Corporate Finance

Differences Between Debt and Equity

Debt financing allows interest rate tax deductions for a tax shield whereas equity dividend's must have taxes paid on them Debt poses a real risk of default and bankruptcy whereas one cannot ever default in an all-equity firm however they may face liquidity issues Debt grants no voting rights to creditors whereas equity issuances grant new voting rights Debt is a liability that must be paid with legal recourse to enforce interest and principal payments whereas equity dividends are not an obligation and can be paid out at managements leisure

Fiduciary duties for bond indentures

No fiduciary duty is owed to a bondholder. They are only entitled to their contractual protections as bargained for in the contract. Metropolitan Life Insurance v. RJR Nabisco No fiduciary duty existed that would require RJR Nabisco to prevent its credit downgrading due to an LBO for the sake of protecting Metropolitan Life Insurance's interests.

Protective Covenants

Restrict the kinds of transactions that the issuing company can enter into and also requires that certain thresholds be met in terms of financials. Must maintain so much working capital, must maintain this TIE ratio. Or cannot do a merger. Cannot issue anymore debt. Cannot sell substantially all assets.

Forwards v. Futures

The agreement between the parties to exchange values at a certain date at a predetermined price and quantity. Futures are just forwards that are traded on an exchange. Futures may be cash settled or physically settled whereas forwards are almost always physically settled.. The value of both a forward and future is the TVM adjusted differential between the cost required at settlement and the current value of the underlying asset on the open market minus any transaction costs.

What is a bond indenture?

The contract that sets up the rights, duties, obligations and privileges between bondholders and borrowers Often governed by New York or Delaware law. Often litigated in Delaware but sometimes in NY too.

316(b)

a bondholder will not have their right to interest and principal payments or their right to litigate over a breach of the bonds impaired unless they give their consent to the impairment.

Currency Swaps

allow firms to exchange currencies at a previously agreed exchange rate as a way to hedge exchange rate movements

Equity swap

allows firms to exchange the a risk free interest rate for interest rate shown by a stock's or a stock index's return. Can be used to hedge against changes in the interest rates or to speculate.

Conversion rights

allows the creditor to convert their bond into another security at their discretion or at the triggering of a condition depending upon the conversion rights

Derivatives and leverage

derivatives allow individuals to earn money through speculation by gaining exposure to movements of underlying assets that would require much more up front investment to profit off of otherwise.

Payment subordination vs. Lien subordination

priority in getting paid v. priority in recovering collateral

Sinking fund provisions

requires the borrower to set aside funds to use to pay back the creditor in case of default if it's getting close to default

Exchange for the purposes of derivatives

- middle man - requires posting of margin to limit losses - serves as a means to limit counter party risk - Dodd Frank requires that most derivatives be traded on exchanges.

Covenants in SPE charter that eliminate bankruptcy risk

- the debts of related legal entities cannot be consolidated - waiver of involuntary bankruptcy - the need for unanimous consent by shareholders to force voluntary BR. Usually the lenders are shareholders. - the prevention of commingling of assets of related legal entites - the SPE cannot engage in any activities except for those related to the Asset Securitization

Trust Indenture Act: Eligibility of a trustee - Section 310

A bank or a person is ineligible to serve as the trustee to a bond indenture if they are directly or indirectly controlled by or they directly or indirectly control or are under common control by the obligor or the underwriter. A person is also ineligible if A they own 5% or more of the voting shares, or 10% or more of any other kind of share, or they own 10% or more of the underwriter's stock.

316(b)'s limitations

A bondholder may not file a lawsuit to get an injunction on any action of the issuer that impairs their right to get paid under 316(b). They may however use this power when the issuer tries to alter the terms of the indenture to injure the bondholder's ability to get paid. 316(b) does protect its right to getting paid and being able to file suit under the indenture to enforce the terms of the indenture. Why? because then the bondholder could essentially prevent any action of the issuer that had a possible chance of causing losses to the business. Marblegate Asset MGMT LLC v. Education Management Finance Corp. The bondholder could not file suit to get an injunction on the issuer's decision to do a reorganization that would likely infringe upon its ability to get paid.

Breach of the implied covenant of good faith and fair dealing in the bond indenture context

A breach of the implied covenant of good faith and fair dealing will occur if one of the parties to the contract acts to subvert the ability of the other party to the contract to enjoy the benefits of the fruits bargained for in the contract. However a court will not find a breach for the failure to conform to a term not bargained for in the contract. Metropolitan Life Insurance Company v. RJR Nabisco While Metropolitan Life Insurance Co. did contract for the interest and principal payments, it did not contract for the prevention of the downgrading of the credit rating. The court was unwilling to find a cause of action based on the breach of the implied covenant of good faith and fair dealing because of the credit downgrading because no prevention of this was contracted for in the indenture.

Bonds after the indenture: Boilerplate provisions

Because boilerplate provisions are interpreted to have the meaning of the industry wide accepted interpretation, the interpretation of a boilerplate provision is a question of law without regard for peculiarities of the indenture contracted for in the particular case. Ex. Sharon Steel Corporation v. Chase Manhattan Bank boilerplate successor obligor clause had to be interpreted under the industry-wide accepted manner which was the successor obligor clause required that all or substantially all of the assets of a company be sold off in order to give rise to the ability to assign the debt. One does not look at the sale in a piecemeal manner but rather looks at the total liquidation process to identify whether all or substantially all of the assets had been sold to a single purchaser.

Syndicated Loans v. Loan Participations

Both of these have a lead arranger, which finds the lenders willing to fund the loan, an administrative agent, which collects payments and monitors the issuer to make sure payments will be made, and a collateral agent, which helps maintain and perfect the lenders interests in the collateral. Syndicated loans create a relationship between borrower and all of the co-lenders because each co-lender has a different promissory note with the borrower. Loan participations on the other hand only create a relationship between the co-lenders and the administrative agent, lead arranger and a collateral agent in a form of a sublease-like transaction. The participating lenders receive cash flow streams from the lead arranger but they do not personally have a contract with the borrower. Done to mitigate exposure to risk by diversifying the sources of funds for a loan. Makes it so one lender does not have to bare the brunt of the costs upfront.

Certificate of Designation

Certificate of designation is an agreement separate from the corporate charter itself that outlines the rights and duties formed through the agreement between preferred shareholders and equity holders. The benefits of the certificate of designation are not guaranteed through fiduciary duties. However, a preferred shareholder is owed a fiduciary duty outside the contractually received benefits from the certificate of designation.

Uses of preferred stock

Corporate issuers rarely ever use because the preferred dividend payment is not tax deductible. Cost of debt tends to be lower because of the interest rate tax deduction. Utilities use more often because the dividend payments can be built into the price to customers since the prices tend to be stable. However, it is attractive to investors because the dividends are often tax deductible for them Corporate issuer will occasionally find it attractive because of the flexibility in the issuance and the infinite maturity because it ends up acting as an endless loan.

Valuation methods in the certificate of designation

If the certificate of designation contracts for a certain valuation technique, or buy out price in the case of redemption during a merger or otherwise, the other valuation techniques will not be available and the court will go with the buy out price so long as the terms of the contract are reasonably clear. They will not be able to get appraisal if the valuation technique spelled out is clear and not against public policy In re Appraisal of Metromedia International Group

Volker Rule of Dodd Frank

Imposes restrictions on banks' abilities to speculate by preventing the extensive relations with hedge funds and prohibits them from engaging in certain kinds of transactions Counter - but basis risk - it is difficult at times to know whether one is hedging or speculating.

Valuation of a preferred stock

It is like a perpetuity. Dividend / discount rate = value of the preferred stock However its price on the open market always remains flat because no one would pay more for a financing instrument than the price that it can be bought out at.

Valuation of Common Stock

It is the expected value of future dividends and capital appreciation

Blockchain as a solution to the convoluted voting system

It would allow voting on a large scale basis without all of the intermediaries because the blockchain ledger would be distributed and immutable for the purposes of voting. It would prevent errors too by removing the human element. However, the tech would need to be perfect to ensure that the errors would not interfere with the true will of shareholders and the current industry players would more than likely oppose this move because it would threaten their bottom line greatly.

What is Mortgage Backed Security?

Mortgage backed security is an asset securitization in which the mortgage is placed into the special purpose vehicle, the loan payments are paid as the income stream to investors, the home owner is the lump sum value receiver and capital markets investors are the lenders. It was very popular because investors with low risk tolerance could invest in lower risk tranches filled with mortgages less likely to default whereas the investors with high risk tolerance could invest in the riskier tranches. Provided for a diversified income stream. The danger lay in the fact that the credit ratings agencies used mathematical models based on faulty assumptions to assess the riskiness of the home market not the individual homes within the market which misled investors to over-invest in the mortgage backed securities. The risks inherent in Mortgages are pre-payment risk (the risk that the holder of the mortgage pays back early) and default risk (that the holder of the mortgage cannot pay back). Both of these risks were offhanded over to other investors down the pipeline as MBS's were traded.

Duties owed to convertible bond holders

No fiduciary duties are owed to convertible bond holders until they convert their bonds into stock. The duties owed under a bond indenture are exclusively that of a contract, not equitable duties exist. Any term in an agreement not expressly bargained for will not be implied for the purposes of identifying a breach of the covenant of good faith and fair dealing. Lorenz v. CSX corporation - there was no duty to inform convertible bondholders of a settlement, dividend or litigation because no fiduciary duties existed between the bond issuer and the bond holder because it was an indenture contract. No provision in the indenture contract provided for the need to notify unless certain conditions were met and they were not. The implied covenant of good faith and fair dealing will also not be invoked in a situation where the alleged fruit of the bargain was not actually bargained for in the agreement. The right to notification was narrowly available in certain circumstances which were not fulfilled in this context.

Objecting v. Non-objecting beneficial owners

Objecting beneficial owners do not permit their information to be public from Broadridge to the issuing institution. Non-objecting beneficial owners do permit their information to be public from Broadridge to the issuing institution The practical implication of these designations, of which the majority of beneficial owners elect to be OBO is that the company has to work within the elaborate structure of the voting system including Cede & Co. and the street names in order to be able to have influence on the ultimate beneficial owners OBO v. NOBO objecting beneficial owners v. non-objecting beneficial owners (unknown to Issuing company v. known to the issuing company) (easier to get v. harder to get access to)

Brokers and market makers in the securities markets

One places an order for a purchase or sale of a stock in the stock market. The broker turns around and places an order to a market maker on a stock exchange like the NASDAQ or the NYSE. The market maker starts with an ask for the sale and finds buyer for the bid and flips it to make money. The smaller the bid ask spread the more liquid and efficient the market is. Unlimited bid ask spreads do not occur because of the competition between market makers.

PV of a Constant Growth Stock

PV = D * ((1+g) / (r - g)

Liquidation preference for preferred shareholders = double dipping distribution vs. straight preference

Preferred shareholders are behind debt holders but ahead of common stock when it comes to distribution of proceeds at liquidation. Straight distribution in a straight distribution for preferred shareholders, they receive the value of their investment cost plus any accumulated dividends before common stock shareholders receive anything Double dipping distribution in a double dipping distribution, the preferred shareholders receive their initial investment cost back plus any accumulated dividends but also receive a percentage of the proceeds that are being split amongst common stockholders as well.

Change of Control Covenant

Provides for the buyout of the pre-existing creditors when ownership changes hands.

Shareholder rights - Proxy Voting

Proxy voting is the system by which the shareholders are able to exert their influence over the corporation by approving or denying through vote the happening of major corporate events including mergers, dissolutions, major sell offs. They can also vote to alter or eliminate by-laws.

Commodities Futures Trading Commission (CFTC)

Regulates futures, forwards and options regardless of whether the underlying asset is physical or intangible.

Indenture Trustee's responsibilities

Responsibilities - to monitor the activity of the bond issuer to make sure that there is no default - its duties are limited before default - it is liable for its own negligence - its primary responsibility is to learn of default and then inform the bondholders - it has to use the standard of care of the prudent man once the breach occurs - it has to notify the bondholders within 90 days of default. - communicates with holders during critical events - can conclusively rely on the statements made by the required documents produced according to the indenture.

Elements of Syndicated Loans: Revolver Loans vs. Term Loans

Revolver loans - financing agreements that permit the borrower to draw on a line of credit to certain limits over time. Term loans - financing agreements that give the lended money to the borrower up front that it can then use at its disposal. Usually higher interest rates and more covenants and disclosure requirements because everything is paid up front so more risk. Common attributes - secured by the collateral of the borrower - have floating interest rates which creates interest rate risks for both of the parties - have more covenants and disclosure requirements than a typical bond agreement.

Shareholder rights: Other rights

Right to dividends Right to proceeds following liquidation if any remain after the distribution to the upper creditors under the absolute priority rule

Options Backdating

The improper practice of executives in which they backdate their decision to exercise their stock option to a date where the stock was extremely low in price even if they did not actually exercise on that date. not illegal per say but does violate sarbanes oxley act's requirement to report executive compensation within 2 days and Dodd Frank act's clawback on executive compensation earned on improper decreases. Also, can be fraudulent in financial statements to the public. Rule 102(e)(3)(i) - violation of securities laws can render an attorney unable to litigate in front of the SEC. In re Matter of David Lubben - attorney back dating the options violated the securities laws by defrauding the public and lost his ability to practice in front of the SEC.

Problem for Syndicated Loan Borrowers: Defaulting Lenders

The lender decides to not fund the loan either because it is bankrupt or because it does not want to. Poses a threat to a borrower because the lender's failure to lend may cause a disruption in the business process. In order to force a payment from a defaulting lender that has failed to fund a revolving line, a credit facility etc., one may try to remove their voting rights, not pay fees, or try to do a yank a bank to remove them from the syndicated loan however this requires that the lender is paid at par and payment of the insufficiency.

Asset Securitization

The process by which an owner of a valuable asset that generates an income stream renders that asset into a security. It does so by creating a special purpose entity (SPE or SPV "vehicle") that receives a loan from an investor through a bond, which from those proceeds the SPE uses to purchase the income generating asset from the owner. The SPE then pays off the interest and principal payments of the bond by paying the lender. The idea behind asset securitization is that the owner receives a lump sum payment in return for the proceeds from its income generating asset because the owner wants cash now through the discounted value of their asset and the investor is willing to invest to be able to receive the ROI through the income later on. The special purpose vehicle's main purpose is to strip the possession of the property from the owner so that if the owner enters bankruptcy the asset will not be subject to the effects of the bankruptcy proceeding.

trustee's lack of exclusivity to enforce claims under 316: Quadrant Structured Products v. Vertin

While the bond indenture's provisions do govern the legal actions taken under the indenture, it does not preclude the bondholders to take legal actions outside of the indenture that exist independently of it. Ex. Quadrant Structured Products v. Vertin - a no action clause forcing bondholders to give their consent to the indenture trustee before indenture trustee filed suit, did not preclude their ability to file suit to enforce the bonds because according to 316 of the TIA nothing in the indenture can limit their ability to instigate suit after a breach.

Call provisions

allows for redemption Deescalating call provisions allow for lower buyback prices as time goes on Deferred call provision allow redemption only after a certain time limit has expired. The call price effectively serves as a ceiling on the price of the bond because no one will ever pay more for something that can be bought back for a certain price call provisions make bonds less valuable to investors because the reinvestment risk rises because they could always be called back when the market rate decreases for the issuer, which limits the return for creditors. This is why callable bonds tend to trade at lower prices.

317

allows the trustee to be able to file suit to recover damages for breach of the bond's payment of interest and principal and also to file proofs of claims in a bankruptcy proceeding on behalf of the bondholders.

IPO v. Exempt Offering

an initial public offering - the first sale of securities that helps a company go from private to public which helps raise funding for the company. This is a way that many venture capitalists firms make a return on their investment. - requires a prospectus - a document that details information about the company - to be distributed to the investing public - also requires a road show which is where a lead bank spearheads an effort to raise funding from initial investors to help fund the company going forward - the subsequent public offerings are known as seasoned public offerings Exempt offerings - exempt offerings are limited financing offerings that raise funds by granting equity interests to only highly sophisticated investors

Call option vs. put option

call option gives me the right to buy whereas the put option gives me the right to sell

interest rate swaps

engaged in between two parties such as banks or companies in order to reduce interest rate mismatch exposure or to speculate on the movement of interest rates. One party exchanges a floating interest rate while the other exchanges a fixed interest rate. The differential between those two values is what is exchanged between either of the two parties. They do not actually exchange both streams of value, only the differential between the two streams of value.

Two main types of derivates: exchange traded v. over the counter

exchange traded derivatives traded through a central clearing house exchange, the products and terms are standardized, clear transparency in the value of the instruments at the end of the day, liquidity is present, counter party risk is limited because the central clearing house serves as the counter party and margin must be posted over the counter derivatives traded in between individual parties, decreased liquidity, collateral negotiated between the parties, valuation is less clear because both parties use different assumptions in their models, and more customization of the terms by the parties.

Black Scholes Model: 5 determinants and how they impact the pricing of the option

exercise price current stock price volatility in the stock price expiration date risk free interest rate if stock price increases, gains increase for call and decrease for a put If exercise price increases, gains decrease for a call and increase for a put. If volatility increases, gains increase for a call and for a put because more movement is possible. If expiration date is extended later, gains increase for a call and for a put because more movement is possible.

What is a convertible instrument?

gives security holders the ability to convert their security into another form of security when certain conditions are met or at their own discretion Convertible bonds Convertible preferred stok

Put provisions

gives the creditor the right to sell back the bond at their discretion

Preferred stock's status as a hybrid security

it does not have a maturity date like common stock but also has a fixed, steady payment like a bond

Difference between low risk and high risk attributes of syndicated loan agreements

low risk - aimed at commercial banks, short term periods, low interest rates, fuller amortization, clear prioritization scheme high risk - aimed at hedge funds, long term periods, higher interest rates, less full amortization, foggier prioritization scheme.

318

mandatory provisions of the TIA will overrule conflicting provisions of the bond indenture.

Bankruptcy's treatment of derivatives contracts

most of the time securities contracts are protected from the touch of bankruptcy as fraudulent transfers or voidable preferences when margin is placed with another entity. this is done in order to promote the integrity and efficiency of capital markets. These are known as safe harbors which allow creditors to still enforce the terms of their derivatives agreements even if the other party enters into bankruptcy.

315(c) of Trust Indenture Act

requires the trustee to carry out its rights and powers according to the standard of the prudent man

315(b) of trust indenture act

requires the trustee to notify the bondholders of defaults of which it is aware.

Basis risk

the risk of speculating instead of hedging when on is trying to hedge. it is the risk that instead of one's hedge limiting one's losses, it actually amplifies those losses. but it can also work in the opposite direction by amplification of gains.

Uses: Hedging and Speculating

Hedging - a trade made to limit one's losses. one locks in a future price to buy or sell at to prevent losses in the case of a great price fluctuation Speculating - a trade made to increase one's exposure to profit on movements in the stock market but with likelihood of loss as well

Cumulative attribute of preferred stock

If management wishes to pay out a dividend to common shareholders, it must pay out a dividend to preferred shareholders equal to all of the previously missed dividends.

151 of Delaware Code

Delaware's code 151 allows the individuals who found the company to set up the corporation in such a way that it permits the shares of the company to have different attributes some of which that have higher voting powers. The higher voting powers are only issued to company insiders whereas the rest of the equity holders receive different shares with less power. This essentially means that the non-insider investors are making a bet on the managment since MGMT controls the stock with all of the voting power.

Rules of Certificate of Designation Interpretation: Contract

A certificate of designation will be interpreted like a contract. The contracts terms will be construed based on their plain meaning. No rights or duties will be presumed other than what was expressly said. Any rights, duties or privileges that are distinct from common shareholders in the certificate of designation for preferred shareholders must be expressly written down in the certificate of designation. Any mistake by the corporate drafter that could mislead the reasonable investor, shall be construed in favor of the reasonable expectation of the investor against the drafter. A court interpreting any contractual provision must give effect to all of the terms of the instrument, must read the instrument as a whole, and must reconcile ambiguous terms with the rest of the meaning of the contract. Elliot Associates v. Avatex Corporation

Syndicated Loan Contract Interpretation: Meeting of the Minds and condition precedent

A court will be hesitant to find that a condition precedent went unfilled as to prevent the finalization of a contract if the parties had mutually assented in their emails and statements to one another in phone calls unless there is an explicit and clear statement that requires a final agreement and a security deposit before the contract will be found enforceable. Stone Capital Managment LLC v. Bank of the West where emails and phone calls indicated that the parties meant to be in a mutual agreement for a contract, the court found that later requirements like a final copy of the agreement and the payment of a security deposit were only conditions subsequent and not necessary for the agreement to be finalized.

Credit default swap: Interpretive Analysis

A court will evaluate different credit default swaps derivative to one another on an independent basis and will also interpret the language used relevant to the country of origin's take on the language. Aon Financial v. Societe General Where there were a number of credit default swaps, the default of one did not mean the default was triggered on the other inducing a payout from the protection seller. This was because the terms of the second CDS were different than the first and did not account for sovereign default's absence of the meaning of a separate government entity associated with the government but not part of the government. Demonstrates that basis risk exists when using swaps because if contracted improperly can result in a default.

Syndicated Loan Contract Interpretation: Contradiction of Market Practices

A court will hesitate to infer a meaning to a clause in a contract if that meaning would contradict typical market practices and complicate the typical transaction unless the parties expressly contract for that arrangement. Tael One Partners Limited v. Morgan Stanley & Co. Where an agreement provided that value would accrue once its destination was determined, accrual was determined to mean not the accumulation of interest and payment of that interest to a previous holder of the bond but rather meant that value would accrue to the individual that held the bond when it matured. The former interpretation would complicate the processing of the transaction and go against the norms in those kinds of transactions and the parties did not expressly contract for that interpretation, which they could have.

Single Name Credit Default Swap

A credit default swap is a contract entered into by a buyer and seller. The buyer pays for the credit default swap by making payments every month to the protection seller in the case that if the company's investment defaults, the buyer will be protected by the sellers payout. It is a lot like an insurance contract. The seller assumes the risk of the default and the buyer gets an investment worthy of higher credit.

What is a derivative?

A derivative is a contract that has a value that is based upon a value of an underlying asset

Participating Dividends

A feature of preferred stock that allows the preferred shareholder to earn the pre-set amount of dividends but also receive any excess value over that pre-set amount that was paid to the common stockholders as well.

Syndicated Loan Agreements: Duty to disclose and duty to inspect Aiding and Abetting

A lead bank i.e. lead arranger usually does not owe a duty to disclose misrepresented details or a duty to inspect for misrepresented information on behalf of the co-lenders because the co-lenders bare a relationship with the borrower so they should do their own due diligence. However, the lead bank can still be subject to a criminal charge of aiding and abetting if it can be shown that it knowingly passed along fraudulent information to the co-lenders because then the lead bank is assisting with fraud to some extent. Unicredito Italiano Spa v. JP Morgan Chase Bank Fraudulent documentation passed along from JP Morgan, the lead bank, to Unicredito the co-lendor may have subjected JP Morgan to aiding and abetting liability if they truly did know that it was fraudulent when they passed it along but it did not breach a duty to disclose or a duty to inspect because that duty was not contracted for and was actually expressly contracted against.

Subordination clause interpretation

A subordination clause must be read with regards to the direct language, the intent to subordinate, its context within the overall agreement, and the market in which contract had a particular purpose. It must be read narrowly in light of the overall intent to subordinate. In re MPM Silicones LLC A subordination clause, that rendered any creditor with a right to payment below any others to be subordinated regardless of lien subordination, did not subordinate a creditor above all others in terms of right to payment yet below others in terms of lien subordination.

What is a swap?

A swap is a reciprocal forward contract in which the parties exchange streams of values at pre-set time intervals. Swaps are used when one wants to alter the attributes of an interest on their balance sheet yet they do not want to sell the interest. Different kinds of swaps - currency swaps, interest rate swaps, commodities swaps, credit default swaps, equity swaps, total return swaps

What is a warrant?

A warrant is an option like instrument that allows a warrant holder to purchase stock in a company at a price usually a bit higher than the current stock. Can dilute previous shareholders shares because one must issue new shares. Usually used to sweeten a deal.

Acceleration Clauses treatment of penalty premiums from make whole call provisions

Acceleration clauses that force payments for premiums and all other monies due under the note at the time of bankruptcy does not include a premium for a Make Whole Call Provision unless expressly contracted for in clear and unambiguous terms. Minority: 3rd Circuit allows for the acceleration of the premium even if the make whole call has not occurred yet.

Letter of credit facility

Allows a company to pay for its expenses on credit through this line of financing but at a low interest rate since it is guaranteed by a bank.

Make Whole Call Provisions

Allows the borrower to redeem the bonds for an extra fee after a special (fee-less) redemption period passes but they also must redeem before the bond has been paid back. Helps protect the creditors.

Poison Put

Allows the holder of a bond to force the redemption of that bond if the purchase of the majority of the shares of the company by one shareholder causes the value of the company to diminish dramatically

Bonds after the indenture: X clause interpretation

An X clause must be interpreted according to the language of the clause, but also regarding the market context in which the agreement is used, the full language of the agreement and the purposes of subordination. In re Dura Automotive Systems An X clause that provided subordination of the senior notes to junior notes when new classes of stock were issued was interpreted to not subordinate the senior notes to the junior notes because that contradicted the definition of the agreement for the junior notes as debt financing, not new classes of stock, the overall market purpose of X clauses which is usually not to allow junior to exceed senior and the purpose of subordination which is to make senior debt priority over junior debt.

Subordination clauses

An express consent from a creditor to subordinate their right to payment to other creditors so that the other creditors get paid before the subordinated creditor

314(a): reporting requirements of the Trust Indenture Act

An indenture trustee shall not be liable for negligence for failing to notify the bondholders of fraudulent or misleading language in a financial statement because 314(a) only requires the reporting of the same financial statements to the bondholders as the bond issuer delivers to the SEC. It is simply a reporting mechanism. So long as the document filed with the SEC is identical to the document delivered to bondholders no liability exists. Racehorse Partners v. JP Morgan Chase Bank - fraudulent financial statements delivered to distressed debt investor did not give rise to liability to the indenture trustee because the delivery was sufficient under 314(a).

What is an option?

An option is the right to buy or sell for one party and the obligation for the other to sell or buy at a pre-determined price if the initial party elects to exercise their option. The return is equal to the difference between the strike price and the market price after transaction costs are subtracted out.

Voting process between the chain of organizations

Corporation needs to get a vote for an important corporate action so they solicit proxy voting. First they notify the record holders which is almost always Cede & Co within the Depository Trust Company. DTC then notifies the street name institutions such as banks and brokerages that can contact the beneficial owners. The street name banks and brokerages contract the beneficial owners of the stock through the use of a business known as Broadridge Co. which informs beneficial owners and collects their votes regarding the proxy vote. Then the beneficial owners vote, pass their votes to Broadridge, Broadridge reports them back to the banks and brokerages, then the banks and brokerages pass them to Cede & Co. and DTC which then process the votes onwards to the corporation. So it goes up the line and down the line like this: Public Corporation > < DTC (Cede & Co.) > < Street Names > < Broadridge > < Beneficial Owners (the shareholders)

Death Spiral Convertibles

Definition: A convertible agreement that allows the holder to purchase a value of shares at a fixed price through conversion instead of a number of shares. They become death spirals when the holder is not prohibited from shorting the stock by the agreement, which allows them to drive the price of the stock downwards which eventually allows them to purchase more shares because the value remains fixed. They convert their debt into shares of stock which they then use to cover their short position. This leads to a repetitive feedback loop to lowering the share price and gaining more shares. Usually engaged in because the party does not have any other choices but needs financing. Rule In order to be able to sue under 10b-5 one must have been an buyer or seller of securities. Rule Common law fraud requires that a plaintiff must either: i) demonstrate a legal duty separate from the duty to perform under the contract or ii) demonstrate a fraudulent misrepresentation collateral or extraneous to the contract or iii) seek special damages that are caused by the misrepresentations and unrecoverable as contract damages Log on America LLC v. Promethean Asset Managment no fiduciary duty existed between the issuer and convertible holder because it was just contractual debt so convertible holder could perform debt spiral operation without being fraudulent. the plaintiff was also neither a buyer or seller of securities in the transaction that was involved with the death trap convertible process so could not sue for fraud on the basis of 10b-5. The terms of the contract did not prevent the bond holder to convert a certain date or to refrain from short selling so nothing stopped it from doing the death trap convertible.

Common features of preferred shares of stock

Dividends - cumulative v. non cumulative. Participating v. non-participating. Must pay preferred shareholders before common shareholders Voting rights - none usually except for in extreme circumstances

Preferred Shareholders' rights according to the certificate of designation Entire Fairness Standard

Entire fairness standard one does not evaluate between shares but rather fairness is evaluated by looking at the history of the disbursements and treatment of the shares as compared to its treatment now. applied when an executive has a conflict of interest that may lead him to enrich himself at the expense of the other shareholders. Certificate of Designation Unless the preferred shareholders had contracted for better treatment in the certificate of designation they will not receive any form of special treatment in evaluation of the fairness of a transaction above the normal fiduciary duty owed from a corporation to a common shareholder. Marilyn Jedwab v. MGM Grand Hotels, Inc.

Shareholder's rights - Voting rights: Cumulative vs. Straight

Equity shareholders either get a right to vote in a cumulative system or a straight system. In a cumulative system of voting, the shareholders get to aggregate their votes onto certain seats rather than others which gives minority shareholders the ability to get someone they are interested in onto the board. In a straight system of voting, the shareholders can vote the number of shares they have for each seat available which essentially means that a majority shareholder can dominate the board with their picks

Rules regarding potential errors in the voting system

Rule 1: the stockholder may only seek appraisal rights when it comes to challenging a merger in the case that they neither voted in favor of the merger nor consented to it in writing. Rule 2: when the stockholder consents to the voting system in place through their street name institution, the stockholder assumes the risk that they may be bound by an error in the voting system. While the proxy voting system in place creates efficiencies in the voting process, it does create a vulnerability for large scale error since all of the voting is channelled through one passage way. In re Appraisal of Dell - a broker, that voted through a system that usually was defaulted to be aligned with management but this time wanted to vote against management yet the computer system remained constant due to error, was unable to obtain appraisal rights or for its clients because they had assumed the risk that error may occur. they had to reimburse the clients for their losses which fortunately insurance paid for. the brokerage was unable to sue the IT company for the error because they were only voting what they received from the broker.

Regulatory legislation and systems upon the common stock framework of America

Securities act of 1933 - regulates the market between the initial issuances of security and the subsequent purchaser of that security - so it regulates Initial Public Offerings and Prospectuses Securities Act of 1934 - regulates the market between secondary purchasers of securities - regulates stock exchanges

Share ownership: Securities Depository

Shareholders, and at least 75% of all shares held by those shareholders, invest through street name brokerage houses and banks. These brokerage houses and banks place the shares with security depositories. The only remaining one in the US is the Depository Trust Company (DTC) which conducts its share exchange business under Cede & Company. The street name brokerage houses and banks place their securities with DTC through the subsidiary Cede & Co. So, the record holder for the vast majority of shares in major publicly traded companies that are incorporated in Delaware is actually Cede & Co. It is virtually impossible to identify the identities of private shareholders.

Problems for Syndicated Loans: Unwanted lenders

Sometimes a company will sell its interest in a loan to a company that the debtor does not want to deal with, like a hard-lining distressed debt investor that bears no sense of community with the lender. In order to get rid of the assignee, the debtor will often times have to pay off the debt or get another entity to pay to assume the debt from the assignee.

Three bodies of law that regulate publically traded companies

State corporate law Securities laws such as the 33 and 34 acts Exchange rules - requires elevated standards in the most prestigious stock exchanges in order to maintain the integrity of the stock exchange

Terminology involved with options

Strike price or exercise price - the price at which one can exercise the strike or exercise price European vs. American options - European options may only be exercised on a designated date - American options may be exercised at any time leading up to the expiration date In the money - means that the market price exceeds the strike price for a call option. Means that the strike price exceeds the market price for a put option. at the money - Breakeven point out of the money - means that the strike price exceeds the market price for a call option. or that the market price exceeds the strike price for a put option.

Bond Indenture Interpretation in the Second Circuit

The purpose of interpretation of the bond indenture should be to give the intent of those who agreed to the contract the full effect of their intent, in light of the plain meaning of the language and the contract's meaning as a whole. A bond indenture is ambiguous when viewed objectively by a reasonably intelligent person could be interpreted to have multiple meanings when examined in the context of the entire integrated document and who is cognizant of all the customs, practices, usages and terminology relevant to a given industry. Cheaspeake Energy Corp. v. Bank of New York Mellon a bond indenture was not ambiguous with language that required to give notice and redeem within a certain time period because it meant that one must give notice to the bondholders and pay the bondholders back within that time range, not just commence the redemption process within that time span.

Comparables

The use of the average ratio for all companies in an industry to estimate the valuation of a new company coming to market or for the use in a merger or acquisition. Different multiples - price to earnings ratio - price to book ratio - Enterprise value (market value + debt - cash) / EBIDTA ratio - price/ sales ratio For any of them, one calculates the ratio for the given companies in the given industry, then averages the ratios together to get an average ratio and then finally one gets the EBIDTA per share or Earnings per share or the target company and multiplies it by the average ratio to get the overall valuation. Most common valuation. DCF model is usually used to provide justification to this original form of valuation.

The decision making schema within Syndicated Loan Agreements

There are usually 3 standards for approval in loan agreements. 1) some actions can be carried out by the administrative agent without approval from the co-lenders, 2) some actions require approval of a majority of the co-lendors and 3) some actions require unanimous consent from the co-lendors. Ex. In re Chrysler - one side argued that the classification of the action required unanimous consent whereas the other argued that the classifcaiton of the actio required only majority approval. Moral of the story is that for the purposes of risk mitigation and efficiency one sometimes gives up control over decision-making when it comes to syndicated loan agreements.

Major purpose of Asset Securitization's use of SPE's and SPV's

To remove counterparty risk. The asset is removed from the credit worthiness of the owner by placing it into the Special Purpose Vehicle. It evades the bankruptcy tax which is the potential that creditors could liquidate or repossess the assess in the case that the creditor defaulted for whatever reason. Because of this securitized loans are less risky than secured and unsecured loans so they have lower interest rates.

Fiduciary Duties owed to warrant holders

Unless expressly contracted for in the warrant contract, a company that has issued a warrant will not owe a fiduciary duty compelling them to notify the warrant holder of stock split or other corporate event or to protect the value of the warrant holder. Fiduciary duties owed to stockholders do not accrue to warrant holders until the warrant holders convert exercise their warrant to purchase the stock. Paul Lohnes v. Level Three Communications - a warrant that had an anti-dilution provision that would be activated in the event of a major reorganization of the equity structure or reclassification of the securities in the equity structure was not activated in the case of a stock split because the stock split neither reclassified nor reorganized in a significant way. The warrant issuer did not owe a fiduciary duty to the warrant holder to inform them of the stock split or to preserve the value of the warrant because it was not contracted for in the warrant agreement and the warrant had not been converted into stock.

The Formula for the weighted average cost of capital

WACC = ((E / E + D + P) * expected return of equity) + ((D / E + D + P) * expected return on debt * (1 - tax rate)) + ((P / E+ D+ P) * expected return of preferred stock)

Possible rights and privileges accrued by the certificate of deposit to preferred shareholders

When dividends do not occur, a merger is about to take place that would remove their rights, or a change to the charter is about to take place that would remove their rights, voting rights may kick in. They may also receive a convertibility clause. Also a call provision which allows for a redemption.

Poling v. Caplease: Rights under state law unaffected by silent certificate of designation

While a certificate of designation can be contracted in such a way to provide protection for preferred shareholders from corporate abuse, so long as the certificate does not expressly prohibit any corporate action permitted under state law, the corporation may carry out that action. However the corporation still owes the preferred shareholder a fiduciary duty regardless just as much as normal shareholders. Poling v. Caplease: where a certificate of designation did not prohibit a company to engage in a merger, the mere fact that the certificate of designation gave the preferred shareholders the right to convert into cash during a merger does not allow them to get an injunction on the merger simply on the basis that they were unable to convert into cash because it was not a merger with a non-publicly traded entity

total return swap

a swap in which one party agrees to exchange a rate either fixed or variable in return for the total income produced and capital gains received from the appreciation of an underlying asset such as a stock, bond, or loan, etc. known as the reference asset.