Soliciting Bondholders Pre-petition: Understanding the Basics
There is a risk with any pre-petition solicitation that the bankruptcy court later could determine that the solicitation was inadequate. If this occurs, the debtor must spend additional time and money resoliciting post-petition. Pre-petition bondholder solicitations are further complicated by the intricate structure in which the bonds generally are held. By understanding this structure and by following bondholder solicitation procedures previously approved by bankruptcy courts, the debtor and its professionals can minimize the risk of resolicitation.
In a pre-packaged bankruptcy case, the bankruptcy court has not approved the solicitation procedures to be employed prior to their implementation. As a result, the plan proponent "takes a substantial risk that, at the confirmation stage of the case, the court may determine that the proposed disclosure statement or process of solicitation are inadequate." In re City of Colorado Springs Spring Creek Gen. Improvement Dist., 177 B.R. 684, 691 (Bankr. D. Colo. 1995). A bankruptcy court must scrutinize the pre-petition solicitation process to ensure that those parties affected by the plan have received proper notice. See In re Pioneer Finance Corp., 246 B.R. 626, 633 (Bankr. D. Nev. 2000). When the creditors to be solicited are holders of publicly traded bonds, concerns about notice are heightened because the entity entitled to actually vote to accept or reject the reorganization plan is generally not accessible (or, oftentimes, known) through traditional methods of solicitation.
Who's Who in the Bond Ownership Structure
Publicly traded bonds generally are held in three layers of ownership. The few entities at the top and in the middle layer generally have no economic interest in the security. These entities, or the "middle-men," hold in name only and merely facilitate "the rapid trading and marketability of securities." In re St. Therese Care Center Inc., Case No. 4-90-7394, 1991 WL 217669 at * 2 (Bankr. D. Minn. Oct. 23, 1991). The numerous entities on the bottom layer, however, have the economic stake in the bonds. Understanding these layers can help a debtor structure its solicitation in a way that satisfies the Bankruptcy Code's concerns of "providing full disclosure to creditors so that those creditors can cast their ballots intelligently," thereby minimizing the risk of resolicitation. Id.
Layer One: The Depository Trust Company
Generally, the largest holder of the bonds at the top layer, or in the case of a global bond certificate, the sole holder, is Cede & Co. Cede & Co. is the account name used by The Depository Trust Company (DTC), which was formed in the 1960s to act as the central depository for virtually all securities held by banks and brokerage firms. DTC has no economic or voting interest in the securities it holds. DTC's sole purpose is to facilitate the electronic trading of securities between the entities that hold the securities at the second layer.
Layer Two: Record Holders
The entities that comprise the second layer of ownership are referred to interchangeably as "participants," "nominees," "record-holders" or "custodial holders." In the bankruptcy context, "record-holder" is the term of art that is most frequently used. These record-holders are generally large banks and brokerage firms that hold either for their own account, or in most cases, for the account of those below them—the beneficial owners.
Layer Three: Beneficial Owners
Although the bonds are held in the name of the record-holder, the beneficial owner has the ultimate interest in the bond. This has implications for solicitation and voting. The Bankruptcy Code provides that "the holder of a claim" is entitled to vote on a reorganization plan. 11 U.S.C. §1126(a). The holder of a "claim" is one who has a "right to payment." 11 U.S.C. §101(5). Because the beneficial holder will receive the benefits of any plan distribution, "it is the beneficial holder, not a holder of record, who has the 'claim' and the 'right to payment.'" Pioneer, 246 B.R. at 633 (denying confirmation where pre-petition solicitation materials only were sent to record-holders, not beneficial owners); see, also, In re Southland Corp., 124 B.R. 211, 227 (Bankr. N.D. Tex. 1991) (finding that beneficial owners, not record-holders, are the proper entities to vote to accept or reject a debtor's plan); Fed. R. Bank. P. 3017(e) (stating that at a disclosure statement hearing the bankruptcy court shall consider procedures for transmitting the solicitation materials to "beneficial holders" of bonds). Thus, the beneficial owner, not the record-holder, is entitled to vote to accept or reject a debtor's plan.
Structuring any solicitation requires that you not only understand the layers of bond ownership generally, but that you also understand the structure of ownership of the bonds you are seeking to solicit.
The Voting Process
The issuer of the bonds will be able to obtain from DTC a list of the record-holders, but generally not the names of all beneficial owners. In essence, you will need to structure a solicitation process that uses the record-holders as conduits to transmit the disclosure statement, reorganization plan and ballots (the "solicitation materials") to the beneficial owners. These record-holders will receive (at least in the first instance) the solicitation materials and will be responsible for making sure the materials are sent to the beneficial owners.
After a record-holder receives the solicitation materials, it typically employs one of two methods to obtain the votes of the beneficial owners. Generally, both methods have been found to be acceptable,2 and it is up to the record-holder to determine which method to use. Whichever method the record-holder chooses, the beneficial owner makes the decision of whether to accept or reject the plan.
The first method is for the record-holder to "prevalidate" the ballot before sending it to the beneficial owner. In this instance, after receiving the solicitation materials from the debtor, the record-holder would (a) indicate the beneficial holder's account number with the record-holder, (b) fill in the principal amount of bonds held by the beneficial owner, (c) execute the signature block (in the name of the record-holder) and (d) forward the prevalidated ballot to the beneficial owner with the other solicitation materials. Upon receipt, the beneficial owner's only task is to check off on the ballot whether it accepts or rejects the proposed plan. Once it has done so, the beneficial owner is then responsible for sending the completed ballot to the debtor or voting agent prior to the voting deadline.
The "master-ballot" process is the second method utilized by record-holders to process the votes of beneficial owners. In this scenario, upon receipt of the solicitation materials by the record-holder, the record-holder will forward these materials to the beneficial owner. The beneficial owner will review the solicitation materials, complete the ballot and then send the completed ballot back to the record-holder. Once the record-holder receives the executed ballots of the beneficial owners, the record-holder will complete a "master ballot."3
A master ballot is essentially a score sheet that lists the following information for each beneficial owner represented by the record-holder: (a) either the name of the beneficial owner, or more likely, the beneficial owner's account number with the record-holder, (b) the principal amount of bonds held by beneficial owner and (c) whether the beneficial owner has accepted or rejected the debtor's proposed plan. After the record-holder has completed the master ballot, it will send it directly to the debtor or its voting agent.
Tallying the Votes
After the voting deadline has expired, a voting agent will review all of the prevalidated and/or master ballots that have been timely received. The voting agent will compare the votes cast on the ballots (prevalidated and master ballots) with the record-holders' position in the bonds, as shown on DTC's records. This comparison ensures that record-holders do not vote more bonds than they hold. In the event of an over-vote, the voting agent will attempt to reconcile the amount with the record-holder. If the over-vote cannot be reconciled, the voting agent will reduce the accept and reject votes proportionately to an amount that represents the actual amount of bonds the record-holder is shown to own according to DTC's records.
As a practical matter, we would like to offer the following suggestions when contemplating a pre-petition solicitation of public bonds:
- Look for guidance from the jurisdiction in which the debtor will be filing its bankruptcy case. Familiarize yourself with the procedures that have been approved in connection with both pre-petition and post-petition solicitations.
- Involve your voting agent in structuring the solicitation. The earlier you get your voting agent involved, the smoother it will flow. While as a practitioner you may be familiar with the Bankruptcy Code and the case law, it is the voting agent's livelihood to understand the intricacies of soliciting holders of public debt. A voting agent helps to bridge the gap between the debtor and the beneficial owners, and works with the record-holders to ensure that beneficial owners receive all solicitation materials.
- Be extremely conservative in the solicitation procedures you design. For example, many judges are uncomfortable with the concept of a "deemed accept" vote (i.e., if a ballot is returned to the debtor with all information completed other than the accept or reject box, it would be counted as an acceptance of the plan).
- Make sure the ballot, master ballot and their instructions are easy to understand, and that the disclosure statement contains a good description of the process. Design the ballot so that it can be used and understood by multiple parties, including registered holders and beneficial owners, whether the record-holder uses prevalidated ballots or a master ballot.4
1 Jason A. Cohen is an associate in the Financial Restructuring Department of Cadwalader, Wickersham & Taft LLP. Jane Sullivan is a director and the head of the Bankruptcy Specialty Practice at Innisfree M&A Incorporated. Return to article
2 See, generally, Procedural Guidelines for Pre-packaged Chapter 11 Cases in the U.S. Bankruptcy Court for the Southern District of New York, General Order 203 (amending General Order 201), dated Feb. 24, 1999 (providing for the use of prevalidated ballots and master ballots to report voting by beneficial owners of claims, and attaching samples of each as exhibits). Return to article
3 It is up to the record-holder to establish an internal deadline by which the beneficial owners must return the executed ballot to the record-holder. This will provide the record-holder with sufficient time to complete the master ballot and return it to the debtor or its voting agent prior to the voting deadline. Return to article
4 See In re ZiLOG Inc., Case Nos. 02-51143-MM and 02-51144-MM (Bankr. N.D. Ca. 2002) (using "plain English," as required by California courts, the ballots and instructions utilized in this pre-packaged bankruptcy case are a good example of clear, well-written procedures). Return to article