U.S. Oncology: An Update on Recent Disputes in Make Whole Provisions

Contributed by Conray C. Tseng
On November 1, 2010, McKesson Corporation, a healthcare services and technology company, announced the acquisition of U.S. Oncology, Inc., an oncology services company, from private equity shop, Welsh Carson Anderson & Stowe.  As part of the transaction, McKesson announced that significant portions of U.S. Oncology’s debt would be refinanced or retired, including, among other things, certain 9.125% senior secured notes due 2017 (the “9.125% Notes”). 
The 9.125% Notes require the payment of a prepayment premium if called before August 15, 2013.  A dispute, however, has arisen on how to calculate the prepayment premium.  While litigation has yet to commence, the dispute highlights one of the more recent issues related to prepayment premiums.
The issue is the appropriate methodology to calculate the prepayment premium.  In particular, one of the inputs into the prepayment premium formula is an appropriate “Treasury Rate.”  As discussed below, to determine the appropriate “Treasury Rate,” one must determine what is a U.S. treasury note with “a maturity comparable to the remaining term” as the 9.125% Notes.  U.S. Oncology takes the position that such a U.S. treasury note is one due at the maturity of the 9.125% notes (i.e., 2017).  Dissenting bondholders believe it is one due when the 9.125% Notes become callable (i.e., 2013).  The difference between the two positions is approximately $40 million.
Let’s take a look a the specific language at issue.  The 9.125% Notes calculate the prepayment premium as follows:

the greater of (1) 1.0% of the principal amount of [the 9.125% Notes] at such time and (2) the excess of (A) the present value at such time of (i) the redemption price of such [9.125% Note] at August 15, 2013 . . . plus (ii) any required interest payments due on such [9.125% Note] through August 15, 2013 (including any accrued and unpaid interest) computed using a discount rate equal to the Treasury Rate plus 50 basis points, over (B) the principal amount of such [9.125% Note].

The crux of the dispute appears to be the appropriate discount rate to calculate the present value of the redemption price plus any applicable interest payments.  The higher the discount rate, the lower the present value of the redemption price and interest payments and, in turn, the lower the make whole premium.
The 9.125% Notes define Treasury Rate as “with respect to any redemption date, the rate per annum equal to the yield to maturity of the Comparable Treasury Issue, compounded semi-annually, assuming a price for such Comparable Treasury Issue (expressed as a percentage of its principal amount) equal to the Comparable Treasury Price for such redemption date.”  A Comparable Treasury Issue is defined as follows:

the United States Treasury security selected by an Independent Investment Banker as having a maturity comparable to the remaining term of the [9.125% Notes] that would be utilized, at the time of selection and in accordance with customary financial practice, in pricing new issues of corporate debt securities of comparable maturity to the remaining term of such [the 9.125% Notes] . . . .

What is the appropriate “Treasury Rate” thus appears to turn on what it means for a treasury to have “a maturity comparable to the remaining term” of 9.125% Notes.  As noted earlier, U.S. Oncology believes that means a U.S. treasury note due in 2017 (the stated maturity of the 9.125% Notes) while dissenting bondholders believe it should be a U.S. treasury note due 2013 (the date the notes become callable).  We will continue to monitor the situation to see how things develop.