This article has been contributed to the Bankruptcy Blog by Jane Sullivan and Christina Pullo of Epiq Bankruptcy Solutions, LLC. Jane Sullivan is Executive Vice President, Director of Restructuring Services, and Christina Pullo is Vice President, Director of Solicitation Services.
Whether to require holders of public securities to surrender the security or, instead, to set a record date to determine who holds the security can have a serious impact on a restructuring. Choosing incorrectly will make the transaction – whether a plan vote, rights offering, distribution or other event – much more difficult, at best. At worst, it could derail it. Below are some basic “rules of the road” that – subject to a review of the specific facts of each transaction – will help you determine whether to require surrender … or not.
Defining Terms …
“Surrender” means that a beneficial holder of a public security, often a bond or note, is returning its security to the issuer (via its agent). This “surrender” can be voluntary or mandatory. We usually see a “voluntary” surrender when the holder has a choice in whether to take action (such as to participate in an exchange offer). If the holder voluntarily surrenders its security, the holder gives up the ability to subsequently trade the security, pending completion of the transaction. On the other hand, with a “mandatory” surrender, the holder has no choice but to return its security because surrender is automatic and requires no action on the part of the holder. The most common “mandatory” surrender is when a security is cancelled on a global basis pursuant to a plan of reorganization. In either case, the surrender event is handled through The Depository Trust Company (“DTC”) for any U.S. issues held in global form.
A “Record Date” is a date set by the issuer to establish who holds a position in the security as of that date. For example, if an August 1st record date is set by the issuer, only holders owning the security as of August 1st would be eligible to participate in whatever event is taking place (i.e., a plan vote, an interest payment, or a distribution). It wouldn’t matter if the “record date” holder trades the security on August 2nd; as long as the holder owned the security on August 1st, the holder’s eligibility is not extinguished.
Bright Lines …
Although a limited list, some events will always call for either a Surrender or Record Date to be used. A Record Date should be used for a notice mailing, most subscriptions, and voting. Surrender of the underlying securities should be used in connection with a tender offer, exchange offer, treatment election, or mandatory securities distribution. The key to deciding whether to require surrender or use a record date is whether you need to lock down the particular holders involved in the event on a permanent basis – or whether you can just look at the records on a single date. As you can imagine, most holders are very resistant to giving up their ability to trade their security, so surrender should only be used when necessary.
Shades of Gray …
For the following events, the determination as to whether to use Surrender or Record Date is a more complicated decision. Certainly it all depends on the particular facts and circumstances of a case to make the right choice, but below are some guidelines for some common events.
- Plan Distributions: In the case of chapter 11 plan distributions, use of either Surrender or Record Date is appropriate depending on whether the underlying securities are to be cancelled pursuant to the plan. Surrender is appropriate for securities that are cancelled under the plan. Surrender facilitates a very smooth procedural process, and it allows for trading in the underlying security to continue right up to the time of the distribution. (Trading doesn’t stop within the depository system until the surrender has occurred, even if the effective date has already passed.) For securities that are not cancelled by the plan, a distribution Record Date should be used, as Surrender does not work in this situation because, simply, there is nothing to surrender if the bond is not being cancelled.
One key fact to remember is that you cannot use both the Surrender and Record Date methods for a plan distribution to a single issuance. Although some chapter 11 plans try to call for both a Distribution Record Date and the Surrender of the underlying securities, it doesn’t actually work from a procedural point of view (although it sounds like it should) – and a decision has to be made about which type of distribution to conduct.
- Rights Offerings: A “rights offering” is an event that allows the holder of a debt or equity security to purchase new securities in the emerging entity for new consideration. You would use a Record Date in connection with a rights offering when all beneficial holders as of the Record Date are eligible to participate regardless of whether they continue to hold their bonds thereafter. In this instance, the rights are allocated pro rata to the Record Date holders, and the beneficial owners who participate simply pay for their exercised rights. The only time a rights offering should be a Surrender event is if it is linked to an “alternative treatment,” i.e., where only those holders who choose the alternative treatment are entitled to participate in the offer. Surrender is used in this case to separate the population of holders between those who elect to receive the alternative treatment and those who do not. Record Date rights offerings are much more typical.
Using Both Methods in Tandem …
Sometimes it is absolutely necessary to use a Record Date and Surrender together, but for different aspects of the same event. For example, holders of an existing security may be entitled to vote on a plan and to make a treatment election. The plan vote should be, as usual, a Record Date event, to ensure the smoothest voting process. However, the treatment election must be set up as a voluntary Surrender event – without a record date attached to the election. It is essential to pin the elected treatment on holders who made the election, and the only way to do that effectively is through voluntary surrender. Under this scenario, Record Date holders who cast votes on the plan may not be the same holders who make the treatment election.
It bears noting that when holders of public securities are balloted, there are usually two types of ballot forms used. The first is the “beneficial owner ballot,” which is used by the actual beneficial owners of the security to cast their votes on the plan. There is also the “master ballot,” which is used by the broker, bank or agent (the “Intermediary”) acting on behalf of one or more beneficial holders. When completing the master ballot, the Intermediary will look to the Beneficial Owner Ballots for instructions on how to vote. Use of a Record Date concept is ideal for this aspect, and Intermediaries are completely comfortable casting master ballots in this way. Although the beneficial owner still must provide the instructions, most surrender events do not require that any paperwork or master form be returned to the issuer or its agent. Typically, it is just the action itself of surrendering the beneficial owner’s securities that will accomplish participation in the voluntary event.
Banks, Brokers and DTC …
In considering any of these actions, it is important to understand how the Intermediaries (i.e., banks and brokers who hold securities in “street” name on behalf of their clients, or the agents that act on their behalf), work because the debtor will need rely on these Intermediaries to carry out (at least in part) the action in question. It is also important to understand DTC, which serves as the sole depository for U.S. issued debt and equity securities. In addition, when dealing with international issues, understanding Euroclear Bank and Clearstream Bank, the primary depositories for such issuances, is critical. How each of these entities works internally will have a direct impact on determining your timetable, method of dissemination of information and documents and, ultimately, how to fulfill distributions of cash or replacement securities.
One example of the nuances that can exist in these institutions is the differences in roles of the traditional Proxy Department and Reorganization Departments at the Intermediaries. The Proxy Department is responsible for managing voting events, including balloting for a plan. The “Reorganization” Department is the department responsible for tender offers and other treatment events. The Reorganization Department does not handle plan voting, except in certain extraordinary circumstances. It is better not to attempt to mix the two functions. Each department should handle what it normally does. For example, when you have a chapter 11 plan that provides for a treatment election, you would need a ballot that allows for plan voting in one document and a separate document for the Intermediary to request instructions from the beneficial owner about the treatment election. By separating these documents, each form, together with the disclosure statement or other transaction documents, can be sent out by and returned to the appropriate Department for processing.
One additional note regarding DTC is that only securities that are “DTC eligible” can typically be processed through DTC’s system. “DTC eligible” securities are generally freely transferable, non-restricted securities. There are real advantages to allocating DTC eligible securities to holders of existing securities already in the DTC system. For example, in a rights offering, the allocation and payment mechanics of DTC are much more efficient than managing the process outside of DTC. Through its electronic rights offering/subscription system, DTC can automatically allocate rights to its participants, automatically deduct payments from participants upon exercise, and institute wire transfers on their behalf. In addition, any allocations of subscribed securities can be paid out by the offeror through a single payment to DTC, which will then split it amongst the subscribing holders. If the subscribed-for securities are not DTC eligible, the entire process is handled manually outside of DTC, and the Intermediaries are typically required to certify the Record Date positions of their subscribing holders or Surrender the underlying positions. The situation is similar for distributions of non-eligible securities under a plan or exchange offer. A special voluntary Surrender event must be established in order to “register” the beneficial owners on an individual basis, so they can directly receive any non-DTC eligible securities exchanged under the plan or exchange offer.
The Bottom Line …
The bottom line is that knowing when to use a Surrender event and when to use a Record Date will help ensure the smooth processing of a chapter 11 plan vote, rights offering, distribution, or other corporate event. Choosing incorrectly can confuse, delay, or even derail such an event.