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March 23, 2020

Managing Capital Markets Debt Obligations in the Coronavirus Crisis: A Liability Management Primer

Coronavirus: Corporate and Finance Advisory

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The coronavirus is impacting the financial health of companies across virtually all industries, raising concerns for many companies regarding sufficiency of liquidity for operations and debt service, as well as access to the capital needed to refinance near and medium-term maturities. For many companies, access to new capital through the debt and equity markets may be limited or unavailable for the duration of the current economic conditions. This same lack of capital for potential purchasers, coupled with uncertainty regarding valuations of companies and assets, will further limit distressed companies' potential strategic alternatives. Without potential suitors or access to new capital, weathering the financial crisis will require, in many cases, that companies and bondholders negotiate to preserve value for all parties.

Revisiting Forecasts and Sensitivity Analysis in Light of Current Crisis

For many companies, the downside scenarios considered by management and boards of directors in financial forecasting increasingly look like "most likely" scenarios. In some cases, scenarios not previously even considered are being evaluated by management on a daily basis. Curtailment of operations, layoffs, supply chain disruption and a reduction in demand for an uncertain period of time will require directors and officers to act quickly to address liquidity concerns and debt maturities.

For companies with bonds or other public debt securities, in addition to bank loans, seeking modifications to the terms of their securities will require time and planning. Time is needed because, unlike with bank loans, amendments to indentures cannot be handled through negotiations with an administrative agent and a known group of lenders. Because debt securities are generally held through DTC in "street name" only, it can be difficult to ascertain with certainty the identity and holdings of bondholders, making it difficult to reach consensus on a path forward with bondholders and mechanically difficult to obtain necessary consents.

The Zone of Insolvency

Making predictions in the current economic environment is difficult, but directors and officers must do so with a view to whether the company has sufficient liquidity for the near term. If not, the company may be insolvent or in what courts refer to as the "zone of insolvency." At this point, in some jurisdictions, directors and officers owe fiduciary duties to the company's creditors—the relationship is no longer merely contractual. These fiduciary duties require that directors and management take steps to preserve value for creditors and not solely consider the interests of shareholders (as would have been the case for a solvent company). In many cases, preserving value for creditors will involve recapitalizing the company.

Out-of-Court Restructurings—The Proverbial Carrots and Sticks

Recapitalizations can be accomplished through a Chapter 11 proceeding overseen by a bankruptcy court or outside of court through a consensual restructuring. Chapter 11 proceedings, although sometimes the only available option for a company, are typically expensive, time consuming and generally disruptive to operations, often causing further deterioration in an already distressed business. A pre-packaged or pre-arranged bankruptcy, where a restructuring arrangement is negotiated before the Chapter 11 proceeding begins, can mitigate some of the expense, time and disruption associated with a bankruptcy filing. Consensual out-of-court restructurings, if the requisite consents can be achieved, are therefore generally preferable for all parties.

For an out-of-court restructuring to be a viable option, management and directors must act sufficiently in advance while the company has the time and financial resources needed to analyze all of its options; craft a solution that is acceptable to the company, its equity holders, its bank lender and bondholders; and execute upon that strategy. An exploration of alternatives often involves retaining financial and legal advisors to assess the company's options, which may include sales of assets, a sale of the company or restructuring of the company's debt and equity.

Out-of-court restructurings vary considerably depending upon a company's capital structure and its circumstances, including the extent to which the company's needs require short-term relief or long-term solutions. To the extent the company is seeking to extend maturities or relief from debt service obligations, a comprehensive recapitalization of the company will generally be required. To accomplish a recapitalization outside of Chapter 11, a company and its debt and equity holders will need to negotiate an agreement that is acceptable to all parties, including the requisite percentage of bondholders needed to amend the indenture and/or exchange securities to successfully execute the recapitalization. Reaching this consensus outside of court generally involves a combination of "carrots" to incentivize bondholders and "sticks" to reduce the number of "hold outs."

This Advisory discusses the options available to companies to execute an out-of-court restructuring, and the applicable legal and structural considerations.

Consent Solicitations and Exchange Offers

Out-of-court restructurings will virtually always entail an amendment of the indenture governing the debt securities through a consent solicitation and/or an exchange of existing debt securities for new debt or equity securities through an exchange offer.

Consent Solicitation to Amend Indenture

Consent solicitations can be used to modify covenants and events of default to permit a specific contemplated transaction or to provide covenant relief, additional debt or lien capacity and/or greater operating flexibility. An issuer may seek to amend the terms of its indenture through a stand-alone consent solicitation in exchange for payment of a consent fee or, as discussed below, combining a consent solicitation with an exchange offer. Even if coupled with an exchange offer, a portion of the total consideration offered may be characterized as a consent payment, usually paid only to security holders who tender on or prior to the consent deadline, commonly 10 business days after commencement of the offer. Withdrawal rights usually terminate on the consent payment deadline. This structure is intended to encourage prompt response to the exchange offer and to provide the issuer with earlier feedback regarding the likelihood of the offer's success.

Typically, the amendment or waivers sought in stand-alone consent solicitations are more limited than exit consents because the target holders are not tendering their securities and expect continued benefits of the covenants following the amendment or waiver. Free-standing consent solicitations are frequently open for a minimum period of 10 business days, although a supplemental indenture giving effect to the amendments or waivers sought may be executed and delivered as soon as the requisite consents from security holders are obtained. Time periods required in exchange and tender offers are discussed below.

Consent Solicitation Combined with Tender or Exchange Offer

When conducted together with a tender or exchange offer, consents are referred to as "exit consents." As a condition to participating in an exchange or tender offer, bondholders generally are required to give consent to the amendment, with the amendment becoming effective prior to, and conditioned upon the closing of the exchange offer or tender offer. Because the terms of the amended indenture will apply only to those bondholders that do not participate in the exchange offer, exit consents can serve as a strong incentive to encourage bondholders to participate.1 In addition, the small amount of notes outstanding following an exchange offer provides further incentive. Not only is the security less attractive, it is likely also relatively illiquid.

Bondholders that choose to "hold out" and not consent to the tender or exchange generally will end up with a security that no longer contains protective covenants and/or is subject to other unfavorable amendments, such as the release of collateral securing the notes. The extent to which the terms of a debt security can be amended through a consent solicitation depends on the terms of the indenture and whether the indenture is governed by the Trust Indenture Act of 1939 (the TIA). Most indentures permit the amendment of covenants and other terms of the indenture with the consent of the holders of a majority of the outstanding principal amount of the notes, subject to certain important exceptions.

In particular, without the consent of each holder impacted, the economic terms of the securities generally cannot be amended. These include maturity, interest rate, interest payment dates, currency in which payments are made, redemption dates, redemption prices, waiver of events of default with respect to the payment of interest or principal, changes to the ranking of the security in respect of the right to payment and often the release of any guarantor's guarantee other than as provided in the indenture. Although not all indentures are subject to the TIA, debt securities issued in a registered offering, including through an A/B Exchange Offer, are subject to the TIA. TIA Section 316(b) provides that the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security, on or after the respective due dates expressed in such indenture security, cannot be impaired or affected without the consent of such holder. Many other indentures, even if not subject to the TIA, are modeled on the same forms and/or nevertheless incorporate certain TIA provisions. Indentures that are not qualified under the TIA may contain additional flexibility but, at least in the US, most indentures follow the TIA in this regard.

This is not to say that the majority cannot eliminate other important protections that bondholders may feel are key components of the security. For example, all of the collateral securing notes can generally be released from the liens of the indenture with the consent of holders of 66 2/3% of outstanding principal amount of the notes.2

Consent Payments

Companies seeking amendments to an indenture are sometimes able to identify and negotiate with the holders of a majority of the principal amount of the bonds prior to launching a consent solicitation. In this circumstance, the question often arises as to whether the company is required to pay the consent fee to all holders. Many indentures contain a "Payments for Consent" covenant that states that the company cannot pay any consideration to or for the benefit of any holder for a consent or as an inducement to any consent, waiver or amendment unless the same consideration is offered to be paid and is paid to all holders that consent, waive or agree to amend in the required time frame. The wording of this covenant varies from indenture to indenture, making it important to consult with counsel to determine whether the structure of any payments or the offer of any securities or other rights to bondholders in connection with an amendment does not violate the indenture.

Exchange Offers

For issuers seeking to reduce the principal amount of outstanding debt, extend maturities or make changes to the interest payment provisions, an exchange offer will generally be required. Because indentures generally do not permit amendment of these terms without the consent of all holders, issuers must structure the offer as an exchange of existing notes for debt securities or some combination of new debt and equity securities.

Although exit consents will provide an incentive for bondholders to exchange, "hold outs" can nevertheless present an obstacle to a successful recapitalization. Bondholders generally are not willing to accept less favorable economic terms unless all or almost all bondholders do so. For this reason, exchange offers are generally conditioned upon a high level of participation (e.g., 95% or higher). If the requisite participation level is not sufficiently high, a prepackaged bankruptcy may prove to be a more cost-effective means of binding the holdouts.

Securities Laws Applicable to Exchange Offers

Exchange offers are subject to the tender offer rules of the Securities and Exchange Commission (the SEC). In addition, because new securities are being offered in an exchange offer, the offer and sale of those securities is subject to the requirements of the Securities Act of 1933, as amended (the Securities Act). The offer and sale of securities in an exchange offer must be registered or, as is more typically the case, an exemption from registration must be available. As outlined below, issuers commonly avoid the registration requirements of the Securities Act by conducting exchange offers as private placements of new exchange securities with accredited investors or qualified institutional buyers (QIBs). This is an increasingly viable option as many debt securities are issued in "144A for life" transactions with trading that remains highly concentrated among QIBs for the life of the bonds. In addition, exchange offers may potentially be structured to comply with the transactional exemption provided under Section 3(a)(9) of the Securities Act.

Tender Offer Rules Applicable to Exchange Offers

Exchange offers for debt securities are subject to Regulation 14E and Rules 14e-1, 14e-2 and 14e-3 of the Securities Exchange Act of 1934 (the Exchange Act). The antifraud provisions of the Exchange Act, including Rule 10b-5, also apply to exchange offer purchases so the offer documents must not contain any material misstatements or omissions. While the offer to purchase and related documents usually follow a common form, unlike tender offers for equity or equity-linked securities that are registered under Section 12 of the Exchange Act, no specific documentation or filings with the SEC are required.

  • Tender Offer Period: Rule 14e-1 requires that a tender offer generally be held open for at least 20 business days from the date tender offer documents are first sent to holders of the target securities, although tender offers for investment grade straight debt securities may be conducted in 7-10 business days if the tender information is disseminated in an expedited manner.3 Frequently, the consideration or other terms of the offer must be modified after launch due to insufficient tenders in response to the original offer. Other amendments to the offer documents may also become necessary during the offer period, often due to events occurring subsequent to, and unforeseen, at launch. In such cases, the tender offer must remain open for at least 10 business days from the date of any change in (1) the percentage of securities being sought if greater than two percent of the original amount sought, (2) the consideration offered or (3) any dealer's soliciting fee. Any other material changes to the offer, or waiver of material conditions, require that the offer remain open for at least five business days thereafter.
  • Withdrawal Rights: Withdrawal rights are not required in tender offers for straight debt securities. However, in tender offers that are made concurrently with a consent solicitation or include an early tender premium, withdrawal rights are usually granted. These rights typically expire at the same time as the rights to receive the consent or early tender consideration, typically after the first 10 business days. If a material change occurs during the tender offer or a material condition is waived after withdrawal rights have terminated, the rights are typically reinstated for holders who previously tendered their securities. The length of the reinstatement typically corresponds to the period that a tender offer is required to remain open (10 or five business days) following a change of the sort noted above.
  • Extension: Any extension of a tender offer's duration must be made by press release or other public announcement by 9:00 a.m., Eastern Standard Time, on the business day following the previously scheduled expiration date of the tender offer. If an amendment to the offer terms or related disclosure is made prior to the expiration date, and the issuer determines that an extension is necessary so that the remaining offer period following the amendment will be at least five or 10 business days, then the announcement of the amendment and extension is usually made by 9:00 a.m. Eastern Standard Time on the next business day following the amendment. Any press release extending a tender offer must also disclose the approximate number of securities tendered to date.
  • Early Tender Premium: In tender offers for straight debt securities, issuers may also structure the offer with an "early tender premium" which is permissible because the "best price" rule applicable to tender offers for equity or equity-linked securities does not apply. In such cases, tendering holders who tender early during the tender offer, typically in the first 10 business days, are eligible to receive the "total consideration" which includes an early tender premium, commonly expressed as a specific dollar amount per $1,000 principal amount of tendered securities. Holders who tender after the early tender date would be eligible to receive a lower price equal to the total consideration less the early tender premium. In addition, as previously noted, the right to withdraw tendered notes also typically expires after 10 business days. The net result of this structure is appealing to issuers because it encourages holders to tender early and gives the issuer earlier certainty as to how many of the target notes are "in the box" (assuming no extension of withdrawal rights would be necessary due to an amendment to the offer). Any other corporate transactions, such as a financing or acquisition, can therefore be completed during the remaining period of the tender offer and closing any such transaction can be coordinated with the settlement of the tender offer.

Documentation for Exchange Offers

Because exchange offers are offerings of securities, the offering documentation will include disclosure that, among other things, includes a description of the offered securities and risk factors addressing the issuer's business and the offered securities. Dealer managers will generally conduct due diligence and obtain comfort letters, legal opinions and negative assurance letters in the same way underwriters in a securities offering for cash do. Similarly, the dealer manager agreement will more closely reflect an underwriting agreement for a securities offering. All of these factors typically result in exchange offers requiring significantly greater time to execute than cash tender offers.

Exemptions from Registration under the Securities Act for Securities Offered in Exchange Offers

If an exchange offer is intended to be exempt from the registration requirements of the Securities Act, it is typically conducted in accordance with Section 3(a)(9) of the Securities Act or as a private placement under Section 4(a)(2) of the Securities Act. It should be noted that, for companies with equity listed on national securities exchange, stock exchange rules may require stockholder approval if the number of shares or voting power of common stock offered as exchange consideration (or underlying conversion shares in the case of equity-linked consideration) exceeds 20% of the issuer's outstanding common stock or voting power and the issue price or conversion price is less than the greater of book or market value per share of common stock.

Section 3(a)(9) Exchange Offer

Section 3(a)(9) provides an exemption for issuances of securities in exchanges by an issuer with its existing securityholders. The availability of the Section 3(a)(9) exemption is subject to the following conditions:

  • Identity of Issuer: The original securities and the exchange securities must be issued by the same issuer. Issues can arise in meeting this requirement when debt securities of a subsidiary are exchanged for equity of a parent company that was not an obligor on the debt securities. The SEC has issued no-action letters providing guidance on when this requirement is met in cases involving the exchange of debt securities with parent and/or subsidiary guarantees.
  • Exclusively with Security Holders: The offer must be limited exclusively to the issuer's existing holders of the target securities.
  • Exclusivity: No cash payments can be made by exchanging stockholders for receipt of the new securities (other than foregoing unpaid interest).
  • No Remuneration or Commissions: An issuer may not pay, directly or indirectly, any compensation in relation to the solicitation of the exchange. In general, officers, directors and employees of the issuer may solicit holders if such persons were not hired for the purpose of soliciting holders, have other duties to which they continue to attend and are not paid additional compensation for such activities.

It is the restriction on remuneration or commissions that often makes a 3(a)(9) exchange offer difficult to accomplish. The SEC has issued no-action letters that permit a financial advisor to undertake certain activities, including pre-launch discussions with sophisticated holders of target securities, so long as the financial advisor is not paid a success fee relating to the 3(a)(9) exchange offer. Despite this latitude, a widespread solicitation or an exchange offer with a complicated underlying business rationale that must be explained to targeted holders, among other scenarios, may require more day-to-day involvement of professional dealer managers. In our experience, however, where there is a relatively limited number of holders of target securities and the rationale for the exchange and terms of the securities are easily conveyed, the 3(a)(9) exchange offer can be attractive to issuers as an alternative to the additional execution time and expense associated with a registered exchange offer.

Private Placement Exchange Offer

If a significant amount of the target securities is held by sophisticated investors such as QIBs or accredited investors, an issuer may elect to structure its exchange offer as a private placement exchange offer pursuant to Section 4(a)(2) of the Securities Act. Before sending offer documents, target holders are typically pre-screened via eligibility questions or other methods, usually coordinated by the dealer managers. Since certain holders will not be eligible to participate in a private placement exchange offer, care must be taken to ensure that the structure of the exchange complies with the issuer's financing documents. For example, indentures often require that any planned consent payment be paid to all holders of the target securities. Therefore any consent payments that would be limited to only a subset of holders eligible for a private placement exchange offer would violate the terms of the indenture. Alternatively, an issuer may decide to extend the consent solicitation and/or consent payment to all holders while the exchange offer (coupled with the consent solicitation) is targeted to only qualified holders.

Registered Exchange Offers

If the limitations inherent to an exchange offer exempt from the Securities Act registration requirements are incompatible with the issuer's restructuring objectives, the issuer can conduct the exchange offer on a registered basis by filing a registration statement on Form S-4 or, in the case of foreign private issuers, on Form F-4.

Registration statements on Form S-4 or Form F-4 are not effective upon filing. The applicable registration statement must be prepared by the issuer and counsel and declared effective by the SEC prior to commencing the exchange offer unless the issuer utilizes the "early commencement" rules. In general, in order to use the early commencement rules in an exchange offer for straight debt, the issuer must provide withdrawal rights equivalent to those required in an exchange offer for equity or equity-linked securities. In addition, if the information published, sent or given to target holders must be revised to correct any material misstatement or omission, the issuer must disseminate revised materials as required in an exchange offer for equity or equity-linked securities and must hold the offer open with withdrawal rights for the minimum time periods specified in those rules. An issuer using the early commencement option in an exchange offer for straight debt will therefore lose some of its flexibility in structuring the transaction.

Under the early commencement procedures, an exchange offer may be launched with a preliminary prospectus. The required 20 business day offering period in such case is commenced while the SEC staff is still reviewing the registration statement. However, the exchange offer may not be consummated until the registration statement has been declared effective by the SEC, which may result in the need to extend the exchange offer period. As a result, issuers often defer commencement of the exchange offer until at least the receipt of SEC comments in order to diminish the risk that the SEC will require the issuer to redistribute an offering document amended in response to SEC staff comments. As a result, a registered exchange offer utilizing the early commencement procedures will still require more time to document and complete than an unregistered exchange offer or a cash tender offer.

Liability Issues

As noted above, the general antifraud provisions of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder apply to the purchase and sale of any security. This includes any privately negotiated or open-market purchases, tender offers and exchange offers. An issuer and its directors, officers, employees or agents may therefore be liable for disseminating false or misleading material information or withholding or omitting material information in connection with any such purchase. In addition, registered exchange offers will be subject to Securities Act liability, in addition to Exchange Act liability. Therefore, in addition to liability under Section 10(b) and Rule 10b-5 of the Exchange Act, liability under Section 11 (relating to registration statements) and Section 12 (relating to prospectuses and oral communications) of the Securities Act must also be considered. As in any securities transaction it is imperative that issuers evaluate disclosure obligations with counsel.

Disclosure Issues

It is often necessary or desirable for the company to consult or negotiate with certain holders of the target securities before formally commencing a consent solicitation or an exchange offer. Often, this is done to assess the market receptivity to an offer or determine the consideration that should be offered to achieve the issuer's objective. Because bonds are securities, issuers must take care in communicating with bondholders to avoid selective disclosure that could result in bondholders buying or selling notes on the basis of material non-public information.

In the context of a restructuring, circumstances are often fluid and bondholders wish to retain flexibility to sell their securities in the market without being concerned they are in possession of material, non-public information that could subject them to liability under Rule 10b-5. There is therefore a tension between the parties desire to share information needed to negotiate a transaction and bondholders desire to be able to trade in the securities. Bondholders therefore must make a determination as to when, and for how long, they are willing to become "restricted."

Bondholders who are willing to become "restricted" and receive material, non-public information for the purposes of facilitating discussions will enter into a confidentiality agreement with the company. The confidentiality agreement with the company will generally be a for a relatively short duration and require that the issuer take steps to "cleanse" the bondholder upon expiration of the agreement. The cleansing provisions will require the issuer to publicly disclose any material, non-public information provided to bondholders, either through a press release, posting to a secure portal in the case of a non-reporting issuer or through a Form 8-K in the case of a reporting issuer.

In addition, if an issuer has a class of securities registered under Section 12 of the Exchange Act or is required to file reports with the SEC under the Exchange Act, it must ensure that any methods used to disclose information to bondholders or "cleanse" bondholders upon expiration of confidentiality agreements comply with Regulation FD.

Tax Issues

Finally, it is important to consider the tax implications to both the company and bondholders of modifications to existing debt securities and of exchanges of existing debt securities for new debt securities. In particular, the company may be subject to tax on cancellation of indebtedness (COD) income when all or a portion of its debt is economically eliminated. COD income can arise not only where existing debt securities are modified and effectively "forgiven", but also in connection with the repurchase of existing debt securities at a discount (either by the issuer or a related person) and the exchange of old debt securities for new debt or equity securities. In addition, the issuance of new debt securities by a distressed company often implicates a number of tax considerations, including the original issue discount (OID) rules, the applicable high yield discount obligation (AHYDO) rules, the contingent payment debt instrument (CPDI) rules, and limitations on the ability to deduct business interest expense under the Tax Cuts and Jobs Act. Issuers and investors should consult with their accounting and tax advisors to understand the full tax implications of any proposed transaction.


The economic environment resulting from the coronavirus crisis requires companies to actively assess their capital needs against their existing debt obligations and restrictive covenants. For bond issuers facing issues such as near-term maturities, burdensome debt service or impending cash needs, an effectively structured liability management transaction can provide relief.

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Please address any questions to your Arnold & Porter relationship partner or any of the attorneys listed below.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

  1. Although there is not substantial case law regarding exit consents, courts have held that exit consents do not violate the implied covenant of good faith and fair dealing. SeeKatz v. Oak Industries, 508 A.2d 873 (Del. Ch. 1986); In re Loral Space & Communs. Consol. Litig., C.A. No. 2808-VCS, 3022-VCS (Del. Ch. Sept. 19, 2008).

  2. In Marblegate Asset Management v. Education Management Corp., 846 F.3d 1 (2d Cir. 2017), reh'g denied (2d Cir. Mar. 21, 2017), the Second Circuit Court of Appeals construed section 316(b) of the Trust Indenture Act to only constrain indenture amendments to the core payment terms affecting the bondholders' legal right to payment, as opposed to the bondholders' practical ability to receive payment. Thus, under Marblegate, amending an indenture to release all of the supporting collateral would not violate section 316(b) because it does not implicate the bondholders' legal right to payment (e.g., payment due dates and amounts due) even though the practical consequence would be that there is no longer a source of recovery to make the payments.

  3. While outside the scope of this Client Alert, certain "any and all" cash tender offers for debt securities that are conducted without a concurrent consent solicitation may be completed in five days.