"Bond Defaults: Critical Issues & Strategies"

This outline and the accompanying presentation were designed to identify various bankruptcy and work-out issues that may arise in the context of indentured debt. If you are confronted with any of the issues noted above, it is recommended that you seek competent counsel to advise you regarding the particular circumstances at hand.

The following outline focuses on bankruptcy and work-out issues arising with holders of indentured debt by corporate debtors.

1. Typical Structures for Bond Debt
   1. The Indenture, the Trustee Concept and the Trust Indenture Act
      1. The Indenture
         1. Source of bondholder rights
            
         2. Provides convenient remedies mechanism through trustee
            
         3. Trust Indenture Act
            
         1. Indentures governing SEC registered debt required to be qualified under Act
            
         2. Provides for minimum bondholder rights under indenture
            
         3. Requires disclosures regarding indenture and trustee
            
         4. Addresses trustee conflicts
            
      2. The Role of the Trustee
         1. Trustee as a fiduciary
            
         2. Powers and duties
            
         3. Influence by major bondholders
            
         4. Role in a work-out/default - differing philosophies
      3. Covenants
         1. "Standard" covenants
            1. Covenant to pay
               
            2. Maintenance of payment offices
               
            3. Covenants regarding corporate maintenance
               
            4. Collateral maintenance for secured bonds
         2. Financial covenants
            1. High yield versus investment grade covenant packages
               
            2. Restrictive negative covenants - incurrence versus maintenance tests
               
            3. Restrictive affirmative covenants
               
            4. Reporting covenants
         3. Repurchase covenants
            1. Repurchase upon change in control
               
            2. Repurchase with asset sale proceeds

               
               

      4. Remedies
         1. Events of default
            1. Payment defaults
               
            2. Covenant defaults
               
            3. Grace periods
               
            4. Notice based defaults - requires notice to debtor before event of default
               
            5. Cure provisions
         2. Rights of acceleration
            1. Action by bondholders
               
            2. Action by Trustee
               
            3. Right of reinstatement after acceleration
         3. Suits for enforcement
            
            1. Action against guarantors
               
            2. Action against collateral for secured bonds
      5. Subordination provisions and their effect - the standstill period
   2. Guarantees and Collateral
      1. Subsidiary guarantees
         
      2. Parent guarantees
         
      3. Secured debt
         
      4. Enforcement issues in bankruptcy/workout
         1. Fraudulent transfers and preferences
            
         2. Perfection requirements
            
         3. Substantive consolidation

            
            

   3. Bond Sales Transactions
      1. The registered public offering
         
      2. Rule 144A private offerings

         
         

         1. Purchaser requirements
            1. Qualified institutional purchasers
               
            2. Institutional accredited investors
               
            3. Regulation S offshore purchasers
         2. A/B exchange rights
            1. Registered offer to exchange original restricted bonds with substantially identical registered
               
            2. Purpose: liquidity - no securities law restrictions on transfer
               
            3. Liquidated damages (i.e., additional interest) payable if exchange offer not completed
               
            4. Creditors` rights issue: are exchanged bonds a separate class?

               
               

      3. Institutional private placements
         
      4. Regulation S offshore offerings
         
      5. Role of investment bankers
         
      6. Role of rating agencies
   4. Trading in the bond aftermarket
      1. Markets and liquidity issues
         1. Stock exchange listing
            
         2. Over the counter trading
            
         3. PORTAL trading - for 144A offered restricted securities
            
         4. Market maker dominated trading
      2. Effect of imminent or perceived default or restructuring
         1. Rating issues
            
         2. Distressed debt buyers
            
         3. The "insider" and restricted trading issues
2. Players in a Bond Workout/Bankruptcy
   1. The company
      
   2. Major bondholders
      
      1. Institutional purchasers
         
      2. Distressed debt buyers
         
      3. "Ad hoc" committees
   3. Other creditors
      
      1. Secured creditors
         
      2. Trade creditors
         
      3. Subordinated versus senior creditors
         
      4. Others
   4. The trustee
      
   5. Financial advisors
      
      1. Issuer restructuring advisor
         
      2. Bondholder advisors
         
      3. The interested investment banker - may have sold bonds to key customers
   6. Counsel
      1. Company restructuring/bankruptcy counsel
         
      2. Company corporate counsel
         
      3. Counsel to trustee
         
      4. Counsel to major bondholders and ad hoc committees
         
      5. Counsel to other major creditors (i.e., banks)
3. Securities Law Issues
   1. Disclosure duties and their impact - duty to disclose material corporate developments
      1. Source of duty
         1. Securities exchange rules
            
         2. 1934 Act periodic disclosure requirements
            1. MD&A disclosure
               
            2. Requirements to disclose liquidity issues
         3. 1933 Act disclosure issues
            1. Disclosure required in registered exchange offer
               
            2. Disclosure required when raising equity capital
         4. Financial statement disclosures under GAAP
            1. the "going concern" opinion
               
            2. liquidity and default disclosures
         5. Indenture reporting requirements
      2. Methods of Disclosure
         1. Press Releases
            1. Warning Releases
               
            2. Notice of Defaults
         2. 1934 Act periodic filings - 10-K`s, 10-Q`s and 8-K`s
            
         3. Reports to indenture trustees and bondholders
            1. Notices of defaults
               
            2. Periodic reports required by indenture - many indentures require 1934 Act filings and financial statements even if issuer has no 1934 Act obligation
         4. Disclosures by third parties
            1. Rating agency downgrades and reports
               
            2. Analyst reports
               
            3. Industry publications
               
            4. Interested party disclosures
               
            5. The "rumor mill" and chat rooms
               
            6. Issues with company response
         5. Selective disclosure issues
            1. Dealing with analysts
               
            2. Dealing with major creditors and stockholders
   2. Disclosure and the impact on workout negotiations - insider trading
      1. Bankruptcy/workout negotiations as confidential, non-public information
         
      2. The "restricted" bondholder - disclose or abstain from trading
         
      3. The role of confidentiality letters
         1. Purposes
            1. Permit frank discussions with creditors using non-public information
               
            2. Avoid premature public disclosure
               
            3. Provide framework for providing non-public information
               
            4. In some cases, provide breathing room and permit focus on negotiations through standstill agreement to delay taking specific actions
         2. Defining confidential information
            
         3. Addressing reluctance of bondholders to become "insiders" yet satisfy desire to be involved
            
         4. Standstill provisions
            
         5. "Come clean" disclosure provisions

            
            

   3. Exchange offers for debt - an offer of securities
      1. Compliance with securities laws
         1. The "3(a)(9) exemption" - 1933 Act exemption for exchanges of securities solely by an issuer
            1. Cannot involve investment bankers or other soliciting agents
               
            2. Must be exchange for securities of the same legal issuer
         2. Private exchange
            1. Impractical in view of numerous holders, trading and need for high acceptance threshold
               
            2. Should be considered with only a handful of holders
               
            3. Holders receive "restricted" securities
         3. 1933 Act Registration
            1. Requires a registration statement
               
            2. SEC review
               
            3. Extensive time requirements
               
            4. No contractual commitments prior to effectiveness
         4. The bankruptcy exemption - Sec. 1145 of the Federal Bankruptcy Code
            
         5. Minimum exchange offer periods - 20 business days if viewed as a public tender offer
      2. Issues with exchange offers out of bankruptcy
         1. Need for high acceptance thresholds - 95% or above is common
            
         2. Holding the deal together
            1. Limitations on legally binding commitments prior to close of offer
               
            2. Losing participants through the trading markets
               
            3. Preliminary negotiation issues
               1. Negotiations as material non-public information
                  
               2. Negotiations as prohibited "jumping the gun" for registered exchange offer
                  
               3. Negotiations as prohibited "general solicitation" for private exchange offers

                  
                  

4. Preparing for Bond Defaults and Workouts

   
   

   1. Understanding default triggers and timing
      
   2. Understanding subordination - the layering of debt and creditor and debtor differentiation
      
   3. Practical issues in avoiding indenture defaults
      1. Finding the holders to negotiate with
         
      2. Limited ability to modify payment terms
         
      3. Waiving or modifying covenants on publicly held debt
         
      4. Impact on other creditor negotiations
   4. Who really takes action for collection and when?

      
      

5. Bankruptcy as an Alternative and Related Issues
   1. The Involuntary Filing
      1. Bondholders` Objectives
         1. Create a forum for orderly disposition of debtor`s assets
            
         2. Move debtor/issuer to action
            
         3. Provide a "seat at the table"
            
         4. Force debtor and other creditors to organize and negotiate
      2. Timing Concerns for Creditor
         1. Generally advantageous to pursue at earliest time permitted by law
            
         2. Senior lender may fund interest payments (on a senior secured basis) to forestall involuntary bankruptcy filing

            
            

   2. The Voluntary Filing
      1. Issuer`s Objectives
         1. Forces creditors to organize to negotiate
            
         2. Forces unwilling creditors and equity holders to negotiate or be "crammed down"
            
         3. Take advantage of the stay of creditor enforcement actions
      2. Issuer`s Concerns
         1. Fiduciary issues with equity holders
            
         2. Loss of control and court supervision
            
         3. Costs and timing
   3. Creditor Organization in Bankruptcy
      1. Official Committee of Unsecured Creditors
         1. Typically - a mixture of trade creditors and unsecured bondholders
            
         2. Legal and financial advisors compensated by the estate
            
         3. Significant voice in bankruptcy process
      2. Official Committee of Secured Bondholders - rarely appointed; only in larger cases
         
      3. Unofficial Committees
         1. Bondholders steering or "ad hoc" committee
            
         2. Professional advisors not compensated by the estate
6. Selected Workout/Bankruptcy Issues
   1. Lender Liability Issues in Workouts/Bankruptcies
      1. Standard of conduct - Exercise of dominion and control
         1. Actual, participatory control of the debtor typically required
            
         2. Suggestions by lender coupled with threat to exercise legal rights - generally insufficient to impose lender liability
      2. Effect of exercising control
         1. Lender/borrower relationship transformed into fiduciary one: giving rise to a duty by the lender to act in the best interest of the borrower
            
         2. Fiduciary relationship may arise even if loan agreement authorizes lender to exercise control

            
            

   2. Setoff Rights for Oil and Gas Receivables
      1. Bankruptcy Code preserves setoff rights
         
      2. Decreases impetus for creditors to file involuntary proceedings
         
      3. Unsecured trade creditor entitled to setoff possesses a right equivalent to secured creditor (to disadvantage of bondholder)
   3. Conflicting Subordination/Lien Priority Issues
      1. Competing lien claimants
         1. Mortgage lenders - blanket liens over various properties
            
         2. Trade creditors - mechanics` liens against assets in the field
            
         3. Secured bondholders - generally subordinated to mortgage lenders
      2. Governing law
         1. State law - governs priority
            
         2. Federal law - deep offshore properties subject to federal law
      3. Marshaling assets
         1. Secured bondholder with junior security interest - generally requests marshaling
            
         2. Unsecured bondholder - typically opposes marshaling; desires senior secured creditors to satisfy their liens in a manner that expunges junior liens(1)