Part I of the article appearing in the June issue of The Metropolitan Corporate Counsel described reporting covenants at the center of recent cases involving default claims by bondholders arising out of the failure of companies to timely file their SEC reports.
I. The Recent Cases
1. BearingPoint
In Bank of New York v. BearingPoint, Inc .,1the New York Supreme Court held that BearingPoint violated Section 314(a)(1) of the TIA as well as the reporting covenant in its indenture, by failing to timely file annual and quarterly reports with the SEC and provide copies of those reports to the trustee for its convertible subordinated bonds. The decision had a significant impact in that, during a period when numerous companies were unable to meet their filing deadlines, it was the only case construing Section 314(a)(1) of the TIA and a standard reporting covenant found in many indentures.
A group of hedge funds, which had acquired more than 25 percent of Bearingpoint's debentures, acting through the trustee, brought an action for breach of the indenture after BearingPoint delayed the filing of its annual and quarterly reports by approximately one year. BearingPoint argued that its failure to deliver reports to the indenture trustee did not constitute an event of default because the indenture did not require it to file reports with the SEC by a specific time but merely required it to deliver to the trustee reports if and only after it files them with the SEC. BearingPoint's indenture was governed by New York law. 2
The court held that BearingPoint's reporting covenant unambiguously obligated BearingPoint to timely file its periodic reports with the SEC and provide copies of them to the trustee within 15 days of the date they were required to be filed under the Exchange Act. The court rejected BearingPoint's construction of the indenture because it would make its obligation to provide information to the trustee "contingent on whether or not it chose to file with the SEC."3To read the reporting requirement "as making SEC filings optional. . . vitiates the clear purpose of the Indenture to provide information to the investors so that they may protect their investment."4
The court also held that Section 314(a)(1) of the TIA requires the timely filing of periodic reports with the SEC, in accordance with deadlines provided in the Exchange Act. It reached this construction based on another provision in the TIA, Section 302(a)(4), that "the national public interest and the interest of investors" are "adversely affected" when the issuer "is not obligated to furnish to the trustee under the indenture and to such investors adequate current information as to its financial condition, and as to the performance of its obligations."5The court entered summary judgment in favor of the bondholders/trustee on their breach of contract claim; a trial on damages was ordered. Following the decision, BearingPoint settled with its bondholders by agreeing to pay a higher interest rate on its bonds.6
2. Cyberonics
In Cyberonics, Inc . v. Wells Fargo Bank Nat'l. Ass'n ,7a United States District Court in the Southern District of Texas, applying New York law, construed a virtually identical indenture covenant to the one at issue in BearingPoint and concluded that the company's failure to timely file a report with the SEC did not constitute an event of default.8
Cyberonics announced that it would delay the filing of its annual report because it had been unable to complete an internal investigation into its stock option grants. Following this announcement, a group of hedge funds which had acquired Cyberonics' notes caused the trustee to issue a notice of default and sought to accelerate the company's $125 million of bond debt. Cyberonics sought a declaratory judgment that it had not breached its indenture.
Rejecting the BearingPoint court's analysis, the court held that the reporting covenant "unambiguously requires only that Cyberonics deliver copies of the annual reports and other documents to Wells Fargo [the indenture trustee] within 15 days after having filed those documents" with the SEC.9The court rejected the bondholders' argument that Cyberonics violated Section 314(a)(1) of the TIA. Section 314(a)(1) does not specify the time by which a company must provide the indenture trustee with copies of reports filed with the SEC.
The court also rejected the bondholders' argument that because they can already obtain documents and reports filed with the SEC from the EDGAR system the reporting provision is "meaningless if read as only requiring copies of documents already filed with the SEC and not as an obligation to actually file with the SEC."10This argument "overlooks the plain language of the provision;" if, as the trustee argues, "the objective of the [reporting covenant] was to insure filings consistent with SEC requirements and guidelines, the parties could have simply declared so."11
Although the court construed an indenture covenant virtually identical to the one at issue in BearingPoint , and applied New York law, it concluded that it was not bound by the BearingPoint court decision: "an unpublished decision from a state trial court" is not binding on a federal court.12 BearingPoint was also distinguished on the ground that BearingPoint supposedly failed to file any reports with the SEC at all, such as on Forms 8-K, while "Cyberonics continued to report information about its operations through 8-K filings."13
3. Affiliated Computer
In Affiliated Computer Servs., Inc. v. Wilmington Trust Co. ,14a United States District Court in the Northern District of Texas construed an indenture substantially similar to BearingPoint's.15Following the reasoning of Cyberonics , the court held that the clear language of Affiliated Computer's reporting covenant simply obligates it "to file with the Trustee copies of the reports that [it] in fact files with the SEC, and to do so within 15 days of filing."16The court also held that neither the indenture nor Section 314(a)(1) of the TIA made the Exchange Act filing deadlines part of the indenture.17
Affiliated Computer received a notice of default and demand for acceleration from noteholders after it filed a Form 12b-25 reporting that it would delay the filing of its annual report due to an ongoing internal investigation into back-dated stock option grants. Affiliated Computer sought a declaratory judgment that it was not in default under the indenture. The trustee, on behalf of the noteholders, counterclaimed for a declaratory judgment.18
The court compared the reporting covenant to other covenants in the indenture which began with language such as, "[t]he Company shall" or "[t]he Company will," noting that the reporting covenant simply recited which reports "the Company is required to file with the SEC" and the trustee (but did not say that the company "shall" file them timely with the SEC).19Because the indenture largely mirrored the language of § 314(a)(1), "there is no reason to believe that the parties intended it to require anything more than what § 314(a)(1) requires, except the addition of a 15-day delivery limit."20
The court declined to follow the BearingPoint construction of Section 314(a)(1) of the TIA,21and rejected related arguments that SEC Rule 19a-1 under the TIA requires issuers to file timely reports with the SEC,22as well as BearingPoint's holding that to "implement Section 302(a)(4) of the TIA," Section 314(a)(1) must be interpreted as requiring timely filing.23The policy concerns of Section 302(a)(4) are effectuated since "note holders through the Trustee possess the same financial information concerning the issuing company that the rest of the investment public has."24The court noted that Affiliated Computer, like Cyberonics, furnished current financial information to investors during the four months that it delayed filing its quarterly reports and thus the trustee could not claim to have been without current financial information during that period.25While "the value of a pure delivery obligation in the post-EDGAR world is considerably less than before . . . even with electronic access, a delivery requirement is not meaningless" because "[w]ith a delivery requirement the Trustee knows when the Indenture obligor has filed something with the SEC and is spared the time and expense of printing the documents and reports."26
The court also rejected the argument that the company's construction of the TIA would enable it "to escape its duty to provide financial information to the Trustee by not filing anything with the SEC at all."27It is the SEC, not the indenture trustee, that is responsible for enforcing statutory filing requirements. Although the company's failure to file with the SEC may not have subjected it to penalties under the indenture, a late filing exposes it to other potential sanctions that are "adequate to prevent [Affiliated Computer] from attempting to take advantage of the note holders."28Thus, the court reasoned, its interpretation does little to encourage companies "to skirt their statutory and contractual filing obligations."29
4. UnitedHealth
UnitedHealth, like Cyberonics, delayed the filing of its quarterly reports with the SEC pending the completion of an investigation into back-dated stock option grants. 30A group of hedge funds accumulated over 25 percent of UnitedHealth's senior notes and caused the indenture trustee to issue a notice of default, after which time they purchased an additional $55.8 million of notes.31UnitedHealth filed a declaratory judgment action, seeking a ruling that it had not breached the following indenture covenant:
So long as any of the Securities [notes] remain Outstanding, the Company shall cause copies of all current, quarterly and annual financial reports . . . which the Company is then required to file with the Commission . . . to be filed with the Trustee and mailed to the Holders of such series of Securities at their addresses . . . in each case . . . within 15 days of filing with the Commission.32
Despite being unable to timely file its Form 10-Q, UnitedHealth reported unaudited financial information with its Form 12b-25 notice of late filing, almost identical to that which would have been contained in its Form 10-Q.33Noteholders nonetheless caused the company's trustee to issue a notice of default, claiming that the failure to timely file a 10-Q constituted an event of default under the indenture. Describing the indenture as clear and unequivocal, the United States District Court for the District of Minnesota held that the indenture simply required the company to provide the trustee "with copies of its SEC filings within 15 days of their being filed with the Commission."34Similarly, the TIA, Section 314 (a)(1) requires "only that plaintiff provide the trustee with copies of SEC filings," but establishes "no deadline whatsoever."35It is the Exchange Act, not the indenture, "which compels [UnitedHealth] to produce a particular report. The Indenture's language merely requires [UnitedHealth] to provide the trustee with copies of the submissions which are required by the [Exchange] Act." 36
Conclusion
A week before the Cyberonics appeal was to be argued, the parties settled, with Cyberonics agreeing to repurchase for par value any notes tendered eight months prior to their maturity date.37Both Affiliated Computers and UnitedHealth are on appeal. Another case involving a substantially similar indenture covenant (Par Pharmaceuticals) is pending in the Southern District of New York.38And Beazer Homes continued to litigate with its bondholders despite the waiver of default it obtained.39
The recent federal court decisions should enhance the ability of companies with BearingPoint-type reporting covenants to fend off the demands of noteholders seeking to capitalize on filing delinquencies. During the period a company delays the filing of its annual or quarterly reports, it may enhance its position in a litigation by releasing current information about its financial performance and condition, to the extent it can, without running afoul of the anti-fraud prohibition of Section 10(b) of the Exchange Act.40While the three federal court decisions turned on the indenture language, the fact that in each case the companies continued to supply investors with current material financial information undercut any argument that bondholders were in the dark about the company's financial condition. 41For instance, even where stock options have been backdated, a company may still be able to report its current revenue as well as expenses that are not impacted by stock option expense or compensation.
Equally as important, these cases reflect the need for counsel to carefully draft reporting covenants. Companies issuing debt securities or restructuring existing public debt should not just lift a reporting covenant from a prior indenture without considering refinements that can achieve greater clarity and protection for the client. In response to the uncertainty created by BearingPoint and the unprecedented number of companies that were unable to file their SEC reports on time, bondholders are now insisting on a new reporting covenant which makes clear that missing a filing deadline with the SEC will be grounds for accelerating the entire debt if not cured within the indenture's cure period. Recently, an association of fixed income investors issued a white paper with a version of a reporting covenant that has already gained traction in the market, and that requires companies not only to file reports with the SEC and furnish them to the trustee and the bondholders within the time periods specified in the SEC's rules and regulations, but to continue to supply bondholders with the same "management discussion and analysis" mandated by Item 303 of Regulation S-K42even after the issuer ceases to be a reporting company.43The TIA contains no such requirements.
While bondholders believe that reporting covenants like BearingPoint's were meant (despite their language) to require compliance with the SEC's filing deadlines, a countervailing concern is that bondholders should not reap a windfall by accelerating millions of dollars of debt (thereby jeopardizing the entire capital structure of an otherwise healthy company) where the company continues to timely pay interest; there is no indication that the bondholders' principal will not be repaid at maturity; and where the company continues to report unaudited financial information. The absence of financial injury or damage to bondholders in the recent trio of cases reflects that the court's literal contract construction not only comported with the language of the indentures at issue but resulted in an equitable outcome.
1 824 N.Y.S 2d 752 (Table); text available at 2006 WL 2670143 (N.Y. Sup. Ct. Sept. 18, 2006).
2 The BearingPoint reporting covenant reads:
[T]he Company shall file with the Trustee, within 15 days after it files such annual and quarterly reports, information, documents and other reports with the SEC, copies of its annual report and of the information, documents and other reports . . . which the Company is required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act.The Company shall comply with the other provisions of TIA Section 314(a).
Id. at *2.
3Id. at *7.
4Id.
5Id.
6 BearingPoint, Inc. Form 8-K (Nov. 8, 2006).
7 2007 WL 1729977 (S.D. Tex. June 13, 2007), appeal dismissed, No. 07-20539 (5th Cir. April 21, 2008).
8 The Cyberonics' covenant reads:
The Company shall deliver to the Trustee within 15 days after it files them with the SEC copies of the annual reports and of the information, documents and other reports . . . which the Company is required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act . . . The Company shall also comply with the other provisions of Section 314(a) of the TIA.
Id. at *1.
9Id. at *4.
10Id. at *4.
11Id.
12Id. at *5.
13Id. In fact, BearingPoint did continue to report current financial information in 8-Ks but this was not referenced in the decision. See e.g., BearingPoint Form 8-K (3/18/05).BearingPoint also filed its 2004 From 10-K on January 31, 2006, only two weeks after plaintiff filed its complaint on January 18, 2006.
14 2008 WL 373162 (N.D. Tex. Feb. 12, 2008), notice of appeal filed, No. 3:06-CV-01770 (5th Cir. March 12, 2008).
15Id. at *2.
16Id. at *4.
17Id. at *1.
18Id. at *2.
19Id. at *4.
20Id. at *6.
21Id . at *7.
22Id. at *5;Under Rule 19a-1, an "'eligible indenture obligor' that files with the indenture trustee those Exchange Act reports filed with the Commission . . . has met its duty under Section 314(a)(1) . . . to 'file with the indenture trustee all reports required to be filed with the Commission pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934.'"17 C.F.R. § 260.19a-1.
23BearingPoint, 2006 WL 2670143, at *7; see 1. BearingPoint.
24Affiliated Computer, 2008 WL 373162, at *6.
25Id.
26Id.
27Id. at *7.
28Id.
29Id.
30 538 F. Supp. 2d 1108 (D. Minn. 2008), notice of appeal filed, No. 06-cv-04307 (8th Cir. April 8, 2008).
31Id. at 1111 n.3
32Id. at 1110.
33Id.
34Id. at 1112.
35Id.
36Id. at 1113.
37 Cyberonics, Inc. Form 8-K (Apr. 24, 2008).
38 Am. Stock Transfer & Trust Co. v. Par Pharm. Cos., 2007 WL 1024673 (S.D.N.Y. Feb. 16, 2007).
39Beazer Homes USA, Inc. v. U.S. Bank Nat'l Ass'n& U.S. Bank Trust Nat'l Ass'n, 2007 WL 4740954 (November 6, 2007); Beazer Homes USA, Inc. Form 8-K (Oct. 30, 2007).
40 15 U.S.C. § 78j(b).
41UnitedHealth, 538 F. Supp. 2d at 1110 ; Affiliated Computer, 2008 WL 373162, at *6; Cyberonics, 2007 WL 172997, at *5.
42 17 C.F.R. § 229.303 .
43 On December 17, 2007, the Credit Roundtable published the following suggested reporting covenant:
"[S]o long as any Notes are outstanding, if the Company is subject to the periodic reporting requirements of the Exchange Act, the Company will file with the SEC and furnish to the Holders of Notes (or cause the trustee to furnish to the Holders of Notes), within the time periods specified in the SEC's rules and regulations: (1) all quarterly and annual reports . . . and (2) all current reports on Form 8-K . . . In addition, the Company will post a copy of each of the reports . . . on its website for public availability within the time periods specified for filing such reports with the SEC . . . If, at any time, the Company is no longer subject to the periodic reporting requirements of the Exchange Act for any reason, the Indenture requires that the Company will nevertheless continue to prepare the financial statements and a 'Management's Discussion and Analysis of Financial Condition and Results of Operations' substantially similar to that which would have been required to be included in each of the reports specified in clause (1). . . and post copies thereof to its website for public availability within the time periods that would have been applicable to filing such reports with the SEC in the rules and regulations applicable to such reports if the Company had been required to file those reports with the SEC . . . "
The Credit Roundtable, Improving Covenant Protections in the Investment Grade Bond Market, available at http://admin.iimemberships.com/downloads_upload//creditroundtable/Covenant%20White%20Paper%20publication%20copy.pdf (Dec. 17, 2007) (emphasis added).
Published July 1, 2008.
