LEGAL ANALYSIS: Windstream exchange offers face Aurelius criticism over bankruptcy claim value - Debtwire

LEGAL ANALYSIS: Windstream exchange offers face Aurelius criticism over bankruptcy claim value

30 October 2017 - 12:00 am

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Windstream Holdings, Inc. is in the midst of an exchange offer and consent solicitation targeting subsidiary Windstream Services, LLC’s senior unsecured notes, asking holders to exchange those notes into a combination of new 8.625% senior secured notes and add-on 6.375% senior unsecured notes due 2023 and obtain consents in connection thereto. On 24 October and again on the 30 October, activist noteholder Aurelius Capital Management, which holds existing 6.375% notes, circulated letters to fellow noteholders criticizing the debt exchange as a waste of money that leaves the new add-on noteholders with significantly less valuable claims in bankruptcy. In this report, the Debtwire legal analyst team summarizes and discusses the implications of the consent solicitations and exchange offers, reviews the allegations in the Aurelius letters, Windstream’s response and the effect of the exchange offer on new noteholders’ bankruptcy claims.

Aurelius-Windstream Chess Game

Aurelius’ letters are the latest moves in a chess game with Windstream that has involved a default notice, litigation, allegations of market manipulation and, in an effort to capture Aurelius’ queen, an exchange offer and consent solicitation.

The gamesmanship began on 22 September after Aurelius sent a notice of default under Windstream Services’ existing 6.375% notes due 2023. The default notice alleges that the company violated the notes’ Sale-Leaseback covenant in connection with its April 2015 spinoff of certain telecommunications network assets and other real estate into Uniti Group Inc., an independent, publicly traded REIT. Windstream asserts that the default notice is merely an effort by Aurelius to manipulate the prices of Windstream notes and other securities.

The propriety of the default is currently being litigated in federal court in the Southern District of New York.[1] If the exchange offer and consent solicitation is unsuccessful, and the court finds that a default has occurred under the indenture, then the company asserts that it will be forced into Chapter 11 as an Event of Default under the 6.375% notes indenture would cause a cross-default under the company’s USD 2.7bn of loans and, upon acceleration, trigger cross-acceleration provisions under the approximately USD 2.4bn of other outstanding notes. The court has extended the date that Aurelius is able to declare such an Event of Default past the 60-day cure period provided in the indenture and ordered that Aurelius shall not declare an Event of Default or serve a notice of acceleration prior to 7 December, or the earlier of the conclusion of a trial on the merits. The indenture trustee and Aurelius have appealed this order.

CLICK HERE to view all filings in the litigation on Debtwire Dockets.

Windstream declares “check” with the consent solicitations and exchange offers

Windstream is hoping to entirely avoid the unpredictability and cost of further litigation through the consent solicitations and exchange offers and make the whole event of default threat go away. First, the company is soliciting consents from holders of all of the company’s notes—including the 6.375% notes due 2023 (including Aurelius’ holdings). The primary intention of the consent solicitations is to waive Aurelius’ alleged default under the 6.375% notes and remove the possibility that such a default could be alleged under the other series of notes in the future. Each series of notes requires majority approval to do so. Holders of each series of notes are being offered a consent fee, including Aurelius, to comply with each notes’ Payments for Consent covenant—25 bps for the 6.375% notes, stepping down to 20 bps, and 25 bps for the other series.

The consent solicitation for the 6.375% notes expires 2 November 2017, with an early consideration date of 31 October at 5pm ET (re-extended from an initial deadline of 24 October), and the other consent solicitations expire 31 October (also extended from 24 October), with no early consideration amount.

Naturally, each consent solicitation is conditioned on approval by a majority of that series. As of 25 October (and re-affirmed 30 October), the company had received consents from a majority of the 7.75% notes due 2020 and the 7.5% notes due 2023. If the company obtains consents from every series, the exchange offers summarized below would be moot, the event of default being waived across the capital structure.

The Exchange Offers

But if Windstream obtains consents from all series except the 6.375% notes (where Aurelius sits), it is still hoping to make the event of default situation disappear by diluting Aurelius through exchange offers. In sum, in this alternate scenario, Windstream hopes enough holders agree to swap into new add-on 6.375% to equal a majority of the newly inflated series, who would then consent to the amendment or waive of the event of default—manufacturing their final needed consent. The exchange offers are conditioned not only on consummation of the consent solicitations with respect to the other notes series, but also on a minimum issuance condition of USD 247m of add-on 6.375% notes (amended from USD 587m to USD 282m and then to USD 247m). We address that amendment a bit further below.

In the exchanges, the company proposes to issue additional 6.375% notes due 2023, at the exchange rates specified below. The additional 6.375% notes will be an add-on to the existing 6.375% notes under which Aurelius alleges a default (or else this would all be a pointless exercise). This is possible because the indenture for the 6.375% notes provides that existing notes and add-on notes are treated as a “single class for all purposes” under the indenture, including waiving defaults and voting for amendments, each of which require majority approval. (This is typical.)

The company also expects to issue an additional USD 250m of new 8.625% secured notes in these exchanges and apply the proceeds to amounts outstanding under its USD 1.25bn ABL facility. There was USD 750m drawn on the facility as of 29 July.

The exchange offers contemplate that at least a portion of the existing 7.75% notes due 2020 will remain outstanding but otherwise contemplate that all the existing notes can be exchanged, except for, of course, the 6.375% notes due 2023. The company has separately been repurchasing 7.75% notes (USD 49.1m since 30 June). The maturity date of the company’s tranche B6 term loan will spring to 15 July 2020 if the 7.75% notes due 2020 are not repaid or refinanced by that date.

The exchange offers are as follows:

  • 7.750% Notes due 2020: Exchange a portion of the USD 650.9m outstanding into up to USD 50m of new 8.625% secured notes, at an early consideration discount of 5%.
  • 7.750% Notes due 2021: Holders of the USD 809.3m outstanding may choose from the following options:
    • (1)Exchange into add-on 6.375% notes, at a 10.0% early consideration premium; or
    • (2)Exchange into up to USD 50m of new 8.625% secured notes, at a 5.0% discount, plus, for any amounts remaining, either (a) a full exchange into add-on 6.375% notes or (b) a partial exchange into up to USD 247m of add-on 6.375% notes, in both cases at a 10.0% premium. (The terms of the initial announcement capped option (2)(b) at USD 587m, the amount of existing 6.375% notes.)
  • 7.500% Notes due 2022: Exchange any and all of the USD 441.2m outstanding into add-on 6.375% notes, at an 8.0% early consideration premium.
  • 7.500% Notes due 2023: Exchange any and all of the USD 343.5m outstanding into add-on 6.375% notes, at a 7.5% early consideration premium. 

All of the exchange offers expire on 14 November 2017, each with an early consideration date of 31 October. Upon expiration of the 31 October early consideration period, the consideration discounts/premiums that are detailed above will increase/decrease by 5%.  The initial cap of USD 587m under option (2)(b) of the exchange offer for the 7.75% notes due 2021 (above) makes clear that the company intends to dilute the existing holders of the 6.375% notes by at least half, the threshold required to affect voting. And the re-amended cap of USD 247m implies that approximately USD 170.2m of the existing 6.375% notes, or 29.1% of the existing amount, have already provided consents. Therefore, disregarding the exchange offers and only considering the consent solicitation for the 6.375% notes, another approximately USD 123.3m of consents from existing 6.375% noteholders would be enough to push consenting 6.375% noteholders to 50.1% of that series.

Aurelius responds to Windstream’s latest move

On 24 October, Aurelius distributed a letter to fellow Windstream noteholders outlining its “observations” regarding the consent solicitations and exchange offers relating to the 6.375% notes that it holds. Not surprisingly, Aurelius describes the transaction as “highly inefficient,” with “serious legal infirmities” and warns that they will “generate[] a raft of new legal headaches” for Windstream. The purported legal infirmities and headaches are centered on the “original issue discount” (OID) that will purportedly be taken into account for the add-on 6.375% notes for tax and bankruptcy purposes, which Aurelius asserts renders the add-on 6.375% notes significantly less valuable than the existing 6.375% notes. In response, Windstream provided a statement to Debtwire, accusing Aurelius of using “scare” tactics in an attempt to “disrupt the proposed consent and exchange process to benefit their investment positions.” This prompted an additional and rather aggressive letter from Aurelius on 30 October in further support of its position and which accuses Windstream and its counsel of talking out of both sides of their mouths regarding whether OID in connection with the add-on notes is subject to disallowance in bankruptcy.

Treatment of OID in bankruptcy

Are the add-on 6.375% notes less valuable in bankruptcy due to their OID? To answer that question, it is important to understand OID and how it is usually treated in bankruptcy. In simple terms, OID is the difference between the face value of notes due upon maturity and the discounted price when the notes are issued. By way of example, if a company issues a note with a USD 1,000 face value for a USD 900 issue price, the OID is USD 100. Despite the fact that OID is paid only when a debt matures, it is typically amortized over the life of the debt and treated as a form of interest for tax and bankruptcy purposes.[2]

In bankruptcy, creditors are generally not entitled to recoup interest that matures postpetition. Bankruptcy Code section 502(b)(2) specifically provides that a claim for interest that has not accrued as of the petition date is disallowed as “unmatured interest.”[3] The legislative history to section 502(b)(2) supports characterizing OID as interest, providing that unmatured interest includes “any portion of prepaid interest that represents an original discounting of the claim, yet would not have been earned on the date of bankruptcy.”

Thus, it would seem clear that a court should disallow claims for unamortized OID (i.e., OID that has accrued postpetition). Well, not so fast. The Second and Fifth Circuits have recognized an exception to this rule for obligations issued in a prepetition “face value” debt exchange. In a face value or what Aurelius refers to in its letter as a “par for par” exchange, existing debt is exchanged for an equal principal amount of new debt. The reasoning behind this exception is to encourage out-of-court restructurings. In particular, if such claims were disallowed, debt holders would be disincentivized from participating in pre-bankruptcy workouts, resulting in an increase in Chapter 11 filings and an unfair windfall for non-participating holdouts.

The other type of debt exchange is a “fair value” exchange in which existing debt is exchanged into a reduced principal amount of debt, thereby reducing a company’s overall debt obligations. While the circuit courts have not yet opined on how OID should be treated in a fair value exchange, the bankruptcy court for the Southern District of New York in In re Residential Capital, LLC (ResCap) held that unamortized OID arising from a fair value debt exchange should not be disallowed as unmatured interest under Bankruptcy Code section 502(b).

In ResCap, the debtor completed a prepetition debt exchange in which it exchanged USD 6bn of unsecured notes for approximately USD 4bn of new junior secured notes, and USD 500m in cash. The official committee of unsecured creditors and ResCap sought a determination from the bankruptcy court that unaccrued OID in this fair market value exchange totaling about USD 377m was not an allowable claim because it was “unmatured interest” under the Bankruptcy Code.

The court found that there was no reason to treat OID generated by the fair value exchange differently from OID generated by a face value exchange. In particular, the court reasoned that the features companies consider in connection with a debt-for-debt exchange–interest rate, maturity date, redemption features, etc.–apply equally in both face and fair value exchanges. Further, the court stated that in both fair and face value exchanges, the market value of the old debt is typically depressed, OID is created for tax purposes, and there are incentives and concessions involved in the exchange. In sum, the court found that both fair and face value exchanges offer companies the opportunity to restructure out-of-court and avoid the time and expense of a bankruptcy. Thus, the court held that there was no reason to disallow unamortized OID in a fair value exchange.

Fair value, face value or something else?

With the legal backdrop in place, the question becomes, will a bankruptcy court disallow an exchanging noteholders’ claim for unamortized OID? The Debtwire legal analyst team believes that there are three key points to consider in answering this question.

The first is jurisdiction, meaning where Windstream files for bankruptcy is important. If the company commences a case in the Southern District of New York, then the Second Circuit’s decision allowing claims for unamortized OID in a face value exchange and the Southern District of New York bankruptcy court’s decision in ResCap allowing such a claim in a fair value exchange will certainly influence the court’s decision. (More on this below). However, as Aurelius points out in its letters, no other federal appellate court has weighed in on whether unamortized OID is permitted in either a face value or fair value exchange. Thus, if Windstream commences a bankruptcy case in Arkansas where it is headquartered (Eighth Circuit) or in Delaware where it is organized (Third Circuit), then the result may be more of a wildcard.

Second, even if Windstream commences a bankruptcy case in the Southern District of New York where ResCap may not be binding but certainly has persuasive value, or in a court which also finds the reasoning in ResCap persuasive, there are factual differences between Windstream’s proposed exchange and the exchange at issue in ResCap which may lead a court to come to a different conclusion. In particular, in a typical fair value exchange such as in ResCap, debt is exchanged for a reduced principal amount of debt, thereby reducing a company’s overall obligations. Here, and as Aurelius points out in its letters, Windstream is proposing to exchange existing notes for a greater principal amount of 6.375% notes which Aurelius asserts will “increase leverage and would only trivially extend debt maturities.”

Windstream asserted in its comment to Debtwire that the exchange offers qualify as fair value exchanges under existing caselaw and the applicable discount or premium, and change in face amount under the add-on notes does not warrant a different result from ResCap. The Debtwire legal analyst team believes that a court would likely find that the exchanges into add-on 6.375% notes does not qualify as a typical fair value exchange because of the increase in principal amount. However, although the principal is being increased rather than decreased, the increase is minimal which arguably renders the exchange more similar to a face value exchange than a fair value exchange.

Third, and most importantly, is how a court would view the policy considerations that formed the basis of the Second and Fifth Circuit’s rulings allowing claims for OID in a face value exchange and the Southern District of New York bankruptcy court’s decision in ResCap permitting OID in a fair value exchange vis-à-vis Windstream’s exchange offer. In this regard, whether or not the exchange offer technically qualifies as a face value or fair value exchange may not be as important if a court determines that allowing a claim for unamortized OID despite Bankruptcy Code section 502(b)’s prohibition on unmatured interest supports the policy rationales of promoting out-of-court restructurings, rather than disincentivizing debt holders from participating in pre-bankruptcy workouts. Aurelius argues in its letters that (1) the Supreme Court has issued several opinions that reject such policy-based exceptions, and, alternatively, (2) the policy considerations do not apply to the Windstream exchange offer because the issuance of new notes is solely motivated to “induc[e] holders of other note series to deliver a purported covenant waiver on behalf of the series they do not yet own.”

Windstream, on the other hand, asserts that the policy rationales invoked by ResCap such as “the need to incentivize holders to exchange their bonds for new debt that is more favorable to the debtor, providing the debtor with the flexibility to restructure out of court” are equally applicable here and “should be the same whether a bond issued as part of a distressed exchange is issued at a discount or a premium.”

The Debtwire legal analyst team finds these waters a bit murky. Although not explicitly stated, the goal of the exchange offer is to restructure Windstream’s debt obligations out-of-court in order to prevent the consequences of an Event of Default being declared by Aurelius, including a Chapter 11 bankruptcy, which is a rationale in line with ResCap and other established precedent. The way the company is going about this, however, is by diluting Aurelius’ position in the 6.375% notes so its default notice can be waived and not ripen into an Event of Default. This type of gamesmanship is likely not what the Second and Fifth Circuits and the Southern District of New York bankruptcy court had in mind when they allowed claims for unamortized OID as a way to promote out-of-court restructurings. However, the chess game is being played by both Windstream and Aurelius and a court may find that the consent solicitations and exchange offers are the best chance Windstream has to avoid an otherwise unnecessary Chapter 11 brought on as a result of Aurelius’ notice of default more than two years after the spinoff transactions and exchanging holders should not be disadvantaged by participating in the exchange.

“Checkmate” for Aurelius?

As previously noted, if successful, the exchange offers will dilute Aurelius’ holdings of 6.375% notes to reach a majority threshold after which the default notice can be waived. The consent fee of 20 or 25 bps is minimal and holders that decide to consent and participate in the exchange offer are likely motivated by the desire to avoid a bankruptcy rather than a large fee or premium. Nowhere in its letters does Aurelius state that it will not declare an Event of Default which may push Windstream into bankruptcy. Indeed, its letters are premised on the reduced value of add-on noteholders’ claims in a Windstream bankruptcy. Thus, noteholders who want to steer clear of Chapter 11 can do so by giving their consent and participating in the exchange offers. Aurelius’ bankruptcy-related arguments are moot if a Windstream bankruptcy is off the table. Regardless of the outcome, Aurelius has shown that it is not backing down and if the consent solicitations and exchange offers are successful, we can likely expect further challenges to the debt exchanges and spinoff transactions down the road. Where will it end? Despite the tenor of its letters, Aurelius states that a consensual resolution is possible “ideally in a way that also reforms the awful lease with Uniti and thereby enhances Windstream’s financial condition.” Whether the parties can get to a consensual resolution may prove to be the biggest challenge of all. 


by Sarah Foss and Joseph Henry


Sarah Foss and Joseph (“Jody”) Henry are members of Debtwire’s legal analyst team. Sarah is a former practicing restructuring attorney. Sarah joined Debtwire in 2017 and previously practiced in the New York and Houston offices of Winston & Strawn LLP in the area of business reorganizations, including complex Chapter 11 cases and out-of-court restructurings. She has represented large corporate debtors, creditors’ committees, secured lenders, distressed asset acquirers and investment banks across a broad range of industries. Jody previously worked as an associate analyst at research firm Covenant Review and joined Acuris in 2015, where his coverage has focused on LBOs, refinancings, and out-of-court restructurings.


Any opinion, analysis or information provided in this article is not intended, nor should be construed, as legal advice, including, but not limited to, investment advice as defined by the Investment Company Act of 1940. Debtwire does not provide any legal advice and subscribers should consult with their own legal counsel for matters requiring legal advice.