Turmoil in emerging markets has made repurchasing debt securities increasingly attractive to issuers. This article examines two alternatives available to issuers seeking to repurchase debt securities and identifies significant legal considerations which are unique to debt securities originally placed in an international offering with a U.S. component.
Emerging market issuers, especially those located in Eastern European countries, have witnessed a strong decline in the secondary market prices for their debt securities, together with a significant decrease in their liquidity. In order to take advantage of the decrease in secondary market prices and, to a lesser extent, to support liquidity in the secondary market, such issuers are frequently being advised to repurchase debt securities.
Through repurchasing debt securities, an issuer, a credit support provider or other related party has an opportunity to retire the indebtedness at a fraction of the original face value of the securities and reduce related interest costs. For example, an issuer may seek to repurchase its debt securities at a fixed price significantly below the original face amount or based upon a price derived from a formula linked to the yield on a benchmark security. Debt securities that have been repurchased may then be presented to the trustee for cancellation.
When the debts securities do not contain a call provision permitting the issuer to redeem or if a call provision cannot be exercised when secondary market conditions are most attractive, the issuer may nonetheless have an opportunity to repurchase the debt securities. The two alternatives for repurchasing debt securities in such circumstances are conducting a tender offer or engaging in a program of open market repurchases or privately negotiated transactions.
In a tender offer, the issuer (or other party making the offer) prepares and distributes to holders of the debt securities a formal offer to purchase disclosing the terms of the offer. Care must be taken to structure the tender offer in a manner which complies with the U.S. federal securities laws and other country-specific laws and stock exchange rules which may apply. If the tender offer approach is not followed, a broker will likely be engaged to repurchase debt securities on behalf of the issuer in the open market or in privately negotiated transactions.
The remainder of this article examines legal considerations involved in each method for repurchasing debt securities, and then discusses certain general considerations to be taken into account when determining which method is appropriate for a given set of circumstances.
Open Market Repurchases and Privately Negotiated Transactions
The most straight-forward method to repurchase debt securities is for the issuer, credit support provider or other related party to enlist a broker to repurchase the securities in the open market or in privately negotiated transactions. This method is most likely to be appropriate when the issuer intends to purchase only a portion of the outstanding debt securities and the debt securities are not held by U.S. persons. The most significant legal considerations to be addressed if this approach is employed are (i) structuring the repurchase program to avoid it being classified as a tender offer and (ii) addressing any potential liabilities based upon the anti-fraud provisions of the U.S. federal securities laws.
Avoiding Classification as a Tender Offer
If the debt securities are not held by U.S. persons, the decision to engage in open market repurchases rather than conducting an international tender offer is less complicated. When U.S. persons hold a portion of the outstanding issue, however, the participants in the transaction must take precautions to ensure any repurchases will not be viewed as being made pursuant to a tender offer subject to Section 14(e) of the Williams Act. [The Securities-Corporate Equity Ownership-Disclosure (Williams) Act, Pub. L. No. 90-439, 82 Stat. 45 (1968)(codified as amended at 15 U.S.C. §§ 78m(d)-(e) and 78n(d)-(f) (1970))(enacted in 1968 and amended in 1979, added sections 13(d), 13(e) 14(3) and 14(f) to the Securities Exchange Act of 1934, the "Williams Act").]
Although the Williams Act contains specific rules applicable to any tender offer, the U.S. federal securities laws contain no definition of what constitutes a "tender offer". Instead, whether a particular repurchase program is a tender offer is determined by applying a series of subjective tests which have evolved from U.S. federal court decisions and suggestions and proposals by the U.S. Securities and Exchange Commission ("SEC").
The most widely-used and cited test for determining the existence of a tender offer is the eight factor test suggested by the SEC and adopted by a U.S. federal court in 1979. [See Wellman v. Dickinson, 475 F. Supp. 73 (S.D.N.Y. 1979), aff'd on other grounds, 682 F.2d 355 (2d Cir. 1982), cert. denied, 460 U.S. 1069 (1985).] The test is subjective and is based upon the existence or non-existence of the following factors:
- Whether there is active or wide spread solicitation of holders.
- Whether the solicitation is for a substantial percentage of the securities.
- Whether the offer is made at a premium over the prevailing market price.
- Whether the terms of the offer are firm rather than negotiable.
- Whether the offer is contingent upon the tender of a fixed minimum number of securities or subject to a fixed maximum number of securities to be purchased.
- Whether the offer is open for a limited period of time.
- Whether holders are pressured to respond and sell into the offer.
- Whether public announcements of a purchase program precede or accompany a rapid accumulation of large amounts of the subject securities.
U.S. federal court cases have made clear that the presence or absence of any one or more of the above factors does not decide the issue of whether a particular repurchase program constitutes a tender offer and other courts have rejected the eight factor test entirely. [See e.g., Securities and Exchange Commission v. Carter Hawley Hale Stores, Inc., 760 F.2d 945 (9th Cir. 1985) and See Hanson Trust PLC v. SCM Corporation, 774 F.2d 47 (2d Cir. 1985).] Given this uncertainty, holders of equity securities have brought numerous actions in the United States alleging that certain open market and/or privately negotiated repurchases constituted a tender offer entitling holders to the protections of the SEC's tender offer rules. To avoid the consequences of such a result, legal counsel should be consulted in connection with the structuring of any repurchase program involving U.S. holders to analyse whether a particular strategy for repurchasing debt securities would likely be construed as a tender offer subject to the Williams Act.
Avoiding Liability Under the Antifraud Provisions of the U.S. Federal Securities Laws
The Rule 10b-5 under the U.S. Securities Exchange Act of 1934, as amended ("Exchange Act"), which, among other things, prohibits material misstatements or omissions in connection with the purchase or sale of securities, applies both in the context of a tender offer and a repurchase program. Due to the broad application of Rule 10b-5, consideration should be given as to whether, among other things, a broker should disclose it is acting on behalf of the issuer in any privately negotiated transaction with a U.S. holder.
International Debt Tender Offers
Over the last decade, emerging market issuers have frequently accessed the capital markets through international offerings. Such offerings often have been structured as traditional Eurobond placements coupled with a simultaneous private placement in the Rule 144A market in the United States. Less frequently, when U.S. retail investors are involved, the portion of the debt securities to be sold in the United States has been registered with the SEC on a Form F-1 registration statement. Due to the SEC registration process and lack of retail demand for lesser known issuers, emerging market issuers have been more likely to use the combined Eurobond/Rule 144A structure.
Where the debt securities were originally placed in an international offering as described above and the issuer is seeking to retire all or a significant portion of the outstanding issue, an international tender offer, made in conformity with the applicable provisions of the Williams Act and other applicable local laws or stock exchange rules, will likely be the only viable means for repurchasing the debt securities. If local laws or stock exchange rules conflict with the Williams Act requirements described below, a decision will need to be made as to whether to include U.S. persons or to seek some form of exemptive relief from the SEC.
In the absence of conflicting local regulations or stock exchange rules, the U.S. federal securities laws become the primary driver behind the structure and documentation of an international debt tender offer.
In order to conduct a debt tender offer in compliance with the applicable provisions of the Williams Act, certain issues of primary important need to be addressed. In particular, the period of time the tender offer will be held open must be established, together with the method for determining how and when the purchase price will be calculated. The person making the tender offer will also need to prepare a disclosure document subject to the antifraud provisions of the U.S. federal securities laws.
Determining the Length of the Tender Period
One of the primary legal considerations involved in conducting a tender offer for debt securities in compliance with the Williams Act is determining the time period which must be given to holders to accept the offer. A number of SEC rules determine the method of calculating the length of the tender period. In general, a debt tender offer will need to be held open for at least 20 business days from the date the offer is first published or sent to security holders. [Rule 14e-1(a) Exchange Act.] If the offer is materially modified during the tender period, notice will need to be given to holders and the tender offer must remain open for at least 10 additional business days. [Rule 14e-1(b) Exchange Act.] If the party making the tender offer determines to extend the tender period, notice must be given to holders of the extension to the tender period. [Rule 14e-1(d) Exchange Act.]
In the case of issuer tender offers for non-convertible debt securities, the Staff of the SEC has in a number of no-action letters permitted the tender offer to be held open for a period of less than 20 business days. In addition to certain other requirements set by the SEC, the shorter time period for the tender offer is available only when the issuer is seeking to purchase any and all of the outstanding debt securities of a particular class or series.
Determining the Purchase Price
A number of possible methods are available for determining the purchase price, including making an offer at a fixed price or at a price determined by a formula linked to the yield on a benchmark U.S. Treasury security plus a fixed spread. When a formula is used to determine the purchase price, the Staff of the SEC has required the yield on the U.S. Treasury security to be determined and the purchase price to be fixed two business days prior to the end of the tender period. Under certain circumstances, the SEC has permitted the purchase price to be calculated during the tender period at the time a particular holder tenders the debt securities. See "Alternative pricing mechanisms" below.
Preparing the Disclosure Document
In addition to preparing and negotiating the various legal agreements required to conduct a debt tender offer, the party making the tender offer will need to prepare a document disclosing the terms of the offer and setting forth other material information about the offer. Due to the applicability of the antifraud provisions of the U.S. federal securities laws, care must be taken to prepare the disclosure document in a manner which will not expose the parties to liability from the persons to whom the offer is made. What information is material and needs to be included in the disclosure document is dependent upon the circumstances of the particular transaction. In transactions involving U.S. holders, the dealer manager assisting in the tender offer will likely insist upon receiving an opinion from U.S. counsel representing the party making the offer as to compliance with Rule 10b-5 under the Exchange Act.
In addition to Rule 10b-5, Section 14(e) of the Exchange Act contains a general antifraud provision which renders unlawful the making of untrue statements of material facts, material omissions and market manipulation in connection with a tender offer. In the context of an international debt tender offer, however, it is unclear whether a non-U.S. holder could bring an action against a non-U.S. issuer predicated on the antifraud provisions of the U.S. federal securities laws.
Restriction on Purchases and Sales Based Upon Material, Non-Public Information
Another basis for liability under the U.S. federal securities laws is the prohibition on purchasing or selling securities that are or are expected to become the subject of a tender offer by certain persons in possession of material, non-public information related to the tender offer. [Rule 14e-3 Exchange Act.] In addition, it is unlawful for any person acting on behalf of the offering person to communicate material, non-public information relating to a tender offer to any other person under circumstances in which it is reasonably foreseeable that such communication is likely to result in an unlawful purchase or sale. These prohibitions apply as soon as a "substantial step or steps" have been taken to commence a tender offer. In light of the above, each party involved in the tender offer should be aware of the restrictions on trading or passing along information regarding the tender offer to someone who might misuse such information.
An exception to the general prohibition on trading is available for any purchases or sales made by a person other than a natural person if, among other things, the individual making the investment decision did not know of the material, non-public information and reasonable policies and procedures are in place to ensure the decision-maker does not know of any such information. [Rule 14e-3b Exchange Act.] This exception permits, in certain circumstances, a dealer manager in a tender offer to continue to make a market in the debt securities provided appropriate procedures are in place.
Alternative Pricing Mechanisms
Although not likely to be available for an emerging market issuer, persons structuring debt tender offers should be aware of alternative methods (other than setting a fixed price at the commencement of the offer) for determining the purchase price. The Staff of the SEC has taken a number of no-action positions permitting alternative pricing mechanisms to be used by an issuer seeking to purchase for cash any and all of its non-convertible, investment grade debt securities.
One such position would permit, under certain conditions, an issuer to tender at a price determined on each day during the tender offer period by reference to a stated fixed spread over the then-current yield on a specified benchmark U.S. Treasury security calculated as of a specific time on the day of the tender or the preceding day. The Staff of the SEC extended this position to permit, under limited circumstances, a "real-time fixed spread" tender offer where the price is determined at the actual time the securities are tendered.
Whether to Include U.S. Persons
Given the considerable regulation of tender offers imposed by the U.S. federal securities laws and their potential conflict with the requirements of local laws or stock exchange rules, a frequently encountered question is whether to include U.S. persons in the tender offer. If U.S. persons are excluded, the tender offer can be conducted without complying with the Williams Act. That strategy has been frequently relied on by foreign private issuers tendering for equity securities, where compliance with the Williams Act is considerably more onerous. In addition to the matters described above, in the case of tender offers for equity securities, the Williams Act also requires, among other things, the issuer to make filings with the SEC and imposes restrictions on the issuer (or its agent) purchasing and selling the securities outside of the tender offer and for 10 business days after the termination of the tender offer. [See Rule 10b-13 and Rule 13e-4(f)(6) of the Exchange Act.]
The SEC recently proposed rules designed to encourage foreign private issuers to include U.S. holders in cross-border tender offers. [ See Securities Exchange Act Release No. 7611 (November 13, 1998)(the "Release").] The SEC cited data gathered by the U.K. Takeover Panel (the entity regulating takeovers in the United Kingdom) for 1997 showing U.S. persons were excluded from equity tender offers in all 30 of the 30 cases where they held less than 15% of the subject securities.
The proposed rules would exempt issuers making a tender offer from most of the requirements of the Williams Act (other than the general antifraud provisions) in the event 10 percent or fewer of the holders were U.S. persons. A more limited exemption would be available if U.S. persons held between 10 and 40 percent of the outstanding securities. Although the proposed rules are not binding until issued in final form, they provide some guidance as to the situations in which the Staff of the SEC would likely grant some form of exemptive relief through the no-action letter process.
The decision as to whether to include U.S. holders boils down to three alternatives: first, exclude U.S. holders entirely; second, include U.S. holders and comply fully with the Williams Act; or third, apply for exemptive relief from the Staff of the SEC to address any potential conflicts with applicable local laws or stock exchange rules which may permit or require different procedures for conducting the tender offer. The interested parties will need to evaluate each of these alternatives in light of the percentage of holders of the debt securities located in the United States.
Legal Considerations Involved in all Repurchase Rransactions
Whether an issuer determines to purchase debt securities through an international tender offer or through a program of open market repurchases or privately negotiated transactions, a number of legal considerations need to be addressed early in the decision-making process.
Compliance with Underlying Bond Documentation
In addition to the matters discussed above, any program for repurchasing debt securities will need to comply with the underlying bond documentation. For debt securities placed in the international capital markets, the underlying bond documentation is governed most frequently by either English or New York law.
Generally, unless the issuer has expressly covenanted otherwise in the underlying indenture or debt instrument, an issuer is free to repurchase its debt securities from time to time in the open market or otherwise. Even if such a covenant exists in the bond documentation, the issuer can engage in a consent solicitation in conjunction with the public tender offer to remove the covenant. In the United States, consent solicitations are a frequent component of public tender offers involving debt securities.
If the debt securities were originally issued as part of a structured transaction, the underlying documentation should be carefully reviewed to ensure the repurchase will not affect any security arrangements or otherwise displace the original structuring of the transactions. Where appropriate, an issuer should request its counsel to review the underlying documentation to determine whether any issues exist which might impact the decision to go forward with the repurchase transaction.
Compliance with Local Laws and Regulations
Whether a tender offer or other repurchase program is used, the parties involved in the transaction must take care to comply with any applicable local laws. As discussed above, the Williams Act provides a framework for conducting the tender offer in the event U.S. persons hold the debt securities. In such cases, that framework will provide the basis for structuring the offer, including the documentation to be used and the substantive terms of the tender offer.
Although the United Kingdom does not have specific laws governing debt tender offers, its laws governing Investment Advertisements may apply to any advertisements or other announcements which appear in the financial press and to the disclosure document to be given to persons holding the securities. In particular, the contents of any investment advertisement will have to be approved by an authorised person unless the issuer can rely on an exemption to section 57 of the Financial Services Act 1986. In relation to the disclosure document, the issuer (but not a third party outside the same corporate group repurchasing on behalf of the issuer) will usually be able to rely on the exemption to section 57 contained in Article 3 of the Financial Services Act 1986 (Investment Advertisements) Exemptions Order 1996 concerning investment advertisements issued by body corporates to members or creditors. Notices in newspapers will usually have to be approved by an authorised person if published prior to the repurchase and if such notice is not a matter of record only.
In addition to the United States and the United Kingdom, an issuer and its adviser must consider any other local laws. The relevant jurisdictions will include the domicile of the issuer and, if different, any third party purchasing on its behalf, and those in which the holders are concentrated (for example, due to the specified currency of the debt securities). Given the predominance of bearer securities in the Eurobond market, identifying the location of the holders of the debt securities may be difficult. This is especially true when the securities were issued in the form of physical certificates with coupons attached.
Compliance with Stock Exchange Rules
If the debt securities are listed on an exchange, care must be taken to comply with any applicable rules of the exchange If the debt securities are listed on the Luxembourg Stock Exchange, the rules applicable to debt tenders offers are drawn from the rules applicable to optional redemption by the issuer. Such rules require notice to be given to the exchange and a public announcement to be made at the commencement of the tender offer. In the case of other repurchases, the Luxembourg Stock Exchange requires the issuer to publish the amount of debt securities repurchased and cancelled. If the debt securities are listed on the London Stock Exchange, then any repurchase transactions need to comply with Chapter 15 of the Listing Rules of the London Stock Exchange. In general, any applicable stock exchange rules should be explored in advance with the listing agent.
Compliance with Procedures of the Clearance Systems
When the debt securities are issued in book-entry form or otherwise held through a clearance system, care must be taken to comply with the procedures of the relevant clearance system. Each of The Depository Trust Company ("DTC"), Euroclear and Cedelbank have procedures which must be complied with in order to effect a repurchase of debt securities held by or through them. Such procedures extend to the manner of communicating the offer to the beneficial owners when the securities are traded in book-entry form, the manner of accepting the offer, and the manner for delivering securities out of the various participant accounts to the depositary or depositaries for the tender offer.
Debt securities issued as part of an international offering with a U.S. component are frequently issued in the form of global notes which are held in DTC, Euroclear and Cedelbank. In those situations, the procedures of each clearance system must be reviewed to ensure an orderly distribution of the offering materials, to address the mechanism for tendering notes, and any related settlement issues.
Reviewing tax consequences to holders. The issuer should review with its tax counsel the tax considerations which might be material to a holder's decision to accept the offer to repurchase. If a tender offer is being made to U.S. holders, any material U.S. federal tax considerations will likely require disclosure in the offer document. If the holders are concentrated in a particular jurisdiction outside the United States, an issuer should consider to what extent disclosure of tax consequences in such jurisdiction would be appropriate.
Given the multitude of legal considerations involved in deciding whether to proceed with an international debt tender offer or engage in a program of repurchasing debt securities in the open market or in privately negotiated transactions, issuers and their professional advisors should consult with their legal counsel early in the process. Analyzing the legal consideration prior to launching a debt repurchase transaction can avoid the potential legal consequences and embarrassment of having to withdraw or otherwise modify a repurchase transaction after it has commenced or otherwise been made public.