Events of Default

Every convertible bond indenture has a list of things that the issuer cannot do or else would constitute a default. These usually include:

1)      Default in payment of interest for a period of 30 days

2)      Default in payment of principal when due and payable on the maturity date, upon any required repurchase, upon declaration of acceleration or otherwise

3)      Failure to comply with its obligation to convert the Notes

4)      Failure to issue a Fundamental Change Notice

And several others.

Failure to comply would accelerate the maturity of the notes.

Technical default

The following contains excerpts from BAC’s report titled, “Technical Default Language Demystified” published 07/14/06.

In 2006, due to Sarbanes-Oxley and backdating employee options accounting, several convert issuers were put into technical default because they were not able to file their 10Qs and 10ks on time. In most indentures, under Article Holders Lists and Reports by Trustee and the Company, there is a requirement that the company file timely reports to the trustee. The first such case in 2006 was MERQ 0% converts with the following language.

Section 7.04. Reports By Company. The Company shall file with the Trustee and the Commission, and transmit to Holders, such information, documents and other reports, and such summaries thereof, as may be required pursuant to the Trust Indenture Act at the times and in the manner provided pursuant to such Act; provided that any such information, documents or reports required to be filed with the Commission pursuant to Section 13 or 15(d) of the Exchange Act shall be filed with the Trustee within 15 days after the same is so required to be filed with the Commission. In the event the Company is not subject to Section 13 or 15(d) of the Exchange Act, it shall file with the Trustee upon request the information required to be delivered pursuant to Rule 144A(d)(4) under the Securities Act. Delivery of such reports, information and documents to the Trustee is for informational purposes only and the Trustee’s receipt of such shall not constitute constructive notice of any information contained therein or determinable from information contained therein, including the Company’s compliance with any of its covenants hereunder (as to which the Trustee is entitled to rely exclusively on Officers’ Certificates). It is expressly understood that materials transmitted electronically by the Company to the Trustee shall be deemed filed with the Trustee for purposes of this Section 7.04.

In Article 5 Remedies, Events of Default stated that

(d) default in the performance of any covenant, agreement or condition of the Company in this Indenture or the Securities (other than a default specified in (a) or (b) above), and continuance of such default for a period of 60 days after there has been given, by registered or certified mail, to the Company by the Trustee or to the Company and the Trustee by the Holders of at least 25% in aggregate Principal Amount of the Outstanding Securities a written notice specifying such default and requiring it to be remedied and stating that such notice is a “Notice of Default” hereunder;

Companies that were late in filing reports were then in default and would be forced to accelerate the maturity. This was a huge benefit to converts that traded below par.

BAC had a report that described the weakest, moderate and strongest reporting covenants.

Weakest reporting covenant

This covenant directly promises only to provide copies of the filed reports, and usually reads as follows:

The 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 (or copies of such portions of any of the foregoing as the SEC may by rules and regulations prescribe) which the Company is required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act… The Company also shall comply with the other provisions of TIA Section 314(a).”

Recent examples of the convertible securities with such or very similar language include:
BE, CYBX, NT, OPWV, PRX, SNRR, VTSS and WG.

Moderate reporting covenant

This covenant directly promises to file the required reports with the SEC, although it omits a variation on the word “time”, and usually reads as follows:

“The Company shall file all reports and other information and documents which it is required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act, and within 15 days after it files them with the SEC, the Company shall file copies of all such reports, information and other documents with the Trustee; … The Company also shall comply with the provisions of TIA Section 314(a).”

Recent examples of the convertible securities with such or very similar language include:
BRKS, NAV, SFNT, SKS, TERN, and UTSI.

Strongest reporting covenant

This covenant directly promises to timely file the reports with the SEC, and usually reads as follows:

The Company shall file with the Trustee (and the Commission if at any time after the Indenture becomes qualified under the Trust Indenture Act), and transmit to holders of Notes, such information, documents and other reports and such summaries thereof, as may be required pursuant to the Trust Indenture Act at the times and in the manner provided pursuant to such Act, whether or not the Notes are governed by such Act; provided that any such information, documents or reports required to be filed with the Commission pursuant to Section 13 or 15(d) of the Exchange Act shall be filed with the Trustee within fifteen (15) days after the same is so required to be filed with the Commission…”

Recent examples of the convertible securities with such or very similar language include:
BRCD, CNET, CNCT, CAO, FLYR, IPXL, MERQ, RSTN, and TKLC

Weakest covenant created most controversy

Holders of convertibles with the strongest or moderate reporting covenants have been largely successful to date in eliciting issuers’ agreement about when a technical default has been triggered, or at least in forcing a default-waiver consent solicitation with a sweetener. On the other hand, the weakest covenant wording does leave room for an issuer to take the position that they have not breached a covenant, with bondholders’ default claims being vigorously disputed in most cases.

While virtually every single indenture we looked at contains a close variation on the words “reports, which the Company is required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act,” we find the weakest reporting covenant to be unclear as to the extent of bondholders’ protection in cases of delayed filings with the SEC. Although we believe that the intent of all indenture covenants is to protect the interests of the bondholders, we wait to see if the ongoing BearingPoint court case will set a clear precedent one way or another.

Technical default trigger process

Technical default usually does not take place automatically, when a company announces a possibility for restatement or any other reason for delaying the financial reporting. Generally, (1) a company has to miss the filing deadline first; then, (2) after 15 days (most common time period we have seen), a written notice of such failure has to be given to the company by the trustee or by the holders of at least twenty-five percent (25%) in aggregate principal amount of the convertible notes outstanding at the time. (3) The company usually has 60 (sometimes, 90) days to cure such failure, before the event of default and subsequent acceleration of notes’ maturity finally occur.

New Language

Most recently, issuers have removed filing of reports from events of default but have instead up tit under Article 4 Particular Covenants of the Company such as LRCX 0.5% 05/15/16 which says,

(d) If, at any time during the six-month period beginning on, and including, the date that is six months after the last date of original issuance of the Notes, the Company fails to timely file any document or report that it is required to file with the Commission pursuant to Section 13 or 15(d) of the Exchange Act, as applicable (after giving effect to all applicable grace periods thereunder and other than reports on Form 8-K), or the Notes are not otherwise freely tradable by Holders other than the Company’s Affiliates (as a result of restrictions pursuant to U.S. securities law or the terms of this Indenture or the Notes), the Company shall pay Additional Interest on the Notes. Such Additional Interest shall accrue on the Notes at the rate of 0.50% per annum of the principal amount of the Notes outstanding for each day during such period for which the Company’s failure to file has occurred and is continuing. As used in this Section 4.06(d), documents or reports that the Company is required to “file” with the Commission pursuant to Section 13 or 15(d) of the Exchange Act does not include documents or reports that the Company furnishes to the Commission pursuant to Section 13 or 15(d) of the Exchange Act.