February 6, 2008

Moody’s Weighs in on Bond Defaults and Late SEC Filings

As Broc noted in the blog last summer, the decision in Cyberonics, Inc. v. Wells Fargo Bank N.A. further muddied the debate on whether the language of a typical delivery covenant in an indenture (which obligates the issuer to deliver SEC reports to the trustee) could serve as a basis for declaring a default when an issuer becomes delinquent in filing its Exchange Act reports. The Cyberonics court interpreted a widely used delivery covenant to require that Exchange Act reports be filed with the trustee only after being filed with the SEC, and stated that Section 314(a) of the Trust Indenture Act does not provide a deadline for filing such reports with the SEC. This decision was in stark contrast to a decision of a New York state court in The Bank of New York v. BearingPoint, Inc., where that court ruled that the company’s failure to file its Exchange Act reports when required by the SEC constituted an event of default under the indenture. Both the Cyberonics and the Bank of New York opinions are posted in our “Late SEC Filings” Practice Area.

More litigation of this sort continues in a number of courts, with the next case likely to see a decision being UnitedHealth Group Inc. v. Wilmington Trust Co. in the U.S. District Court for the District of Minnesota.

Moody’s recently issued a report that outlines the issues raised in these decisions and similar litigation, as well as a useful appendix compiling the delivery covenants of a sampling of companies who have received default notices for failure to comply with those covenants. The Moody’s report highlights that of the two most prevalent variations on the delivery covenant, the one with language that states “the Company covenants and agrees to file with the Trustee, within 15 days after the Company is required to file with the Commission” is most protective of bondholder rights. Moody’s reaches this conclusion because – unlike the covenant at issue in Cyberonics and The Bank of New York that merely says reports will be filed with the Trustee “after it files” with the SEC – the more protective covenant expressly requires timely SEC reports while providing a default remedy if the promise is breached, and would avoid the necessity for costly litigation over this issue.

Moody’s notes that while many issuers will take a public stance that they are not in breach of the delivery covenant, only a small minority of issuers will actually choose to litigate this issue. In many cases, Moody’s found that issuers take preemptive action, such as conducting consent solicitations to eliminate events of default.

My two cents: As a devotee of the Trust Indenture Act, I think that Section 314(a) of the Trust Indenture Act does not impose a new or separate filing obligation on the obligor, but rather relies on what the issuer has to file under its obligations pursuant to Exchange Act Sections 13(a) or 15(d). This view is consistent with the holding on this issue in the Cyberonics decision.

Current Reporting Obligations When an Event of Default is Declared

While on the topic of declaring an event of default under an indenture, it is important to keep in mind the potential triggering event under Item 2.04 of Form 8-K around the time of an event of default.

The Staff clarified in Question 20 of its November 2004 Form 8-K FAQs that if the indenture requires notice before an acceleration and notice has not yet been provided, then no 8-K is triggered at that point – but if the acceleration happens automatically without declaration or notice, then the issuer must file the 8-K within four business days of when all of the facts necessary to trigger the default have occurred.

Even if an issuer takes the position that the notice of default fails to state a legitimate claim (as noted above is often the case with delivery covenant defaults), I believe that the Staff would still expect to see the Form 8-K filed within four business days of the triggering event – however, the issuer may include disclosure in the Form 8-K describing why it believes no event of default has occurred.

Executive Compensation Disclosure Webconference: Transcript Posted

The transcript has been posted for the first part of the two-part webconference – “The Latest Developments: Your Upcoming Proxy Disclosures—What You Need to Do Now!” You can now read about some of the latest guidance from the Staff based on its targeted review of executive compensation disclosure, including:

– Performance Target Disclosures – Materiality and Confidentiality Standards
– Disclosure of Operational versus Financial Performance Targets
– Disclosure of Performance Targets for Completed versus Current or Future Periods
– “Degree of Difficulty” Disclosure Concerning Performance Targets
– Benchmarking Disclosures – Naming Peer Group Companies
– Presenting Two Years of Compensation Data and Related CD&A Disclosure
– Dealing with FAS 123R Reversals in the Summary Compensation Table

– Dave Lynn