The Redemption ‘Make Whole’ Remedy Controversy cannot be described

An unexpected controversy has arisen recently in the high-yield bond market, one involving limiting the available remedies following default in the wake of last year’s decision by the Southern District of New York in Wilmington Savings Fund Society, FSB v. Cash America International Inc. (See Debt Dialogue October 2016.) 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. Accordingly, where an issuer financially capable of refinancing bonds and paying the redemption premium defaults under an indenture, other than by reason of involuntary circumstances (e.g., a bankruptcy or insolvency default, judgment default, cross default, or loss of collateral or guarantees), it can be compelled to redeem the bonds and pay the applicable redemption premium.

Issuers have recently attempted (successfully, in certain instances) to include language in indentures that eliminates the redemption premium remedy, and 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 the issuer that ignited the recent kerfuffle.

The reaction to the new language by high-yield investor constituencies cannot be described 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” is 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 “doing 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” — but 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 specter of loss of shelf registration availability is obviously a nonevent. 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 relief.

Some middle ground solutions have been proposed, essentially limiting the redemption premium remedy to circumstances where the issuer has acted in bad faith. To date, these have not taken hold widely in the market. For the time being, the battle between high-yield bond issuers and investors continues.