Successor Obligor Clauses: Transferring 'all or Substantially All' Corporate Assets in Spin-off Transactions

• Publication year: 2001
• Pages: 45
• Citation: Vol. 30 No. 1 Pg. 45

30 Colo.Law. 1 Colorado Lawyer 2001.

2001, February, Pg. 45. Successor Obligor Clauses: Transferring 'All or Substantially All' Corporate Assets in Spin-Off Transactions

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Vol. 30, No. 1, Pg. 1

The Colorado Lawyer
February 2001
Vol. 30, No. 2 [Page 45]

Specialty Law Columns
Business Law Newsletter
Successor Obligor Clauses: Transferring 'All or Substantially All' Corporate Assets in Spin-Off Transactions
by Thomas O. McGimpsey, Darren R. Hensley

In the face of unprecedented stock market valuations for emerging technology companies, many larger, more established companies are looking for ways to realize what they believe is the true market value of their organizations. Although most of these companies spare no expense in an attempt to educate and convince stock market analysts to value their companies based on a sum-of-the-parts analysis, this effort can lead to inconsistent results

To address these concerns, some companies reorganize their assets and businesses, and may either issue a tracking stock or spin off portions of their businesses. As part of this effort, management may need to transfer a significant amount of corporate assets between or to subsidiaries. To the extent the company transfers important revenue-generating assets that support the payment of corporate bonds, bondholders may seek to challenge the transfer. Accordingly, prior to transfer, counsel to the company should conduct an in-depth analysis of the governing law and covenants in the indenture governing the bonds

Indenture covenants regarding the transfer of corporate assets can take various forms. The most restrictive form of covenant requires bondholder consent for any significant transfer of assets to another person (occasionally, a percentage as low as 20 percent of a corporation's assets will be specified in this covenant). Another form of covenant requires bondholder consent for the transfer of "all or substantially all" of the assets of the corporation. A third type of covenant, known as a "Successor Obligor Clause," is more commonly found and is the least restrictive form of covenant. It allows for the transfer of "all or substantially all" of the assets of the corporation, without bondholder consent, as long as the transferee assumes, by supplemental indenture, all of the obligations of the transferor under the indenture, with the transferor being released from such obligations. Such nonconsensual release of the transferor may surprise bondholders who purchased bonds based on the credit of the transferor

This article reviews the implications of a Successor Obligor Clause and the key phrase "all or substantially all" of the assets of a corporation in the context of a spin-off transaction.1 This article also identifies other potential claims by bondholders challenging such a transfer, including breach of fiduciary duty, breach of implied covenant of good faith and fair dealing, fraudulent conveyance, federal and state securities law violations, common law fraud, and negligent misrepresentation.

The Hypothetical

For illustrative purposes, these authors have chosen a hypothetical with the typical real world scenario of a Delaware corporation that is a party to an indenture governed by New York law. Indentures are typically governed by New York law and, as a result, the law in states such as Colorado is undeveloped in this area.

Assume Company A, a Delaware corporation in the telecom business, wants to create Newco, initially a wholly owned Delaware subsidiary, for the purpose of pursuing fiber optic communications. Significant fiber optic assets of Company A ("Fiber Optic Assets") represent 30 percent of the total book value of Company A's assets and generate 10 percent of the gross revenues and less than 5 percent of the net revenues of Company A. These assets will be transferred to Newco in exchange for all of the outstanding capital stock of Newco. Company A had previously issued ten-year unsecured corporate bonds ("Bonds") under an indenture governed by New York law ("Indenture"), which contains a Successor Obligor Clause. Company A will distribute Newco's stock to Company A's shareholders in a spin-off transaction subsequent to the transfer of the Fiber Optic Assets and continue its historical core telecom business.

For purposes of this hypothetical, assume that the transfer of the Fiber Optic Assets will not result in a breach of any other covenant in the Indenture and that no misrepresentation or omission has occurred in connection with the sale of the Bonds or the transfer of the Fiber Optic Assets. Thus, the only provision of the Indenture addressing a transfer of Company A's assets is the Successor Obligor Clause. The issue is whether Newco would have to assume the obligations under the Indenture, given the quality and quantity of the assets being transferred to Newco by Company A.

"All or Substantially All" Of the Assets

The case law interpreting the "all or substantially all" language in the context of Successor Obligor Clauses is thin.2 Little authority exists to make a determination of whether a corporation has transferred "all or substantially all" of its assets in the context of such indenture covenants; thus, it is likely courts will look for guidance in the context of shareholder approval statutes for the sale of corporate assets.3 Some commentators have suggested that bondholders should not be required to assume the same magnitude of risk as shareholders and that, as a result, what constitutes "substantially all" of the assets of a corporation should be substantially lower in indenture cases than in the context of shareholder approval statutes.4 However, the courts have not drawn such a distinction.

Counsel to Company A must undertake an analysis of the case law interpreting indenture covenants and shareholder approval statutes to either (1) ensure that the transfer of the Fiber Optic Assets does not constitute a transfer of "substantially all" of Company A's assets, or (2) if the transfer to Newco of the obligations under the Indenture is desired, ensure that "substantially all" of Company A's assets are being transferred.5 Three cases in New York and Delaware directly interpret the meaning of "all or substantially all" of the assets in the context of an indenture, whereas the remaining cases in these jurisdictions interpret the phrase in the context of shareholder approval statutes.6

Indenture Case Law

". . . [P]rior to transfer, counsel to the company should conduct an in-depth analysis of the governing law and covenants in the indenture governing the bonds."

In the case of B.S.F. Co. v. Philadelphia Nat'l Bank,7 a Delaware case interpreting Pennsylvania law, a corporation sold a substantial block of its American Hardware Company ("AHC") stock and argued it was not a sale of "substantially all" of its assets. The Delaware Supreme Court interpreted a Successor Obligor Clause in an indenture based on the Pennsylvania shareholder approval statute. The AHC stock represented approximately 75 percent of the corporation's total assets, and dividends on the AHC stock accounted for most of the corporation's income Therefore, the court concluded that the sale of the AHC stock was a sale of "substantially all" of the assets of the corporation. Noting that these facts were set forth in the prospectus offering the debentures at issue, and a major portion of the proceeds from the sale of the debentures was used to buy additional AHC stock, the court stated that "[n]o other conclusion seems justified since the major asset leading to the purchase of the debentures has been...