The White & Case Capital Markets team updates its March 2018 publication on bond repurchases given the current environment where issuers may consider whether, if their bonds are trading at a discount to par, they should repurchase their bonds. The following guide highlights the key points to consider when planning an open market bond repurchase transaction.
A bond repurchase, or bond buyback, refers to the process whereby the issuer approaches the open market and repurchases its bonds from holders. If the bonds are trading at less than their par value, issuers can use this tool opportunistically to acquire debt, which will both reduce overall interest expense and result in a P&L debt on any gain if the bonds are cancelled. Although there are other liability management processes issuers can use to reduce their outstanding indebtedness (for example, a tender offer), repurchases are advantageous for issuers that wish to capitalise relatively quickly on a depressed market price for their bonds. One benefit of bond repurchases is that they do not require legally mandated time periods (for example, tender offers for bonds in the US are, with limited exceptions, required to remain open for 20 business days) or offering documentation.
First off—what do you know?
It may go without saying, but when you approach the market and make repurchases, you should be aware that as you are offering to acquire debt, information unrelated to the buyback you may have about the company, its financial condition or operations or the course of its business could amount to non-public information that could be price sensitive. As such, consideration needs to be given as to how to manage any material non-public information and if this must be released prior to conducting any market purchases, determine that you are prepared to do so. This will likely be fact-specific and advice should be sought before seeking to engage in one or more buybacks.
We recommend that any closed periods that issuers already have in place for, for example, management sales of securities be observed (including trading "windows" observed before the release of results and immediately thereafter). If you have no official windows in place, you should avoid being in the market for a reasonable period before your interim or annual results are made public. Each "window" is reasonably fact-specific and dependent on how information typically crystallises before each report (for example, a company with far-flung operations that take a long time to consolidate may be comfortable that their results come together quite close to a reporting date, whereas companies that have fewer jurisdictions or tighter controls may be more sure of their results earlier).
We note that the following "creeping tender" analysis is primarily relevant only in situations where bonds were initially sold into the US pursuant to Rule 144A or other exemptions. However, even where bonds were initially sold outside the US in reliance on Regulation S, there is a possibility that bonds may have subsequently flowed in to the US in secondary market sales, and so this analysis is also potentially relevant to bonds initially sold only outside the US.
The issue is that when structuring your bond repurchase program, you must ensure that you are not conducting what is, under US securities law, essentially a tender offer by another name; otherwise, you would risk being in violation of US tender offer rules if your repurchase program targets US holders. Even small repurchases can, in some circumstances, be grouped together in a way that violates the tender offer rules. Although these rules regulate tender offers, they, somewhat unhelpfully, do not define what a tender offer is. So US courts have stepped into the void, setting forth various factual tests to determine whether or not a securities repurchase program is actually a tender offer.
The most prominent among these tests are the so-called "Wellman" factors (as developed in Wellman v. Dickinson, 475 F. Supp. 783, 823-824 (S.D.N.Y. 1979)), which are weighed when making this determination. Under this test, your bond repurchase program could be seen to be a tender offer if at least some of the following statements about it are true:
- the offer is disseminated in a widespread manner to the market, for example by press release;
- a premium to the market price is offered;
- there is no meaningful opportunity to negotiate price or terms of the offer (it is effectively "take it or leave it");
- the offer is for a substantial percentage of the outstanding issue;
- the offer is contingent on a minimum principal amount of bonds being tendered;
- the offer is open for only a limited period of time;
- recipients of the offer are under pressure to respond to the offer; and
- the announcement of an acquisition program has been followed by a rapid accumulation of bonds.
The factors are effectively an attempt to distil the traditional features of a tender offer—i.e., if it looks like a tender offer and smells like a tender offer, it is one.
Practical structuring steps
We would recommend the following common-sense steps to try to ensure your bond repurchases would not be considered tender offers in disguise.
- Instruct a limited number of banks to make enquiries on your behalf. Engaging one or two brokers who understand the above limitations and what you are trying to do will ensure things are coordinated.
- Ensure that your banks carefully manage the potential audience by only making calls to a limited number of institutions that they know are likely to be holding the bonds (versus a Bloomberg or other similar communication sent to the entire market).
- Conduct the offers over a reasonable period of time and avoid coercive behaviour and pressure. Think private, individually negotiated transactions rather than "take it or leave it" behaviour.
- Control the size of the repurchase. The repurchase program should not be for the entire series of the notes or a substantial percentage (more on this below).
We are also asked from time to time whether it is possible to launch a tender offer after doing some repurchases. Care should be taken to ensure that no decision has been made to commence a tender offer while repurchases are being made, so a decision to conduct a tender offer and any preparations for a tender offer should start only after the repurchase program is finished.
25% rule? Maybe (or maybe not)
Market participants often cite the '25%' rule for determining the threshold of what is considered a "substantial percentage" of a particular class of notes—meaning that you are relatively safe below 25%. The '25%' rule comes from US case law (Hanson Trust PLC v. SMC Corporation, 774 F. 2d 47 (2nd Cir. NY 1985)), where the court found that a combination of privately negotiated and open market repurchases of equity securities totalling less than 25% of the total outstanding securities did not constitute a tender offer. Some practitioners in the market take the view that this '25%' rule may not necessarily apply to repurchases of debt securities, because the context and potential effect of a debt repurchase versus an equity repurchase are different. We believe that it can be a reasonable rule of thumb to follow for the purposes of determining the 'creeping tender offer' question. However, particularly given disclosure obligations (see below), which may dictate that you must disclose purchases at levels significantly below 25% of the total outstanding securities where the buyback program gives rise to inside information, it is important that a wider regulatory analysis is carried out on a case-by-case basis based on context, facts and circumstances.
Disclosure to the market
We are frequently asked whether bond repurchase programs need to be disclosed (and when).
If bonds are listed on an exchange in the EU, then in most cases you will be subject to the Market Abuse Regulation ("MAR") when it comes to your bonds. The general rule is that issuers must inform the public as soon as possible of inside information, which directly concerns the issuer or its securities. In this regard, any buyback of outstanding bonds that, if made public, would have a significant effect on the price of such bonds, or on the price of related derivative financial instruments, would constitute inside information. This may arise either where knowledge of the proposed buyback program itself will constitute inside information, or where the transactions themselves will likely give rise to inside information, such as a reduction of liquidity in the bonds. Your investment bank should be consulted to ensure that the amount of the outstanding issue that you propose to repurchase would not be considered price-sensitive. You will also need to be comfortable that the buyback is not price-sensitive for other reasons, such as reducing the overall cash position of the issuer as a result of the buyback.
It is important to remember that for issuers subject to MAR, even if a repurchase program may involve the purchase of bonds that would not trigger an issue under the 25% rule, the provisions of MAR would most likely limit what can be undertaken via open market purchases, absent a regulatory announcement of the trading activity. This is because there is no defined 'safe-harbour' percentage that is relevant to debt securities. Instead, consideration needs to be given as to whether there is non-public price sensitive information already or if the buyback program itself could give rise to inside information.
In some cases, for example where these trades are conducted in less liquid securities, even relatively small purchases of bonds could move prices, and activity should be monitored to assess the impact of open market repurchases on the trading price or value of such bonds to determine if a disclosure obligation may be necessary, including to the extent that trading activity by an issuer in its illiquid securities could give a false or misleading impression to the market of the value of those securities.
Accordingly, it will be particularly important for issuers to consider and document, on a case-by-case basis, whether the proposed buyback program is price-sensitive and if a disclosure obligation arises.
If MAR does not apply to you as an issuer, a reference to the repurchase program should generally be made to bondholders in the next interim or annual report. You should also consider whether the stock exchange where the bonds trade would require disclosure. As a general rule, exchanges do not require prior disclosure as long as the repurchase is not material and is otherwise permitted by the bond documentation. To the extent that regular disclosure is made in interim or annual reports, this can also be helpful in the context of disclosure requirements given that markets are already aware that you may buy bonds the future. In this regard, companies may wish to consider adding a line in their annual reports or results announcements stating for example that "the company may, from time to time, consider opportunistic buybacks of its own debt subject to market prices and trading liquidity". Although the analysis regarding inside information will nonetheless need to be considered on a case by case basis as described above.
What does the documentation say?
European high yield bond indentures typically permit voluntary repurchases of bonds with no limit (and sometimes affirmatively include a statement to the effect that they are permitted). This is also usually expressly stated in the offering memorandum related to issuance of the bonds.
High-yield style restricted payments covenants treat repurchases of "subordinated" indebtedness (traditionally, contractually subordinated debt only—i.e., not indebtedness that is structurally junior or unsecured) as a restricted payment. It is also worth noting that under a typical indenture, if you repurchase notes and cancel them, you (unlike in a simultaneous refinancing) may lose capacity to re-incur the debt.
You should also confirm that your senior credit facility, if any, does not restrict or limit repurchases of other indebtedness.
It is also very common in English law governed bond terms and conditions for open market purchases to be permitted without restriction. However, there may be restrictions on what an issuer may do with bonds so purchased.
To cancel/not to cancel
European high yield bond indentures typically do not require notes acquired to be cancelled (they may be re-sold or held in treasury indefinitely). However, typically any notes held by the issuer or any of its affiliates are, under the terms of the notes, no longer considered outstanding for voting purposes (and thus cannot be voted by the issuer or its affiliates in a consent solicitation or a waiver process, for example).
For English law governed bonds, there may be a requirement to promptly surrender bonds for cancellation rather than holding them for re-sale. Such a provision was historically included in large part owing to the fact that most English law terms and conditions of bonds are drafted as if the bonds are in definitive form, and that this assumes that if you acquire your own debt, you cannot owe it to yourself. However, it is now common in English law bond terms and conditions to permit issuers flexibility in this regard, since as a practical matter, such bonds are invariably in global form traded through international clearing systems. Unless there is a specific contractual requirement to cancel bonds that are acquired, in most cases an issuer should be free to acquire bonds, hold and then re-sell them.
It is also worth remembering that any re-sale by an issuer must comply with an exemption from registration under the US Securities Act.
It is worth mentioning that if bonds are repurchased and held by an affiliate which is not a subsidiary of the issuer (a parent company, for example), the ability of that holder to exercise voting rights in respect of the bonds will commonly be different if governed by English law eurobond-style documentation, as opposed to high yield-style documentation (as described above). Often, English law bond documentation will not exclude affiliates from the definition of "outstanding" bonds for voting purposes, and it is not uncommon that the definition disenfranchises from voting the issuer and its subsidiaries only.
As with any transaction, issuers should consult their tax advisers to confirm the tax treatment of the proposed repurchase and when any gain will be recognised for income tax purposes.
Open market repurchases of bonds can provide issuers with a useful tool to manage their outstanding debt, in particular taking advantage of instruments that may be trading below par. However, careful consideration needs to be given to US rules related to planned repurchases, as well as the impact of MAR on any such potential repurchases to ensure rules designed to prevent market manipulation or distortion are adhered to.
Often circumstances will be very fact-specific, and so issuers should consult their financial and legal advisers before conducting open market repurchases to help navigate transactions and ensure compliance with such rules and regulations, breach of which can in some cases result in criminal liability.
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