Enter to open, tab to navigate, enter to select
Financial Crisis Series: Impact on Companies
Practical Law Article 7-384-0312 (Approx. 15 pages)
Financial Crisis Series: Impact on Companies
by PLC Corporate & Securities and PLC Finance
| Published on 13 Feb 2009 • USA (National/Federal) |
This Article is part of a series on the causes and impact of the financial crisis and gives an overview of the impact of the financial crisis on companies.
Financial Crisis Series
This Article is part of a series on the causes and impact of the financial crisis. The other practice notes in the series are:
What Steps should Companies take if Major Customers or Suppliers are in Financial Difficulty?
There are certain steps a company can take to protect its business if its major customers or suppliers are in (or are at risk of experiencing) financial difficulty.
Customer in Distress
Even before a customer files for bankruptcy or otherwise alerts the company that they are in financial difficulty there are practical steps the company can take to protect against the possibility of a key customer defaulting.
Stay Informed
Having up-to-date information on the customer will enable the company to protect itself in the most efficient way possible.
- Talk to the sales force. The sales force is in close contact with customers and can observe their condition as well as listen for rumors in the industry.
- Watch out for signs of trouble such as abrupt management departures or other major changes.
- Subscribe to and closely monitor business reports (for example, Dun & Bradstreet reports) which provide important information such as payment history of key customers.
- Consider asking customers for updated credit applications. These credit applications will contain updated financial information about the customer.
Maintain Contact with Customers
If a customer is in financial difficulty and cannot meet all of its payment obligations, the supplier that it is in most contact with is often the first paid. It is therefore good practice to have the accounts receivable department follow-up with customers regularly to help increase the chances of the company getting paid ahead of other potential creditors.
Set-off Unpaid Amounts
If a customer has stopped making payments, consider taking permissible set-offs against any amounts the company owes to them. It is important to advise accounts receivable, customer service and sales departments of this action so that they are prepared to communicate with the customer.
Contractual Protection
When a customer appears to be in financial difficulty, other steps the company should take include:
- Review terms and conditions of any credit arrangements and seek to renegotiate payment arrangements in the company's favor. Enforce credit limits strictly.
- Seek cash-advance payments where possible. Review rights to terminate contracts.
- For large customers consider alternative methods of protection such as:
- Letter of credit. A letter of credit guarantees the customer's payment up to a stated amount for a period of time.
- Guaranty. If possible, obtain a guaranty of payment from the customer's parent company or affiliate.
- Take out credit insurance. An insurance policy between the supplier and an insurance company insuring against risk of the customer's default.
Protections Available Under the Uniform Commercial Code
- Demand adequate assurance of due performance. A written demand that enables the company to stop performance until timely assurance is received (UCC § 2-609).
- Obtain a purchase-money security interest. A security interest in goods supplied on credit that has priority over other existing liens (UCC § 9-103).
When a Customer Files for Bankruptcy
If a customer files for bankruptcy, there are several steps a company should take to protect their interests:
- Determine how much money is at stake. The size of any potential losses should help determine whether it is worth exerting time and money to pursue recovery.
- Immediately stop any goods in transit and demand return (known as reclamation) of any goods already delivered.
- Consider retaining specialist bankruptcy counsel to assist the company with:
- Establishing the company as a "critical vendor" of the customer. Critical vendors may be able to receive payment for pre-bankruptcy amounts due.
- Obtaining approval for set-offs. Once the customer has filed for bankruptcy, set-offs require prior court approval.
- Participating as part of the creditor group and stay abreast of all filing deadlines.
- Filing reimbursement claims for "administrative expenses" for any goods delivered to the customer (that were not paid for) or "adequate protection payments" for any goods that the company has a perfected security interest in.
Supplier in Distress
Even before a supplier files for bankruptcy or otherwise alerts the company that they are in financial distress there are steps the company can take to protect against the possibility of a key supplier defaulting.
- Find alternative sources. Have a plan in place for alternate sources of key products and services.
- Build up inventory. Try to build up inventory of critical supplies.
- Review contract terms. Review supply agreements with particular attention to the remedies for default.
- Support the supplier. Sometimes it is beneficial to support a struggling supplier by paying in advance or otherwise providing beneficial terms. It may be possible to help the supplier delay (or avoid) bankruptcy and deliver product.
- Arrange consignment or obtain a security interest. Consider entering into consignment agreements with the supplier or obtaining a security interest in goods in the supplier’s possession. The UCC outlines filing and notice requirements for each of these arrangements.
- Arrange direct payments with a third party. If the company is supplying a component of a larger product made by another supplier (for example, the engine to a car manufacturer), arrange to be paid directly by the end user or set up an escrow account to receive payments for the company's portion.
What are the Restructuring Options for Financially Distressed Companies?
Financially distressed companies have a wide range of restructuring options, both in and outside of bankruptcy. The principal restructuring strategies are summarized below.
Out-of-Court Restructuring Options
Companies may use one or a combination of the following techniques when restructuring out of court: exchange offers, debt/equity swaps, debt restructuring, debt tender offers, spin-offs, asset sales and raising new capital.
Exchange Offers
An exchange offer is an offer by a company to its existing security holders to exchange existing securities (typically debt) for new securities (either debt, equity or a combination of both). The new securities have less burdensome terms, such as reduced or postponed interest or dividend payments, longer maturities or reduced principal amounts, or are of a different class of security, such as conversions of debt into equity (see Debt/Equity Swaps below). In recent years, exchange offers have often been used as a tool to restructure high-yield bonds.
Exchange offers must comply with the registration requirements of the US securities laws, unless they qualify for an exemption from registration. Exchange offers may also be private if made only to qualified institutional investors.
The company typically requests that holders tendering their securities agree to "exit consents" (they consent to amendments to the original indenture which strip it of its restrictive covenants and events of default). This is to discourage "hold outs" who refuse to exchange their old securities for the new ones. Participating security holders often demand a high participation rate (at least 90%) as a condition to the exchange offer to limit the number of hold outs. Many exchange offers fail because they cannot satisfy this requirement.
Companies sometimes simultaneously solicit acceptances of an exchange offer with votes for a "prepackaged" Chapter 11 plan of reorganization, which does not require as many votes (see Prepackaged Bankruptcy).
Debt/Equity Swaps
A debt/equity swap is a type of exchange offer where investors are offered the right to exchange their debt for a specified amount of equity, reducing the company's debt obligations. The exchange rate is generally determined by reference to current market rates, but the company may offer a higher rate to induce investors to participate. On conversion of debt to equity, investors lose their rights as creditors but gain stockholder rights, such as voting rights.
Debt Restructuring
Distressed companies can negotiate with their lenders or other creditors to modify the terms of existing debt. Creditors may agree to concessions if they believe they will benefit more by granting concessions than by not granting them. The debt is continued, but with new terms which make it easier for the company to comply. Typical concessions include a combination of interest rate adjustments, payment extensions or holidays, or a reduced principal amount. Non-cash terms may also be modified, such as covenants, waiver of defenses, or granting of collateral. The creditor may also demand representation on the company's board of directors.
Alternatively, the debt may be settled outright by exchanging it for equity or an asset swap (where the creditor agrees to cancel the debt in exchange for an asset).
Debt Tender Offers
A company can offer to buy back all or a portion of its debt securities at a specified price within a fixed period (see Are any Companies Buying Back Their Own Stock or Debt? ). This strategy reduces the company's outstanding debt obligations. The company also saves money if the debt tender offer is made at a time when the debt is trading below par. If the debt is trading below par, the company can retire the debt at less than face value.
Alternatively, if interest rates have fallen significantly since the debt was issued, the company can refinance the debt by conducting a new debt offering at the lower interest rate and using the proceeds of the offering to buy back the original debt.
Spin-Offs
In a pure spin-off, the parent company splits off a division by distributing 100% of its ownership interests in the division as a dividend to existing shareholders. The spin-off results in two separate companies with the same shareholder base. The parent company offers support and resources to the spun-off company. A financially-troubled company may wish to spin off under-performing subsidiary operations to remove them from its books. Conversely, a company may wish to spin off profitable divisions which it believes might create more value as an independent entity.
In a partial spin-off (also known as a carve-out), the parent company can raise capital by splitting off a profitable division and selling less than a 20% interest in the new company to the public in an initial public offering. The parent company retains a majority interest in the new company, which it may ultimately spin off to existing shareholders. A company may use this strategy to allow the market to value the division independently, as its true value may be obscured when combined with the parent company's other operations.
Asset Sales
Distressed companies can sell underperforming assets which do not fit with their long-term business plans, drain cash or otherwise reduce value. Sales of such assets provide much-needed liquidity for distressed companies, and buy them more time to restructure their business operations or balance sheet. Asset sales can be conducted in or out of bankruptcy (see Bankruptcy Restructuring Options).
In bankruptcy, asset sales can be provided for under a plan of reorganization or assets can be sold in an auction under Section 363(b) of the Bankruptcy Code (known as a section 363 sale). While the bankruptcy sales process is often disruptive and entails high transaction costs, it has advantages for both the buyer and the seller:
- The seller is more likely to obtain a maximum price for the assets in a section 363 sale where it must, under the scrutiny of creditors and the bankruptcy court, encourage competing bids to obtain the highest and best price.
Asset sales outside of bankruptcy involve lower transaction costs but more risk, including higher risks of fraudulent conveyance claims and stockholder litigation against the directors of the selling company for breach of fiduciary duty. For more on sales of assets from distressed or bankrupt companies, see Article, Financial Crisis Series: Impact on M&A and Private Equity: What Special Considerations Apply to Acquisitions of the Assets of Distressed Companies?.
Raising New Capital
New and existing investors are sometimes willing to invest more capital in the distressed company, despite difficult market conditions. The additional capital can ease the company’s liquidity problems, or can be part an overall restructuring strategy that also includes exchange offers or debt restructuring. The new capital can also be used to de-leverage the company by repurchasing outstanding debt, resulting in reduced debt obligations.
New capital can be raised in several different ways, including equity financing (selling common or preferred stock), debt financing (issuing new debt securities) or rights offerings (issuing rights to existing shareholders to buy additional securities at a specified price, usually at a discount, within a fixed period). These financings can be completed in an SEC-registered offering of securities to the public or in one or more private placements of securities (that is, unregistered offerings of securities to a few, select institutional investors).
Bankruptcy Restructuring Options
For most companies, bankruptcy is a last resort principally because of high costs, the stigma attached to bankruptcy and its unpredictability. It is often used when a company fails to reach a consensual out-of-court agreement with a sufficient number of creditors.
An important advantage of bankruptcy is the ability to bind non-consenting parties if certain requirements are met. Bankruptcy also provides debtors with the protection of the automatic stay, allowing debtors a breathing spell to address their problems and reorganize their affairs without interference and pressure from creditors. However, swaps, repurchase agreements and other financial contracts are subject to safe harbors from the automatic stay. Counterparties to these contracts are not stayed from liquidating collateral or exercising other remedies (see Article, Financial Crisis Series: Impact on Loans and Credit Markets: What are the Legal Consequences if a Bank Fails?).
There are three types of bankruptcy cases under Chapter 11 of the Bankruptcy Code: traditional Chapter 11, prepackaged bankruptcy and pre-arranged bankruptcy.
Traditional Chapter 11
In a traditional Chapter 11 bankruptcy case, the company does not have any restructuring agreements with creditors in place before filing for bankruptcy. Traditional Chapter 11 offers many tools for companies to address and fix operational issues, such as the ability to reject unfavorable executory contracts.
Restructuring debt under a traditional Chapter 11 case has become more difficult since the 2005 BAPCPA amendments to the Bankruptcy Code, which have made several changes unfavorable to debtors, including reducing the debtor's period of exclusivity to propose its own plan of reorganization.
In the financial crisis, restructuring under traditional Chapter 11 has become even more difficult as DIP financing has become harder to obtain (see Article, Financial Crisis Series: Impact on Loans and Credit Markets: What Impact has the Financial Crisis had on DIP Financing?).
Prepackaged Bankruptcy
In a prepackaged bankruptcy (or prepack), a plan of reorganization is drafted, negotiated and voted on by creditors before the bankruptcy case is filed. Solicitation of votes must comply with both the bankruptcy laws and federal and state securities laws. The plan must be accepted by two-thirds of the dollar amount and more than half in number of the claims voting in each impaired class. If these voting requirements are satisfied, all creditors, including dissenters and holdouts, are bound by the terms of the plan. For this reason, companies sometimes prepare a prepackaged bankruptcy as a back-up to an exchange offer, which usually requires at least 90% creditor approval.
Although prepacks offer speed, cost-effectiveness and allow the company to maintain more control over the process than a traditional bankruptcy, there are several risks. For example, prepacks give advance notice to creditors of the company's intention to file for bankruptcy, which can cause creditors to file an involuntary bankruptcy case against the company. There is also a risk that the bankruptcy court does not approve of the company's pre-bankruptcy solicitation or disclosure statement, forcing the debtor to resolicit votes which can be expensive and cause delay.
Pre-arranged Bankruptcy
A pre-arranged (or pre-negotiated) bankruptcy is a hybrid between a traditional Chapter 11 bankruptcy and a prepack. Like a prepack, a restructuring deal with major creditors is negotiated before the bankruptcy is filed. The company typically enters into "lock-up" or "plan support" agreements with key creditors who promise to vote for a particular plan. However, like a traditional Chapter 11 case, solicitation of votes occurs after the bankruptcy is filed and the court has approved a disclosure statement.
What Issues should Directors of a Company in Financial Difficulty Bear in Mind?
Director Duties
The board of directors of a company, regardless of its financial position, is required to act in the best interests of the company and its stockholders. In taking any action, the board of directors owes fiduciary duties to the stockholders of a company. Two of the most important director duties are:
- Duty of care. Directors must take action using the care that an ordinarily prudent person in a similar position would exercise under the same circumstances.
- Duty of loyalty. Directors must put the interests of the company ahead of their own personal interests.
To ensure that directors can take necessary business risks to advance the best interests of the company and its stockholders and to prevent any second-guessing of directors' decisions by stockholders, actions taken by directors are generally subject to the business judgment rule. The business judgment rule presumes that in taking action or making a decision, directors:
- Were fully informed and disinterested.
- Acted in good faith.
- Reasonably believed that the decisions were in the best interest of the company and its stockholders.
Generally directors will not be second-guessed or held personally liable unless a plaintiff can prove one of the following: fraud, conflict of interest or gross negligence.
When a company is experiencing financial difficulties, it may be considered to be in the "zone of insolvency", which may be determined by financial tests, such as whether the company's liabilities exceed its assets, whether the company has the cash flow to satisfy its obligations as they become due or whether the company has the capital necessary (or can obtain the capital necessary) to fund future obligations.
If there are indications that the company may be insolvent, the board of directors should take additional precautions. When a company is in the zone of insolvency, the board of directors may need to consider the interests of the company's creditors as well as the interests of the stockholders and the company itself. Some courts have found that directors of companies in the zone of insolvency owe a duty to creditors or should manage the assets of the company for the benefit of creditors, but the Supreme Court recently held that creditors cannot assert claims against directors for breach of fiduciary duty (see Practice Note, Fiduciary Duties of the Board of Directors: Insolvency).
What Should Directors Do Now?
As a result of the financial crisis, many companies are experiencing financial difficulties, whether because their access to new capital has been restricted, their investments have declined in value or their operating cash flows have decreased. Given the intense scrutiny of actions taken by a company and its board of directors when the company is in the zone of insolvency, the board of directors of a company experiencing financial difficulties should re-evaluate and more actively monitor the company's risk profile and risk management. Directors should consider what risks the company has taken on, the company's appetite for risk and how it manages that risk in practice. Specifically, directors should review the company's financial position (including its liquidity and capital resources), its public disclosure (if applicable), its relationships with third parties and its corporate governance practices.
Many of the items listed below for consideration by a board of directors are actions that directors should already be taking or considering on an ongoing basis as part of their obligations as directors of a company, regardless of that company's financial condition. Some other items are actions that are ordinarily obligations of the audit committee. However, in the financial crisis, directors should pay special attention to these actions, as stockholders are more likely to second-guess director decisions or question whether the directors satisfied the duties owed to them.
First Steps
The board of directors should consider whether it should retain its own independent counsel. This would alleviate any potential conflicts between the interests of management of the company and of the board of directors in carrying out its fiduciary duties. In addition, the board of directors may want to obtain the advice of independent auditors or financial advisors when evaluating the company's financial position.
Monitoring the Company's Financial Position
The board of directors should consider the following actions to evaluate the company's financial position:
- Review the company's investments to see if it (or any of its pension or benefits plans) holds any mortgage-backed securities, credit default swaps or other derivative securities or has any other exposure to these securities. Directors should ensure that they understand the terms of any assets held by the company that should be marked-to-market under current accounting rules.
- Review the company's credit facilities and other debt agreements. Directors should focus on the covenants, default and termination provisions in the agreements (paying particular attention to what is considered a material adverse change and what penalties a material adverse change may trigger) and the company's compliance with those provisions.
- Review the company's business plan to evaluate whether the company has sufficient liquidity for the short term and the long term. Directors should focus on the company's projected operating cash flows, availability of bank credit and ability to raise capital by issuing debt or equity.
- Consider whether the company should focus on cutting costs and evaluate potential cost-cutting measures.
Public Company Disclosure
If the company is a public company, the board of directors should also:
- Review the company's filed Exchange Act reports, including its risk factors and information disclosed in its Management's Discussion & Analysis of Financial Condition and Results of Operations section for the purpose of updating or correcting any information presented.
- Monitor drafts of any ongoing and future Exchange Act reports. Directors should evaluate whether there are any new trends or changes to any previously disclosed trends that should be disclosed.
- Monitor ongoing developments to ensure that any events that may give rise to the need to file a current report on Form 8-K are timely reported (see Practice Note, Form 8-K).
- Review earnings guidance given to research analysts to see if any of the information should be updated or withdrawn (see Practice Note, Guidance Policies on Future Operating Results).
- If the company has outstanding registration statements on Form S-3 and/or has qualified as a well-known seasoned issuer, re-evaluate the company's eligibility and status in light of declining stock prices and decreased public float valuations.
Monitoring the Company's Relationships with Third Parties
The board of directors should consider the following actions to evaluate any potential impact that its relationships with third parties may have on the company's liquidity and capital resources:
- Review the company's insurance policies (including the company's D&O insurance policy) and the status of its insurance providers.
- Monitor to what extent the company is affected by the liquidity position of its customers and suppliers.
Other Corporate Governance Matters
The board of directors should ensure that they hold regularly scheduled meetings, and all directors should attend these meetings. The directors should ensure that they have the opportunity to ask questions of management and the company's auditors; this may necessitate separate executive sessions with individual members of management or the auditors.
The directors should review and discuss the board's oversight of the company's risk assessment and risk management policies. Under the New York Stock Exchange's (NYSE) corporate governance standards, this is an obligation of the audit committee (see Practice Note, Corporate Governance Standards: Overview: Audit Committee). The directors may want to consider setting up either a new board committee or a new subcommittee under the audit committee to deal with risks, or enhancing the audit committee's duties to be more involved in evaluating the company's risk profile.
The directors should review, and redistribute to the employees of the company, the company's insider trading policy to prevent any insiders from buying or selling company securities while the actions described above are being undertaken.
Are any Companies Buying Back Their Own Stock or Debt?
Stock prices and interest rates have fallen dramatically in the financial crisis, and many securities investors are looking to liquidate their portfolio investments.
This means that, if a company has a solid liquidity position (that is, sufficient and accessible financial resources to meet its needs), the financial crisis may present a good opportunity for it to repurchase its own securities.
A debt repurchase program may enable a company to reduce debt and income expenses. For a publicly traded company, a stock repurchase program may help support a stock's trading price. However, for most companies, continuing uncertainty in the markets means that liquidity and capital preservation may take precedence over repurchases of securities at lower prices.
Some companies are also looking at repurchasing their loans (see Article, Financial Crisis Series: Impact on Loans and Credit Markets: What Impact has the Financial Crisis had on Existing Credit Facilities?).
How are Repurchases Effected?
A repurchase program may be effected through one or more open market transactions, privately negotiated transactions, transactions structured through investment banking institutions or a combination of all three. In addition, a company that is listed on a securities exchange may effect a securities repurchase program through the facilities of the securities exchange(s) on which it is listed (domestic or foreign securities exchanges). The company must effect its stock repurchases in compliance with Rule 10b-18 of the Exchange Act to get the benefit of the safe harbor that rule provides (this safe harbor is not available for debt repurchases) (see Box, What is the Rule 10b-18 Safe Harbor?).
If a company's board of directors decides that the company's outstanding securities (equity or debt) may be repurchased on favorable terms, the directors must authorize a maximum dollar amount of securities to be repurchased. The company is not obligated, however, to repurchase any or all of the outstanding securities it is authorized to repurchase. A company can conduct a simultaneous stock and debt repurchase program.
Before repurchasing securities, a company must determine that it is not in possession of material non-public information (such as proposed merger, changes in earnings or financial results). If a company decides to initiate a repurchase program, this information would itself generally be considered to be material and should be promptly disclosed to the public.
Which Companies are Effecting Repurchase Programs?
Stock Repurchase Programs
- Overstock.com, Inc. announced in January 2008 that it will undertake a two-year stock and debt repurchase program. The company is authorized to repurchase up to $20 million of its common stock or convertible notes.
- Amazon.com, Inc. announced in February 2008 that its board of directors authorized it to repurchase up to $1 billion of the company's common stock by February 2010.
- Microsoft Corp. announced in September 2008 that it intends to repurchase up to $40 billion in stock over the next five years.
- Hewlett Packard Co. announced in September 2008 that it intends to repurchase up to $8 billion in stock in addition to its existing repurchase program.
- Nike Inc. announced in September 2008 that it intends to repurchase up to $5 billion in stock.
- Oracle Corp. announced in October 2008 that it intends to repurchase up to $8 billion in stock, in addition to the $1.3 billion it plans to repurchase under existing repurchase programs.
- Atlas Air Worldwide Holdings, Inc. announced in October 2008 that it intends to repurchase up to $100 million in stock.
- Red Hat, Inc. completed a repurchase of $30 million in stock in October 2008.
Impact of Stock Repurchase Programs
Generally, these companies are able to undertake stock repurchase programs because they are in good financial condition and have cash available for the repurchase programs. In addition, Oracle, Microsoft, Hewlett-Packard and Red Hat, each of which is a technology company, are implementing stock repurchase programs (or supplementing their existing repurchase programs) to take advantage of the sharp fall in prices of technology stocks.
Stock repurchase programs affect value in two ways:
- They convey signals about the company's future operations and plans.
- Positive impact. A repurchase program can signal that a company has excess cash available. A company may repurchase shares of its own stock if it thinks the shares are selling below a level that they are actually worth. This may send a signal to investors that the company thinks its own stock is the best investment it could make. The repurchase can also signal that the company is trying to mitigate dilution from outstanding options.
- Negative impact. A repurchase program can signal that a company is repurchasing its shares because it cannot find any other investments to make. This may indicate to the market that the company does not believe there is any future growth in their industry. In addition, the market may also react poorly to a repurchase program if investors believe the company should be doing something different with the cash, such as investing in its business or making acquisitions.
- If financed by a debt issue, a repurchase can change a company's capital structure, increasing its reliance on debt and decreasing its reliance on equity.
Markets typically initially reward a stock repurchase program and bid shares up a few percentage points when the plan is announced. This effect is usually not long-lasting.
Debt Repurchase Programs
- Charter Communications, Inc. bought $81 million of debt and convertible notes during the second quarter of 2008 which permitted it to record a $4 million gain based on a reduction in interest expense. In the fourth quarter of 2008, Charter announced an additional bond repurchase program to further cut its interest expenses.
- Freescale Semiconductor Inc. bought $147 million of notes during the first two quarters of 2008 which permitted it to record a $26 million gain based on a reduction in interest expense.
- Yankee Candle Inc. bought $12 million of its notes during the third quarter of 2008 which permitted it to record a $2.1 million gain based on a reduction in interest expense.
- Cubist Pharmaceuticals bought $50 million of its convertible notes during the first quarter of 2008 which permitted it to record a $2 million gain to its earnings before tax. Acquiring the debt prior to conversion also permitted the company to return 1.6 million shares to treasury.
- Dish Network Corporation announced in June 2008 that it would repurchase $500 million of convertible debt from AT&T.
- Red Hat bought $200 million of its convertible debentures during the fourth quarter of 2008. It also announced a possible repurchase of an additional $85 million by the end of November.
- Amazon.com, Inc. announced in February 2008 that its board of directors had approved a debt repurchase program allowing it to repurchase, redeem or retire $899 million of convertible notes and EUR 240 million of convertible notes.
- Ford Motor Co. announced in October 2008 it would sell up to $500 million worth of stock to repurchase debt owed by its credit arm.
Impact of Debt Repurchase Programs
Debt repurchase programs affect value in two ways:
- Positive impact. In certain cases, a company can repurchase its high-yield debt at a discount. The company can reduce its annual interest expenses and retire debt at a fraction of the principal.
- Negative impact. A company sacrifices its liquidity to reduce its leverage. While these repurchase programs have been advantageous to some companies, other high-yield issuers have higher debt levels relative to their earnings. In addition, a debt repurchase program may negatively impact a company's stock price. For example, the shares of Dish Network fell upon the announcement of the repurchase program (investors believed that AT&T was less likely to acquire Dish Networks if the repurchase program was completed).
Overall, unless companies are financially strong and cash rich, they are not rushing into debt repurchases because of concerns that cash may become scarce given the current economic slowdown.
What is the Rule 10b-18 Safe Harbor?
Rule 10b-18 provides a non-exclusive safe harbor for a company (and any affiliated purchasers) from liability under the Exchange Act's anti-manipulation provisions (Section 9(a)(2) and Rule 10b-5, Exchange Act) for open market repurchases of common stock (or equivalent interests) in the US that comply with specific conditions as to the manner, timing, price and volume of the repurchases.
While companies are not required to follow Rule 10b-18 when repurchasing their stock, if they want the protection given by this safe harbor, their repurchases on a daily basis must meet all of the conditions.
Failure to abide by Rule 10b-18 does not automatically create a presumption that the company has violated the anti-manipulation provisions of the Exchange Act.