October High Yield Bonds. An Issuer s Guide (3rd Edition)

Transcription

1 October 2013 High Yield Bonds An Issuer s Guide (3rd Edition)

2 This document is confidential and accordingly its contents are not to be disseminated or copied to anyone without our consent. It is to be used solely for the purpose of making a determination on the provision of legal services and for no other purpose. If we are not selected to represent the recipient of this document all information (whether in physical or electronic form) which we have supplied to you or which you have compiled or derived from information we have given to you should be destroyed or (in relation to electronic materials) deleted save to the extent the material is contained in electronic back up tapes not generally accessible to your personnel and such destruction is not feasible. For the avoidance of doubt our provision of this document does not create a client relationship with the recipient of this document or any organisation affiliated with the recipient and if we are not selected to represent the recipient of the document we are therefore not precluded from acting for another party in any matter in which the recipient or any affiliated organisation is involved (whether or not such matter is the same as or related to one contemplated by this document) by virtue of any confidential information we receive during the course of this selection process.

3 Contents Page TRADITIONAL CREDIT FACILITY VS. HIGH YIELD BONDS 1 INTRODUCTION 2 THE HIGH YIELD COVENANT PACKAGE 13 INDICATIVE TRANSACTION TIMETABLE 26 GLOSSARY 29 If you have any questions about high yield bond offerings, please contact the author of this guide or any of the other key members of our global high yield practice listed on the last page of this guide. Bernd Bohr Partner [email protected] 201 Bishopsgate 1675 Broadway London EC2M 3AF New York, NY United Kingdom United States T T F F

4 TRADITIONAL CREDIT FACILITY VS. HIGH YIELD BONDS Traditional Credit Facility High Yield Bonds Maintenance and incurrence covenants Less onerous incurrence covenants only Typically term of 3 5 years Typically terms of 5 10 years Interim payments generally required by banks Bullet maturity Generally repayable at any time Non-call period generally 3 to 5 years and thereafter decreasing prepayment / call premium - typical call features: 5nc2, 7nc3, 8nc4, 10nc5 Amendments relatively common and uncomplicated Amendments require consent solicitation from investors, which can be costly and time-consuming Documentation relatively straightforward Documentation requires more time and expenses Senior and typically secured and guaranteed Potentially more flexibility; senior or subordinated and frequently unsecured with only negative pledge Floating Rate Fixed or Floating Rate Private reporting (monthly or quarterly) Public reporting (quarterly) Minimal public market awareness Creates awareness in public capital markets and benchmark that can facilitate further fund raisings, including possible IPO Rating not necessarily required Rating required (typically by Moody s and S&P) Investors are banks, institutional funds Investors are mutual funds, hedge funds, insurance companies, pension funds, private wealth management accounts Potential prospectus liability mayer brown 1

5 INTRODUCTION WHY HIGH YIELD? Traditional reasons for high-yield offerings include: y established companies that do not carry (or have lost) an investment grade rating (i.e. rated Ba 1/ BB+ and below by Moody s and S&P, respectively); y private companies looking to reorganize their capital structure; and y financings for leveraged buy-outs. Mutual benefits for issuers and investors include: y issuers benefit from long-term debt financing with covenants that are typically less onerous than the standard covenants included in a typical credit facility; and y investors benefit from higher interest rates with the added benefit of capital appreciation. THE IDEAL HIGH YIELD BOND CANDIDATE Other than investors in investment grade debt that may primarily focus on an issuer s credit profile / metrics (e.g. leverage and credit ratings), high yield bond investors also focus on some of the same factors in making their investment decision as equity investors, such as the issuer s strategy and growth prospects. The ideal candidate for a high yield bond exhibits some or all of the following characteristics: y a stable and resilient business model / financial track record and/or growth/recovery story; y market leading positions and favorable industry trends / growth prospects; y an experienced management team with a proven track record; y solid cash generation and future deleveraging potential; y financing needs of at least 150 million to 200 million and with limited bank financing available; and y the proceeds prospects of the offering are to be used for refinancing of existing indebtedness, acquisition financing or (defined) general corporate purposes. 2 High Yield Bonds - An Issuer s Guide

6 SUBORDINATED DEBT High yield bonds are generally structured to be junior to bank debt, i.e. they will either be expressly subordinated ( Subordinated Notes ) or effectively subordinated (but still referred to as Senior Notes ). There are three potential options for subordination: y express contractual subordination; y structural subordination; and y lien subordination. Only Subordinated Notes have express contractual subordination provisions, while structural or lien subordination may be a feature of both Senior Notes and Subordinated Notes. Subordination allows the Issuer to incur more debt cost-effectively than it could if all its debt were senior. Contractual Subordination High yield bonds may be expressly subordinated by contract, which means that: y upon a bankruptcy or liquidation of the Issuer, the holders of the bonds agree not to be paid until any senior debt is paid in full; and y the holders of the bonds agree to pay to holders of any senior debt any amounts received until the senior debt is paid in full. One way to achieve this result is the inclusion of so-called payment blockage provisions in the relevant documentation, whereby upon a default under the senior debt, no payments are permitted to be made on subordinated debt for a specified period of time. In addition, the relevant documentation will include so-called standstill provisions whereby holders of the subordinated debt must give notice to the senior lenders and wait for a certain period of time before accelerating the subordinated debt. In the case of contractual subordination, it is possible to specify exactly which other debt the bonds are subordinated to and they need not necessarily be subordinated to all other debt. mayer brown 3

7 Structural Subordination In the most common form of structural subordination, the high yield bonds are issued by a (toplevel) holding company, whereas structurally senior debt is issued by a (lower-level) operating company further down the group structure where the operations and assets of the group are located. This senior debt will likely have restrictions on payments to the holding company from the operating company, i.e. so-called dividend stoppers. Notes (Structurally Subordinated Debt) HoldCo Divided Stoppers by Senior Debt OpCo Structurally Senior Debt Sub Sub Sub Sub In this structure, the subordinated debt is structurally subordinated because the holders of the HoldCo debt have no direct access to the assets or cash of OpCo. Instead, the only claim HoldCo creditors have on assets of OpCo is through the shares of Opco held by Holdco. In a bankruptcy or liquidation of OpCo, this (equity) claim would be junior (i.e. subordinated) to the claims of the creditors of OpCo and its subsidiaries, including the claims of unsecured creditors, such as subordinated debt holders or trade creditors. Stated differently, under applicable bankruptcy or insolvency laws, OpCo would be required to repay all is creditor in full before it would be permitted to distribute any remaining liquidation proceeds to its shareholders (i.e. HoldCo), which could then be used to satisfy obligations under the structurally subordinated debt issued by HoldCo. 4 High Yield Bonds - An Issuer s Guide

8 Lien Subordination To the extend the company s capital structure includes secured debt, bank debt will normally be first lien debt, i.e. the bank debt (credit facility) will benefit from security interests (e.g. mortgages, pledges,.) over some or all of the assets of the company and its subsidiaries whereby the bank creditors get paid in full before any other creditors receive any proceeds from the sales of such assets in the case of a bankruptcy or insolvency. High yield bonds may be either unsecured or secured and may be either first lien or second lien debt. If the high yield bonds are first lien debt, they will share pari passu with bank debt in the proceeds from the sale of any collateral. If they are second lien debt, they would receive proceeds from the sale of collateral only after the first lien debt has been paid in full. In either case, the high yield bonds are generally silent, meaning that bank creditors typically call the shots on enforcement remedies with respect to the collateral. The specific rights and limitations between different groups of secured creditors with respect to the collateral are typically spelled out in a so-called Intercreditor Agreement. KEY DOCUMENTS A high yield bond offering typically involves the preparation of the following key documents. Offering Memorandum The offering memorandum is a disclosure document intended to provide potential investors with all material information necessary to make an informed decision as to whether or not to invest in the bonds. In addition to a description of the terms and conditions of the bonds (typically referred to as the Description of the Notes or DoN ), the offering memorandum will contain a description of the risks associated with an investment in the bonds, a description of the company s business (including strengths and strategies of the company) and of the industry and markets in which the company operates, a section entitled Management s Discussion and Analysis of Financial Condition and Results of Operations (MD & A), historical financial statements, biographies of officers and directors, information about their compensation, information about any significant pending or threatened litigation, a list of material properties, a description of material agreements and any other material information. In addition to providing potential investors with information about the proposed offering, the offering memorandum also serves to protect both the company and the underwriting banks from liability under applicable securities laws for alleged material misstatements or omissions in connection with the offer and sale of the bonds. The term offering memorandum (OM) or offering circular (OC) is typically used in a high yield bond offering instead of the term prospectus to indicate that the bonds are being offered in a (private) transaction that relies on certain exemptions under applicable securities laws from the requirement to prepare a formal prospectus that has been reviewed and/or approved by the relevant securities regulator, as would be required in many jurisdictions (including the United States and the European Union) for a broadly marketed offering to the general public. mayer brown 5

9 Indenture In case the high yield bonds are governed by New York law, the issuer will be required to enter into a bond indenture (the Indenture, also sometimes referred to as trust indenture or deed of trust ). The Indenture is the legal contract entered into among the issuer of the bonds (the Issuer ), any guarantors of the bonds (the Guarantors ) and a bond trustee (the Trustee ), as trustee for the holders of the bonds from time to time. It contains the key terms of the bonds such as the interest rate, maturity date, pledge, promises, representations, covenants, and other terms of the bonds. The terms of the Indenture will be summarised in the offering memorandum in the Description of the Notes section. In case the high yield bonds are governed by a law other than New York law, the issuer will enter into a similar contract customary for bond offerings under the relevant local law, for example, a so-called Fiscal Agency Agreement with a fiscal agent. However, the substance of the relevant contractual provisions and key commercial terms will be substantially similar. Purchase Agreement The purchase agreement (also frequently referred to as underwriting agreement or subscription agreement ) is typically entered into very late in the offering process after the Issuer and the investment banks involved in the offering (the Underwriters or Initial Purchasers ) have completed the marketing of the bonds (i.e. the road show ) and are prepared to price the offering and fix the exact principal amount, interest rate, maturity, of the bonds. In the purchase agreement the Issuer agrees to issue and sell the bonds to the Underwriters and the Underwriters, subject to certain conditions, agree to purchase the bonds from the Issuer at an agreed price at closing (typically 3-5 business days after the signing of the purchase agreement). In addition, the Issuer makes numerous representations and warranties, including with regard to its business and the completeness and accuracy of the offering memorandum, and agrees to indemnify the Underwriters for any losses as a result of a breach of the representations and warranties, most importantly any losses as a result of any material misstatements or omissions in the offering memorandum. Upon execution of the purchase agreement, the Underwriters take on the risk of distributing the bonds to investors, i.e. underwrite the offering. Should they not be able to find enough investors that agree to purchase the bonds, notwithstanding the (positive) feedback from investors during the marketing process, they will have to hold some of the bonds themselves. The Underwriters earn the fees for their services from the price difference (the underwriting spread or underwriting discount ) between the price they agree to pay the Issuer for the bonds in the purchase agreement and the public offering price at which the bonds will be (on-)sold to investors. Intercreditor Agreement The Intercreditor Agreement is entered into between the main creditors of the Issuer to govern the common terms and relationships among the creditors in respect of the Issuer s obligations. Among other things, the intercreditor agreement will contain provisions that limit the ability of creditors to vary their respective rights and address issues such as voting rights, notifications of defaults as well as the order of applying the proceeds of any debt recovery efforts, including from the sale of collateral. To the extent certain groups of creditors are subordinated to other groups of creditors, the intercreditor agreement will set forth the terms of subordination and other principles to apply as between the senior creditors and the subordinated creditors. 6 High Yield Bonds - An Issuer s Guide

10 Legal Opinions and Disclosure Letters Under the U.S. securities laws, the Underwriters can avoid potential liability to investors in the bonds for material misstatements or omissions in connection with the offering process if they can demonstrate that they have conducted a reasonable investigation into the affairs of the Issuer before selling the bonds (so-called due diligence defence ). To support this due diligence defence, the Underwriters, their lawyers and the lawyers of the Issuer in a Rule 144A offering will therefore conduct a thorough review of the affairs of the Issuer, including by reviewing certain legal documents as well as financial and business information of the Issuer and by attending due diligence meetings with the management of the Issuer and the Issuer s auditors. In addition, the lawyers of both the Underwriters and the Issuer will be required to provide certain legal opinions, for example, with regard to due organization of the Issuer, due authorization of the bonds, no violation of any laws or agreements by which the Issuer is bound and the availability of relevant exemptions under applicable securities laws. In case the bonds will be marketed to investors in the United States, both law firms will also be required to provide formal disclosure letters (also called negative assurance letters or Rule 10b-5 letters after the relevant liability provision under the U.S. securities laws) indicating that, in the course of their work on the offering and as a result of their own investigations, nothing came to their attention to cause them to believe that the offering memorandum was materially incomplete, inaccurate or misleading. Comfort Letters Comfort letters are typically provided by the Issuer s auditors at or immediately prior to pricing (i.e. signing of the purchase agreement) and are another key component of the due diligence defence of the Underwriters. In the comfort letter, which will follow a standard format prescribed by the relevant accounting body (e.g. Statement of Accounting Standards (SAS) 72 for U.S. comfort letters), the auditors of the Issuer will typically reaffirm their independence and that they stand by their audit opinion on the Issuer s audited financial statements included in the offering memorandum, describe any (review) procedures they have performed on any interim financial information included in the offering memorandum or on any internal management accounts for any stub periods between the date of the latest audited or reviewed financial statements of the Issuer and the date of the offering memorandum, describe any additional agreed upon procedures they have conducted with regard to the Issuer s financial information included in the offering memorandum and provide negative assurance as to the absence of material changes with regard to certain specified financial line items since the date of the most recent financial statements included in the offering memorandum. At closing of the offering, the auditors will provide a so-called bring-down comfort letter to re-verify, as of the closing date, that the original comfort letter is still valid. PARTIES The following is just a brief overview of the various entities within the Issuer group that may be involved in a high yield bond offering and of their respective roles within the bond structure. The Issuer For public companies, the Issuer will likely be the public company itself. For private companies, the identity of the Issuer is less clear. Depending on what the overall capital structure of the company and any existing (senior) bank debt will permit, the Issuer could either be the ultimate parent (holding) company, an intermediate holding /operating company or a lower-level operating company. See also -Subordinated Debt-Structural Subordination above. mayer brown 7

11 The Guarantors Frequently, high yield bonds will be guaranteed by most (if not all) Restricted Subsidiaries (as defined below) of the Issuer ( up-stream guarantees ) and in many transactions, the Guarantors will also provide asset security for the high yield bonds. This will give holders of the high yield bonds a direct claim against the relevant guarantor subsidiaries and therefore brings the obligations under the bonds closer to the physical assets of the Issuer group, overcoming some of the structural subordination issues described on page 3. If the Issuer is an entity other than the ultimate parent company of the group, there may also be a ( down-stream ) parent guarantee. In some jurisdictions, guarantees by foreign subsidiaries can have negative tax consequences and it is therefore necessary to consult tax specialists early in the structuring process. For example, foreign subsidiaries of U.S. issuers usually do not act as Guarantors, because under U.S. tax rules a guarantee by a foreign subsidiary of a U.S. parent company s debt is deemed a dividend, subject to certain exemptions. As a general matter, the Issuer and Underwriters should consult local law experts as to any requirements for and the validity of subsidiary-parent guarantees under applicable fraudulent conveyance, insolvency or similar laws. Restricted Subsidiaries vs. Unrestricted Subsidiaries Controlled Group Issuer For covenant compliance, inter-company transactions between entities within the Controlled Group and those outside the Controlled Group are more difficult than those solely within the Controlled Group Foreign Restricted Sub Restricted Sub Restricted Sub Unrestricted Sub Pontential legal/tax hurdles for being a Guarantor Subject to Covenants May or may not be Guarantors Not a Guarantor Income of Unrestricted Subsidiaries is not included in the calculation of financial ratios under covenants 8 High Yield Bonds - An Issuer s Guide

12 By default, all subsidiaries of the Issuer will be restricted in the sense that they are in the system, unless they are specifically designated as unrestricted. Being a Restricted Subsidiary means that: y all income produced by the relevant subsidiary will count for purposes of compliance with various covenants; y the relevant subsidiary will be limited in its ability to take actions limited by the covenants; and y the relevant subsidiary will be free to transact with other Restricted Subsidiaries. Unrestricted Subsidiaries, on the other hand, are ring-fenced in the sense that they are outside the system (i.e. outside the so-called Controlled Group 0r Restricted Group ), which means that: y income produced by the relevant subsidiaries will not count for purposes of compliance with various covenants; y the relevant subsidiary will not be subject to the covenants and thus not subject to any restrictions on their activities; and y the relevant subsidiaries will not be free to transact with Restricted Subsidiaries. Formation or designation of Unrestricted Subsidiaries may be useful, for example, if the Issuer plans a geographic or business line expansion that it plans to fund separately. It is possible to designate a subsidiary as unrestricted at a later date but the requirements for doing so are onerous. These requirements and the consequences of such designation are described on pages 22 and 23. CERTAIN SECURITIES LAW CONSIDERATIONS The securities laws of many jurisdictions, in particular the United States, impose various restrictions on publicity and the release of information generally in connection with proposed offerings of securities. Publicity for this purpose can be construed very broadly and may include any form of communication, whether in written, oral or electronic form, that (i) relates to or concerns the offering, (ii) relates to the performance, assets, liabilities, financial position, revenues, profits, losses, trading record, prospects, valuation or market position of the Issuer, (iii) might affect an investor s assessment of the financial position and prospects of the Issuer, or (iv) otherwise has the purpose, or reasonably could have the effect, of conditioning the market in a particular jurisdiction (i.e. generating or promoting interest in the offering) or influencing or encouraging an investor s interest in the Issuer or the offering or a decision to purchase the securities in question. Failure to observe these publicity restrictions may result in prospectus publication, registration or similar requirements under the securities laws of various jurisdictions and adversely affect the offering, including by way of delays related to a cooling off period that may be imposed after improper publicity under the U.S. securities laws. In addition, the release of information that is inaccurate, misleading or inconsistent with the offering memorandum to be published in connection with an offering is undesirable, may cast doubt on the accuracy of the offering memorandum and ultimately may result in liability for alleged material misstatements or omissions in the offering memorandum. It is important that all information released in connection with an offering should be verifiably accurate and consistent with the offering memorandum. To ensure compliance with all applicable securities laws and regulations, the lawyers of the Issuer typically prepare publicity guidelines at the outset of a proposed offering, which will be reviewed by mayer brown 9

13 the lawyers of the Underwriters and must be observed by all offering participants. In order to avoid the legal risks of uncontrolled communication with the public, it is often advisable to appoint one representative of the Issuer to serve as the initial point of contact with the press and securities analysts, and to serve publicity and other broad-based communications during the offering process in order to ensure compliance with the restrictions set out in the publicity guidelines. All representatives of the Issuer and other offering participants who are likely to be approached by, or come in contact with, the press or securities analysts should each be familiar with the publicity guidelines and should ensure that no publicity is undertaken or permitted except in accordance with the publicity guidelines. U.S. Securities Law Considerations Section 5 of the U.S. Securities Act of 1933, as amended (the Securities Act ), prohibits any sales or offers for sale of securities unless a registration statement (including a prospectus that meets statutory requirements) has been filed with the U.S. Securities and Exchange Commission ( SEC ) or unless an exemption from such registration is available. Most securities offerings by European issuers are conducted in reliance on one or more exemptions from the registration requirement under Section 5 of the Securities Act. In particular, substantially all high yield bond offerings in Europe are conducted as private placements to institutional investors in certain jurisdictions, including (i) in the United States exclusively to so-called qualified institutional buyers or QIBs in reliance on Rule 144A under the Securities Act ( Rule 144A ) and (ii) outside of the United States in reliance on Regulation S under the Securities Act ( Regulation S or Reg. S ). Rule 901 of Reg. S contains a general statement of the applicability of the registration requirements of the Securities Act. It clarifies that any offer, offer to sell, sale, or offer to buy that occurs within the United States is subject to the registration requirements of Section 5 of the Securities Act while any such offer or sale that occurs outside the United States is not subject to Section 5. The determination as to whether a transaction occurs outside the United States will be based on the facts and circumstances of each case. Helpfully, Reg. S also contains a number of more specific safe harbor provisions, including most notably the safe harbor provided by Rule 903 of Reg. S whereby an offer or sale of a security is deemed to occur outside the United States if (i) the offer or sale are made in offshore transactions and (ii) no directed selling efforts are made in the United States by the Issuer, the Underwriters, any other distributor, any of their respective affiliates, or any person acting on their behalf. Directed selling efforts means any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the U.S. for any of the securities being offered in reliance on Reg. S, and it is therefore necessary for the U.S. securities lawyers involved in an offering to analyze any relevant activity or communication in terms of its audience, timing and content as well as in light of both the various exceptions included the definition of directed selling efforts and the relevant SEC staff positions. The requirements that offers or sales are made in offshore transactions and not involve any directed selling efforts apply to any offering intended to fall within one of the safe harbors provided by Reg. S. However, in order to qualify for a given safe harbor, certain additional requirements (e.g. the implementation of additional offering restrictions and the imposition of a distribution compliance period ) may have to be met as well. These requirements vary depending principally on the status of the Issuer and are generally least restrictive when it is least likely that securities offered abroad will flow into the U.S. market (Category 1) and most restrictive when adequate information about the Issuer is not publicly available in the United States and existing potential U.S. market interest is 10 High Yield Bonds - An Issuer s Guide

14 sufficient (i.e. there is so-called substantial U.S. market interest or SUSMI with respect to the relevant securities) to suggest that offerings of the Issuer s securities outside the United States may not come to rest abroad (Category 3). When adequate information about the Issuer is publicly available in the United States (Category 2), the concerns about securities flowing into the U.S. market are reduced, and the restrictions fall between these two extremes. Rule 144A provides a safe harbor that permits resales of securities (including resales by the Underwriters in a securities offering) only to qualified institutional buyers in the United States. Qualified institutional buyers include various enumerated categories of sophisticated institutional investors with at least $100 million of securities of non-affiliates under management as well as SEC-registered broker-dealers owning and investing at least $10 million in securities of non-affiliates. In addition, to be eligible for the Rule 144A safe harbor, purchasers must be notified that a proposed sale is made pursuant to Rule 144A (typically by way of appropriate legends and disclaimers in the offering memorandum) and the relevant securities must (i) not be of the same class as securities listed on a U.S. exchange or quoted on a U.S. automated inter-dealer quotation system (i.e. Nasdaq), (ii) not be convertible or exchangeable into listed or quoted securities with an effective premium of less than 10%, and (iii) not be issued by an open-end investment company. Finally, holders of the relevant securities and prospective purchasers designated by the holders must have the right to obtain from the Issuer, certain reasonably current information about the Issuer. Because resales of securities pursuant to Rule 144A (like any other offers and sales of securities in the United States) are fully subject to the liability / anti-fraud provisions under the U.S. securities laws (including Rule 10b-5 under the U.S. Securities Exchange Act of 1934, as amended (the Exchange Act )), it is market practice to provide disclosure in connection with a Rule 144A offering that is substantially similar to the disclosure required for an SEC-registered offering, both in terms of quality and scope. See also Legal Opinions and Disclosure Letters on page 7. European Securities Law Considerations Across the European Economic Area (the EEA ), Directive 2003/71/EC (as amended from time to time, including by Directive 2010/73/EU, the Prospectus Directive ) has harmonized the requirements for the preparation, approval and publication of prospectuses for securities offered to the public or admitted to trading on a regulated market situated or operating within a member state of the EEA. In particular, Article 3 of the Prospectus Directive prohibits offers of securities to the public in any EEA member state that has implemented the Prospectus Directive unless a prospectus has been published in, or published elsewhere and notified to, that member state in accordance with the Prospectus Directive. Similarly, EEA member states must ensure that any admission of securities to trading on a regulated market situated or operating within their territories is subject to the publication of a prospectus. Pursuant to Article 13 of the Prospectus Directive, no prospectus must be published until it has been approved by the competent authority of the home member state of the Issuer. If the debt securities proposed to be issued have a minimum denomination of at least 1,000, the Issuer can choose to have its prospectus approved by the competent authority either (i) where it has its registered office (if an EU entity), (ii) where it is making the offer to the public, or (iii) where it is making an application for admission to trading on a regulated market. The competent authorities for purposes of the Prospectus Directive include the UK Listing Authority (UKLA) / Financial Conduct Authority (FCA) in the United Kingdom, the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg, the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) in Germany and the Central Bank of Ireland (CBI) in Ireland, to name just a few. mayer brown 11

15 Provided the relevant securities will not be admitted to trading on a regulated market within the EEA, an offer of securities to the public is exempt from the requirement to publish a prospectus in accordance with the requirements of the Prospectus Directive if (i) it is an offer to qualified investors only, (ii) the offer is made to fewer than 150 persons (other than qualified investors) per EEA member state, (iii) the minimum consideration paid by any person is at least 100,000, (iv) the securities are denominated in amounts of at least 100,000 (so-called whole-sale debt exemption ), (v) the total consideration is not more than 100,000, or (vi) the total consideration for securities offered in the EEA is less than 5 million. Substantially all high yield bonds in Europe are offered in minimum denominations of 100,000 and are listed on unregulated markets (i.e. exchange-regulated markets ) only, in particular either on the Euro MTF Market of the Luxembourg Stock Exchange and, to a lesser extent, the Global Exchange Market of the Irish Stock Exchange. This saves the time and effort involved in getting the offering memorandum approved as a prospectus by the competent authority in the relevant EEA member state in accordance with the requirements of the Prospectus Directive, a process which can easily take a month or more from submission of the first draft document, depending on the relevant member state s competent authority. Instead, the offering memorandum will only have to be reviewed by the relevant stock exchange for compliance with the relevant stock exchange listing requirements, which typically takes less time and generates fewer comments. 12 High Yield Bonds - An Issuer s Guide

16 THE HIGH YIELD COVENANT PACKAGE This section provides a high-level overview of some of the general principles and key covenants that Issuers will have to understand when negotiating and agreeing a traditional high yield covenant package. However, it is critical that the management of the Issuer carefully reviews (and understands) the full contractual terms of any high yield bonds as set forth in the Description of the Notes in the offering memorandum for the bonds and in the Indenture. GENERAL OBSERVATIONS What are the overall objective and process of negotiating a high yield covenant package? The overall objective in negotiating a high yield covenant package is to ensure adequate protections for the future holders of the bonds (i.e. there is little point in negotiating a highly issuer friendly package that may be perceived as off market and therefore may potentially not be acceptable to investors or only in return for a higher coupon) while preserving the necessary operating and financial flexibility to allow the Issuer to execute its business plan. To be able to do so, it is critical for all parties involved in the drafting process to analyse and be fully familiar with the Issuer s existing organization and capital structure and with the Issuer s business plan. In particular, it will often save significant time and energy during the negotiation process if the parties take sufficient time at the outset of a transaction to consider and explore all reasonably foreseeable transactions and activities that the Issuer may engage in while the bonds will be outstanding and that might be restricted under the covenants, including (i) future acquisitions, joint ventures or other investments, (ii) future financing plans (e.g. equipment financing, sale leaseback transactions, receivable financings or other secured debt transactions), (iii) debt or debt-like arrangements incurred in the ordinary course of business, (iv) plans for potential geographic expansion and/or new lines of business, (v) the need for letters of credit or other credit enhancements, (vi) expected intra-group funds flows and (vii) potential related party transactions. As a practical matter, counsel for the Underwriters typically prepares the first draft of the Description of the Notes for the offering memorandum, which will closely track (typically largely verbatim) the relevant contractual provisions that will later be included in the Indenture. Although Issuer s counsel will then take a leading role in marking up this initial draft, it is essential that senior management of the Issuer and its financing and accounting staff are closely involved in this process as outside counsel cannot be expected to anticipate all flexibility the Issuer may need during the term of the bonds. How are high yield covenants different from those contained in a typical credit facility? Other than a typical credit facility, the Indenture will not include any so-called maintenance covenants which may require the Controlled Group, for example, to maintain certain ratios or to prevent certain conditions from coming in to existence. Instead, high yield covenants impose restrictions on certain types of activities and, in particular, the transfer of value out of the Controlled Group. These negative covenants or incurrence covenants typically will be triggered upon the taking of specified types of actions by the Issuer or its Restricted Subsidiaries and are basically promises by the Issuer and its Restricted Subsidiaries to refrain from certain acts that could hurt the Issuer s ability to meet its obligations under the bonds. In particular, high yield covenants are mayer brown 13

17 designed to (i) prevent the Controlled Group from becoming over-leveraged by either borrowing too much or decreasing its assets without concurrently decreasing its debt, (ii) protect the position of the bond holders in the Controlled Group s capital structure by limiting the ability of the Issuer and its Restricted Subsidiaries to effectively subordinate the bonds through structural or lien subordination, and (iii) preserve the assets of the Controlled Group and the Issuer s access to those assets. The covenants therefore limit the ability of the Issuer and its Restricted Subsidiaries to, among other things: y incur additional debt; y pay dividends, invest outside the Controlled Group or make certain other Restricted Payments that would result in value leakage out of the Controlled Group; y grant security interests on their assets (securing indebtedness other than the bonds); y make sales of assets and subsidiary stock; y enter into affiliate transactions; y issue guarantees of debt of other members of the Controlled Group; y engage in mergers or consolidations or sell substantially all the Issuer s or a Guarantor s assets; y enter into transactions that would fundamentally alter the ownership structure of the Controlled Group; and y agree to restrictions on distributions and transfers of assets within the Controlled Group. Issuers that are finance subsidiaries will further be limited to acting in just that capacity. How do baskets work? The ability of entities within the Controlled Group to engage in the types of transactions that are restricted by a particular covenant will often depend on the capacity available under so-called baskets. For example, as a series of exemptions from the general limitation on incurring additional Indebtedness, the Limitation on Indebtedness covenant may include several specified baskets denominated in the currency of the bonds, including possibly a basket for local currency debt issued by foreign subsidiaries (for working capital purposes) and, most importantly, a basket for Indebtedness issued under the company s senior credit facilities. Certain baskets may grow and get depleted over time (e.g. based on accumulated consolidated net income of the Issuer and restricted payments made, respectively, since the date of issuance of the bonds) and/or be refillable, while other baskets may be one-time only. The Issuer would naturally prefer to be able to refill baskets, for example, as Indebtedness incurred under a particular basket is repaid, and refillable baskets have become more common. While many baskets are traditionally expressed as specified fixed amounts in the currency of the bonds, many transactions increasingly use soft caps that are expressed as the greater of a fixed amount and a percentage of, for example, total assets. These soft caps reward Issuers for strong financial performance and provide them with flexibility for growth over the lifetime of the bonds. In addition to specific baskets for specific categories of transactions, covenants may also contain a so-called general or hell or 14 High Yield Bonds - An Issuer s Guide

18 high water basket, which may, for example, permit a limited amount of Indebtedness to be incurred for any reason or no reason at all. Issuers should guard this basket particularly carefully, as hell or high water events tend to occur far more frequently during the lifetime of the bonds than the parties normally expect at the outset. As a general matter, it will always be more advantageous to the Issuer to rely on a general (i.e. non-basket ) exemption to a covenant for a particular transaction or a basket designed for a specific category of transactions, rather than on a general basket. How long will the restrictions under the covenants apply? Generally, the covenants will apply for as long as the bonds are outstanding. Other than with relatively common and uncomplicated waivers or amendments under a traditional senior credit facility, waivers or amendments of the terms of a bond typically require the Issuer to solicit consents from a (qualified) majority or possibly all bond holders, which can be costly and time-consuming. It is therefore particularly important to get everything right at the outset. For some Issuers on the cusp of investment grade, it is sometimes possible to negotiate fall away covenants whereby most of the high-yield covenants will automatically fall away (i.e. actually only be suspended), if (and for as long as) the long-term debt of the Issuer receives an investment grade rating from both Moody s and Standard & Poor s (or 2 out of 3 rating agencies). In that case, only the basic (i.e. less restrictive) investment grade covenants would remain, such as the covenants with regard to liens, sales and leaseback transactions, mergers, change-of-control events and reporting. What law should govern the bonds? High yield bonds originally developed in the United States and most traditional high yield bonds (including high yield bonds issued by Issuers in Europe and Asia) continue to be governed by New York law, although there have been a growing number of local law governed high yield bonds in certain jurisdictions (e.g. Germany). Which law should govern the bonds should be discussed at the outset of a transaction between the Issuer, the Underwriters and their counsels and may depend on a variety of factors, including marketability considerations and the target investor audience for the particular offering (i.e. depending on the particular Issuer and current state of the market, U.S. investors may be a key target group and there may well be a bias in favour of New York law). Due to the long history of high yield bonds and well established case law in New York, New York law also offers the additional advantage over certain other local laws that it is tried and tested and may therefore offer greater legal certainty to both the Issuer and investors, in particular in case of necessary future restructurings. On the other hand, many non-u.s. issuers may be reluctant to agree to the jurisdiction of the New York courts to decide any future disputes with holders of their bonds and may generally be more familiar and comfortable with their own, local law. Irrespective of which law governs the bonds, the substance and wording of the covenants in a typical high yield bond as described below will be substantially similar, and it is therefore frequently possible to switch (i.e. change the governing law) without too much extra work shortly before the Launch of an offering in response to shifting market conditions. mayer brown 15

19 LIMITATION ON INDEBTEDNESS What does this covenant restrict? The Limitation on Indebtedness covenant limits the ability of the Issuer and its Restricted Subsidiaries to incur additional Indebtedness and is intended to prevent the Issuer from getting over-leveraged, which could negatively affect the capacity of the Issuer to service all its outstanding debt (including the bonds) and, as a result, the market value of the bonds. Indebtedness for the purpose of the covenant is typically defined broadly and generally includes all borrowed money as well as other obligations similar to claims against the issuer for borrowed money or related to different financing methods, such as capital leases, sale and lease back transactions, obligations to pay deferred purchase prices for property and other obligations to pay money. It typically does not include ordinary course trade payables or other debt routinely incurred and repaid in the ordinary course. See also The Permitted Debt Exemption on page 17. Were the Controlled Group to become more highly leveraged, this covenant would generally prevent it from incurring additional Indebtedness until its financial condition improves. The Coverage Ratio Exemption Whether or not the Issuer and its Restricted Subsidiaries are permitted to incur additional Indebtedness under the Limitation on Indebtedness covenant is typically determined by reference to the so-called Coverage Ratio or Fixed Charges Coverage Ratio, i.e. the Issuer and its Restricted Subsidiaries will only be permitted to incur additional Indebtedness (so-called Ratio Debt ) so long as the Coverage Ratio is at least equal to an agreed ratio on a pro forma basis after giving effect to the incurrence of the proposed additional Indebtedness. The Coverage Ratio is negotiated between the Issuer and the Underwriters and will therefore vary for different Issuers. In the Western European market, however, a Coverage Ratio of around 2.00 to 1.00 is common. In some transactions, Issuers may be able to negotiate a Coverage Ratio that steps up over time, but the Coverage Ratio Exemption is typically not available at the time of issuance of the bonds. The Coverage Ratio serves as an indication of the capacity of the Controlled Group to generate sufficient amounts of cash to service their fixed obligations, such as regular interest expenses under outstanding Indebtedness, and it is calculated for any given point in time by dividing: y Consolidated EBITDA (earnings before interest, taxes, depreciation, amortization and certain non-cash charges) of the Controlled Group for the preceding four fiscal quarters by y the sum of the fixed charges of the Controlled Group (i.e. Consolidated Interest Expenses and certain other interest-equivalent items) for the same period. Consolidated EBITDA, Consolidated Interest Expense and Coverage Ratio will typically contain a number of detailed, negotiated adjustments or add-backs to the related standard accounting measures under the generally accepted accounting principles (GAAP) applied by the Issuer in preparing its financial statements (i.e. IFRS, US GAAP, HGB,.). These adjustments / add-backs may include, for example, adjustments for certain extraordinary items and non-cash items; pro forma adjustments related to permitted investments, acquisitions or divestments and adjustments for related expenses; as well as add-backs for certain financing expenses. It is therefore critical for the Issuer, its accountants and its legal advisers to carefully review all relevant definitions. 16 High Yield Bonds - An Issuer s Guide

20 The Permitted Debt Exemption In addition, the Limitation on Indebtedness covenant will also specify numerous categories of Permitted Debt that will be permitted to be incurred by the members of the Controlled Group regardless of their financial performance or condition and without their having to meet the Coverage Ratio test. The specific categories of Indebtedness covered by this exemption will be negotiated between the Issuer and the Underwriters and set forth in the text of the Limitation on Indebtedness covenant. These exemptions will typically include various categories of technical indebtedness, i.e. items that are technically Indebtedness, but should not be prohibited such as undrawn letters of credit, qualified securitizations or hedging obligations. These items may either be designated as Permitted Debt or carved-out of the definition of Indebtedness altogether. In addition, the covenant will include a number of specific baskets subject to caps, for example, for debt issued under senior credit facilities or for local currency debt issued by foreign subsidiaries for working capital purposes. Which exemption applies? To the extent the incurrence of a specific item of Indebtedness satisfies more than one exemption or basket, the Issuer has the right under the Limitation on Indebtedness covenant to designate the specific exemption or basket under which the relevant item of Indebtedness is being incurred. Because Indebtedness incurred in reliance on a basket will count against the Issuer in calculating future compliance with the Coverage Ratio and also use up capacity under the relevant basket, an Issuer will typically want to designate as much additional debt as possible as having been incurred pursuant to the Coverage Ratio Exemption, as opposed to pursuant to a specified basket amount. In the event an item of Indebtedness meets the criteria for either Ratio Debt and/or more than one of the types of Permitted Debt, the Issuer, in its sole discretion, will be permitted to classify and may from time to time reclassify any item of Indebtedness other than Indebtedness incurred under the Permitted Indebtedness basket that exempts Indebtedness incurred under the senor credit facilities. In particular, if the financial performance of the Issuer improves (resulting in increased debt incurrence capacity under the Coverage Ratio exemption), the Issuer will typically (but not always) be permitted to reclassify debt initially incurred under one or more Permitted Debt baskets as Ratio Debt, thereby freeing up capacity under the relevant Permitted Debt baskets, which will continue to be available even if the financial performance of the Issuer subsequently deteriorates again. Other potential limitations on Indebtedness? In evaluating whether the Limitation on Indebtedness covenant provides sufficient flexibility for the Issuer, the Issuer and its advisers should also consider the Limitation on Liens covenant to the extent the Issuer may need the ability to incur Indebtedness that is secured by liens on any assets of the Issuer or its Restricted Subsidiaries. In capital intensive industries, in particular, companies may rely heavily on certain secured finanincing arrangements with customers or suppliers in the ordinary course of business. The Limitation on Restrictions on Dividends and Other Payments from Restricted Subsidiaries covenant may also be relevant, because lenders may require contractual restrictions on dividends, asset transfers and other payments by the borrowing entity within the Controlled Group. mayer brown 17

21 LIMITATIONS ON RESTRICTED PAYMENTS What does this covenant restrict? The Limitation on Restricted Payments covenant is designed to prevent leakage of funds from the Controlled Group by limiting the ability of the Issuer and its Restricted Subsidiaries to transfer cash or other assets to persons or entities outside of the Controlled Group. Specifically, the covenant restricts the ability of the Issuer and its Restricted Subsidiaries to make certain Restricted Payments, which include: y the payment of cash dividends or certain other distributions to shareholders (other than to another member of the Controlled Group and to minority shareholders of Restricted Subsidiaries on a pro rata basis); y repurchases, redemptions or (pre-)payments, as applicable, of equity interests or Indebtedness that is subordinate in right of payment to the bonds; y Investments in any third parties (i.e. entities that are not majority controlled, including 50/50 joint ventures); and y loans to or credit support for any third parties. The term Investment is defined very broadly and consists generally of: y purchases of equity or debt securities of another entity; y capital contributions to any entity; and y loans to or guarantees or other credit support for the benefit of any entity. Investments are generally treated as Restricted Payments because they typically involve assets of the Issuer or its Restricted Subsidiaries being transferred to a third party outside the Controlled Group and therefore not subject to the restrictions under the Indenture. The covenant does not restrict acquisitions of companies that become Restricted Subsidiaries, capital expenditures and most intra-group loans and guarantees as all of these transactions represent investments in the system / within the Controlled Group. The Net Income Basket Exemption Under the Limitation on Restricted Payments covenant, members of the Controlled Group are typically prevented from making any Restricted Payments unless: y the Issuer would have been able to incur at least 1.00 of additional Indebtedness under the Coverage Ratio on a pro forma basis after giving effect to the Restricted Payment (the 1.00 of Additional Indebtedness Test ); y the Issuer is not in default under the Indenture; and y the aggregate amount of Restricted Payments does not exceed the sum of the following: 50% of consolidated net income (or in the case of a loss, minus 100% of the loss) from the first day of the first fiscal quarter commencing either immediately prior to or after the issue date of the bonds and the most recent fiscal quarter ending prior to the date of the Restricted Payment for which consolidated financal statements for the Issuer are available; 100% of the aggregate net cash proceeds and fair market value of marketable securities from sales of the Issuer s stock and certain other types of capital contributions received since the issue date of the bonds; 18 High Yield Bonds - An Issuer s Guide

22 100% of the value of certain Restricted Payments that are reversed (e.g. sale of a Restricted Investment or Investments in entities that subsequently become Restricted Subsidiaries); 100% of distributions received from Unrestricted Subsidiaries; and the amount by which Indebtedness has been reduced on the Issuer s balance sheet as a result of the conversion or exchange of such Indebtedness into equity of the Issuer after the issue date of the bonds (collectively, the Net Income Basket or Builder Basket ). Permitted Restricted Payments and Permitted Investments Certain Restricted Payments can be made without regard to the Net Income Basket and the specific categories of such Permitted Restricted Payments or Permitted Investments (including in some cases specific baskets) will be negotiated between the Issuer and the Underwriters and set forth in the text of the Limitation on Restricted Payments covenant and the related definitions. In this context, the parties must take special care in drafting the relevant exemptions to permit the creation of, or investment in, joint ventures that are not controlled by the Issuer. LIMITATION ON DIVIDENDS AND OTHER PAYMENT RESTRICTIONS FROM RESTRICTED SUBSIDIARIES What does this covenant prohibit? This covenant is designed to ensure that the Issuer has adequate access to the assets and cash flows of its Restricted Subsidiaries, i.e. that any cash generated by the Restricted Subsidiaries can flow freely up to the Issuer to enable the Issuer to meet its obligations under the bonds. The covenant therefore prohibits the Issuer and its Restricted Subsidiaries from creating contractual obligations (so-called Dividend Blockers or Dividend Stoppers ) that limit the ability of the Restricted Subsidiaries to declare and pay dividends, make loans or transfer property or assets to the Issuer or any other Restricted Subsidiaries. This can create problems in the case of joint ventures entered into by the Issuer or its Restricted Subsidiaries because the partner in a joint venture will typically have a say in the payment of dividends (i.e. may be able to veto a dividend payment). One possible solution may be the formation of a joint venture that is less than 50% owned by the Issuer. In this case, the joint venture would be a non-subsidiary that is not subject to the covenants under the Indenture. However, any Investment in the joint venture would then be a Restricted Payment that would have to meet the conditions under the Limitations on Restricted Payments covenant. What are common exemptions to the covenant? The covenant will include a number of common exemptions from the general prohibition, including for Dividend Blockers or other payment restrictions that arise under or are imposed by: y existing Indebtedness; y restrictions already in place when a subsidiary is acquired; y applicable law; y customary lease provisions; or y refinancings of existing Indebtedness if the limitations are not more restrictive than those being refinanced. mayer brown 19

23 What other covenants might be relevant? The covenant should be reviewed in conjunction with the Limitation on Indebtedness covenant since Indebtedness that otherwise may be incurred may be limited by this covenant if the terms of the additional Indebtedness contain any provisions that restrict the movement of cash or assets around the Controlled Group. LIMITATION ON LIENS What does this covenant restrict? The Limitation on Liens covenant is designed to ensure that in a potential bankruptcy, insolvency or restructuring scenario, other creditors of the Controlled Group do not have any prior claims over the assets of the members of the Controlled Group compared to the bondholders. To achieve this goal, the members of the Controlled Group provide a negative pledge that limits their ability to grant liens (other than Permitted Liens ) on assets that do not constitute collateral for the bonds, unless they grant equal and ratable liens to holders of the bonds. It will also generally not allow the creation of a lien on any asset that does constitute collateral for the bonds other than specific Permitted Collateral Liens defined in the Indenture. The covenant will be almost identical to the relevant covenant contained in a typical senior credit facility and it is important to match up the definition of Permitted Liens with same definition in the Issuer s senior credit facility. There should not be any liens permitted by the Issuer s senior credit facility that would not be permitted under terms of bonds, although the terms of the bonds may permit additional liens. Permitted Liens typically include: y liens securing Indebtedness under credit facilities (generally tied to the amount permitted under the clause for bank debt under the definition of Permitted Indebtedness); y purchase money liens; y liens on acquired property; y liens on refinanced secured indebtedness; y existing liens; and y liens necessary to operate the Controlled Group s business. What other covenants might be relevant? As discussed on page 17 above, it is important to evaluate the Limitation on Liens covenant together with the Limitation on Indebtedness covenant. LIMITATION ON SALES OF ASSETS AND SUBSIDIARY STOCK What does this covenant restrict? The Limitation on Sales of Assets and Subsidiary Stock covenant describes the permitted use of proceeds from Asset Sales by the Issuer and its Restricted Subsidiaries. Asset Sales are a potential cause for concern for holders of the bonds because they may result in potentially income producing assets leaving the Controlled Group. The covenant therefore requires the Issuer and its Restricted Subsidiaries to either reinvest the proceeds of significant Asset Sales in their current businesses (i.e. by 20 High Yield Bonds - An Issuer s Guide

24 purchasing Replacement Assets or Additional Assets, typically defined as other long-term assets used in their businesses) or to use those proceeds to permanently repay Indebtedness. Assets Sales is typically defined broadly and will generally include traditional asset disposals as well as any direct and indirect sales of interests in the Restricted Subsidiaries, including any issue of new shares of a Restricted Subsidiary or any disposition by means of a merger, consolidation or similar transaction. At the same time, the definition will list numerous categories of asset disposals that do not need to satisfy the Asset Sale Test, including various ordinary course transactions and a carve-out for transactions below a specified minimum fair market value. For any transactions that are covered by the definition of Asset Sale, the covenant typically requires (the following conditions together, the Asset Sale Test ) that: y the Issuer or its Restricted Subsidiaries receive consideration equal to the fair market value of the assets sold; y at least a specified percentage (e.g. 75%) of the consideration received is in the form of cash and cash equivalents or a combination thereof (i.e. no asset swaps); and y the net available cash proceeds from the Asset Sale are applied by the Issuer or relevant Restricted Subsidiary within a specified period of time (e.g. 365 days) either: to repay, prepay or repurchase certain types of qualifying Indebtedness; or to purchase Replacement Assets or Additional Assets. To the extent the net available cash proceeds from an Asset Sale are not applied in accordance with the Asset Sale Test and exceed a specified minimum threshold amount (i.e. a basket negotiated by the Issuer), the Issuer must use those excess proceeds to make an offer to repurchase (a portion of ) the bonds at their face value plus accrued interest and other pari passu Indebtedness with similar provisions. Cash, of course, is fungible, and as long as a company undertakes (budgeted) capital expenditures on property, plant and equipment within the relevant timeframe following an Asset Sale and in amounts at least equal to the related sales proceeds, compliance with the covenant should not normally be too difficult and not require any offer to repurchase bonds. LIMITATION ON AFFILIATE TRANSACTIONS The Limitation on Affiliate Transactions covenant prohibits transactions between the Issuer and its Restricted Subsidiaries on the one hand and affiliated parties outside the Controlled Group on the other hand, unless they meet the following conditions: y the affiliate transaction must be on an arm s length basis, i.e. on terms no less favorable to the Issuer or the relevant Restricted Subsidiary than those that could have been obtained from a third party; y if the value of the transaction exceeds a specified threshold amount, the transaction must be approved by a majority of the disinterested directors on the Issuer s board; and y if the value of the transaction exceeds a higher specified threshold amount, the Issuer must also obtain a written fairness opinion from an independent recognised expert. By its terms, the Limitation on Affiliate Transactions covenant will expressly not apply to various categories of ordinary course transactions and transactions permitted by the Limitation on Restricted Payments covenant. mayer brown 21

25 LIMITATION ON DESIGNATION OF RESTRICTED OR UNRESTRICTED SUBSIDIARIES What is the purpose of this covenant? This covenant is intended to ensure that the various other covenants are not thwarted through the designation and re-designation of Restricted and Unrestricted Subsidiaries. It will typically be a stand-alone covenant, but sometimes the following concepts are integrated in the definitions of Unrestricted Subsidiary, Incurrence or Investment and/or within the Limitations on Restricted Payments covenant. What are the consequences of re-designating a subsidiary as restricted or unrestricted? As a general rule, the Issuer may designate and re-designate its subsidiaries as either restricted or unrestricted at any time. However, because the covenants generally will not apply to Unrestricted Subsidiaries, bondholders will view the designation by the Issuer of subsidiaries as restricted or unrestricted as a way to potentially circumvent the restrictions on investments, on incurring indebtedness or on making acquisitions and dispositions that would otherwise apply. By designating a subsidiary as unrestricted, the Issuer will therefore be deemed to have made an Investment (in an amount equal to the fair market value of the Issuer s or its Restricted Subsidiary s interest in the subsidiary at the time of the designation) in that subsidiary. The Issuer must therefore typically be able to satisfy the following conditions to be able to re-designate a Restricted Subsidiary as an Unrestricted Subsidiary: y it must comply with the Limitation on Restricted Payments covenant (i.e. the fair market value of the Issuer s (deemed) Investment in the relevant subsidiary at the time of re-designation must be permitted under that covenant); y it must comply with the Limitation on Indebtedness covenant (i.e. any guarantee by the Issuer or the remaining Restricted Subsidiaries of any Indebtedness of the Unrestricted Subsidiary will be deemed to be an incurrence of additional Indebtedness); y the relevant subsidiary cannot hold capital stock or Indebtedness of, or hold any liens on the assets of, or have any Investment in, the Issuer and its remaining Restricted Subsidiaries; y it must comply with the Limitation on Affiliate Transactions covenant (i.e. any agreement, transaction or arrangement between the newly Unrestricted Subsidiary and the Issuer and its remaining Restricted Subsidiaries must comply with that covenant; y the Issuer and its remaining Restricted Subsidiaries must not have any obligation to (i) subscribe for additional equity of the newly Unrestricted Subsidiary or (ii) maintain or preserve the financial condition of the newly Unrestricted Subsidiary; and y no default or event of default under the Indenture would exist following the re-designation. In addition, the net income and cash flow of Unrestricted Subsidiaries are normally excluded from the relevant calculations in determining any capacity by the Issuer and its Restricted Subsidiaries, for example, to pay dividends, make Investments or incur additional debt under the various ratio tests. Conversely, the following conditions must be satisfied for the re-designation of an Unrestricted Subsidiary as a Restricted Subsidiary: y any Indebtedness of the newly Restricted Subsidiary must be able to be incurred under Limitation on Indebtedness covenant (i.e. because any such Indebtedness would be deemed to have been incurred by the Controlled Group at the time of re-designation); 22 High Yield Bonds - An Issuer s Guide

26 y any Investment by the newly Restricted Subsidiary must be able to be made in accordance with Limitations on Restricted Payments covenant; y any liens on assets of the newly Restricted Subsidiary must be in compliance with the Limitation on Liens covenant; and y no default or event of default under the Indenture would exist following the re-designation. LIMITATION ON ISSUANCES OF GUARANTEES OF INDEBTEDNESS The Limitation on Issuances of Guarantees covenant is intended to prevent the Issuer from structurally subordinating the bonds to other Indebtedness by putting bondholders in the same position as if potential guarantees by non-guarantor subsidiaries had not been made. Bondholders would be effectively subordinated if a Restricted Subsidiary were to guarantee other Indebtedness of the Issuer or a Restricted Subsidiary without guaranteeing the bonds on an equal basis, because in a potential default/insolvency scenerio, proceeds from the sale of assets of that subsidiary would be applied first to satisfy its creditors and the debt guaranteed by it before they would be available to satisfy obligations under the bonds. The covenant therefore provides that no Restricted Subsidiary that is not a Guarantor of the bonds may guarantee any other Indebtedness unless it also guarantees the bonds on at least a pari passu basis with any such other Indebtedness. LIMITATION ON MERGER, CONSOLIDATION AND SALE OF SUBSTANTIALLY ALL ASSETS The goal of this covenant is to prevent a business combination in which the surviving entity is not financially healthy, as measured by the Coverage Ratio test and (sometimes) a consolidated net worth test, or otherwise does not have the same basic characteristics of the Issuer. The covenant prohibits the Issuer from merging with or consolidating into another entity, or transferring all or substantially all its assets and the assets of its Restricted Subsidiaries, as a whole, to another entity, unless the following general conditions are satisfied: y either the Issuer is the surviving entity or the surviving entity is an entity organized under the laws of a specified jurisdiction (e.g. the laws of the Issuer s jurisdiction of organization or the laws of a European Union member state or the United States); y the surviving entity, if other than the Issuer, assumes all of the Issuer s obligations under the Indenture; y the Issuer or the surviving entity would be able to satisfy the 1.00 of Additional Indebtedness Test; and y no default or event of default under the Indenture exists either before or as a result of the transaction. Sometimes, this covenant contains an additional condition that the consolidated net worth of Issuer or the surviving entity must be at least equal to the consolidated net worth of the Issuer prior to the relevant transaction. Because certain transactions restricted by this covenant may also constitute a Change of Control, that would potentially give bondholders the option to put their bonds back to the Issuer, this covenant must be reviewed and negotiated together with the Change of Control covenant. mayer brown 23

27 CHANGE OF CONTROL The Change of Control covenant protects bond holders from fundamental changes in the ownership structure of the Issuer. Investors have traditionally insisted on a change of control put option, because the identity (and track record) of the ultimate owners / sponsors of an Issuer can be a significant factor in their overall investment decision. This can be particularly true for portfolio companies of private equity sponsors that are repeat players in the high yield markets. Upon the occurrence of any of a series of specified Change of Control Events, the Issuer is therefore typically required to make an offer (a Change of Control Offer ) to repurchase the bonds at a specific percentage (typically 101%) of their principal amount. The specific Change of Control Events can be heavily negotiated between the Issuer and the Underwriters (especially where an IPO or partial sale of the Issuer within the term of the bonds are viewed as a realistic scenario), but will ordinarily include: y the acquisition by a person or group of persons (other than Permitted Holders ) of more than a specified percentage (< 50%) of the Issuer s voting capital; y a change in the majority of the board of directors of the Issuer, unless approved by the outgoing directors; and y certain dispositions of all or substantially all of the assets of the Issuer and its Restricted Subsidiaries. At the same time when private equity ownership, for example, can be a key factor in the investment decision of a bond investor, portability of a bond is typically significantly more important for private equity sponsors (who are in the business of buying and selling companies), than for other / corporate-owned issuers. As a result, there has been a growing trend in European high-yield issuances by private equity-owned companies in recent years to include additional conditions for when a Change of Control Event triggers the requirement to make a Change of Control Offer, thereby providing private equity sponsors greater flexibility to exit their investments. For example, these additional conditions may include the requirement for a change in ownership to result in a ratings downgrade or withdrawal or, more frequently, the failure of the Issuer to meet a specified leverage test, both immediately before the event and immediately thereafter and giving pro forma effect thereto. In practice, the relevant provisions often take the form of specifically negotiated Specified Change of Control Events that are deemed not to constitute a Change of Control Event. Although these so-called portability features have become more common in European high yield issuances for private equity-owned companies, they are still considered very sponsor-friendly, and they are not generally a feature of high yield bonds issued by corporate-owned issuers. 24 High Yield Bonds - An Issuer s Guide

28 REPORTING The purpose of this covenant is to ensure the continuous availability of current information on the financial performance of the Issuer. Although it may seem like a boiler-plate provision, potential investors in the bonds can be very sensitive about the content of this covenant and generally require the Issuer to provide full public disclosure for as long as the bonds are outstanding. This is because the public availability of current information on the financial performance of the Issuer is not only critical for the development of a liquid market in the bonds, but is also necessary to protect bondholders that may wish to sell their bonds from potential liability for market abuse (i.e. insider trading). In addition, the availability of current financial information about the Issuer is also necessary to permit U.S. investors in the bonds to on-sell their bonds within the United States in reliance on Rule 144A. See Introduction Certain Securities Law Considerations U.S. Securities Law Considerations on pages 10 and 11. mayer brown 25

29 INDICATIVE TRANSACTION TIMETABLE Under ideal circumstances and with the full commitment of all parties involved in the offering, the preparations for a high yield bond offering for a first-time issuer can be completed within about 8 weeks from the initial kick-off meeting to launch of the offering, although the actual preparation time will always depend on a variety of factors that are specific to the individual Issuer and each offering. Key factors that can (very significantly) extend the preparation time required for a particular offering include (i) the lack of existing, high-quality, English language disclosure language for the Issuer that can be recycled when preparing the offering circular, (ii) the time required by the Issuer s internal accounting team and external auditors to prepare required financial information, (iii) potential general resource constraints / availability of dedicated staff at the Issuer for the offering, (iv) complications and delays in any necessary negotiations with existing creditors of the Issuer, (v) potential complexities involved in releasing existing security interests (in favor of creditors that are being repaid) and in creating new security interests (in favor of the bondholders), potentially in multiple jurisdictions, (vi) potential delays and complications in the ratings process, as well as (vii) general market conditions. Time Tasks Week 1 Issuer s counsel to prepare initial outline of offering memorandum and discuss with Issuer Issuer, Underwriters and Issuer s counsel to agree structure Issuer and Issuer s counsel to have covenant discussion, make proposal to the Underwriters regarding any key concerns Issuer to prepare data room based on due diligence request list provided by Issuer s counsel and Underwriters counsel Underwriters circulate management due diligence questionnaire Publicity guidelines circulated by Issuer s counsel Research guidelines circulated by Underwriters counsel Week 2 Management presentation to working group Issuer, Underwriters and their counsel to agree approach with regard to existing lenders and security trustee Working group to provide high level feedback on draft offering memorandum Issuer and Issuer s counsel to work together on updating draft offering memorandum Issuer s counsel and Underwriters counsel commence documentary due diligence Underwriters and counsel draft description of notes/terms and conditions and bond documentation 26 High Yield Bonds - An Issuer s Guide

30 Time Tasks Week 3 Stock exchange for listing bonds selected Trustee and Trustee s counsel selected Draft of offering memorandum recirculated by Issuer s counsel Draft description of notes circulated by Underwriters counsel Draft documentation for Trustee accession arrangements to existing security (if applicable) Review of draft offering memorandum by Underwriters and counsel and preparation by them of consolidated mark up Issuer and Issuer s counsel to discuss description of notes Drafting session on offering memorandum Draft accountants engagement and comfort letters circulated Draft purchase (underwriting) agreement circulated by Underwriters and counsel Issuer and Underwriters work on ratings agency presentation Further discussions with regard to security trustee and lender consents and approach to existing lenders if required Week 4 Draft offering memorandum recirculated to working group Mark up of description of notes circulated by Issuer s counsel Review of draft offering memorandum by Underwriters and counsel and preparation by them of consolidated mark up Underwriters, Issuer and counsel to discuss description of notes Drafting session on draft offering memorandum Issuer and Issuer s counsel to discuss and comment on purchase agreement, distribute mark up to Underwriters and Underwriters counsel Issuer and Underwriters work on ratings agency presentation Week 5 Drafting sessions on offering memorandum as necessary Discussions on description of notes (including with Trustee and its counsel), Trustee note accession arrangements Discussions on purchase agreement as necessary Issuer and underwriters work on ratings agency presentation Work on road show presentation Week 6 Draft offering memorandum submitted to stock exchange and send draft offering memorandum to printers (if sufficiently advanced) Drafting sessions on offering memorandum as necessary Discussions on purchase agreement as necessary Meetings with rating agencies Work on road show presentation Week 7 Receive stock exchange comments and incorporate into offering memorandum and resubmit offering memorandum to exchange Finalise description of notes Discussions on purchase agreement as necessary mayer brown 27

31 Time Tasks Week 8 Board meeting to approve issue of preliminary offering memorandum, appoint committee to approve pricing, approve contractual documentation when finalised Finalise preliminary offering memorandum, including with stock exchange Finalise purchase agreement Finalise road show presentation Security trustee and any lender consents obtained Receive preliminary feedback from ratings agencies Print preliminary offering memorandum Announce and launch offering Following the Launch of the offering (i.e. the formal, external announcement of the proposed offering), the Issuer and the Underwriters will go on an investor roadshow (typically for between a few days and two weeks), while other members of the working group finalise the listing, bond rating and contractual documentation (including Indenture, guarantees and security documents). Since most of the key European high yield investors are based in London, Paris or Frankfurt, most European high yield roadshows will include visits to those three cities. Other common roadshow stops include Amsterdam and Edinburgh, and further stops may be included based on the nationality or particular industry of the Issuer, the market environment or other factors. Following completion of the roadshow, a final bring-down due diligence call with management of the Issuer and delivery of a comfort letter from the Issuer s auditors, the Issuer and the Underwriters will meet for the Pricing of the bond offering, i.e. agree on the exact terms of the offering (e.g. size, coupon and maturities). Following the Pricing meeting, the Issuer, any Guarantors and the Underwriters will sign the purchase agreement, at which point both the Issuer and the Underwriters are contractually committed to complete the offering, subject to certain closing conditions. Following the Pricing and execution of the purchase agreement, Issuer s and Underwriters counsel will prepare the final offering memorandum and finalize and collect signatures for the various closing documents (including bring-down comfort letters, legal opinions and disclosure letters) in preparation for the Closing of the transaction. The Closing is the formal issuance and delivery of the bonds by the Issuer against payment therefore by the Underwriters and will take place a few business day after Pricing to allow sufficient time to prepare the necessary documentation and collect the purchase price for the bonds from investors. 28 High Yield Bonds - An Issuer s Guide

32 GLOSSARY Term Page 1.00 of Additional Indebtedness Test Additional Assets Affiliate Transactions Asset Sale... 20, 21, 23 Asset Sale Test Baskets Builder Basket Closing Change of Control Change of Control Event Change of Control Offer Comfort Letter... 7 Competent Authority Consolidation Controlled Group... 9 Covenants Coverage Ratio Disclosure Letter... 7 Directed Selling Efforts Dividends... 18, 19 Dividend Blockers Dividend Stoppers Description of Notes (DoN)... 5 Documentation... 5 Down-stream Guarantees... 8 Due Diligence... 7, 27 EEA Exchange Act Exchange-Regulated Market Fall Away Covenants Fiscal Agency Agreement... 6 Fixed Charges Coverage Ratio Governing Law Guarantees mayer brown 29

33 Term Page Guarantors... 8 Hell-or-High Water Incurrence Covenants Indebtedness Indenture... 6 Initial Purchasers... 6 Intercreditor Agreement... 5, 6 Investment Issuer... 6 Joint Ventures... 18, 19 Launch Legal Opinions... 7 Liens Maintenance Covenants Merger MD & A... 5 Negative Assurance Letter... 7 Negative Covenants Net Income Basket Offering Circular (OC)... 5 Offering Memorandum (OM)... 5 Offshore Transactions Parties... 7 Payment Blockage Provisions... 3 Permitted Debt Permitted Holders Permitted Liens Permitted Investments Permitted Restricted Payments Portability Pricing Prospectus... 5 Prospectus Directive Publicity... 9 Publicity Guidelines High Yield Bonds - An Issuer s Guide

34 Term Page Purchase Agreement... 7 Qualified Institutional Buyers (QIBs) Underwriters... 7 Ratio Debt Regulated Market Regulation S (Reg. S) Replacement Assets Reporting Restricted Payments Restricted Subsidiaries... 8, 9, 14, 22, 23 Roadshow... 26,27 Rule 10b-5 Letter... 7 Rule 144A SEC Securities Act Securities Laws... 9 Senior Notes... 3 Standstill Provisions... 3 Subordinated Notes... 3 Subordination... 3 Contractual Subordination... 3 Structural Subordination... 4 Lien Subordination... 5 Subscription Agreement... 6 Substantial U.S. Market Interest / SUSMI Time table Trustee... 6 Up-Stream Guarantees... 8 Unregulated Market Unrestricted Subsidiaries... 8, 9, 22 Underwriters... 6 Underwriting Agreement... 6 Underwriting Discount... 6 Underwriting Spread... 6 Whole-Sale Debt Exemption mayer brown 31

35 OTHER KEY MEMBERS OF OUR GLOBAL HIGH YIELD PRACTICE INCLUDE: Hong Kong New York Jason T. Elder Partner 16th - 19th Floors, Prince s Building 10 Chater Road Central Hong Kong T F John P. Berkery Partner [email protected] 1675 Broadway New York, NY United States T F Houston London/Paris Bill Hart Jr. Partner [email protected] 700 Louisiana Street Suite 3400 Houston, TX T F Robert Flanigan Partner [email protected] 201 Bishopsgate 20 Avenue Hoche London EC2M 3AF Paris United Kingdom France T T F F High Yield Bonds - An Issuer s Guide

36 About Mayer Brown Mayer Brown is a global legal services organisation advising clients across the Americas, Asia and Europe. Our presence in the world s leading markets enables us to offer clients access to local market knowledge combined with global reach. We are noted for our commitment to client service and our ability to assist clients with their most complex and demanding legal and business challenges worldwide. We serve many of the world s largest companies, including a significant proportion of the Fortune 100, FTSE 100, DAX and Hang Seng Index companies and more than half of the world s largest banks. We provide legal services in areas such as banking and finance; corporate and securities; litigation and dispute resolution; antitrust and competition; US Supreme Court and appellate matters; employment and benefits; environmental; financial services regulatory & enforcement; government and global trade; intellectual property; real estate; tax; restructuring, bankruptcy and insolvency; and wealth management. OFFICE LOCATIONS AMERICAS Charlotte Chicago Houston Los Angeles New York Palo Alto Washington DC ASIA Bangkok Beijing Guangzhou Hanoi Ho Chi Minh City Hong Kong Shanghai Singapore EUROPE Brussels Düsseldorf Frankfurt London Paris TAUIL & CHEQUER ADVOGADOS in association with Mayer Brown LLP São Paulo Rio de Janeiro Please visit for comprehensive contact information for all Mayer Brown offices. Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the Mayer Brown Practices ). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorised and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC ); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. Mayer Brown and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions. This publication provides information and comments on legal issues and developments of interest to our clients and friends. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek legal advice before taking any action with respect to the matters discussed herein The Mayer Brown Practices. All rights reserved. 0611cor October 2013