Amazing grace (periods)

Investors expect certain “sacred rights” when they lend money to a company: they agree on when they will get paid, for example, and how much.

To change any “sacred” parts of the contract, all affected investors have to approve, while other parts can be changed with a sign-off from just a majority.

But corporate borrowers have been losing their debt religion for decades. Now even “sacred rights” aren’t looking all that sacred anymore, according to Covenant Review.

In a Wednesday note, the analysts highlight a couple of companies that are challenging investors’ ability to punish them for any missed interest payments with a clever loophole.

Diebold Nixdorf, which makes ATMs and checkout machines, changed the terms of one of its bonds in December to extend its “grace period” for missed interest payments. These grace periods dictate how long companies have after missing a payment before it’s considered an “Event of Default” under the contract.

It’s obviously bad for a company to default on its debt, and even worse for it to have an “Event of Default”. If an “Event of Default” occurs, sometimes a fraction of lenders or bondholders can get together and “accelerate” the debt, or force the company pay them back immediately. It is also often an Event of Default — not a default with a lower-case d — that pushes a borrower’s other debts into default, and raises the spectre of cross-acceleration.

Normally companies get 5 to 10 days, sometimes as long as 30 days, to make a payment without facing those types of consequences.

Yet under an amended contract for Diebold Nixdorf’s 8.5-per-cent bonds maturing in 2024, the company extended the grace period until the time the bonds mature, according to Cov Review, without unanimous approval.

This threads a weird needle. Because payment amounts and timing are seen as “sacred rights”, 100-per-cent of bondholders would need to agree to let the company skip an interest payment. But this isn’t waiving the interest payment, it’s simply extending the grace period as long as the bond is outstanding.

So why would investors accept this deal? Diebold Nixdorf’s amendment was part of a broader transaction that restructured other debt and raised $400mn of capital with warrants, so presumably investors got something out of it.

Consumer-products retailer Premier Brands has more recently sought to refinance a loan with a similar adjustment extending its grace period until the loan’s maturity date, according to Cov Review’s sister publication LevFin Insights. (Both companies are owned by Fitch Ratings.)

Now, a company or expert could argue that bondholders and lenders don’t really want to let 30 or 50 per cent of their fellow lenders to decide to put the company into collection right away, and risk pushing it into bankruptcy, when lenders could simply restructure the debt outside of court and keep some payments coming.

But then why include the acceleration and cross-default clauses in the contract in the first place?

As Covenant Review puts it:

The key effect of an Event of Default is that it allows creditors to pursue certain remedies, the most important and powerful of which is accelerating the maturity of the debt. By taking away the right of non-consenting creditors holding the Diebold 2024s (and other debt) to accelerate [maturity], creditors could argue that these companies have made it impracticable . . . to actually enforce their right to receive interest when due. Therefore, these companies have effectively “extend[ed] the stated time for payment of interest on any Note” without the consent of each affected holder, in violation of creditors’ contractual sacred rights.

Now, the analysts stop short of predicting their interpretation above will rule the day in court. Maybe this loophole will remain open! Who knows?

They do, however, describe it as “wildly aggressive” and “an apparent attempt to skirt the line on [the] customary creditor protection” of sacred rights. Profane indeed.

*We did not come up with this term, to be clear.