A recent decision by New York County’s Commercial Division threatens to be a new tool for helping shareholders make big returns in a short period of time. In Bank of New York v. BearingPoint, Inc., No.600169/06, 2006 N.Y. Misc .LEXIS 2448 (N.Y. Sup Ct.Sept.18, 2006), a Supreme Court judge ruled that a bond issuer violated the terms of its indenture by failing to file financial reports with the Securities Exchange Commission ("SEC") and the indenture trustee. In the past, bondholders have not typically viewed such a filing delinquency as a material breach. Peter Lattman & Karen Richardson, Hedge Funds Play Hardball With Firms Filing Late Financials, Wall St.J., Aug.29, 2006, at A1. Instead, bondholders would either ignore the failure to file or look the other way upon receiving minimal consent fees from the bond issuer.Id. A new trend is emerging, however, as an increasing percentage of corporate bonds are held by activist investors and event driven hedge funds who use their equity or debt in companies to force corporate action by managers.These investors can make substantial profits by buying bonds, often below par value, and forcing accelerated redemption at par value from delinquent filers. Caroline Salas, Hedge Funds Threatening Option Scam Defaults Win Case, Bloomberg News, Oct.6,2006, http://www.bloomberg.com (search "Search News"for "Hedge Funds Threatening"; then follow hyperlink to article). Companies that do not have the resources to redeem their bonds on an accelerated basis are sometimes willing to pay large fees to avoid insolvency and bankruptcy.Id.
BearingPoint, Inc., a publicly held global management and technology consulting firm, issued $175 million of 2.27 percent convertible bonds to be due in 2024. BearingPoint, 2006 N.Y. Misc. LEXIS, at *2. Due to internal accounting problems, BearingPoint failed to file its annual report for year-end 2004, then subsequently failed to file its next two quarterly reports. Id. The company also failed to file copies of the annual and quarterly reports with the indenture trustee, as it was specifically required to do under the indenture. Id.
In response to these failures to file, The Bank of New York, as indenture trustee on behalf of all holders of the bonds, served BearingPoint with a notice of default, giving the company sixty days to cure the default. Id. at *3. When BearingPoint still failed to provide the reports within the cure period, the trustee served a notice of acceleration upon the company demanding the outstanding debt be paid in full. Id. at *4. BearingPoint ignored the notice of acceleration, and The Bank of New York brought suit against BearingPoint for breach of contract. Id. at *5. The Bank of New York alleged that BearingPoint breached the indenture by failing to file with the trustee, and also by failing to file with the SEC, which the trustee claimed was a condition precedent for filing with the trustee. Id. The trustee sought either an acceleration of the debt, or damages. Id. at *6.
BearingPoint responded that its obligation to provide copies of reports to the trustee was dependent upon its filing with the SEC, and that it did not have an independent duty to the Bank of New York to make any SEC filings. Id. at *10. Thus, BearingPoint claimed that it could choose not to file with the SEC, and therefore avoid its obligation to file with its investors. Id. at *18.
The court rejected BearingPoint’s argument, asserting that BearingPoint’s "tortured parsing"of the filing provision in the indenture "vitiates the clear purpose of the Indenture to provide information to the investors so that they may protect their investment."Id. The court observed that "only by guarding against incomplete information, can investors make informed decisions about their investment and guard against the risks attendant to incomplete information."Id. at *20. In support of its decision, the court pointed to the language of the indenture, which expressly required the company to file with the trustee copies of any documents that it was required to file with the SEC under Sections 13 or 15(d) of the Exchange Act. Id. at *18.
The court was also influenced by language in the indenture requiring the company to comply with Section 314(a) of the Trust Indenture Act of 1939 ("TIA"). Id. at *19. The TIA prohibits the sale of bonds over $5 million unless the issuer and holders sign an indenture detailing the terms of the bond issue. 15 U.S.C. § 77nnn. The TIA also requires the appointment of an indenture trustee who may seize company assets in the case of insolvency. Id. Section 314(a)(1) of the TIA specifically provides that the issuer must file copies of its SEC filings with the appointed indenture trustee. Id.
Because BearingPoint failed to fulfill its filing obligations, the court granted summary judgment to the plaintiff on the breach of contract claim and ordered a trial to determine damages. BearingPoint,2006 N.Y.Misc.LEXIS,at *23. However, the parties subsequently came to an agreement upon which BearingPoint would file their financial reports on an agreed-upon schedule and pay a higher interest rate on the debentures if the plaintiffs would discontinue the lawsuit. Press Release, BearingPoint, BearingPoint Reaches Agreement in Principle with Holders of a Majority of Series A and B Debentures for Consents and Waivers and to Drop Pending Lawsuit (Nov.3,2006), http://www.bearingpoint.com/ (follow "News"menu to "Press Releases").
The BearingPoint decision was handed down at time when many corporations are vulnerable to similar claims. The SEC is reportedly investigating over 120 companies for fraud related to the back-dating of stock options to executives. Lattman & Richardson, supra at A1. As these companies scrutinize their financial statements for inaccuracies that may have resulted from the back-dating, some miss their filing deadlines. Id Delinquent filers are susceptible to default notices, litigation, forced bond redemptions, and consent fee negotiations. Because the back-dating scandal has also caused the bonds of the companies under investigation to trade at lower prices, bondholders may be further tempted to give notice of default and demand acceleration so they may recoup their investment at face value. Over the past eighteen months, at least twenty-five companies have had their bonds accelerated or were forced to pay multimillion dollar fees to bondholders.Id.
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