Thu 03/25/2021 05:00 AM
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Bond indentures, which contain the covenants governing high-yield bonds, are complex legal instruments. The language in bond indentures and offering memoranda is not always straightforward. In our Covenant 101 series, we demystify key concepts and provisions of high-yield covenants, explaining them concisely in plain English. We hope this series will be a valuable resource and reference tool for market participants’ forays into high-yield covenants.

In this installment of our Covenant 101 series we will explain the structure and constituent parts of the high-yield change of control provisions and illustrate the application of the provisions through case studies. The change of control provisions are one of the most important and often analyzed clauses in high-yield documentation. Continue reading for the latest installment of the EMEA Covenants team's Covenant 101 series, and request a trial to access legal analyses of many more debt situations in the region.

Change of control provisions can be found in many financing arrangements, including high-yield bonds. In making an investment decision, investors will evaluate the management and ownership of issuers. The change of control provisions take this into account. These provisions are designed to prevent the ownership or management of the credit from being changed or replaced without the debt investors having an opportunity to exit as well as be compensated for the premature termination of their investment.
What happens if there is a Change of Control?

The change of control provisions protect investors by giving bondholders a right to sell their bonds back to the issuer in the event of a change of control. The issuer is required to make an offer to buy back its bonds, typically, at a price of 101% within a specified time period after a change of control occurs - this is known as a change of control offer. In most cases, an acquirer can make the change of control offer on behalf of the issuer. Triggering a change of control offer can have a costly impact on a proposed M&A or leveraged buyout transaction.

A potential change of control offer will also often have an economic impact in the secondary market because market participants will anticipate the offer to purchase at 101%. The change of control provision provides investors an opportunity to take a second look at their investment in the issuer and decide whether they want to continue holding that bond following the change to the credit. At the same, the change of control provisions may also buoy the bond price while the investors make that decision. Without such provisions, a potential change of control could lead to a steep fall in prices.
What Is a Change of Control?

The first threshold question in determining whether there is a change of control with respect to a high-yield bond issuer is to analyze the definition of “Change of Control” used in the indenture governing the bonds, which can also be found in the offering memorandum.

Typically, “change of control” is defined in relation to:

  1. Beneficial ownership and

  2. Sale of all or substantially all assets.

Other measures are also sometimes used by issuers, such as an insolvency event or a change to the parent company, for example if a new holding company is introduced. Historically, a change to the majority of the board of directors was also a change of control but that measure is now seen less frequently.

A sample definition of “Change of Control” is below:
“Change of Control” means the occurrence of any of the following:
(1) the consummation of any transaction (including, without limitation, any merger or consolidation) the result of which is that any “person” (as that term is used in Section 13(d)(3) of the Exchange Act) becomes the Beneficial Owner, directly or indirectly, of more than 50% of the outstanding Voting Stock of PublicCo, measured by voting power rather than number of Equity Interests;
(2) the direct or indirect sale, transfer, conveyance or other disposition (other than by way of merger or consolidation), in one or a series of related transactions, of all or substantially all of the properties or assets of FinCo and the Guarantors, taken as a whole, to any “person” (as that term is used in Section 13(d)(3) of the Exchange Act), other than to any Parent and any Subsidiary of any Parent; and
(3) the adoption of a plan relating to the liquidation or dissolution of the Issuer or any successor thereto.

Calculating Beneficial Ownership

Generally, if beneficial ownership of a majority of voting power of the issuer of the bonds or the main operating company in the group changes hands, this would fall within the definition of change of control. The concept of beneficial ownership in most high-yield bonds is based on U.S. securities laws and typically make reference to specific rules of the U.S. Securities and Exchange Act of 1934. As a result, the jurisprudence and interpretations under such rules are incorporated in the use of the term. A beneficial owner is defined as any person who, directly or indirectly, has or shares voting power and/or investment power over the voting stock of the company. In essence, the beneficial ownership concept requires looking through layers of ownership to identify the ultimate control entity and looks across as well to entities under common control. In the case of a “group” that is under common control, the beneficial ownership of one entity is attributed to the whole group. Control can be exercised through the ability to vote or the ability to dispose of the bonds and bonds can be beneficially owned by more than one person.
Sale of All or Substantially All Assets

As mentioned in our Covenants 101 on the merger covenant, the interpretation of “all or substantially all” assets is uncertain under New York law, which governs most high-yield bond documentation, and there is no bright line rule.

What constitutes “substantially all” assets is determined on a fact-based inquiry, looking at both quantitative and qualitative factors. Factors that have been examined by courts in litigation surrounding the meaning of “substantially all” include what percentage of consolidated assets were represented by the assets sold, what percentage of consolidated sales and EBITDA were represented by the assets sold, whether the assets comprised the “crown jewels” of the group’s business, whether the assets formed part of a separate, standalone business, among others. If the proposed transaction is a sale of all or substantially all assets, then a change of control offer would be triggered.

In the case of a sale of all or substantially all assets, it may trigger both the change of control provisions and the merger covenant unless there is an exception made to the change of control definition for a sale of all or substantially all assets by way of a merger. Therefore, both the change of control provisions and the merger covenant should be examined.
An Exception to Change of Control: Permitted Holders

One of the biggest carve-outs or exceptions to the change of control provisions is the concept of “Permitted Holders”. Even if a transaction would otherwise constitute a change of control, if the new owners are certain designated “Permitted Holders” then the transaction will not be deemed a “Change of Control” under the bonds and no put option will be available.

The definition of “Permitted Holders” can be more or less expansive, depending on how aggressive the documentation for the bonds might be. The term varies deal-by-deal and is tailored to each credit. Initial equity holders, founders, private equity sponsors and management are often included in the definition; whether each of their related parties or affiliates, such as portfolio companies, are also included is often negotiated. If portfolio companies are captured by the definition, then a private equity sponsor has the ability to sell or combine the issuer of the bonds with other companies in its portfolio without having to make a change of control offer and give investors a second look at the changing credit. In deals where the Permitted Holders is defined broadly, this is sometimes considered “disguised portability” because it allows the bonds to be ported to a new owner without having an explicit double-trigger.

A sample definition of “Permitted Holders is below:
“Permitted Holders” means, collectively, (i) the Investor, (ii) the Management Stockholders (including any Management Stockholders holding Capital Stock through an equity holding vehicle), (iii) any Person who is acting solely as an underwriter in connection with a public or private offering of Capital Stock of any Parent Entity or the Issuers, acting in such capacity, (iv) any group (within the meaning of Section 13(d)(3) or Section 14(d)(2) of the Exchange Act or any successor provision) of which any of the foregoing, any Holding Company, Permitted Plan or any Person or group that becomes a Permitted Holder specified in the last sentence of this definition are members and any member of such group; provided that, in the case of such group and without giving effect to the existence of such group or any other group, Persons referred to in subclauses (i) through (iii), collectively, have beneficial ownership of more than 50% of the total voting power of the Voting Stock of the Issuers or any Parent Entity held by such group, and (v) any Holding Company. Any Person or group whose acquisition of beneficial ownership constitutes a Change of Control in respect of which a Change of Control Offer is made or waived in accordance with the requirements of the Indenture, or a Permitted Change of Control, will thereafter, together with their Affiliates, constitute an additional Permitted Holder.

In bonds that have a portability feature (which we discuss further below), any persons or groups that acquire beneficial ownership in a transaction where the portability feature is used, may automatically become a Permitted Holder under the bonds. This language can be found in the last sentence of the sample definition above.
Portability: Two Different Types

Portability is another exception to the change of control provisions. While it was once seen as an aggressive term in Europe pushed by only the most heavyweight private equity sponsors, it is becoming more and more prevalent and can now even be found in some leveraged loan agreements. By creating an exception to the change of control offer, the bonds become portable, allowing a potential acquirer to buy an issuer without having to make a change of control offer and buy back any tendered bonds.

When portability is included as a carve-out, the change of control provisions are often referred to as having a “double-trigger” - a Change of Control as defined on its own will not trigger a change of control offer. The second trigger is usually either a leverage-based test or a ratings-based test (in some deals, both triggers will be included).

Using the portability feature can result in a re-set of the build-up basket under the restricted payments covenant.
Leverage-based Portability

For bonds that have a leverage-based portability clause, a specified leverage ratio would have to be exceeded, on a pro forma basis, for a change of control offer to be triggered. The test ratio for the portability exception is often found in the definition for “Specified Change of Control Event” or “Change of Control Triggering Event”.

There are a number of key points that are negotiated in leverage-based portability clauses that follow along the same lines as other leverage-based tests that feature in high-yield bond documentation.

  • How much (or sometimes even whether) the company will have to delever for portability to be accessible from opening leverage;

  • Calculation of leverage on a net or gross basis;

  • EBITDA add-backs to improve leverage ratios, including pro forma for the proposed transaction; and

  • Other calculation flexibilities that seek to lower the leverage ratio to be met to achieve portability, including testing the portability ratio ahead of the consummation of the change of control.

Usually leverage-based portability can only be used once during the lifetime of a bond (as shown in the sample language below) but there are aggressive deals that allow multiple or unlimited uses of the feature. Additionally, the ratio test may be subject to step-downs over the life of the bond. For example, in the sample provision below, the ratio test tightens after the second anniversary of the issue date. This reflects investors’ expectations that the issuer will improve its leverage over time.

A sample leverage-based portability clause is below:
‘‘Specified Change of Control Event’’ means the occurrence of any event that would constitute a Change of Control pursuant to the definition thereof; provided that immediately prior to the occurrence of such event and immediately thereafter and giving pro forma effect thereto, the Consolidated Net Leverage Ratio of the Company and its Restricted Subsidiaries would have been less than (x) 4.5 to 1.0 if the event occurs within the first 24 months of the Issue Date, and (y) 4.0 to 1.0 thereafter. Notwithstanding the foregoing, only one Specified Change of Control Event shall be permitted under the Indenture.

Ratings-based Portability

For bonds that have a ratings-based portability clause, a credit ratings downgrade must occur in connection with the change of control for a change of control offer to be triggered.

Given that credit ratings depend on an external third party, the ratings agencies, the ratings-based portability clause is drafted to regulate and set out the parameters of the ratings action that would constitute a ratings trigger for purposes of the change of control provisions. This includes:

  • Downgrade notches - If a bond is rated investment grade, losing the investment grade may be enough to trigger the change of control offer but if a bond is not initially rated investment grade then how many notches of downgrade is required might be negotiated; in both cases, how many or whether specified ratings agencies need to take action is usually specified in the clause;

  • Time periods - When the ratings agencies need to announce an adverse action, e.g. within 60 or 90 days of the change of control announcement; and

  • Causation - whether the rating agencies’ downgrade must be specifically attributed to the change of control transaction, either publicly or by written confirmation.

A sample ratings-based portability clause is below:
“Ratings Event” shall be deemed to occur if on, or within 60 days after the earlier of, (i) the occurrence of a Change of Control or (ii) public notice of the occurrence of a Change of Control or the intention by the Company to effect a Change of Control (which period shall be extended so long as the rating of the notes is under publicly announced consideration for a possible downgrade by any of the Rating Agencies), (1) the rating of the Notes by each Rating Agency shall be decreased by one or more gradations to or within a Rating Category (including gradations within Rating Categories as well as between Rating Categories) as compared to the rating of the Notes on the Rating Date, and (2) the Notes are rated below the respective rating of the Notes on the Issue Date by both Rating Agencies.

Change Of Control Flowchart

The flowchart below depicts the general analysis to undertake when there is a potential change of control transaction. The flowchart follows the most relevant documentary and market considerations and possible outcomes.

As shown in the flowchart above, a change of control analysis, particularly in the context of an M&A transaction, requires consideration of both the requirements under the documents governing the bonds and the trading price of the bonds in the secondary market.

Even if a change of control offer is required under the bonds, an issuer or acquirer may want to consider open market purchases in advance of making the change of control offer if it can buy back bonds at a discount, rather than paying 101% of the principal amount in the change of control offer. Additionally, if the bonds will be redeemed as part of the financing package for the potential acquisition, then no change of control offer needs to be made under the documents. If the bonds are redeemable at par at the time of the change of control, the issuer will choose to redeem the bonds at par and save on the 1% premium it would need to pay under the change of control put option.

If the bonds are trading at a premium above 101%, then usually bondholders are unlikely to exercise their change of control put right. However, bondholders may determine that the post-change of control credit is unattractive due to leverage or other considerations and take up the change of control offer despite the market trading price.

All change of control data points tracked by Reorg Debt Explained in our Market Maker database are HERE.
Change Of Control Case Studies

Presented below are four case studies of how change of control provisions apply in M&A transactions, including links to our reports with in-depth analysis.

Case Study 1: Arrow Global/TDR Capital

In February 2021, TDR Capital announced a possible offer for Arrow Global Group plc of the entire issued and to-be issued ordinary share capital of the U.K. debt collector at 305 pence per share after previous offers were unanimously rejected.

Our legal analysts examined the possible takeover transaction and concluded it would trigger the change of control put right under the bonds issued by Arrow Global Finance plc, an indirect wholly owned subsidiary of Arrow Global Group plc. The change of control provisions did not include a portability feature.

However, both series of floating rate notes issued by Arrow Global Finance can be redeemed at par at the issuer’s option from March 1, 2021 (one series was already in its non-call period). Its fixed rate notes are currently in the last year of their call schedule and must be redeemed at a price of 101.281% until Sept. 15, 2021, after which point they can also be redeemed at par. Depending on timing, using the optional redemption provisions is likely to be the cheaper option than a change of control offer.

Earlier this month, Arrow Global announced that its board is minded to recommend TDR Capital’s revised preliminary conditional offer of 307.5 pence per share. TDR Capital has until March 23 to confirm whether it intends to make a firm offer.

Case Study 2: Entain/MGM

In January 2021, when MGM Resorts International (MGMRI) submitted a takeover proposal for British sports betting and gaming group, Entain plc, formerly known as GVC Holdings, our analysis concluded that the proposed takeover would likely trigger the change of control put option under bonds issued by Entain’s subsidiary Ladbrokes Group Finance plc. The Ladbrokes bonds contain a ratings-based double-trigger change of control provision.

With respect to the first change of control trigger, MGM’s share-for-share offer to Entain shareholders would result in a person or group acquiring more than 50% of the issued shares of Entain, the guarantor under the Ladbrokes bonds. The second ratings-based trigger was met due to the Ladbrokes bonds being rated non-investment grade.

The proposed takeover was abandoned as MGM announced it would not make a revised offer for Entain, following the rejection of their offer of 0.6 of MGMRI share for each Entain share.

Case Study 3: Groupe Ecore/Derichebourg

In January 2021, French recycling group Groupe Ecore’s shareholders entered into exclusive talks with Derichebourg to sell the entire capital stock of Groupe Ecore.

Our analysis concluded the proposed acquisition would likely trigger a change of control offer to purchase the outstanding €255 million senior secured floating rate notes due 2023 at 101%. We noted that a portability exemption would be available if significant de-leveraging resulted in the pro forma consolidated net leverage ratio being 2.25x or less at the time of the acquisition.

On March 1, Derichebourg announced that it had entered into a contract to buy Groupe Ecore subject to authorisation from the competent merger control authorities. Management of Group Ecore stated during its earnings call last Thursday that antitrust approval could take 6 to 8 months or even longer.

Case Study 4: AS Roma/Friedkin Group

In September 2020, Italian football club AS Roma launched a consent solicitation to holders of its €275 million 5.125% senior secured notes due 2024. The primary purpose of the consent solicitation was to facilitate the acquisition of 86.6% of the equity interest in AS Roma by Friedkin Group. The consent solicitation included waiving the 101 change of control put right and amend the change of control, permitted holders, and permitted reorganization language in the notes indenture. Noteholders who vote in favor of the proposed amendments by the specified deadline were entitled to receive a consent fee of 4.5%.

On Sept. 18, the company said it had received all necessary consents from bondholders to waive the put right. In our Consent Solicitation Analysis, our legal analysts examined the implications for the noteholders.

--Claudia Kim, Michael Malvenda, Aaron Spence
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