The Redemption 'Make Whole' Remedy Controversy — An Easy Fix

The new year has brought an unexpected controversy in an otherwise very issuer-friendly high yield bond market, one involving limiting the available remedies following default that were expanded in last year’s decision by the Southern District of New York in Wilmington Savings Fund Society, FSB v. Cash America International Inc. The court in Cash America held that when a default is caused by voluntary actions of the issuer and the issuer has the ability to make the applicable redemption payment, a bondholder may pursue a remedy of specific performance of the redemption provisions of the indenture for the payment of the applicable redemption premium.

Prior to Cash America, most market participants believed that such a remedy would only be available where an issuer intentionally defaulted for the purpose of avoiding paying the redemption premium (under the reasoning set forth in Sharon Steel Corp. v. Chase Manhattan Bank NA, 691 F.2d 1039 (2d Cir.1982)). After Cash America, an issuer financially capable of refinancing bonds and paying the redemption premium that defaults under an indenture other than by reason of an involuntary default (e.g., a bankruptcy or insolvency default, judgment default, cross default, or loss of collateral or guarantees) can be compelled to redeem the bonds and pay the applicable redemption premium.

In response to this extension of the redemption premium remedy, issuers have recently attempted (successfully, in certain instances) to include language in indentures that eliminates the redemption premium remedy — but not only in circumstances when there is no bad faith. This new language would eliminate the redemption premium remedy even where an issuer intentionally breaches for the express purpose of avoiding paying the redemption premium. It is this “land grab” by issuers that ignited last week’s kerfuffle.

The reaction to the new language by high-yield investor constituencies is difficult to describe as measured: “If investors do not rapidly start rejecting these deals, it is the beginning of the end of bond covenants,” announced Adam Cohen, founder of Covenant Review, which has successfully staked out for itself the role of vigilant gatekeeper of high yield bond covenants (much to the chagrin and at times fury of issuers and underwriters and their counsel). As if on cue, prominent counsel representing issuers and underwriters pooh-poohed the concerns raised by Covenant Review, claiming that the new language could not be expected to have a practical impact on issuer behavior. Their reasoning, though, is rather disarranged: “companies rarely intentionally default” — true enough but now that the new language provides a compelling economic incentive to do so, it is not hard to imagine an aggressive sponsor doing so; and “[D]oing so triggers a number of negative consequences for the issuer, including cross defaults in other debt, cross defaults in hedges, leases and other financial obligations, supplier retraction of credit, going-concern qualifications in financial statements and loss of shelf registration eligibility” — again, this ignores the intentional nature of the breach. If the issuer simply arranges committed take out financing for the bonds in advance of the planned breach, it could obtain cross default waivers (which would quite likely be obtainable on reasonable terms), and there would be no supplier contraction of credit or going-concern qualification because the issuer’s credit would be unimpaired. Finally, for the majority of sponsor portfolio companies in this era of 144A-for-life distribution that are not SEC reporting companies, the spectre of loss of shelf registration availability is obviously a non-event. Lastly, the cudgel of injunctive relief was raised, but without any explanation as to why the availability of money damages would not be sufficient to defeat such a claim for such relief.

If the goal is to return to the post-Sharon Steel, pre-Cash America status quo, it seems the fix is rather simple: A scaled-down version of the controversy-provoking new language that retains protection against bad faith breaches. For example:
 
“Notwithstanding any other provision of the indenture or the notes, Holders of the notes shall not be entitled to specific performance of the optional redemption provisions described under 'Optional Redemption' above, and no premium will be due or available as a remedy (and no damages or remedy shall be payable that are based on the loss of or deprivation of the amount of any such premium), in each case in connection with or following (x) any Default or Event of Default other than a Default or Event of Default resulting from an intentional breach of the terms of the Indenture with the purpose of avoiding the payment of such premium or (y) any acceleration of all, or any portion of, the notes (other than an acceleration in respect of an Event of Default (1) resulting from an intentional breach of the terms of the Indenture with the purpose of avoiding the payment of such a premium or (2) for failing to pay the redemption price when due following any election to redeem notes pursuant to the optional redemption provisions described under  'Optional Redemption' above, to the extent any premium is due as part of the redemption price”.