Bondholders Concerned About Missed Filing Deadlines

Can a company default on its bonds if it doesn’t file its quarterly or annual financials on time? That issue has become the subject of a heated battle between BearingPoint and investors in two of its convertible securities, who claim the company is in default because BearingPoint has not filed its 2004 report or its 2005 quarterly reports. The holders of the debt are demanding that the company repay the debt immediately.

“I would not call this an aberration,” says Kenneth Eckstein, Partner at Kramer Levin Naftalis & Frankel, and chairman of the firm's Corporate Restructuring and Bankruptcy Department. “Bondholders are more and more becoming aggressive and taking action.”

Gover

“There is a growing initiative by bondholders to assert anticipatory breach claims to get ahead of troubled situations,” adds Alan Gover, partner at Dewey, Ballantine. “It’s a pressure exercise that you see going on a lot more.”

The backdrop to the dispute is the fact that BearingPoint—the $1.5 billion consultancy that was formerly part of KPMG—still has not filed its 2004 financials and 2005 quarterly reports, due in part to a Securities and Exchange Commission investigation stemming from internal control deficiencies identified on March 18, prior restatements, and other matters.

And the firm is not alone. As Compliance Week has covered extensively over the past year, a growing number of companies has been missing quarterly and annual filing deadlines, while scores are considered serial delinquents by the Commission (see related coverage at above, right).

“Wholly Without Merit”

In September, BearingPoint said it received notices of default from law firms claiming to represent certain holders of $200 million Series B Convertible Subordinated Debentures issued in December 2004, and $250 million Series A Convertible Subordinated Debentures issued in January 2005. The company said the law firms asserted that the consultancy is in default because it has failed to make certain SEC filings in a timely fashion.

"We believe these notices are invalid and completely without merit,” BearingPoint said in a statement. “It is our view that there is no requirement in the Series A and Series B Debentures for BearingPoint to file its annual and quarterly reports within the deadlines set forth in the SEC's rules and regulations."

In any case, because it received the notices, the company was entitled to a 60-day period to cure any “purported default” by filing its 2004 annual reports and quarterlies for 2005. This cure period was scheduled to expire on Nov. 8 for the Series B Debentures, and on Nov. 14 for the Series A Debentures.

SELECT POINTS

BearingPoint's key points below are excerpted from an exhibit titled, "Select Points Concerning Company's View Of It's SEC Reporting Obligations To Debentureholders," filed by the company on Form 8-K Nov. 8, 2005:

A. PURPORTED NOTICES OF DEFAULT (SERIES A/SERIES B) ARE INVALID AND WITHOUT MERIT.

A “Notice of Default” must be provided by at least 25% of the recordholders (or by the Trustee). See Section 7.01 (which specifically refers to specially-defined persons called “Holders”) and the definition of “Holder” in Section 1.01 (a Holder is a person in whose name a debenture is “registered on the Registrar’s books”) in the Indenture relating to the debentures. Exhibits 1.01 and 1.02.

NEITHER “NOTICE OF DEFAULT” IS PROVIDED BY RECORDHOLDERS.

A “Notice of Default” must be signed by the recordholders. See Section 1.04 (any notice must be signed by the recordholders in writing). Exhibit 1.03.

NEITHER “NOTICE OF DEFAULT” IS SIGNED AS THE INDENTURE REQUIRES.

A “Notice of Default,” if given by an agent, must be accompanied by written proof of the agent’s appointment. See Section 1.04 (any notice to be given by Holders may be given in an instrument signed by an agent duly appointed in writing).

NEITHER “NOTICE OF DEFAULT” IS SIGNED BY A DULY-APPOINTED AGENT WITH WRITTEN PROOF OF APPOINTMENT. INDEED, THE PURPORTED SERIES B “NOTICE OF DEFAULT” DOES NOT EVEN IDENTIFY ANY DEBENTUREHOLDERS.

The Trustee itself has not given a “Notice of Default.”

B. WITHOUT A PROPER NOTICE OF DEFAULT CONCERNING THE COMPANY’S SEC REPORTS, ANY SUBSEQUENTLY-PROVIDED NOTICE OF ACCELERATION ATTEMPTING TO FORCE PAYMENT OF DEBENTURES IS, IN TURN, INVALID AND WITHOUT MERIT.

A notice of acceleration can only be provided after a proper “Notice of Default” has been provided to the Company. See Section 7.01 (clause (g) (which refers to a failure to comply with the Company’s covenants under its Indenture (see Section 5.02)) is not an event of default unless recordholders first comply with the specific Indenture requirements). Exhibit 2.01.

NO PROPER “NOTICE OF DEFAULT” WAS PROVIDED (SERIES A OR SERIES B) TO THE COMPANY. THUS, THERE CAN BE NO PROPER NOTICE OF ACCELERATION.

If a proper “Notice of Default” had been given, at least 25% of the recordholders must sign a notice of acceleration to make the Debentures in question immediately due and payable. See Section 7.02 (if a proper “Notice of Default” occurs and is continuing, a notice of acceleration may be given (in a proper manner)). Exhibit 2.02.

NO PROPER “NOTICE OF DEFAULT” OCCURRED. NO PROPER “NOTICE OF DEFAULT” IS CONTINUING. THUS, THERE CAN BE NO PROPER NOTICE OF ACCELERATION.

C. SUBSTANTIVELY, THE COMPANY’S SEC REPORTING COVENANT ONLY REQUIRES THE FILING OF SEC REPORTS WITH THE TRUSTEE AFTER THE COMPANY FILES THE REPORTS WITH THE SEC. SEE SECTION 5.02.

The plain meaning of the language is clear (file with the Trustee “after” filing with the SEC). Since the Company has not filed certain SEC reports with the SEC, none are due to be provided to the Trustee at this time.

The Indenture section in question (Section 5.02) states in relevant part:

“The Company shall file with the Trustee, within 15 days after it files [its] annual and quarterly reports . . . with the SEC, copies of its annual report and . . . other reports . . . which the Company is required to file with the SEC pursuant to Section 13 of the Exchange Act.” (emphasis added).

Other companies do have explicit obligations to file their SEC reports on a timely basis with the Trustee. The Company does not.

Some examples are indenture provisions from a service company (Exhibit 3.01), a machinery company (Exhibit 3.02), an entertainment company (Exhibit 3.03), and a health care company (Exhibit 3.04).

When one company had a potential breach of its SEC reporting covenant for its debentures because it was not timely in delivering SEC reports to the Trustee, it refinanced with a new Indenture provision only requiring the delivery of SEC reports to the Trustee after filing with the SEC. Compare Exhibit 3.05 with Exhibit 3.06 (a pharmaceutical company).

The Company’s position is well-supported, among other things, by the legislative history of the Trust Indenture Act provision in question, a further comparative analysis, and the very context within which the Series A and Series B debentures were issued.

Source:

BearingPoint Nov. 11, 2005, 8-K Exhibit 99.8: Select Points Concerning Company’s View of Its SEC Reporting Obligations.

However, the company did not file the delinquent reports, so the lawyers deemed the company to be in violation of its covenants.

On Nov. 7, the day before the first 60-day cure period was to end, BearingPoint fired off another press release, saying it will reject as invalid and “wholly without merit” any acceleration notice that it may receive regarding its two convertible issues. "Since the alleged notices of default are wholly defective, we believe that any related notice of acceleration is in turn without any basis whatsoever,” the release stated.

“Moreover, as to the substance of the claims, it is our view that under the plain language of the relevant indenture BearingPoint has complied fully with its obligations under the Series A and Series B Debentures with respect to SEC filings.”

The company would not reveal to Compliance Week the names of the two law firms that sent the notices.

A Deteriorating Situation?

Eckstein

Lawyers not involved in the case say the issue should be fairly straightforward: Either the covenants require the company to make timely filings or not. But Eckstein at Kramer Levin Naftalis & Frankel says these explicit stipulations are “typically in bank loan agreements”; they are less common in public debt.

In BearingPoint’s case, however, the requirement seems to be clearly spelled out. According to the 8-K that detailed the debt offerings: “The company’s SEC reporting covenant only requires the filing of SEC reports with the trustee after the company files the reports with the SEC.” It then adds: “Other companies do have explicit obligations to file their SEC reports on a timely basis with the Trustee. The company does not.”

A BearingPoint spokesman says this explicit language was intentional. “These [convertibles] were issued in December and January when we knew we would have some issues regarding our ability to file,” he explains.

Wall Street’s analysts also seem to feel the issue is straightforward. “The language in both the Series A & Series B convert prospectuses is explicit that BE [BearingPoint] must provide the financials to the convert trustees only after they have filed them with the regulators,” says a recent Goldman, Sachs report. “Importantly, there is no stated deadline for BE to file the documents with the government. As a result, the potential plaintiff case seems weak in our view.”

But, even if the language was not explicitly worded in BearingPoint’s favor, lawyers say it is rare that creditors would try to accelerate the repayment of bonds simply because the issuer missed a non-financial-related promise, even if they were legally entitled to call the bonds. “It is less common to accelerate for a covenant default than a payment default,” Eckstein asserts.

Dewey Ballantine’s Gover speculates that one reason aggressive bondholders might press a company for accelerated repayment for a non-financial reason is so they can be first and get ahead of the other parties in a deteriorating situation. However, he adds, “This is more imagined than real. No debtor is going to pay out big money and favor one group.”

In addition, there are serious potential ramifications for calling bonds ahead of time. If a company doesn’t have enough cash to suddenly pay off the bonds, for example, the move could actually force the company to file for bankruptcy. And in reorganizations, it is not uncommon for bondholders to receive only a fraction of their principal. As a result, some question the bondholders’ motives in the BearingPoint incident. “I’m not saying reporting covenants are not important,” says Eckstein, “but I’m not sure [the] bondholders’ goal is to bring the situation to a head.”

Related documents released by BearingPoint can be found in the box above, right.