June 12, 2019

Debt Default Activism: Using Indenture Terms to Play Defense

We’ve previously blogged about the debt default activism phenomenon and how it shows that no aspect of a company’s balance sheet is safe from opportunistic attacks by activist hedge funds.  The recent unpleasantness involving Windstream & Aurelius Capital Management – which culminated in the company’s bankruptcy – demonstrates that this type of activism also has the potential to destroy significant value.

This Wachtell memo says that following the Windstream situation, a consensus has begun to emerge among companies & creditors that appropriate contractual deterrents to default activism are in everyone’s best interest.  Here’s an excerpt that describes some of the as yet untested contractual provisions designed to thwart default activists:

Mandatory Disclosures and Voting Restrictions. One provision to emerge in recent weeks requires debtholders to disclose if they are “net-short” and deprives “net-short” holders of the right to vote their long positions on amendments to the applicable debt agreements. The goal of the provision is to align voting power and economic interest so that those incentivized to maximize the value of a given debt instrument control relevant decisions.

Default Time-Bars. Also notable in Windstream was the gap between the time that Windstream completed the challenged spin-off transaction (April 2015) and the time Aurelius actually asserted a default (September 2017). An even longer gap applied to the recent objection by Safeway bondholders to the company’s acquisition by Albertsons. A new provision addresses such “default archaeology” by imposing a time-bar on default claims, requiring that any default notice be delivered within two years of the date that the challenged transaction is reported publicly. Whether two years, three years or six months emerges as a standard, it is clear that many market participants are not content with the longer limitations periods dictated by state law (in New York, six years for contract claims).

Anti-“Cash America” Provisions. In the Cash America case of 2016, the Court held that a borrower’s covenant default may be treated as an “optional redemption” of the defaulted debt, and, therefore, that lenders may be entitled to a redemption premium from their defaulting borrowers. Cash America came as a surprise to many market participants, as the prevailing view had been that if a borrower did not intentionally breach a covenant, then the only remedy available to debtholders would be acceleration of their principal at par. In response, some borrowers sought to include language in debt documents stating that a prepayment premium would never become due upon an acceleration of debt. But investors pushed back, and this fix to Cash America has not taken hold.

Since then, however, Debt Default Activists have advanced “premium hunting” claims in which they buy debt, allege a default under that debt, and demand to be repaid at par plus a redemption premium. It is possible that a milder form of the contractual fix previously proposed by borrowers might deter activist overreaches while protecting bargained-for call protection: it would echo the pre-Cash America consensus view and provide that no premium will be due on account of an event of default, other than in situations in which the borrower consummated the transaction with the intent to breach a covenant.

For some of these potential fixes, the devil is in the details – and speaking of that, you should check out this Milbank memo on some of the issues associated with a “net short lender” voting restriction that Sirius recently put in place.

John Jenkins