Wilmington Savings Fund Society, FSB v. Foresight Energy, LLC, et. Al., C.A. No. 11059-VCL, memo. Op. (Del. Ch. Dec. 4, 2015)
Sophisticated workarounds to avoid tripping indenture provisions are not atypical in mergers or acquisitions where the target (or one of its subsidiaries) has outstanding debt that the parties do not wish to refinance. However, the Court of Chancery of the State of Delaware (the “Court”) recently held that a particular bit of structuring to avoid triggering a change of control put was a bridge too far.
Foresight Energy GP, LLC (the “General Partner”) is the general partner of Foresight Energy, L.P. (“Foresight Parent”), whose subsidiaries (the “Issuers”) issued senior notes governed by an indenture. Nearly all of the equity interests in the General Partner were owned by Foresight Reserves (“Foresight Reserves”).
The indenture contained typical provisions requiring that in the event that Foresight Parent underwent a “Change of Control”, it would be required to offer to purchase the notes at 101% of the principal amount thereof. The indenture defined Change of Control as, among other things, “the consummation of any transaction … the result of which is that any “person”… excluding [the current owner], becomes the Beneficial Owner, directly or indirectly, of more than 35% of the Voting Stock of [the General Partner], measured by voting power…” The Indenture defined “Voting Stock” as securities that have the power (i) to “vote for the election of” directors or managers of the General Partner, (ii) to “control the election of directors or managers” of the General Partner, or (iii) to “control” the General Partner. As is customary, the indenture drew on the Williams Act, defining “Beneficial Owner” as having “the meaning assigned to such term in Rule 13d-3 of the Securities Exchange Act of 1934.”
In 2015, Murray Energy Corporation (“Murray”) sought to acquire control of the Foresight group, first in an attempt that failed and second in the transaction that is the subject of this decision. The original acquisition structure was an 80% voting stock acquisition of the General Partner (the “Original Deal”). When the Original Deal was not able to be financed, it was restructured (the “Revised Deal”). The key differences between the Original Deal and the Revised Deal were that for a $25 million reduction in purchase price, Murray would be granted (i) a 34% voting interest in the General Partner (as compared with 80% in the Original Deal), (ii) the same 80% interest in the economics, and (iii) a $25 million, five-year option (the “Option”) to acquire an additional 46% voting interest in the General Partner (i.e., yielding the same voting interest it would have had in the Original Deal). In addition:
- The Option was subject to two conditions: a 61 day advance notice provision and a third party refinancing condition, both intended to ensure that the Option holder’s right to acquire the securities was more than 60-days in the future (and avoid acquisition of beneficial ownership under Rule 13d-3(d)(1)).
- The parties entered into a new general partnership agreement (the “New GP Agreement”) which, among other things, granted Murray significant veto rights over transactions outside the ordinary course of business (the “Blocking Rights”), and veto rights over any attempt by Foresight Reserves to transfer any of its voting interests in the General Partner to a third party (the “Transfer Veto Rights”).
- The parties entered into a management services agreement (“Management Services Agreement”) which authorized a subsidiary of Murray to oversee all day to day operations and business of the Foresight companies. The parties also agreed to replace the then current CEO of the General Partner and Parent company with an executive officer of Murray Energy.
When the Revised Deal closed, the trustee brought suit on behalf of holders of the notes, contending that a Change of Control had occurred, and the Court agreed. The Court’s analysis turned on two aspects of beneficial ownership under Rule 13d-3: (i) shared investment power arising as a result of the Transfer Veto Rights, and (ii) an application of the anti-evasion provisions of Rule 13d-3 to find that a de facto change in control had occurred.
Shared Investment Power –
Under Rule 13d-3(a) (2), a beneficial owner of a security includes persons who have or share “investment power which includes the power to dispose, or to direct the disposition of, such security.” Drawing on administrative and secondary commentary arising in the Williams Act context, the Court found that the Transfer Veto Rights gave Murray shared dispositive power over the voting interests in the General Partner owned by Foresight Reserves, and therefore that Murray had become a Beneficial Owner of those voting interests, thus exceeding 35% and triggering a Change of Control. See BankAmerica Capital Corp., SEC No Action Letter, 1979 WL 13099 (Apr. 6, 1979). This result is not terribly surprising, and should serve as a reminder to us all that possession of a veto power can lead to a finding of shared dispositive or voting power.
Anti-evasion – More interesting is how the Court imported and applied the anti-evasion principals of Rule 13d-3(b) into the indenture. The decision recites, “in relevant” part, Rule 13d-3(b) (the “anti-evasion provisions”) as
(b) Any person who, directly or indirectly, creates or uses a … contract, arrangement, or device with the purpose or effect of divesting such person of beneficial ownership of a security or preventing the vesting of such beneficial ownership . . . shall be deemed … to be the beneficial owner of such security.
The Court found that where the parties had structured the transaction to avoid running afoul of the beneficial ownership requirements but de facto control had passed to the acquiring party, it was sufficient to find a Change of Control. On these facts, the Court determined that the acquiring party had acquired practical control over the General Partner, in both (i) extraordinary transactions, through the Blocking Rights it had acquired, and (ii) ordinary course of business transactions, by way of the Management Service Agreement and the replacement of the CEO with a Murray executive (who was also a relative of the Murray CEO). The Court found that the purpose of this type of covenant is to ensure that the current controlling party remained “basically in charge”; the New GP Agreement and the new CEO meant that Murray was now “basically in charge” of the General Partner, even if that had not been achieved through ownership of Voting Stock.
The decision is a little selective in its editing of the anti-evasion provision, as the penultimate ellipsis in the quoted section above replaced the words “as part of a plan or scheme to evade the reporting requirements of Section 13(d) or 13(g) of the Act.” The sin that 13d-3(b) is aimed at are techniques that purport to evade the reporting requirements of the Williams Act, and keep a significant ownership position a secret from the trading markets. The Court dismissed arguments that 13d-3(b) wasn’t implicated in this case because there was no concealment involved, indicating that “while requiring an element of concealment makes perfect sense for purposes of [the Williams Act]”, it did not believe the indenture parties were concerned about concealment when they incorporated the definition of “beneficial ownership” into the indenture. It was sufficient that the parties had sought “to use a … contract … with the purpose or effect of preventing the vesting of … beneficial ownership” and accordingly, Murray Energy was “deemed … to be the beneficial owner of such security.”
Notably, the Court also looked at the lack of a pricing difference between the Original Deal and the Revised Deal, which should have reflected a control premium, as indicative of de facto control. Under the original deal, Murray would have paid $1.39 billion for 80% of the voting rights, including economics. In the Revised Deal, Murray paid $1.37 billion for a 34 percent voting stake, the Blocking Rights, the Transfer Veto Rights and 80% of the economics, with the option of paying $25 million for an additional 46 percent voting interest later. The Court found it “preposterous” that the Foresight principal, “a savvy businessman with over 30 years’ experience in the coal industry,” would have settled for just 1.8% more for a change in control than the price he accepted for the 34% stake.
The result reached by the Court in the second part of the decision is particularly interesting, as the Court both (i) changed the meaning of Rule 13d-3(b) in its efforts to incorporate it into the indenture (i.e., by eliminating concealment as a component of the rule), and (ii) based on its understanding of the purpose of change of control clauses, added a gloss to the definitions of Change of Control and Voting Stock in the indenture (i.e., perhaps influenced by the third prong of the definition of “Voting Stock,” asking whether someone new was “basically in charge” of the General Partner, notwithstanding that such control came about through the terms of the New GP Agreement and the Management Services Agreement, rather than the ownership of the Voting Stock itself).
When an indenture or other agreement incorporates a term specifically drawn from a body of law and regulation, we should expect that a court will construe the agreement considering
- the entirety of the definition of the term,
- the way the term has been construed and used, in the context of the relevant regulatory scheme,
- the court’s view of the purpose of the covenant, in the context of the agreement,
- whether tension between the regulatory context in which the term is defined and the purpose of the covenant in the agreement in which it is used should influence the meaning of the term as used in the agreement, and
- the reasonable expectations of the parties or, in the case of an indenture, investors.
The more important, commercial lesson requires a look beyond the Court’s decision, to the aftermath. The Court’s decision was issued on December 4, 2015. By mid-December 2015, the lenders to Foresight had issued a notice of default to the company, restructuring counsel had been engaged and changes in market conditions were such that commentators speculated that refinancing options may be limited. Now, in mid-March 2016, re-structuring talks are ongoing, the Issuers of the Notes have delayed a coupon payment and the ultimate resolution for both the debt and equity holders of Foresight Energy remains uncertain.
Foresight Energy could be reason to consider excluding the anti-evasion prong of the definition. The first example of an issuer taking that approach appears in the preliminary offering memorandum for bonds recently marketed by GCP Applied Technologies (a recently spun-off subsidiary of W.R. Grace). The Change of Control definition in the GCP Applied Technologies bonds specifically excluded the anti-evasion provision of 13d-3(b), as well as 13d-3(a)(2) (beneficial ownership based on investment power) and 13d-3(d)(1) (relating to rights to acquire securities exercisable within 60 days). However, investors must have pushed back during the marketing, because the issuer removed those provisions prior to closing. (XTract Research issued a report, after the release of the preliminary offering memorandum, asserting that the issuer was “gutting” the definition of beneficial ownership.) It remains to be seen whether there will be market appetite for a revised approach to beneficial ownership definitions, or whether other issuers will push harder for this type of exclusion.