Previously, we described the plight of Mr. Wonka and his company, WWCC, a global candy maker and high yield issuer that has fallen on hard times. Mr. Wonka is absolutely thrilled with your proposal to have WWCC grant an “equal and ratable” lien over the factory in favor of WWCC’s outstanding notes. This will allow WWCC to obtain new secured bank financing without breaching the terms of its outstanding notes. Mr. Wonka even offers to take you for a ride in his Great Glass Elevator – if you can just get the deal closed before WWCC runs out of cash! You’re almost there, but keep in mind a few traps for the unwary that will arise when WWCC proceeds to grant liens in favor of the outstanding notes.
Regulation S-X Rule 13-02
If the existing notes are registered (or are due to become registered), and as the result of equally and ratably securing the notes, stock in the issuer’s subsidiaries will be pledged, the issuer should be aware of becoming subject to the requirements of Regulation S-X Rule 13-02. S-X Rule 13-02 requires that the issuer provide financial and non-financial disclosures about the affiliate of an issuer (often a subsidiary) that pledges stock and the collateral arrangement if it would be material to investors/holders of the secured notes. Required disclosures include the summarized financial information specified in S-X Rule 1-02(bb)(1), for each subsidiary whose securities are pledged as collateral, which may be presented on a combined basis, along with any other quantitative or qualitative information that would be material to making an investment decision with respect to the secured notes. For more discussion, see our publication on financial statements (foreign private issuers have their own guide).2
How about the TIA?
In a different WoW we discussed some issues under the Trust Indenture Act in connection with Section 3(a)(9) exchanges. Luckily, you do not need to worry about the TIA in connection with many typical unregistered debt offerings. As we previously explained, TIA 304(b) exempts Section 4(a)(2) and Rule 144A offerings, while TIA 304(a) exempts a grab-bag of exempt offerings (including Section 3(a)(2) offerings for banks and Section 3(a)(3) commercial paper).
However, if you find yourself without an exemption from the TIA, you’ll need to be mindful, since Section 314(d)(1) of the TIA generally requires the delivery of certain certificates and opinions of fair value in connection with obtaining the release of collateral subject to the lien of an indenture. The SEC Staff has historically granted no-action relief from the requirements of Section 314(d)(1) in cases where the notes trustee does not control decisions regarding whether the collateral is maintained or released.1 Accordingly, where existing notes are equally and ratably secured as the result of the subsequent incurrence of new secured debt, and a party other than the existing notes trustee (such as the collateral agent under new credit facilities) controls the release of collateral, the issuer need not comply with Section 314(d).
Once the existing notes become secured, the TIA imposes an additional compliance obligation. Under Section 314(b) of the TIA, on an annual basis an issuer must deliver to the existing notes trustee an opinion of counsel stating that, in the opinion of counsel, such action has been taken with respect to the recording, filing, re-recording, and refilling of the indenture as necessary to maintain the lien of such indenture. The opinion must recite the details of the actions taken, or state that, in the opinion of counsel, no action is necessary.
1 See, e.g., Pregis Corp., SEC No-Action Letter, 2007 WL 4328651 (Dec. 7, 2007).
2 Secured note offerings registered before January 4, 2021 continue to be governed by Rule 13-02's predecessor, Rule 3-16. Rule 3-16 was triggered when the stock of an affiliate of an issuer constituted a “substantial” portion (defined as 20% or more of the principal amount of notes being secured) of the collateral for notes that were registered. The issuer was required to file the financial statements of the subsidiary that would have been required had the subsidiary itself been the issuer (generally three years of audited financial statements). Because S-X Rule 3-16 compliance was burdensome, many issuers negotiated to cut back the collateral to exclude the portion of stock in subsidiaries that would have otherwise triggered the rule. The security agreement would contain a cut-back provision that works automatically so the excluded securities are never part of the collateral, and S-X Rule 3-16 isn’t implicated. The extension of the Rule 3-16 regime for the life of these securities ensures that the provisions are not unintentionally triggered.