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Covenants Restricted Payments And Net Worth Outline

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IV. Covenants
C. Restricted Payments and Net Worth
Freeport-McMoran Indenture, Section 4.04
Petrohawk Indenture, Section 4.4
Alleco v. IBJ Schroeder, 745 F.Supp. 1467 (1989) (Part II) (review Alleco (I) for facts)
Northwest Note Agreement, Section 10.2
Newpage Credit Agreement, Section 6.5(a), (c), (e)(2), (h), (k), 6.7
Restricted Payment Covenant
- Limitation to Co. on transactions that constitute outflow of assets
- Company's outflow of asset is limited: only outflow if there is sufficient inflow
- 3 components 1) Definition of outflow/ restrictive payment
 Traditionally outflows of value from the Company to its shareholders without anything in return that is of value to creditors
 Cash dividends to company shareholders (except stock dividends)
o How about stock dividend? Outflow for shareholders; but not an outflow value 
o Wholly-owned Sub paying dividend  stays within the company
 Purchase of stock by company

Company's own stock doesn't worth any to the company
 Purchase of stock by sub

If wholly-owned sub buys stock from co.  payments within corporate family  no change

Partial (e.g. 75%) owned sub  75% goes to co.; 25% goes to outside party  not outflow
 Economically, creditors only own 75% of the $100
 they were owe 75% of the 100%  now have 100% claim to the $75 left
 Expanded to include
 Certain payments on subordinated debts

If debt subordinated to you (more senior)  treated as an outflow
 Certain investments
 E.g. Freeport 4.04:
 (a) Restricted payments include "dividend, purchase of stock of company, payments to subordinated debt, investments"; Conditions:
no default, incur $1 indebtedness, pot test (4 components)
 (b) Not prohibit 2) Conditions for making RP, when RP is satisfied:
 Pot condition
 "Inflows" (such a profits, sale of equity)
 Restricted Payments are "outflows"
 RPs are only permitted if there is enough money left in pot, i.e. up to the limit of All prior inflows LESS All prior outflows
 Permitted to incur additional $1 indebtedness under debt restriction covenant
 No default 1 IV. Covenants 3) Special rules
 Outflow that are permitted, despite insufficient money in the pot
 But still affects co's future ability to make restricted payments
 Outflow that are not prohibited and do not count as outflow
Problem Set #10

1. Which of the following actions results, from the perspective of creditors, in a outflow of valuable assets from the company to its shareholders? In which actions does the Company receive valuable consideration from the perspective of creditors? What is the net effect?
(a) Company pays a cash dividend;
 outflow, nothing of value in return
(b) Company repurchases its stock for cash;
 outflow, nothing of value in return (Company stock has no value to Company creditors)
(c) Company purchases stock of a subsidiary for cash;
 outflow, value in return (Subsidiary stock has value, e.g, if purchases raise
Company's % stake in subsidiary)
(d) a subsidiary of Company pays a cash dividend;
 no outflow if dividend goes to Company or is proportionate
(e) a subsidiary of Company purchases Company stock for cash;
 outflow, nothing of value in return (Company stock has no value to Company creditors)
(f) a subsidiary of Company purchases its stock for cash;
 outflow, value in return (Subsidiary stock has value)
(g) Company pays a stock dividend;
 no outflow, at least if Common Stock
(h) Company purchases its stock in exchange for stock of another class;
 no outflow, at least if paid with Common Stock
(i) Company purchases its stock in exchange for stock of a subsidiary;
 outflow, Subsidiary stock has value
(j) Company sells common stock in a public offering;
 inflow
(k) Company sells common stock to a subsidiary.
 No inflow

2 IV. Covenants
Problem Set # 11

1. How do the following actions affect the ability of Company to make Restricted Payments? (Answer with respect to company noted in brackets.)
(a) On January 2, Company issues $50 million of Common Stock. On June 2, Company repurchases these stock for $50 million. [Freeport-McMoran]
o Kahan: inflow 1/2; outflow 6/2

Issuance of redeemable convertible preferred Stock  inflow

Does it count? 3(B) Issue of common stock and repurchase fits under (B) "the aggregate Net Cash Proceeds received by the Company from the issue or sale of its Capital Stock (other than Disqualified Stock)
subsequent to the Closing Date (other than an issuance or sale to
(x) a Subsidiary of the Company or Q an employee stock ownership plan or other trust established by the Company or any of its
Subsidiaries)"
 Repurchase of Stock  outflow under the Indenture

Does it count? 4.04(a)(ii) The Company shall not, and shall not permit any Restricted Subsidiary, directly or indirectly, to (ii) "Purchase,
repurchase, redeem, retire or otherwise acquire for value any
Capital Stock of the Company or any Restricted Subsidiary held by Persons other than the Company or a Restricted Subsidiary"
 Prof: note this is drafted overbroadly  but to draft overbroadly is less problematic than too narrowly  prevent company to abuse the loophole (esp. since bondholders are not organised)
(b) Same as (a), except that stock is sold and repurchased from a subsidiary. [Petrohawk]
 Kahan: no inflow 1/2; no outflow 6/2
 Economically all these transactions don't change anything  net affect is zero
 This constitutes 4 transactions
Issuance of Stock to sub 1) Company selling stocks to sub  inflow for co.? No
 4.4(a) Company shall not (i) pay any dividend…
 But not an inflow under (3)(B) 100% of net cash proceeds received by the
Company from the sale of Equity Interest stocks sold to subsidiary
 (3)(B) "other than Disqualified Stock" [same in Freeport]
 Disqualified Stock means stocks that is mandatorily redeemable
 Rationale: equity that may disappear, junior debt that is paid out before you would in effect be senior 2) Sub buying stock from company  outflow for sub? No
 4.4(a)(2) "other than Equity Interests owed by the Company"
Repurchase of Stock from Sub 1) When co. repurchases  outflow for co.
2) Sub selling stock  inflow for sub
 Hence, the indenture provides:
1) Co. repurchases the stock from sub is not counted as an inflow/outflow 2) When sub sell company's stock to third party  not counted as inflow (no net cash proceeds received by the Company)
 (B) inflow transaction refers only to sells of stock received by the Company 3 IV. CovenantsProf: drafted broadly  intentional mistake to allow co. to sell to sub and then the sub sell to third party  no harm being done as co. would just structure the transaction

(c) On January 2, Company issues $50 million of Series A Preferred Stock (redeemable at the option of the holder at face value and convertible into common stock). On June 2, Company repurchases these shares for $50 million. [Freeport-McMoran, Petrohawk]
 Kahan: no inflow 1/2 since Disqualified Stock; outflow 6/2
Freeport
 Issuance of redeemable stock  4.4 "other than Disqualified Stock"  no inflow
 Repurchase of stock  50M outflow
- 4.04 (a)(ii)"purchase, repurchase, redeem, retire, or otherwise acquire for value"
 C.f. Petrohawk: 4.4 "purchase, redeem or otherwise acquire or retire for value"
 Both fine, but must be consistent
- Repurchase is a restricted payment  counts as outflow
 Economically neutral in aggregate  but for the purpose of indenture, transaction generated 50M outflow  wrong, doesn't correspond the economic effects
Drafting Assignment: Indenture to reflect economic effect
 Preferred stock was sold for 50M and may be repurchased for

40M
o 50M
o 60M
 What is the right result for the size of the pot given each amount at the end of the day and does your fix lead to that result?
o 40M  inflow of 10M (+10M)
o 50M  no aggregate effect (0)
o 60M  outflow of 10M (-10M)
 What is the desired result of the period between the sale of stock and repurchase and does your fix lead to that result? What should happen to the pot when you sell the Disqualified
Stock?
o Desired result = 0 for all transactions

40M  0

50M  0

50M  0
 Assume that there is not enough money in the pot. Should the Company be permitted to repurchase the preferred stock at any price and does your fix lead to the desired result?
o On June 2, co pays 50M and get stock  real outflow  bondholder would not like this, would prefer co. keeping the money  may want to impose restriction as there is an outflow economically
 Correct result is the netting of the proceeds from the sale and the amount spent to repurchase

Until repurchased, proceeds do not increase pot

Probably should not be permitted

 Repurchase counts as RP but retroactive credit to "pot" for sale proceeds.
 Ways to fix this:
4

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