A third-party offer in respect of bonds is an autonomous obligation of a person other than the issuer, set out in a separate document and made in favor of an indefinite class of bondholders.
1. Structure and functions of third-party offers in Russia and abroad
In Russia, third-party offers in respect of bonds are executed as separate documents, usually titled “offer” or “irrevocable offer.” Under these documents, a third party, often affiliated with the issuer, undertakes, upon receiving an application from a bondholder (acceptance), to repurchase the bonds from such holder, including upon the occurrence of certain events (covenants).
Offers may be made at different times and serve different functions:
before the bonds are sold to investors:
1) an analogue of a guarantee or suretyship in respect of bonds from a third party;
2) modification of the terms of the issuance documentation, including additional options and covenants;
after the bonds are sold to investors:
1) an offer to bondholders during the life of the issue to repurchase or exchange securities as part of refinancing or debt restructuring;
2) additional support.
Russian offers combine features of different structures from foreign practice.
Offers announced during the circulation of bonds are similar to a debt tender offer — a public offer to repurchase bonds. In the United States, the requirements for a debt tender offer are established by law. Rule 14E (Regulation 14E, CFR) provides the main procedural safeguards for all tender offers, including those involving bonds, and prohibits fraudulent, deceptive, and manipulative acts in connection with them.
Offers announced before the bonds are sold to investors have certain similarities to the concept of a deed of covenants under English law — a written unilateral undertaking in a prescribed form. However, while a deed is still an obligation that arises immediately upon execution of the document, an offer, when it is “made” under Russian law, creates only a right of acceptance, but not an obligation.
Names in Russian and foreign practice
Author: Ekaterina Patynskaya, lawyer
2. Protective offers and how rating agencies view them
Rating agencies (Expert RA, National Rating Agency) regard a third-party offeras a credit support mechanism or compensation mechanism and assign ratings to individual issues taking into account the presence of offers [1].
Although Expert RA does not directly identify the presence of “offers” as credit support tools in its methodologies, in practice it takes into account the presence of bond offers and the credit quality of the offeror.
For example, the series 002Р-05 bonds (issue volume of at least RUB 2 billion) planned to be issued by JSC ABZ-1 were assigned a rating of ruA-(EXP). The offeror under the public irrevocable offer is JSC PSF Baltic Project, as a result of which the agency established parity between the current rating of the offeror, JSC PSF Baltic Project (ruA-), and the rating of the series 002Р-05 bonds.
3. An offer in the “gray zone” of legislation
Today, practice proceeds from the premise that a third-party offer does not form the terms of a bond loan (although, taking the totality of circumstances into account, there is every reason to qualify it otherwise), but instead creates additional rights and opportunities for bondholders that arise upon the occurrence of certain circumstances (for example, a coupon default) and only after acceptance by the holder.
An offer may be classified as a unilateral transaction, since it is based on an outward expression of will by the offeror to assume a set of obligations in favor of bondholders after its acceptance. In this regard, all those offers that contain certain “obligations” of the offeror prior to acceptance are in the “gray zone” (it should be recalled that, pursuant to Article 154 of the Civil Code of the Russian Federation, a unilateral transaction creates legal effect only if this is provided for by law or agreement).
However, in the legal literature there is no unanimous position regarding an “offer,” since the issue of the legal qualification of offer and acceptance is debatable. In the view of some scholars [2], offer and acceptance are independent unilateral transactions. Others consider the offer and acceptance to be constituent parts of a single bilateral volitional act [3].
4. There are many accumulated problems, and we are waiting for change
It is worth highlighting some features of the qualification of third-party offers that arise in practice.
1) A protective offer is similar to a guarantee, although formally it is not a unilateral transaction, since at the moment it is “made” it does not give rise to obligations. In such circumstances, the market may create the illusion that obligations to investors arise, although in fact the made offer creates only the so-called secondary right for the investor, and the obligation to repurchase the bonds and pay money under the offer arises only after its acceptance.
2) An offer is “marketed” and perceived by the market as some standardized protective instrument. However, in fact, there is still no standardization. On the contrary, depending on the terms of the offer, the scope of the offeror’s obligations may vary, and the terms and procedure for acceptance may become more complicated. In practice, this aspect may not be reflected in bond marketing materials.
3) An offer (regardless of who the offeror is — the issuer or a third party) is, of course, always perceived by the parties to the transaction as a document that determines the scope of rights under the bonds. In fact, the offer is one of the elements in structuring the entire financial transaction (as a whole), which includes investors. And yet, once again, such offers are not typified in legislation and remain in the “gray zone.” This creates a situation in which the market perceives the offer as part of the bond terms, although, from a legal standpoint, this is not the case. Here there is a divergence between the market’s perception of the investment and the legal reality.
4) The offer falls outside the issuance documentation, so the issue of the powers of the bondholders’ meeting remains unresolved, in particular, it is unclear when and under what conditions the bondholders’ meeting may decide to waive the offer or consent to amend its terms.
5) The market perceives an offer as some kind of credit support mechanism for a financial transaction, placing it on a par with an independent guarantee and suretyship. However, unlike offers, the law expressly establishes requirements for the net assets of the surety and the guarantor for these methods of securing obligations. They may not be less than the amount of the suretyship or guarantee, respectively.
In addition, the law establishes a requirement to disclose information about the third party and the security provided before the placement of secured bonds, if the registration of the bond issue is not accompanied by the preparation and registration of a prospectus for such bonds.
Offers are not formally a method of securing obligations, so these requirements do not apply to them. Such a dichotomy and “regulatory disproportionality” in relation to the scope of requirements can potentially serve as a basis for abuse (and sometimes does so).
6) Third-party offers are not subject to the rules governing issuer offers (Articles 17.1 and 17.2 of the Securities Market Law). These rules are designed to ensure equal rights of bondholders vis-à-vis their issuer, including in the event of restructuring. When an offer is issued by a controlling person or a subsidiary of the issuer, such rules may not be observed, which may lead to a breach of parity among bondholders.
5. Interim conclusions
It can be said that an “offer” is a forced and artificially created instrument in the bond market.
Historically, when the practice was only emerging, there were almost no alternatives capable of ensuring unilateral assumption of guarantees or covenants. For example, an independent guarantee could be provided only by banks.
In our legislation, there is still no independent line of unilateral financial transactions tailored to the assumption of credit risk or behavioral obligations in relation to an indefinite class of persons. In these circumstances, the market resorted to the structure of an “offer” as a quasi-unilateral transaction.
Under the current conditions and taking into account the above-mentioned issues of legal qualification and positioning of offers in the market, the following tactical and strategic steps appear advisable:
1) In the future, consider developing a body of rules in civil law and securities market legislation devoted to bond offers as a separate institution and type of unilateral transactions giving rise to obligations at the moment they are entered into (i.e., at the moment the offer is made).
2) Bring legislation into line with market expectations regarding the nature of offers as a complex transaction: establish a legal link between the issuance documentation and the offer so that such offer is part of the financial transaction not only in the investor’s perception, but also by operation of legal rules.
3) Take a careful approach to drafting the text of offers so that they reflect precisely the purpose for which they are intended, with a well-developed scope of rights and covenants (if any), and also discuss and agree on the terms of offers with the bondholders’ representative (if any) before issuance.
________________________ [1] See, for example, NKR (Methodology for Assigning Credit Ratings to Individual Bond Issues under the National Rating Scale for the Russian Federation), ACRA (Methodology for Assigning Credit Ratings to Financial Instruments under the National Scale for the Russian Federation).
[2]Denisov S. A. Some general issues concerning the procedure for concluding a contract // Current Issues of Civil Law: collection of articles. Issue 1 / ed. by M. I. Braginsky. Moscow: Statut, 1998. P. 267.
[3] Braginsky M. I., Vitryansky V. V. Contract Law. Book One: General Provisions. 3rd ed., stereotyped. — Moscow: Statut, 2011. — P. 202.
