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An indenture is a contract governing the rights of bondholders.
The word was coined to describe a medieval service contract (thus, someone who signed an indenture was "indentured"). Medieval indentures were written in duplicate on one big piece of paper and then cut apart. Each party got a half. The cut was intentionally made wavy, "indented," so that when the pieces were reunited, it was clear they were originals.
I can't explain how this term came to the world of corporate debt. If you know, please tell me!
The earliest corporate debt indentures created a trust for the benefit of bondholders. Issuer assets were placed in the trust and administered by a trustee for the benefit of the bondholders. So, if the issuer missed a payment the trustee could sell the assets. The indenture protected the bondholder's investment and guaranteed that all bonds were worth the same amount.
The Trust Indenture Act (15 USCA s. 77aaa) requires that debt sold to the public be governed by an indenture and that there be a trustee.
No assets are transferred in modern indentures. Instead, the trustee acts as the bondholder's representative. It oversees a trust containing the bondholder's contract rights. "Modern" is a relative term in the indenture context - the most important book on the subject, Commentaries on Model Debenture Indenture Provisions was written in 1965.
Let's look at an example: last year, General Motors Corporation entered into an indenture with The Bank of New York as trustee (ex. 10.3 to 8-K filed 2/25/08). The indenture is a 60-page contract. It contains very broad language about what kind of debt will be issued and very specific language about the duties of the issuer and the trustee. For example, if GM defaults the trustee is empowered to "declare the principal amount ... immediately due and payable" and to "instigate any action or proceeding at law," on behalf of the bondholders.
An indenture is meant to be a durable document. GM's previous indenture was signed in 1995. Also attached to the same 8-K is the first supplemental indenture (ex 10.4) which adds a new section to the indenture describing "4,372,500,000 - 6.75% Series U Convertible Senior Debentures."
A couple of days ago, the Corporate Counsel blog had a post about steps, outlined on the phone by SEC staff, that will allow issuers who lose WKSI status to continue to use an existing automatic shelf registration.
WKSI is an acronym of "well-known and seasoned issuer," an issuer category created by the '33 Act reforms which became effective in December of 2005 (release 33-8591 (pdf)). A company is a WKSI if it has $700 million in market capitalization and a year of '34 act reports filed and up-to-date. Because of falling stock prices, many WKSIs have dropped below the $700 million threshold. First Midwest Bancorp (FMSI), for instance, was a WKSI yesterday. Since yesterday their share price has gone down about a dollar and their market cap it currently $686.09 million. See this memo from Paul Hastings for more on what happens when you lose WKSI status.
WKSI status confers a bunch of benefits. See this White & Case Q&A for a quick summary and this giant Sullivan & Cromwell memo (pdf) for a very thorough treatment.
Mary Schapiro's written testimony (pdf) is available on the Senate Banking Committee's website.
The Harvard Corporate Governance blog has posted Francis G. X. Pileggi's rebuttal (complete with sneaky digs, "My cursory review ... is not as scholarly ... I do not have the time (thankfully, due to my busy practice)" to Race to the Bottom's 5 Worst Delaware Cases of 2008.
The House is currently considering HR 384: The TARP Reform and Accountability Act of 2009, proposed by Barney Frank. It's a big bill. In addition to imposing lots of requirements on institutions that got TARP money it has provisions aimed directly at benefiting homeowners and car companies.
Another day, another giant ponzi scheme. Is it me, or is this getting depressing?
Release 33-8996 adopting rules 151A and 12h-7: the defintions of "annuity contract" and "optional annuity contract," and, yes, the dissent.
Release 33-8995: the new oil and gas reporting rules.
Appointment of acting chief accountant and acting head of the Division of Corporation Finance.
Agenda for the Commission's 1/7 open meeting.
Another terrific article from the increasingly genuis Currents Extra on banks that have gone back for more TARP money.
And ... Pequot. Again!
Today's WB Currents Extra has a nice article about companies that have announced they are getting into the CDS trading and/or clearing business. The article points out (as has been noted here) that the SEC has bestowed the mantle of "offical" CDS trading and clearing facility on an NYSE sub. However, the SEC's power to regulate credit default swaps is pretty limited so lots of companies are trying to get into the business.
I guess that's how the New York City subway got built.
Today I'm starting a series of posts that explain legal concepts that I wish someone had explained to me when I was a law librarian. After the discussion, some research tips. Coming soon: indenture, underwriter, derivative and multi-jurisidictional disclosure. If there's something you want explainified, let me know. Enjoy?
POISON PILL ZERO
To give you an idea of how a poison pill works, I’ll tell you the story of the very first poison pill …Once upon a time, in the go-go 80’s, Brown-Forman, manufacturer of Jack Daniels, decided that its liquor cabinet would not be complete without Lenox Inc., stodgy manufacturer of presidential china. The president of BF approached Lenox about a merger on friendly terms. The Southern ruffians were rebuffed. So, on June 8, 1983, BF launched a hostile tender offer at $87 per share, a 60% premium over Lenox’s market price. The next day Lenox shares shot up to $86.50.
Lenox hired Wachtell Lipton partner Martin Lipton to oversee its takeover defense. Lipton gets credit for inventing the poison pill. On June fifteenth, Lenox activated its pill. The board rejected BF’s offer and issued a “special cumulative dividend” to Lenox shareholders. The cumulative dividend was in the form of the right to purchase shares (called a share purchase right). Now watch closely: in the event that BF and Lenox merged the share purchase right would entitle the holder to buy, at a steep discount, Class A shares of Brown-Forman. Class A shares were the only voting shares of BF and they were held only by the Brown family. After the merger, the former stockholders of Lenox would control BF! How, I hear you ask, could Lenox think this would work? Contract law: if BF acquired Lenox, BF would become successor-in-interest to Lenox’s contracts. So, BF would be responsible for Lenox’s contract responsibilities.
This is a flip-over. No one has yet had the courage to challenge this mechanism in court. In my opinion, “poison pill,” with its images of a spy taking cyanide to avoid capture, is a deceptive name. This thing is more like the Trojan horse. You may be taking us over, but surprise, we’re taking you over, too! It also brings to mind the atomic bomb – a weapon so frightening that the bidder has no choice but to negotiate. A poison pill can be adopted by the board without shareholder approval. Once the pill has been activated, only the board can turn it off. In fact, the whole edifice rests on the power of the board to use the pill without resort to the shareholders. Starting with Moran v. Household Insurance in 1985, courts have consistently found that the adoption of a pill is within the board’s power under the business judgment rule.
The present model for poison pills follows the Lenox blueprint: the target issues share purchase rights. An event (or trigger) activates the rights. The activated rights give target shareholders power to complete a lucrative transaction that injures the bidder. A share purchase right is like a coupon – it is an option contract that offers to sell something at a discount. The rights are created and governed by an agreement between the company and a third party called a shareholder rights agreement. The third party is called the rights agent. The rights agreement sets out the mechanics of the pill. When the rights are created, they are “attached” to the common shares and can’t be exercised, if the triggering event happens, they “detach.”
What causes the rights to activate? A typical plan works this way:
TRIGGER 1: If there is a tender offer for a set percentage of the company’s securities the rights agent distributes the rights. Existing shareholders, except the bidder, are issued rights. As initially issued, rights have unfavorable terms.
REDEMPTION: Between triggers is a period called the “redemption window:” typically a few days. During that time, rights may be redeemed by the board for very little, often a tenth of a cent on the dollar.
TRIGGER 2: Closing by the bidder of a share purchase transaction activates the rights. Activation changes the terms from very unfavorable to very favorable.
And what does your share purchase right give you the right to purchase?
Flip-in rights: give the holder the right to purchase discounted shares of the target. Flip-in is also used to describe the first trigger.
Flip-over rights: give the holder the right to buy discounted shares of the merged entity, or of the acquirer.
EDGAR SEARCH TIPS:
Adoption or amendment of a poison pill is an 8-K event. Item 601 of Regulation S-K requires that an in-force shareholder rights agreement be attached as exhibit 4 to every registration statement and form 10-K.
WESTLAW RESOURCES
Treatises:
Corporate Anti-Takeover Defense: The Poison Pill Device (SECPILL). A handbook for drafting rights agreements, by Joy Marlene Bryan. Contains brief discussion, definitions, and sample language.
Special Study for Corporate Counsel on Poison Pills (CCPPILLS). A West publication containing discussion of the law and sample documents – it is updated every year and has a drafter’s checklist.
BNA Corporate Practice Series 6-3: Responses to Takeover Bids (BNACPS-RTB). This publication contains an overview of the process of responding to a takeover bid including a discussion of defensive mechanisms - updated monthly.
Reports:
Poison Pill Reports database from SDC Platinum (POISONPILL). Contains reports summarizing every pill ever adopted starting with Lenox Inc - updated daily.
For those that need to know the ending: BF managed to acquire Lenox for more than $400 million. In 2005, BF sold most of Lenox to Department 56 for $190 million. Wachtell Lipton respresented BF.
In case you missed it (I did) the new year has already brought changes.
From DealBook: about $40 billion in bank mergers closed when B of A bought Merrill Lynch and Wells Fargo bought Wachovia.
From the Harvard Law School Corporate Governance blog: The SEC's eProxy rules took effect.
