staff has provided similar relief in the context of cashtender offers and combined cash and common stock offerswherein the offers involved similar formula-based pricingmechanisms. See for example the letters issued to: Textron,Inc. (Oct 7 2011), CNO Financial Group, Inc. (Feb 112013), Group 1 Automotive, Inc. (May 16 2014), SonicAutomotive, Inc. (July 24 2012) and American EquityInvestment Life Holding Company (Aug 23 2013). Ineach case, there were structural protections incorporated inthe tender offers, such as a determinable and fixed pricingformula, daily publication of indicative purchase prices ona webpage available to holders, final pricing based onreadily observable trading prices for securities listed on anational securities exchange, and dissemination of pricingand related information by the issuer. The time periodsincorporated in the VWAP averaging pricing formulae in

each case may have varied in order to address the particularmarket factors affecting the subject security. The SEC staffappears to have focused principally on certainty related tothe pricing formula, and information transparency as itrelates to the indicative pricing.

Concerns with creeping tender offers and purchasesoutside of the offerIn certain circumstances, purchases of securities in themarket or through negotiated transactions could bedeemed to constitute a tender offer that is not incompliance with the rules described above. Further, whena tender offer commences around the time of open marketor negotiated purchases, security holders could potentiallyobject to the terms of the transactions outside of the tenderoffer.

Courts that have addressed the issue of tender offerintegration have taken disparate approaches. Most claimshave arisen in connection with claims of violations of thebest price and all holders provisions applicable to tenderoffers, or violations of the prohibitions on purchasesoutside of a tender offer. Some courts have strictlyconstrued the time frame of the tender offer to start withpublic announcement or commencement and end withwithdrawal or termination, while others have adopted anapproach of determining whether the questionedtransaction was an integral part of the tender offer. Morespecifically, several courts have held that share purchases bythe acquiror made in advance of a tender offer are notimproper, because the tender offer rules are only applicableupon announcement or commencement of the tenderoffer.27 Some courts, however, have taken a broader view ininterpreting whether transactions occurring before or afterthe precise technical commencement and termination orwithdraw of the tender offer were considered part of thetender offer.28

Issuers must carefully structure any ongoing marketpurchases or negotiated acquisitions of securities so as tocomply with the prohibitions on purchases outside of thetender offer in Rules 13e-4 and 14e-5. In this regard, it isoften important to analyse whether the targeted securitiesin the outside purchases are of a separate class from theclass of securities that are the subject of a tender offer. Classis not defined specifically for the purposes of Rule 13e-4and Regulation 14E, however, the term has been definedfor other purposes under the Exchange Act. In section12(g)(5), it is defined to include “all securities of an issuerwhich are of substantially similar character and the holdersof which enjoy substantially similar rights and privileges”.Further, the SEC has provided guidance regarding thedetermination of whether different series of preferred stockare the same class for the purposes of Rule 144A, stating


that the test under Rule 144A to determine whethersecurities would be of the same class would be the sametest as under section 12(g)(5) of the Exchange Act andwould be interpreted in the same manner.

Regulation MWhile Regulation M does not apply to investment gradenon-convertible debt securities, it does apply to equitysecurities, non-investment grade debt and convertibledebt. An issuer that engages in a tender offer must ensurethat it complies with Regulation M. Rule 102 underRegulation M makes it unlawful for an issuer or itsaffiliates “to bid for, purchase, or attempt to induce anyperson to bid for or purchase, a covered security during theapplicable restricted period”. This prohibition is intendedto prevent an issuer from manipulating the price of itssecurities when the issuer is about to commence or isengaged in a distribution. If debt being exchanged in anexchange offer is convertible into the issuer’s equitysecurities, under certain circumstances, repurchases ofconvertible debt securities could be deemed a forcedconversion and, therefore, a distribution of the underlyingequity security for Regulation M purposes.

Special rules for European tendersIt may be the case that the holders of an issuer’s debtsecurities are located in foreign jurisdictions. For instance,if an issuer sold its securities pursuant to Rule 144A in theUnited States and pursuant to Regulation S outside theUnited States. Many frequent debt issuers issue and selltheir debt securities pursuant to Euro medium-term noteprograms or market and sell US registered securities intothe European Union or other foreign jurisdictions. Forthese tenders, an issuer must not only focus on the variousconsiderations described above, but also must be cautiousthat its tender does not violate any rules in the homecountry of its security holders.

In the EU, there are two directives about which an issuershould be concerned. First, the Market Abuse Directive(MAD). As its name suggests, MAD is intended to preventabuses relating to insider trading. Similar to RegulationFD, MAD requires that an issuer announce without delayinformation directly concerning it. MAD applies tofinancial instruments admitted to trading on a regulatedmarket or for which a request for admission to trading hasbeen made. The statute is intended to address insiderdealing, market manipulation and the dissemination offalse or misleading information. Under MAD, an issuershould perform an analysis similar to that underRegulation FD: is the insider in possession of materialnonpublic information. In the case of a debt tender, theterms of the transaction likely was announced, so an issuer

need only consider whether it possesses other informationthat may be considered material.

On April 16 2014, a revamped version of MAD wasformally adopted by the Council of the European Union,taking the form of a Market Abuse Regulation (MAR)which shall apply automatically in all EU states when itbecomes effective in July 2016. While the existing MADregulates financial instruments traded on regulatedexchanges, as discussed above, MAR will also coverinstruments traded on other markets known asMultilateral Trading Facilities (MTFs) and OrganizedTrading Facilities (OTF). Other changes made by MARinclude extending the scope of the existing MAD byregulating market soundings (discussions with investorsprior to commencement of a transaction to gauge interestand determine pricing) and the introduction of a newoffence of attempted insider dealing and marketmanipulation.


1 475 F. Supp. 783, 823–24 (S.D.N.Y. 1979), aff ’d on other grounds, 682

F.2d 355 (2d. Cir. 1982), cert. denied, 460 U.S. 1069 (1983). See also

SEC v. Carter Hawley Hale Stores, Inc., 760 F.2d 945, 950 (9th Cir.

1985).

2 See Rand v. Anaconda-Ericsson, Inc., 794 F.2d 843, 848-49 (2d Cir.

1986), cert. denied, 479 U.S. 987 (1986) (citing Hanson Trust PLC v.

SCM Corp., 774 F.2d 47 (2d Cir. 1985)).

3 Regulation 14E applies to tender offers for any securities other than

“exempt securities” as defined by section 3(a)(12) of the Exchange Act.

As a result, the rules that comprise Regulation 14E apply to tender offers

for debt securities, equity securities, and the securities of companies that

do not have a class of securities registered under section 12 of the

Exchange Act or are otherwise required to file reports under the

Exchange Act.

4 Rule 14d-1(g) states that when “computing any time period under

section 14(d)(5) or section 14(d)(6) of the Act or under Regulation 14D

or Regulation 14E, the date of the event which begins the running of

such time period shall be included.” Therefore, the date on which the

tender offer is first published or sent to holders of the subject securities is

counted as the first day of the 20 business day period.

5 See SEC Release No. 34-42055 (October 22 1999).

6 In tender offers for straight debt securities, it is standard practice to

provide holders with withdrawal rights. These withdrawal rights typically

expire after an initial period, often after the first 10 business days. An

issuer also should consider whether it should reinstate limited withdrawal

rights following the occurrence of any material change in the terms of

the tender offer or the waiver of a material condition.

7 SEC No Action Letter, American Financial Corporation (December 20

1982).

8 SEC No Action Letter, American Financial Corporation (March 9

1989).

9 SEC No Action Letter, Republic New York Corporation (March 5

1985).

10 The Staff has previously indicated that “[the Trust Indenture] Act

generally would apply...to preferred securities issued by a trust that

represent an interest in debt issued by a single obligor”. See SEC


Interpretations: Trust Indenture Act of 1939 (#101.04) (March 30

2007), available at


11 SEC No-Action Letter, BBVA Privanza International Limited and Banco

Bilbao Vizcaya Argentaria, S.A. (December 23 2005).

12 The requirements of Rule 13e-4 applicable to issuers are also applicable

to affiliates of the issuer. For the purposes of this discussion of Rule 13e-

4, references made to the issuer also include affiliates of the issuer.

13 For the purposes of Rule 13e-4, commencement means 12.01 am on the

date that the issuer has first published, sent or given the means to tender

to security holders. The means to tender includes the transmittal form or

a statement regarding how the transmittal form may be obtained.

14 Instruction I to schedule TO provides that information previously

disclosed in the schedule TO may be omitted in an amendment

disclosing a material change.

15 At the time of making the initial schedule TO filing, the issuer will be

required to pay a filing fee computed in accordance with Rule 0-11 of

the Exchange Act. If a fee has been paid under section 6(b) of the

Securities Act with respect to any of the securities issued in connection

with the proposed transaction, then the required fee is reduced by that

amount. Similarly, the fee required for a Securities Act registration

statement would be reduced by the amount of any fee paid in

connection with the schedule TO filing.

16 See Instruction 1 to Rule 13e-4(c). The filing person need not respond

to the specific line items of schedule TO when filing pre-commencement

written communications, and no fee is required with the filing.

17 Instruction 2 to Rule 13e-4(e)(2) provides that a preliminary prospectus

cannot omit information under Rule 430 or 430A of the Securities Act.

Instruction 3 to Rule 13e-4(e)(2) provides that when a preliminary

prospectus is used and the issuer must disseminate material changes, the

tender offer must remain open for the period specified in Rule 14d-

4(d)(2). If a preliminary prospectus is used, tenders may be requested in

accordance with Securities Act Rule 162(a), pursuant to Instruction 4 to

Rule 13e-4(e)(2).

ENDNOTES


18 An issuer may accept for payment up to an additional 2% of the class

without triggering the additional 10 business days. For the purposes of

this rule, the percentage of the class is calculated in accordance with

section 14(d)(3) of the Exchange Act.

19 Rule 13e-4(a)(6) specifies that the term security holders means both

holders of record and beneficial owners of securities of the class which is

the subject of the tender offer. As a result, a tender offer open to only

holders of record would not satisfy the all holders requirement.

20 The SEC has indicated that a tender offer may be made for fewer than

all outstanding securities, but all security holders must be eligible to

accept the offer if they choose. See Release No. 34-23421 (July 11

1986).

21 In the SEC staff ’s view, a put option whereby the issuer is obligated to

repurchase securities at specific dates pursuant to the terms of an

indenture would not be considered a redemption for the purposes of this

exemption.

22 Under the SEC’s guidance, all security holders whose securities are

accepted in a modified Dutch auction issuer tender offer subject to Rule

13e-4 must be paid the highest consideration paid to any other security

holder whose securities are accepted. See Release No. 34-23421 (July 11

1986). The Release also notes that pure Dutch auctions are not

permitted under Rule 13e-4, stating: “In a pure Dutch auction cash

tender offer, the bidder invites security holders to tender securities to it

at a price to be specified by the tendering security holder, rather than at

a price specified by the bidder. Securities are accepted, beginning with

those for which the lowest price has been specified, until the bidder has

purchased the desired number of securities.”

23 See Release No. 34-23421 (July 11 1986) at note 64.

24 See SEC No-Action Letter, Tektronix, Inc. (June 19 1987); SEC No-

Action Letter, Janet S. Thiele (December 21 1987).

25 SEC No-Action Letter, Alliance Semiconductor Corp. (September 22

2006).

26 SEC No-Action Letter, Thermo Fisher Scientific Inc. (November 13

2009)

27 See, e.g., Lerro v. Quaker Oats Co., 84 F.3d 239, 257 (7th Cir. 1996);

Kahn v. Virginia Retirement Sys., 13 F.3d 110, 113 (4th Cir. 1993); Heine

v. The Signal Companies, Inc., 1977 US Dist. LEXIS 17071 (S.D.NY

1977).

28 See, e.g., Millionerrors Investment Club v. General Electric Co. PLC, 2000

Dist. Lexis 4803 (W.D. Pa. March 21 2000); Perera v. Chiron

Corporation, 1996 US Dist. Lexis 22503 (ND. Cal. May 8 1996); Field

v. Trump, 850 F.2d 938 (2d Cir. 1988), cert. denied, 109 S. Ct. 1122

(1989) (April 23 1990).


Tax issues can be an important consideration inany liability management transaction. Evenwith sound tax advice certain tax consequencesare inescapable and must be carefully

considered. The following sections discuss severaladditional nuances that arise when reshuffling acorporation’s liability structure as well as some of the mostrecent and significant changes to the Internal RevenueCode (the Code) and Treasury regulations thereunderaffecting liability management. As reflected below,Congress and Treasury appear to have turned theirattention toward the international arena.

Section 108(i) and the deferral of COD incomeAs discussed under Liability Management Overview,corporations with outstanding debt may be subject to taxon cancellation-of-indebtedness (COD) income when allor 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, therepurchase of debt by the issuer at a discount, the exchangeof one debt instrument of the issuer for another, themodification of debt and the exchange of debt for equityof the issuer. Additionally, repurchases or exchanges bypersons related to the issuer can create COD income.

Section 108(a) of the Code provides a number ofexceptions to the inclusion of COD income, includingexceptions related to insolvency and bankruptcy. In eachcase, the COD income is permanently excluded fromtaxation. As a price for the bankruptcy and insolvencyexclusions, the tax attributes of the taxpayer (for example,its net operating losses, tax credits or adjusted tax basis inproperty) are correspondingly reduced.

OID and AHYDO reliefOriginal issue discount (OID) generally arises when a noteis originally issued at a discount to its face amount or, moretechnically, its “stated redemption price at maturity”. OIDequals the amount of the discount. Issuers generally accrueand deduct, and holders general accrue and include inincome, OID on a current, constant yield basis, subject toan exception for instruments issued with a de minimisamount of OID.

An “applicable high yield discount obligation”(AHYDO) is a debt instrument with: (i) a maturity inexcess of five years; (ii) a yield that equals or exceeds thesum of the “applicable federal rate”1 plus five percentagepoints; and (iii) “significant original issue discount.”2 Theissuer of an AHYDO is denied a deduction for a portion(the “disqualified portion”) of OID.3 In addition, thenon-disqualified portion of OID is deductible only whenpaid.

Exchanges or modifications of publicly tradeddebt instrumentsAs also discussed under Liability Management Overview, anissuer of a debt instrument that exchanges its existing debtfor newly issued debt faces the possibility of recognisingCOD income. Conversely, an exchange generating CODincome could generate a corresponding amount of OID.In addition, an investor that had purchased suchexchanged debt instrument at a discount could recognisegain if such exchange was not a recapitalisation for taxpurposes. Note the same consequences obtain when anexisting debt instrument is significantly modified, inwhich case, for federal income tax purposes, a deemedexchange of a new debt instrument (having the modifiedterms) for an old debt instrument (having the originalterms) occurs.

Generally, the amount of COD income and OIDresulting from an exchange equals the excess of the paramount of the old debt instrument over the issue price ofthe new debt instrument. Similarly, the amount of anygain recognised by an investor equals the excess of the issueprice of the new debt instrument over such investor’s costtax basis in the instrument.

The issue price of a debt instrument issued in anexchange differs markedly depending on whether suchinstrument, or the instrument for which it has beenexchanged, is publicly or privately traded for federalincome tax purposes. While public trading results in anissue price equal to the fair market value of theinstrument, private trading generally results in an issueprice equal to par. Such difference leads to markedlydifferent tax consequences, as reflected in the followingexample:

CHAPTER 7

Tax issues


• A debt instrument with an outstanding principalamount equal to its original issue price of $100 ispurchased by an investor for $30 in an over-the-countertransaction for a price negotiated between a securitiesdealer and the investor. The investor and issuersubsequently agree to lengthen the maturity and reducethe interest rate on the debt instrument; suchmodification is significant for federal income taxpurposes. The debt instrument after the modification isquoted at a purchase price of $35.

• If the debt instrument was publicly traded, the issueprice of the new debt instrument would be $35. Theissuer would recognise COD income of $65 ($100 parless $35 issue price), the debt instrument could have $65of OID and the purchaser could recognise $5 of gain($35 issue price less $30 of tax basis). By contrast, if theinstrument was not publicly traded and no change wasmade to the outstanding principal amount, the issueprice of the new debt instrument would be $100. Theissuer would not recognise COD income on the deemedexchange and no OID would arise but the purchasercould recognise $70 of gain ($100 issue price less $30basis).

For these purposes, property, such as a debt instrument,is publicly traded – or more precisely, “traded on anestablished market” in the following situations: (1) thesales price for property is reasonably available; (2) a firmprice quote to buy or sell the property is available; or (3) aprice quote (i.e., an indicative quote) is provided by adealer, broker or pricing service. The fair market value ofsuch property is presumed equal to its trading price, salesprice or quoted price, whichever is applicable. If more thanone price quote exists, taxpayers can reconcile thecompeting prices in a “reasonable manner.” In the case ofan indicative quote, however, if the taxpayer determinesthe quote materially misrepresents fair market value thetaxpayer is entitled to use a reasonable method todetermine fair market value.

Contingent convertible debt instrumentsUS corporations have raised billions of dollars by issuingso-called contingent convertible debt instruments(CoCos). CoCos are debt instruments convertible intostock of the issuer that provide for the payment of“contingent interest”. For example, a typical CoCo mayprovide that the amount of interest payable equals theamount of the dividends paid on the stock into which thedebt converts and that the CoCo becomes convertible onlyafter the CoCo’s price exceeds a percentage (for example,120%) of its adjusted issue price. As a result of the

contingent interest feature, CoCos are treated as“contingent payment debt instruments” for US federalincome tax purposes, and the issuer and holder are subjectto the “non-contingent bond method” rules provided forin applicable Treasury regulations. Under this method, theholder is required to include in income, and the issuerdeducts, as interest over the term of the CoCo based on thecomparable yield of non-contingent debt instruments ofthe issuer. Differences between taxable income includedand cash received are reconciled when a contingentpayment is made (which, often, is not until maturity orconversion of the CoCo into stock of the issuer).

On a restructuring or repurchase of a CoCo prior tomaturity, the issuer’s COD income is not determined byreference to the CoCo’s face amount but rather byreference to its accreted adjusted issue price, whichgenerally increases as interest is deemed to accrue underthe non-contingent bond method. For example, a CoCoissued 10 years ago with a face amount of $1000x and acomparable yield at the time of issuance of 5% currentlyhas an adjusted issue price of approximately $1600x. As aresult, a repurchase of the CoCo by the issuer prior tomaturity for its face amount would result in COD incometo the issuer of $600x. Even absent a repurchase ormodification of the CoCo, the issuer faces the samesituation at maturity of the instrument. If the CoCo isretired at maturity for its face amount, the issuer wouldhave to include $600x in income. Issuers of CoCos mustcarefully weigh all available options – alternatives that havesubstantially the same economic result may not havesubstantially the same tax result.

Different, and at times more complicated, tax issues ariseif the debt instrument is not publicly traded. Suchinstruments can result in the restructured debt instrumentbeing split into two components for US federal income taxpurposes: a non-contingent component and a contingentcomponent. The application of these rules can beextremely complex and must be carefully worked throughby issuers and holders that participate in debtrestructurings and workouts involving non-public debt (orthat result in non-public debt).

Debt reopeningsDebt issues are often reopened, meaning an issuer issues anadditional tranche of notes at some point after the issuanceof the original notes. The additional notes bear the sameterms and security identification code (for example, theCUSIP number) as the original notes. The issuer’s intent isthat the original notes and the additional notes beindistinguishable and, therefore, completely fungible. Onebenefit of fungibility is that it adds liquidity to the marketfor the notes. Reopening a debt issue can cause significant


tax consequences, particularly where the additional notesare issued with OID.

By way of background, OID is an attribute of a noteitself (in other words, OID travels with the note and doesnot vary depending on whether an original investor or asecondary market investor holds the note). In contrast,market discount generally arises when an investorpurchases a debt instrument in the market at a discountafter original issue. Unlike OID, unless the holder electsotherwise market discount is not currently taxable as itaccrues but is taxable on retirement or disposition of thenote. Original notes often are not issued with OID.Nevertheless, additional notes may be priced at a non-deminimis discount because, for example, interest rates haverisen after original issue. Notwithstanding the foregoing, aholder generally would prefer the original notes and theadditional notes be fungible from a tax standpoint, so thatthe additional notes are not treated as having been issuedwith OID, but rather are treated as being acquired withmarket discount. The reopening rules discussed belowpolice the boundaries within which additional notes maybe treated as fungible with original notes in this manner. Iforiginal and additional notes do not meet the requirementsdescribed below, the tax law treats the additional notes as afresh issuance issued with OID and, accordingly, theoriginal and additional notes would not be fungible froma tax standpoint.

To be fungible from a tax standpoint, the original andadditional notes must have terms identical in all respectsand must satisfy one of three tests, the first of whichfocuses entirely on time of issuance and the second andthird of which focus on whether the reopening is qualified.

Under the first test, the original notes and the additionalnotes must be issued within thirteen days of each other.

Under the second test, a reopening of debt instrumentswill be a qualified reopening, and hence will result infungible notes, if:

• the original notes are “publicly traded” within themeaning of applicable Treasury regulations;

• the issue date of the additional notes is not more than sixmonths after the issue date of the original notes; and

• on the pricing date of the reopening (or, if earlier, theannouncement date), the yield of the original notes(based on their fair market value) is not more than110% of the yield of the original notes on their issuedate (or, if the original securities were issued with nomore than a de minimis amount of OID, their couponrate).

Under the third test, a reopening of debt instruments(regardless of whether the reopening occurs within sixmonths of original issuance) is treated as a qualifiedreopening if:

• the original notes are publicly traded; and

• the additional notes are issued with no more than a deminimis amount of OID.

In 2012, the Treasury regulations were issued thatexpand the definition of a qualified reopening to twoadditional circumstances. A reopening of non-publiclytraded debt will be a qualified reopening if:

• the additional notes are issued to persons unrelated tothe issuer; and

• one of the following requirements is met:

• the issue date of the additional notes is not more than sixmonths after the issue date of the original notes and, onthe pricing date of the reopening (or, if earlier, theannouncement date), the yield of the additional notes(based on their cash purchase price) is not more than110% of the yield of the original notes on their issuedate (or, if the original securities were issued with nomore than a de minimis amount of OID, their couponrate); or

• the additional notes are issued with no more than a deminimis amount of OID.

The new regulations also allow for qualified reopeningsmore than six months after the original notes were issuedwhere:

• the additional notes are either publicly traded or areissued to persons unrelated to the issuer; and

• on the pricing date of the reopening (or, if earlier, theannouncement date), the yield of the additional notes(based on their fair market value or cash purchase price,whichever is applicable) is more than 100% of the yieldof the original notes on their issue date (or, if the originalsecurities were issued with no more than a de minimisamount of OID, their coupon rate).

As a practical matter, if neither the original notes nor theadditional notes would be viewed as issued with OID(each tested on a separate basis), the original notes and theadditional notes may, nonetheless, be fungible for tax


purposes regardless of whether the reopening is a qualifiedopening.

If the original and additional notes are not fungibleunder the foregoing rules but the original and additionalnotes are, nonetheless, issued as indistinguishable (issuedwith the same terms and CUSIP number), it would beimpossible for secondary market purchasers or, for thatmatter the Internal Revenue Service, to trace such notesthrough the chain of intermediate ownership anddetermine whether a particular note was issued as part ofthe original issuance (without OID) or the additionalissuance (with OID). As a result, there is a risk additional,non-fungible notes may taint original notes, with theInternal Revenue Service treating both the original andadditional notes as having OID.

Source rules for guarantee incomeSubject to numerous exceptions, the United Statesgenerally imposes a 30% withholding tax on US-sourcefixed or determinable, annual or periodical income(FDAP) of a nonresident alien individual or foreigncorporation that is not effectively connected with theconduct of a US trade or business. FDAP includes interestand guarantee fees. While it has detailed rules to determinethe source of various types of FDAP such as interest, theCode is silent with respect to other types of FDAP, such asguarantee income.

In response to a Tax Court decision to the contrary,4 theSmall Business Jobs Act of 2010 (the SBJ Act) enacted anew Section 861(a)(9) of the Code, under which US-source income includes: (i) amounts received (directly orindirectly) from a non-corporate resident or a domesticcorporation for the provision of a guarantee ofindebtedness of such person; and (ii) amounts receivedfrom a foreign person (directly or indirectly) for theprovision of a guarantee of indebtedness of that foreignperson if the payments received are effectively connectedwith the US trade or business of such foreign person.

In addition, the SBJ Act provides that this new ruleapplies to payments made indirectly for the provision of aguarantee. The legislative history provides the followingexample:

A foreign parent of a US subsidiary guarantees the debtof such US subsidiary owed to a foreign bank. However,instead of receiving a guarantee fee from its US subsidiary,the foreign parent receives a fee from the foreign bank,which recoups this cost by charging additional interest tothe US subsidiary.

In this case, new Section 861(a)(9) would treat the feesreceived by the foreign parent from the foreign bank asUS-source guarantee fees.

Foreign Account Tax Compliance ActOn March 18 2010, President Obama signed into law theHiring Incentives to Restore Employment Act, whichincorporated the Foreign Account Tax Compliance Act(Fatca). Fatca included provisions which: (i) introduce anew 30% withholding tax on certain payments, includinginterest, made to foreign entities that fail to comply withspecified reporting or certification requirements; and (ii)effectively end the practice whereby US issuers sold bearerbonds to foreign investors by repealing the US bearer bondexception. The new withholding tax began applying topayments made after June 30 2014. Importantly, debtobligations outstanding on July 1 2014 are grandfatheredfrom the new withholding tax and debt obligationsoutstanding on March 18 2012 are grandfathered from therepeal of the US bearer bond exception.

New withholding taxFatca introduced a new 30% withholding tax (subject torefund or credit under certain circumstances) on any“withholdable payment” made to a foreign entity unlesssuch entity complies with certain reporting requirementsor otherwise qualifies for an exemption. A withholdablepayment includes interest. Beginning January 1 2017, italso includes gross proceeds from the sale of property thatis of a type that can produce US-source dividends orinterest, such as debt issued by domestic corporations. Inresponse to Fatca, several dozen countries have enteredinto intergovernmental agreements with the United Statesin order to modify the reporting requirements with respectto that country’s financial institutions.

Repeal of bearer bond exceptionIn 1982, Congress passed the Tax Equity and FiscalResponsibility Act (Tefra), which restricted the issuance ofdebt instruments in bearer form. Under Tefra, issuers ofdebt instruments in bearer form generally are denieddeductions for interest paid with respect to such debtinstruments and are subject to an excise tax equal to 1% ofthe principal amount of such instruments times thenumber of years to maturity. Various additional sanctionsalso apply to holders. However, the aforementionedsanctions have not applied with respect to bearer debtinstruments issued under circumstances in which they areunlikely to be sold to US persons. These circumstancesinclude an issuance of foreign-targeted bearer debtinstruments that complies with Treasury regulationsreferred to as Tefra C and Tefra D. In addition, Congressprovided that debt instruments in bearer form do notqualify for the “portfolio interest” exemption from the30% withholding tax generally applicable to the paymentof interest to foreign persons unless such instruments are


issued in compliance with the foreign-targetedrequirements imposed by Tefra.

Many US issuers have European medium-term note orother foreign-targeted programs under which they issuebearer notes to non-US investors. These issuances complywith the Tefra regulations and, as such, the instruments arenot subject to the sanctions described above or to USwithholding tax. In addition, many non-US issuersinclude Tefra restrictions in their debt offerings outside theUS to ensure they are not subject to the Tefra excise tax.

Fatca effectively ended the practice of US issuers sellingbearer bonds to foreign investors under Tefra C and TefraD. With respect to US issuers of foreign-targeted bearerbonds, Fatca repealed the exception to a denial of interestdeduction for interest on bearer bonds. In addition,interest paid on such bonds no longer qualifies fortreatment as portfolio interest. As a result, US issuersrevised their existing programs to prohibit bearer debt.Fatca did, however, preserve the exception to the excise taxfor bearer bonds issued under Tefra-compliant procedures.As a result, foreign issuers of a foreign-to-foreign bearerdebt offering that is Tefra-compliant are not subject to theexcise tax.

For more detailed information regarding Fatca, pleasesee our website at www.knowfatca.com.

Interest expense allocationsOn August 10 2010, President Obama signed into law theEducation Jobs and Medicaid Assistance Act of 2010 (theEducation Jobs Act), which, among other things, affectsthe allocation of interest expense for foreign tax credits andrepeals the rules regarding 80/20 companies.

In determining a taxpayer’s foreign tax credit limitation,interest expense is allocated to each affiliate in a group,including domestic corporations and, in certain limitedcircumstances, foreign corporations. For purposes of theinterest expense allocation rules, the Education Jobs Acttreats a foreign corporation as an affiliate of a group ifmore than 50% of its income is effectively connected witha US trade or business and if it is at least 80% owned (byvote or value) by the affiliated group. As a result, a largerportion of interest expense may be allocated to foreignsubsidiaries, thereby reducing foreign source income andlimiting the use of foreign tax credits.

Under prior law, if a US corporation, during a three-yeartesting period, derived at least 80% of its gross incomefrom foreign sources and such income was attributable tothe active conduct of a trade or business in a foreigncountry (generally referred to as an 80/20 company), theninterest paid by such corporation was treated as foreignsource and therefore was not subject to US withholdingtax. Subject to certain grandfathering clauses, the

Education Jobs Act repeals the 80/20 rules effective fortaxable years beginning after December 31 2010. Underthe grandfather clauses, if a US corporation: (i) meets theabove-described 80/20 test for its taxable year beginningbefore January 1 2011; (ii) meets a new modified 80/20test with respect to each taxable year beginning afterDecember 31 2010; and (iii) has not added a substantialline of business after August 10 2010, then any payment ofinterest will be exempt from US withholding tax to theextent of its active foreign business income. In addition,under the grandfather clauses the repeal of the 80/20company provisions does not apply to the payment ofinterest to unrelated persons on obligations issued beforeAugust 10 2010.


1 The “applicable federal rates” are interest rates published monthly by

the US Treasury for purposes of applying various provisions of the

Code.

2 Under Section 165(i)(2) of the Code, OID is significant if,

immediately before the close of any accrual period ending more than

five years after issue, the aggregate amount that has been included in

gross income with respect to an instrument exceeds the sum of actual

interest payments plus an amount equal to the product of the

instrument’s issue price and yield to maturity.

3 Under Section 165(e)(5), the disqualified portion of OID is the lesser

of (i) all OID or (ii) the product of (a) the sum of OID and stated

interest on the instrument and (b) the ratio of (X) an amount by

which the yield to maturity exceeds 6% plus the AFR to (Y) the yield

to maturity.

4 Container Corp. v. Comm., 134 T.C. No. 5 (February 17 2010).

ENDNOTES


CHAPTER 8

liability management handbook 2015 update

Documents