There has been a lot of news reports and advisories in the aftermath of the downgrade by Standard & Poor’s (S&P) of the sovereign rating of the United States. This set of questions and answers is intended to help you sift through the information to determine whether you need to take any action under your existing Continuing Disclosure Agreements entered into pursuant to SEC Rule 15c2-12 and whether there are other issues you should be considering in light of this rating action. Our intent is to provide a general discussion of the issues involved and is not to be considered legal advice with respect to any specific set of facts or circumstances.
Q. Your debt rating hasn’t changed but the downgrade by S&P’s of the sovereign rating of the US may lead to a rating change of bonds you have already refunded that are now being paid under an escrow deposit agreement backed by US Treasury securities. Do you have to file a material events notice for this rating change?
A. The short answer is "probably not." If your refunded bonds carry a rating by S&P,1 this is a "rating change" that is one of the listed events requiring filing of a notice under a Continuing Disclosure Agreement entered into pursuant to SEC Rule 15c2-12. Nonetheless, it is likely that your refunded bonds were "legally defeased"2 when they were refunded and it is also likely that your continuing disclosure obligation ended with the legal defeasance of the refunded bonds.
Q. Do you have to engage legal counsel to determine whether your bonds were legally defeased and your continuing disclosure obligations terminated?
A. Not necessarily. There are a few things you can check on your own without having to engage legal counsel and incur fees.
Check the notes to your audited financial statements. Typically, legally defeased debt will only be referenced up to the fiscal year in which the defeasance occurs. In subsequent years, the debt is usually not referenced at all.
Check your bond closing transcripts.3 In the transcript for the bonds that were refunded, review the continuing disclosure agreement (which may be a separate document or incorporated into your bond resolution or trust indenture). Review the termination provision. It may state something along the lines of "this agreement will terminate when the bonds are no longer outstanding under the Resolution." That would typically mean the agreement ends upon the legal defeasance of the bonds. If your continuing disclosure covenant is contained within the bond resolution or indenture, the defeasance section would typically provide that you have no further obligations with respect to those bonds upon legal defeasance.
In the transcript for the debt issued to refund the defeased bonds, check for a defeasance opinion from your bond counsel. You could also check the official statement for the refunding bonds (look for a heading entitled "The Refunding Program" or "Plan of Finance").
Q. What if your bonds were not legally defeased?
A. If your bonds were not legally defeased, it is likely this was done for a particular reason (financial or legal) and it is also likely that you have continued to include these bonds in the annual reporting typically required under continuing disclosure agreements. If they were rated by S&P, and the rating was based upon the securities in the escrow, then you will likely need to file a material events notice through the MSRB on EMMA, just as you would for any of your other bonds.
Q. What if your bonds were only partially refunded so that the continuing disclosure agreement is still in effect but a portion of the bonds were legally defeased?
A. A likely available interpretation of the provisions of the continuing disclosure agreement is that once the refunded bonds were legally defeased, your continuing disclosure obligation ended as to the legally defeased portion. This is supported by the SEC’s statements in a 1995 letter to the National Association of Bond Lawyers.
Q. What if you are not able to determine whether you need to file an event notice?
A. You can contact your bond or disclosure counsel. Additionally, there is nothing to prevent you from voluntarily filing an event notice when you are not required to do so. There may, however, be at least one practical difficulty. Frequently, when bonds are refunded and set up to be paid from a US Treasury-backed escrow, the underwriter (or some other party) requests new CUSIP identification numbers and a new rating (on the basis of the Treasury escrow). In order to file an event notice, you would need the new CUSIP number for those bonds. This can be obtained from the CUSIP Bureau without charge (or you may be able to find these on EMMA by searching your own CUSIP number (just the first six numbers, which is the issuer identification portion).
Q. What other things might be of concern in light of the US S&P downgrade?
A. There are a few things we know of now that might be of concern:
1. Permitted investments under a bond resolution, trust agreement or general investment policy – Now would be a good time to review the restrictions on investments contained in bond resolutions, trust indentures and general investment policies. While references to federal securities such as US Treasuries (or "direct obligations of the US") would not typically include a ratings threshold, references to some federal agency or other "government-supported entities" investments such as Fannie Mae and Freddie Mac may have rating thresholds.
2. More rating downgrades may be imminent – It is likely that S&P will continue to evaluate the ratings of issuers and other entities (hospitals, universities and student loan providers, for example) that may rely on federal assistance payments or guaranties as an important source of revenue. S&P has already taken action to downgrade some municipal debt directly supported by federal leases. If a significant portion of your revenues of the security for your bonds are derived from federal assistance or other federal payments or guaranties, and your debt carries a rating from S&P, you may want to consult with your financial adviser to determine if your rating is at risk for downgrade as a result of the current or any future US downgrade.
If you have any questions regarding the need to file an event notice under your continuing disclosure agreements or related issues, please contact your principal Squire Sanders lawyer or one of the lawyers listed in this alert.
1 You can look up ratings on the S&P website.
2 A "legal defeasance" terminates the lien and security for the bonds under the specific terms of the bond resolution or trust indenture for those bonds. Typically there would be a verification report delivered that confirms the sufficiency of the escrow cash flow, as well as a legal opinion that confirms the discharge of the debt.
3 The collection of closing papers (book-bound, unbound or CD-ROMs) put together when bonds are issued.